Tuesday, 25 April 2017

Unpacked: President Trump’s border wall

This video comes from the Brookings Institution:
Vanda Felbab-Brown, senior fellow at the Brookings Institution, unpacks the security, economic and environmental impacts of President Trump’s proposed border wall. Felbab-Brown explains that the wall may accomplish very little and instead jeopardize Mexico-U.S. relations in addition to escalating issues with the existing fence, wildlife and the flow of drugs.

20% off

The publisher, Routledge, of my book "The Theory of the Firm: An Overview of the Economic Mainstream" is offering 20 percent off right now.

That means its just 76 pounds, so be in quickly!!

Those of you with a Kindle can get the Kindle edition for US$50.81 (no idea how they came up with that price!) from Amazon.

Sunday, 23 April 2017

Mental experiment on the effects of minimum wages

This thought experiment is from Don Boudreaux at Cafe Hayek.
Imagine that you’re given the option of buying ten-dollar bills for $5 a piece. How many will you buy? The answer is obvious: as many as the sellers of these discount-priced ten-dollar bills will sell to you. Of course, in reality $10 bills are never available for sale at $5 a piece. Or are they?! In a very real way, reality does indeed sometimes offer such deals. If a worker that can produce $10 per hour worth of output is currently paid by his or her employer only $5 per hour, a competing employer can profit by hiring, at some wage higher than $5 per hour, that worker away from his or her current employer. Indeed, employers will compete for this worker until this worker’s hourly wage is bid up to $10. (If you doubt this outcome, the burden is on you to explain why this worker’s wage will stop rising at some amount less than $10 per hour. It’s a surprisingly difficult burden to meet.)

Now imagine that you’re offered the prospect of buying five-dollar bills for $10 a piece. How many $5 bills will you buy? The answer again is obvious: none. Even if you’re a billionaire, you have no incentive to spend $10 to buy a $5 bill. The fact that you can “afford” to do so is irrelevant. If someone is asked to predict how many $5 bills, say, billionaire Nick Hanauer will buy if each of these bills is priced at $10, that someone would surely say “none.” And that someone would surely be correct.

The minimum wage is economically identical to a scenario in which government prohibits the sale of Federal Reserve notes at any price below $10 each. No bill worth less than $10 would be purchased. No one will knowingly buy something worth only $5 for a price higher than $5.

The above example involving Federal Reserve notes is easy to grasp. Yet change the item for sale from “five-dollar bill” to “low-skilled worker who can produce on average no more than $5 worth of output per hour,” and many people – including even some economists – somehow mysteriously find reason to believe that people will pay for $5 bills some price greater than $5.

Saturday, 22 April 2017

The drive to mandate paid family leave

From the Cato Institute comes this Cato Daily Podcast in which Vanessa Brown Calder talks to Caleb O. Brown about the effects of mandate paid family leave.
What can federally mandated unpaid family leave tell us about the likely impacts of a proposed mandate for paid family leave?

Thursday, 20 April 2017

Relative prices and inflation (updated)

A recent discussion on twitter went as follows:

The basic point is that relative prices changes and inflation are not the same thing despite the fact that the way we calculate inflation makes them look as though they are.

To quote the Federal Reserve Bank Of Cleveland
Relative Price Changes Are Not Inflation

Relative-price changes, like inflation, can cause price pressure in an economy. We experience them every day much like we experience inflation, and they cause changes in standard price indexes. But there the similarity ends. Relative-price changes are not a monetary phenomenon. They arise in market economies as individual prices adjust to the ebb and flow of the supply and demand for various goods. Relative-price movements convey important information about the scarcity of particular goods and services. A rising relative price indicates that demand is outstripping supply (or that supply is falling behind demand), while a falling relative price denotes just the opposite. A rising relative price induces consumers to conserve on the good in question and to look for substitutes. A rising relative price also, by increasing profit opportunities, entices producers to bring more of the good in question to market.

In this way, relative-price changes—no matter how uncomfortable they are for consumers or producers—transmit vital information necessary for the efficient allocation of resources throughout any market economy. Inflation, by contrast, contributes no information useful to our consumption, production, or labor choices. If anything, inflation can temporarily distort vital relative-price signals, leading people to make unsound economic choices. It can even cause people to shift their time and resources away from activities that foster production and long-term economic growth to activities intended to protect their wealth rather than expand it.

