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op-ed on presidential tax plans

by Andrew Chamberlain
Tuesday, August 24, 2004


Got an op-ed in the Providence Journal (free registration required) and some smaller papers in the last few days comparing the Bush and Kerry tax plans:

For those of us who aren’t tax lawyers and accountants, how should we choose between tax plans this November?

One way is to ask the common sense question, “What makes a good tax?” and then compare plans to that ideal. Thankfully, economists over the years from Adam Smith to Milton Friedman have done this for us, and have boiled down their tax wisdom into five simple rules:

Simplicity: Taxes should be easy to understand, and easy to pay.

Transparency: Taxpayers need to know the cost of government in a democracy. Taxes shouldn’t be hidden or misleading in their impact.

Stability: Good economic decisions require stable “rules of the game.” Tax law shouldn’t change continually or apply retroactively.

Neutrality: Taxes should aim to raise revenue without economic distortion, and shouldn’t attempt to “socially engineer” the economy.

Growth-friendliness: Taxes should consume as small a part of national income as possible, and shouldn’t interfere with trade or capital flows.

Nothing groundbreaking here—just a reminder that economists broadly agree on basic rules for “good” taxation, and framing debates in terms of them lets people talk sensibly about tax policy without pulling out the ideological clubs.

See also the short version from the Myrtle Beach Sun News.

Filed under: Economics | Permalink | Feedback?



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bush vs. kerry tax plans

by Andrew Chamberlain
Friday, August 13, 2004


I’ve got a little piece comparing President Bush and Sen. Kerry’s tax proposals for a new pub I’m doing, Tax Watch.

Bottom line: Bush wins by a nose on taxes. However, both plans are pretty terrible by the usual standards of simplicity, transparency and efficiency.

Download the full article here (PDF).

And don’t miss the “wacky taxes” on page four. Good times.

Filed under: Economics | Permalink | Feedback?



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australia's baby economics

by Andrew Chamberlain
Thursday, August 5, 2004


Birthrates in rich countries have been falling for decades. The reason is simple: babies have gotten more expensive (See previous entries here and here).

Childbirth follows the law of demand like everything else. So we get fewer babies when the price goes up.

What does a baby cost? There are two parts—out-of-pocket costs like diapers and school tuition, and opportunity costs for time spent childrearing. Not surprisingly, both depend on how much money you make.

Rich parents spend more on babies. According to the U.S. Department of Agriculture’s Consumer Expenditure Surveys, families making $65,800 a year or more will spend a staggering $249,000 to raise a child through age 17. Poor families spend a lot less: those earning $39,100 to $65,800 spend about $170,000, and those making less than $39,100 spend about $125,000. (More here, full data here [PDF]).

But those estimates don’t include the opportunity costs of bearing children. For all the joys of forming family, kids take away from leisure and work time. As income rises, so do the opportunity costs of time. That’s why we see birthrates falling in rich countries vs. poor countries, and among the wealthiest within rich countries.

Falling birthrates may be good for individuals making the decisions behind the numbers, but they’re bad for politicians. They reduce future tax collections, economic growth, and threaten to bankrupt pay-as-you-go social insurance schemes.

Europe’s birthrates have fallen most sharply, and legislators have been aggressively crafting policies to boost birthrates. The latest plan comes from Australia, where the federal government began offering a “baby bonus” of 3,000 Australian dollars (U.S. $2,100) to new moms starting July 1, 2004.

Will the plan work? Compared to the total costs of childrearing, a $2,100 bonus is peanuts for most of us. But as economists always point out, at the margins there are always people who are indifferent between two actions. $2,100 per baby may not induce the next baby boom, but tiny changes in incentives tipping people at the margin one way or the other can have big social consequences.

A trivial example comes from the AP account of the baby-bonus launch. Births were down just before the launch of the baby bonus, and surged just afterward:

St. John of God Hospital in the west coast city of Perth reported that the number of babies born there fell 21 percent in the second half of June compared with the corresponding period last year, the West Australian newspaper said. But the number of births in the first half of July increased 30 percent compared to a year earlier.

More important than the timing of births may be the impact of these plans on the distribution of births between rich and poor. All else constant, we’d predict a baby-bonus to increase births among those with the lowest opportunity costs—poor, uneducated, single parents.

If that happens, expect a demographic bulge of males from poor, single-parent households to reach maturity between 15 and 25 years from now—and a classic policy boomerang in the form of a surging Australian crime rate.