Recently, the relative prices of petroleum, agricultural goods, and some other commodities have risen sharply. One factor responsible for much of these increases is the world’s unprecedented economic performance in recent years. Between 2004 and 2007, world output expanded an average of 4.8 percent each year, according to IMF data. While emerging markets, notably China and India, appear to have led the way, nearly every nation on earth shared in the expansion. This growth and development, which itself stems from an increasing willingness of countries to embrace globally integrated markets, has placed greater demand on world resources, leading to sharp increases in the relative prices of commodities. Foods imported into the United States, for example, have increased 4 percent on average each year since 2002 relative to other goods, while the relative prices of imported industrial commodities have increased 17 percent over the same period. Meanwhile, the relative price of petroleum increased 28 percent each year on average—and because petroleum is required to produce food and industrial commodities, its hike fed into their prices as well.
What we need to keep in mind is the difference between what may be called "true or pure inflation" and "relative price changes". One thing that seems odd about much discussion of inflation is the failure to make this distinction.

As noted by the Cleveland Fed changes in relative prices are important because it is relative prices that direct resource allocation. These are the price signals that are important for the smooth functioning of the economy, they provide the incentives for people to change their behaviour. As Cowen and Crampton (2002: 5) put it [t]he Canadian plumber's knowledge of substitutes for copper piping influences the French electrician's choice of home wiring through its effect on the market price of copper. "Pure inflation", on the other hand, is signal jamming noise which can result in the misallocation of resources. One of the major problems with inflation is the fact that people can't tell the difference between changes in relative prices and pure inflation. This is, in part, because the standard measures of inflation, eg changes in the CPI, contain both components: relative price changes and "pure inflation". Sorting these two factors out however is far from easy.

But what exactly is meant when we talk about "true or pure inflation"? Imagine an economy in which every price exogenously doubled. What used to cost $1 now costs $2, those who were paid $10 per hour now are paid $20, and what was worth $100 now is worth $200 and so on. Note that there has been no relative prices changes here. Thus, because people care about trade-offs when making choices, no one will behave any differently in the new "high price" world than they did previously. We would say, there is no "money illusion" in that changes in the unit of account don’t change anything real at all. (In microeconomic theory you learn this when you are told that demand functions are homogeneous of degree zero in prices and income.) Such an equiproportional price level increase, in the example just given the price level has doubled, is what can be called pure inflation.

In a paper - Relative Goods' Prices and Pure Inflation by Ricardo Reis and Mark Watson, CEPR 6593, December 2007 - it is pointed out that central to the story told above is a measure of inflation which is defined by two properties:
  1. all prices increase in exactly the same proportion, and
  2. the change is unrelated to any relative-price movements.
Reis and Watson argue that the extent to which (2) holds is an inflation measure's "purity." A measure of inflation is purer the more it has been stripped from relative-price changes and so it is closer to the thought experiment carried out above. How then to purify a measure of inflation?

Reis and Watson note that,
[i]n our own work, we noticed that factor analysis also gave a natural way to purify the measure of inflation. Factor analysis produces a set of components (or factors) that explain why prices move together. One of these factors is the equiproportional change in prices that Bryan and Cecchetti emphasised. But the other factors are just as interesting. These factors are measures of relative-price changes due to some common source (say productivity, fiscal, or monetary shocks), and it turns out that a few of these alone account for a great deal of the variability of price changes. Therefore, we can use them to statistically purify our measure of inflation from these main sources of relative price movements.
Using US data Reis and Watson found that
... most of the movements in conventional measures of inflation like the Consumer Price Index (CPI), its core version, or the GDP deflator are due to relative-price changes. Only around 15-20% of the movements in these measures of inflation correspond to pure inflation.
Given that they had measures of relative price changes and pure inflation Reis and Watson could look for evidence of money illusion in their data. They found that once they controlled for relative price changes, the correlation between (pure) inflation and real activity is essentially zero. So,
... when we see that high inflation typically comes with low unemployment or high output, this is indeed driven by the change in relative prices hidden within the inflation measure. When there is pure inflation, that is when all prices increase in the same proportion independently from any relative price changes, nothing happens to quantities.
Update: In a related blog post Michael Reddell at the Croaking Cassandra blog asks What to make of the CPI?

Ricardo and comparative advantage (updated)

David Ricardo is probably most famous because of his introduction of the idea of comparative advantage into economics. Today comparative advantage is the standard reason given as to why countries gain from trade. And as noted in this twit by the great trade economist Doug Irwin, Ricardo's book "Principles of Political Economy" is 200 years old.

But is Ricardo the author of the famous pages in his "Principles of Political Economy"? Some have argued that James Mill is the true author.