Filed under: Economics | Permalink | Feedback?



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fun with the L.A. Times

by Andrew Chamberlain
Monday, July 19, 2004


I landed a couple nice quotes on “jock taxes” in the Los Angeles Times over the weekend (free registration required):

Passing federal laws to restrict state taxation is a tricky issue, but it needs to be addressed for workers and companies, said Andrew Chamberlain, a spokesman for the Tax Foundation. Otherwise, business travelers could face such a nightmare of multiple state tax forms that they might become reluctant to travel on business at all.

“This is a real slippery slope,” Chamberlain said. “If jock taxes continue to be applied this aggressively, more and more professionals that travel to other states are going to be subject to them. Eventually, a traveling executive would have to pay tax in every state that he visits during the year. That creates an untenable level of complexity.”

In case any state tax collectors are paying attention—no, I’ve never traveled for business to any income-tax collecting states.

Never, I swear.

Filed under: Economics | Permalink | Feedback?



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interview

by Andrew Chamberlain
Tuesday, July 13, 2004


Just in time for the Major League Baseball All-Star Game, I’ll be on Houston’s KSEV radio talking about “jock taxes” today around 5:20pm EDT.

Click here to listen live.

Filed under: Economics | Permalink | Feedback?



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"jock taxes" and baseball

by Andrew Chamberlain
Sunday, July 11, 2004


Been working on “jock taxes” lately at work.

Just in time for next Tueday’s Major League Baseball All-Star Game in Houston, we’ve got an op-ed in today’s Houston Chronicle.

For more on “jock taxes”, check out the Tax Foundation’s website at www.taxfoundation.org.

FYI—That’s where most of my labor’s going these days, rather than here.

Filed under: Economics | Permalink | Feedback?



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thinking about prostitution

by Andrew Chamberlain
Thursday, May 27, 2004


You won’t find a chapter on prostitution in most economics textbooks. But if economists Lena Edlund and Evelyn Korn have their way, that may change.

Prostitution as an industry is full of economic puzzles: Prostitutes are low-skilled, but highly paid. Both women and men supply prostitution, but demand is almost uniformly men. Prostitutes are well-paid, but occupy a low rung on the social ladder. And so on.

In a recent paper in the Journal of Political Economy, economists Lena Edlund and Evelyn Korn build a model of prostitution that demystifies much of the economics of the world’s oldest profession. [Download paper here (PDF)]

The authors nail some interesting questions. One is, Why is prostitution more common in poor countries? One obvious explanation is that prostitution falls as women’s income and opportunity costs rise. What’s less obvious is that prostitution falls as men’s income rises, too.

Why does that happen? Because to some extent—here come the nasty emails—wives and prostitutes are substitutes, with prostitutes being what economists call an inferior good. As income rises men prefer stable marriages over occasional hookers. And this has policy implications: the best way to reduce prostitution may be making both women and men richer, rather than legal penalties and informational campaigns.

Another question is, Why is prostitution more common in areas with high migration? The authors’ note that one cost of being a prostitute is reduced value in the marriage market. Most guys won’t marry ex-hookers. Prostitutes can avoid this cost by hiding the fact that they’re prostitutes. Frequent migration helps do that, by avoiding a social reputation. And that’s exactly what we see.

More interestingly it explains why, ceteris paribus, foreign prostitutes are cheaper in places where both exist—they’re the low-cost producers of prostitution.

Of course, the big question the authors don’t address is whether prostitution’s spillover effects—spread of disease, impact on the stability of marriage and the likelihood of out-of-wedlock children, etc.—justify the widespread bans we see today.

Food for thought on your next trip to Vegas.

Filed under: Economics | Permalink | Feedback?



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at what price taxis?

by Andrew Chamberlain
Thursday, May 27, 2004


How much would you pay for a monopoly?

Last week, New York City auctioned off 126 taxi medallions, which grant the monopoly right to operate cabs in the city. Among 270 bidders, medallion prices reached $300,000, prompting outrage from some onlookers.

$300,000 sounds like a lot. But is it really? Sure, medallions cost money—but they also earn income. On net, how much is a taxi medalion really worth?

If you ask an economist, he’ll tell you to calculate the present value of the expected future revenue from a medallion, and compare that to the cost.

So let’s do the math. Given a medallion cost of $300,000, how much does a cabbie have to make to justify buying one? Assuming he’ll use it for 20 years, and assuming, say, a 7 percent discount rate—the forgone return he could’ve earned on a similar investment—he’d need to earn about … $28,300 a year.