In a footnote on page 132 of the fifth edition of his "Economic Theory in Retrospect" Mark Blaug writes
Ironically enough, it is now been shown that the famous pages on comparative advantage in the chapter on foreign trade were almost certainly written by James Mill. Moreover, Ricardo's own conception of foreign trade never effectively went beyond the idea of absolute advantage; in short, he does not deserve the credit he has been given for the theory of comparative advantage.
The basis for Blaug's claim is the paper, by William O. Thweatt, "James Mill and the Early Development of Comparative Advantage", History of Political Economy 8 (Summer 1976) 207-34.

A quick look at Douglas Irwin's book "Against the Trade: An Intellectual History of Free Trade" gives rise to another footnote, from page 91, which reads,
Thweatt's case is plausible because Mill worked closely with Ricardo on the Principles and commented extensively on drafts. Inconclusive evidence against his interpretation comes in a letter from Mill to Ricardo in which he states: "... that it may be good for a country to import commodities from a country where the production of those same commodities cost more, than it would cost at home: that a change in manufacturing sill in one country, produces a new distribution of the precious metals, are new propositions of the highest importance, and which you fully prove." See David Ricardo (1952, 7: 99). Further, in his article on colonies Mill also credits Ricardo with the theory.
It has also argued that Mill explained the idea of comparative advantage better in his "Elements of Political Economy", published after Ricardo's "Principles".

But whoever wrote about comparative advantage Ricardo's book is worth celebrating. So joint Irwin and many other economists in raising a glass of wine, from a country of your choice, to David Ricardo!

Updated: In the comments section to this posting Jorge Morales Meoqui writes,
The authorship debate about comparative advantage has mostly revolved about the relative merits of Ricardo's statement in the Principles and Robert Torrens’ statement in Essay on the External Corn Trade (1815). James Mill never claimed merit for it, and in the letter to his friend Ricardo he indicated unequivocally who should be credited for the insight.
For more on Morales Meoqui's work on the comparative advantage debate see here.

Sunday, 16 April 2017

When usury laws are counterproductive

Is it a good idea have a ceiling on the interest rate, be that zero or some positive rate.
We study the effects of interest rate ceilings on the market for automobile loans. We find that loan contracting and the organization of the loan market adjust to facilitate loans to risky borrowers. When usury restrictions bind, automobile dealers finance a greater share of their customers’ purchases, which allows them to price credit risk through the mark-up on the product sale rather than the loan interest rate. Despite having little effect on who receives credit, usury limits therefore have a substantial effect on who provides credit and on the terms of credit granted. Usury limits may harm defaulting borrowers, who face greater liabilities in default than they would if loan contracts were unconstrained.
This is the abstract of a new working paper, Loan Contracting in the Presence of Usury Limits: Evidence from Automobile Lending (Consumer Financial Protection Bureau Office of Research Working Paper No. 2017-02) by Brian Melzer and Aaron Schroeder.

Melzer and Schroeder explain,
Usury restrictions are often motivated by the argument that lenders, if unchecked, will exercise market power and raise interest rates on risky borrowers beyond the level required to compensate for credit losses, origination costs, and required capital returns. Supporters of usury limits thus argue that lenders will respond to interest rate caps by extending credit at lower prices. Opponents counter that price ceilings will cause credit rationing, which reduces access to credit and harms precisely the risky borrowers that supporters of usury limits intend to help. We propose and investigate an alternative view that applies to the large market for certain subprime automobile loans: vehicle sellers can creatively contract around binding usury limits by financing their customers’ purchases and pricing default risk through the mark-up on the vehicle sale rather than through the interest rate.

The strategy of automobile dealers is simple. Vehicle loans are structured as installment contracts that require constant monthly payments for a fixed maturity (typically 3-6 years) and allow the lender to repossess the vehicle if the borrower defaults. Holding fixed the collateral, loan maturity, and principal amount, a lender is typically constrained to adjust the price of credit by changing the interest rate specified in the contract. For a lender that also serves as the vehicle seller, however, there is an additional degree of freedom—marking up the sales price of the vehicle. When the usury limit binds, the integrated dealer-lender can subsidize a negative net present value loan with a higher-margin sale. Within the loan contract, this change amounts to increasing the stated loan amount (along with the sales price) rather than the interest rate, thereby achieving the desired monthly loan payment while still complying with usury law. To give an example, a $9,000 loan at 30% interest has the same required monthly payment as a $10,650 loan at 20% interest over a four-year, fully amortizing term.