That’s not much. So how much do taxi drivers actually earn? According to the New York Times here and here, most drivers pull in about … $30,000 a year.

So it turns out those medallions may not be so expensive after all, and a little simple economics helps us see that.

Of course, this doesn’t answer the important question: whether taxis should be a monopoly in NYC, or whether medallions should be made cheaper by allowing more of them. But it does help us resist the temptation to hastily denounce medallion prices as “unfair” just because their price looks large in absolute terms.

Still not convinced? Go do the numbers—download the Idea Shop’s “Should I Buy that Taxi Medallion?” decision-model here [MS Excel spreadsheet].

Fun for the whole family.

[Update: Jim Henley adds a some complexity to this back-of-the-envelope calculation here.]

[Update 2: Tim Lee adds more on taxi driver’s opportunity cost of time here—though in the model above this can be accounted for by simply adjusting expected future income streams downward…]

[Update 3: Tyler Cowen has more on the economics of optimal taxi regulation here.]

[Update 4: Will Baude has more on intertemporal problems with stable taxi quotas here.]

[Update 5: Via email, a reader suggests three things to make the above calculation more realistic: ”(1) The $30,000 annual income often reported is net income—net of a leasing fees paid to the medallion owner. (2) Cabs run around the clock, a single cabdriver does not. A medallion owner can use the medallion himself for 8 to 12 hours per day, and then lease the medallion to someone else for the rest of the hours—the medallion stays with the cab, not the owner. (3) A medallion can be sold, so it has more than a twenty year useful life.”]

Filed under: Economics | Permalink | Feedback?



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the baby factory

by Andrew Chamberlain
Thursday, May 27, 2004


Remember when overpopulation was making headlines? So much for that. The new demographic crisis du jour is underpopulation caused by falling birthrates worldwide.

In the last 30 years, birthrates have plummeted in rich countries, and poor countries are beginning to follow suit. By 2045 world fertility rates will have fallen below replacement levels. By 2070 demographers predict world population will peak at 9 billion, and begin slowly contracting thereafter.

So what? Well, there’s a growing consensus that falling birthrates are a social problem with bad economic consequences. A recent article from Phillip Longman in the current issue of Foreign Affairs is representative.

In it, Longman argues rising average ages means fewer young productive workers and more dependent elders, and this threatens to bankrupt pay-as-you-go social insurance programs. Declining population also means lower total GDP growth potential, and lower total tax revenue. Population aging may also slow technological innovation and entrepreneurship, which tend to flourish among the youth. And so on. His conclusion? States need a policy solution to correct this, and boost birthrates.

In econ-speak, this is an argument about externalities. Saying “childbearing has social consequences”—rather than individual—is really saying “babies cause positive externalities” for the rest of society.

So do they? In one sense, of course. By giving birth to Thomas Edison, Mrs. Edison generated lots of social benefits she didn’t take into account before getting pregnant. But what about Ted Bundy’s mother? If we count benefits, we have to count costs, too. Back when overpopulation was making headlines, it was argued that babies give off negative externalities, in the form of strain on urban infrastructure, environmental destruction, etc.

Which claim is true? That’s an empirical question. Unfortunately, it’s one that’s probably unanswerable even conceptually. That’s why—when deciding if falling birthrates are a social problem—we should probably look at more than aggregate consequences. We should also look at causes, at the level of individual mothers.

From Longman:

... the changing economics of family life is the prime factor in discouraging childbearing … [A]s more and more of the world’s population moves to urban areas in which children offer little or no economic reward to their parents, and as women acquire economics opportunities and reproductive control, the social and financial costs of childbearing continue to rise.

So the main causes of falling birthrates are urbanization, rising wealth, and the improved status of women. As I’ve written before, all these are good things (see here). And because of the overwhelming force of these economic and social trends, there’s almost certainly no way to boost overall birthrates without halting or reversing at least one of these factors.

If there ever was a cure worse than the disease, a policy that encouraged more babies at the expense of halting the trend toward making women less equal—and all of us poorer—would definitely be it.

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guest post: galton's fallacy

by michael
Thursday, May 27, 2004


Imagine you want to conduct a study on the effectiveness of punishment and reward on flight training. You praise trainees for good landings and reprimand them for near crashes, and observe whether this has any effects.