While dealers’ contracting flexibility allows them to approximate an unconstrained loan, it does not completely eliminate the friction introduced by the usury limit. First, the constrained and unconstrained contracts are not identical. When a dealer raises the stated loan amount instead of the interest rate, the borrower’s loan balance starts higher and remains higher until the end of the contract. Borrowers who prepay or default thus owe more to the lender when they terminate the contract. Second, risky borrowers may pay higher prices for credit, as their purchases depend upon financing from automobile sellers rather than a broader, and potentially more competitive, universe of third-party lenders. In an equilibrium with usury limits and dealer financing, therefore, few borrowers are completely excluded from the market, but dealers provide captive financing for a larger share of purchases and borrowers that receive dealer financing face different loan terms—lower interest rates, larger loan-to-value ratios, and possibly higher loan payments—than they would in the absence of usury limits (pp. 2-3).

Saturday, 15 April 2017

The problem with "ban the box"

Often even well intentioned policies can have harmful unintended consequences. One such example is the "Ban the box" policies that are becoming more widely implemented in the US. Ban the box is a policy that prohibits employers from asking about criminal records. In the short video below, Amanda Agan (Assistant Professor of Economics at Rutgers University) discusses whether these policies affect racial disparities in the chance of getting a job interview.

Julian Simon's "Almost Practical Solution to Airline Overbooking"

The problem of airline overbooking has made headline over the last week. An obvious question this gives rise to is, how do we deal with the problem?

Timothy Taylor at the Conversable Economist blog gives us this explanation of economist Julian Simon's method for dealing with the problem of overbooking. Simon wrote a short note, "An Almost Practical Solution to Airline Overbooking" (pdf), in the May 1968 issue of the Journal of Transport Economics and Policy.
Here's how Simon described the idea in 1968:
Perhaps the reader has suffered a fit of impotent rage at being told that he could not board an aeroplane for which he held a valid ticket. The explanation is clear, and no angry letter to the president of the airline will rectify the mistake, for mistake it was not. The airline gambles on a certain number of cancellations, and therefore sometimes sells more tickets than there are seats. Naturally there are sometimes more seat claimants than seats.

The solution is simple. All that need happen when there is overbooking is that an airline agent distributes among the ticket-holders an envelope and a bid form, instructing each person to write down the lowest sum of money he is willing to accept in return for waiting for the next flight. The lowest bidder is paid in cash and given a ticket for the next flight. All other passengers board the plane and complete the flight to their destination.

All parties benefit, and no party loses. All passengers either complete their flight or are recompensed by a sum which they value more than the immediate completion of the flight. And the airlines could also gain, because they would be able to overbook to a higher degree than at present, and hence fly their planes closer to seat capacity. ...

But of course this scheme will not be taken up by the airlines. Why? Their first response will probably be "The administrative difficulties would be too great". The reader may judge this for himself. Next they will suggest that the scheme will not increase net revenue. But the a priori arguments to the contrary make the scheme worth a trial, and the trial would cost practically nothing and would require no commitment.

What are the real reasons why this scheme will not be adopted? Probably that "It just isn't done", because such an auction does not seem decorous; it smacks of the pushcart rather than the one price store; it is "embarrassing" and "crass", i.e., frankly commercial, like "being in trade" in Victorian England.
It does seem better than beating people up and dragging them off planes.

When business loves regulation

From NPR's Plant Money comes this audio on

A few years ago, Jestina Clayton started a hair braiding business in her home in Centerville, Utah. The business let her stay home with her kids, and in good months, she made enough to pay for groceries. She even put an ad on a local website. Then one day she got an email from a stranger who had seen the ad.

"It is illegal in the state of Utah to do any form of extensions without a valid cosmetology license," the email read. "Please delete your ad, or you will be reported."

To get a license, Jestina would have to spend more than a year in cosmetology school. Tuition would cost $16,000 dollars or more.

On today's show: Why it was illegal to braid hair without a license in Utah. And why hundreds of licensing rules in states all around the country are a disaster for the U.S. economy.
The good news in this story comes in the update at the end.

Thursday, 13 April 2017

Yes, a lot of economists do agree on somethings,

and one of those things is the benefits that immigrants to a country bring. The following is the text of An Open Letter from 1,470 Economists on Immigration (pdf).
Dear Mr. President, Majority Leader McConnell, Minority Leader Schumer, Speaker Ryan, and Minority Leader Pelosi:
The undersigned economists represent a broad swath of political and economic views. Among us are Republicans and Democrats alike. Some of us favor free markets while others have championed for a larger role for government in the economy. But on some issues there is near universal agreement. One such issue concerns the broad economic benefit that immigrants to this country bring.
As Congress and the Administration prepare to revisit our immigration laws, we write to express our broad consensus that immigration is one of America’s significant competitive advantages in the global economy. With the proper and necessary safeguards in place, immigration represents an opportunity rather than a threat to our economy and to American workers. We view the benefits of immigration as myriad:

  • Immigration brings entrepreneurs who start new businesses that hire American workers.
  • Immigration brings young workers who help offset the large-scale retirement of baby boomers.
  • Immigration brings diverse skill sets that keep our workforce flexible, help companies grow, and increase the productivity of American workers.
  • Immigrants are far more likely to work in innovative, job-creating fields such as science,
  • technology, engineering, and math that create life-improving products and drive economic growth.

Immigration undoubtedly has economic costs as well, particularly for Americans in certain industries and Americans with lower levels of educational attainment. But the benefits that immigration brings to society far outweigh their costs, and smart immigration policy could better maximize the benefits of immigration while reducing the costs. We urge Congress to modernize our immigration system in a way that maximizes the opportunity immigration can bring, and reaffirms continuing the rich history of welcoming immigrants to the United States.


Sonny Bill Williams has made the news over the last week for this objection to the BNZ logo on his Blue's jersey. My first reaction to hearing his news was, will he return that part of his salary that the BNZ pays? If the BNZ are the modern day version of the baby-eating Bishop of Bath and Wells then along with covering up the BNZ logo should SBW not, for the sake of consistency, also return whatever part of his salary the bank provides? Where does Williams think the money for his salary comes from if not the sponsors? Money made by charging interest.

At the Stuff website Tony Smith writes,
The practising Muslim issued a statement on Wednesday, saying his objection was "central to my religious beliefs". "As I learn more, and develop a deeper understanding of my faith I am no longer comfortable doing things I used to do. So while a logo on a jersey might seem like a small thing to some people, it is important to me that I do the right thing with regards to my faith and hope that people respect that."
But is this central to his religion? Yesterday I was reading, for other reasons to do with the Islamic approach to the corporation, Timur Kuran's (Professor of Economics and Political Science, and Gorter Family Professor in Islamic Studies at Duke University) book "The Long Divergence: How Islamic Law Held Back the Middle East" when I came across this comment,
In its strict interpretation, classical Islamic law requires every loan, regardless of size or purpose, to be free of interest. The principal justification is that the ban appears in the Quran. What the Quran explicitly prohibits is riba, an ancient Arabian practice whereby the debt of a borrower doubled if he failed to make restitution on time. Riba commonly resulted in confiscation of the borrower's assets, even in his enslavement. In banning the practice, Islam effectively prohibited immiserization and enslavement for debt (Kuran 2011; 144-5).
Sounds all fairly sensible. But then Kuran writes,
It is not self-evident that a ban on riba requires a general and timeless prohibition of interest (Kuran 2011; 145).
Thus how did we get the ban?

A little later Kuran sends a couple of pages (pp. 147-150) explaining how in practice people evaded the interest ban. Clearly interest free loans would diminish lenders incentive to lend. Thus borrowers often compensated their creditors through payments that amounted to interest, if not actually being interest. Kuran goes on to say,
All such firms of casuistry received religious stamps of approval, although the legality of any given form could very across Islam's schools of law (Kuran 2011: 150).
If Kuran is right and interest in general is not prohibited and the prohibition is honoured in the breach then how did Islamic law get from this to the position SBW is taking?

Also one has to ask if we accept SBW's objection to the BNZ logo where does this end? In his Stuff article Smith wants the All Blacks to lodge an objection to the sponsorship by AIG. And this raises the important point, if we accept SBW's objection, what objections to sponsors can be rejected?

If a player has strong environment beliefs can they object to a sponsor on that firm's environmental record? Does the firm pollute waterways? What if a player is a "social justice warrior" can they lodge an objection on the grounds of the social effects of a given firm's actions, say their use of "sweatshops" in other countries? What if someone is an economic nationalist, can they object to a sponsor on the grounds that that firm closed a New Zealand plant and "moved those jobs overseas"? Which objections are acceptable and which are not? And how is the difference to be determined?

Accepting any "conscientious objection" to a sponsor could be seen as opening a real can of worms for future sponsorship deals. If sponsors think they may not get the exposure they thought they would get do they cutback on the amount of money they offer or even pullout of sponsorship deals altogether. Either way this can't be good for professional sport.

  • Kuran, Timur (2011). The Long Divergence: How Islamic Law Held Back the Middle East, Oxford: Oxford University Press.