After spending some time on the airfield your data indicate trainees did worse on their next flight if they had just been praised, and fly better just after being yelled at.

Then you have a conversation with the flight instructor who does the written examinations. He tells you that experience shows students who do well on midterms slack off on their final exam, while students who do badly generally get better.

What does this mean? Do students’ test scores tend to revert to some mean?

If you answered yes, you’ve just committed the famous “Galton’s fallacy”.

What did the 19th century statistician and geneticist Sir Francis Galton, Charles Darwin’s cousin, do wrong?

Well, he plotted the height of fathers against the height of their sons and discovered sons of tall fathers tended to be tall, but on average not as tall as their fathers. Similarly, sons of short fathers tended to be short, but on average not as short as their fathers. He—and this was his mistake—was immediately concerned that the sons of tall fathers are regressing into a pool of mediocrity along with the sons of everybody else.

So what’s wrong with that? Well, height tends to be normally distributed—i.e., the distribution takes a bell-shaped form—and sons’ heights are, due to heredity, correlated with the father’s height. So there is a linear dependence between fathers’ and the sons’ heights.

To see why this leads to a fallacy, let’s do a simulation where we generate, loosely speaking, 2*250 standard normally distributed random variables with a correlation coefficient of 0.5 and plot them against each other.

The resulting scatterplot is similar to what Francis Galton was looking at about 120 years ago. In this case, just imagine the average height was rescaled to zero in the plot:

The blue line is the regression line and the red line is the 45 degree line (standard deviation line). Galton expected the regression line to be the 45 degree line—that is, he expected a father with a height of 2 on the x-axis should, on average, have a son with a height of 2 on the y-axis. But because of the correlation between x and y, the regression line shows that a father with a height of 2 is expected to have a son of height 1.

The technical explanation is that the slope you get from regressing two normally distributed random variables with equal variances against each other is the correlation coefficient, and therefore a father with height 2 would give us:

1 = 0.5*2,

since the regression equation is y = 0.5*x.

So this appearance of “regressing to the mean” is a statistical mirage due to regressing two random but correlated variables upon each other. Mistakenly attaching some special meaning to this phenomenon is the technical explanation of Galton’s fallacy.

The non-technical explanation is a little more tricky. Let’s go back to our first two test-taking examples at the flight school.

First, set up the following model:

Y = T + e.

“Y” is the test score you actually receive on a certain exam. “T” is the “true” test score—the score you actually deserve—and “e” is a chance error due to, say, being sick before the test or lucky guessing on exam day.

Now assume that the distribution of true scores follows a normal distribution with a mean of 100 and a standard deviation of 15. Suppose further that the standard error, “e”, is either -5 or 5 with equal probability.

Now, if someone scores Y = 140 on his test, there are two possible explanations: either his true score is 135 (= 140 – 5) or 145 (= 140 + 5). The first outcome is, of course, more likely than the second, since “T” is assumed to be normally distributed and the more an outcome deviates from the mean, the more unlikely it is to occur. If you plot the test scores of the first exam against the test scores of the second exam, you will notice that those with very low scores on the first exam will see their average move up toward the overall mean (some of those who had a negative chance error will have a positive chance error this time) while those with high scores on their first exam will see their scores move down.

That’s what gives the appearance of a “regression to the mean.” And the same explanation applies to the father-son sample: a father with a height of 2 (which is 2 standard deviations taller than the average father) does not have on average a son with an equally extreme height.

For more on Galton’s fallacy, I highly recommend reading “Galton’s Fallacy and Tests of the Convergence Hypothesis” by Danny Quah—a well-known paper among economists, especially growth theorists.

[Read more from guest blogger Michael Stastny at Mahalanobis.]

Filed under: Math & Stats | Permalink | Feedback?



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no such thing as a free-market economist?

by Andrew Chamberlain
Thursday, May 27, 2004


What is free-market economics? Is it different from regular economics?

Seems like a silly question. After all, the term is ubiquitous in media and politics. But on closer inspection, it’s a surprisingly nebulous concept.

A reasonable start might be a definition. But good luck finding one. Google returns more than 22,000 search results, none of which—as far as I can tell—offers a clear and defensible definition.

A search on onelook.com—which scans 970 dictionaries—turns up 96 common modifiers to “economics”, and free-market isn’t one of them (thanks to Andrew Walsh for the pointer). Not even Liberty Fund’s Concise Encyclopedia of Economics—with entries from a range of self-described free-market economists—has an entry for free-market economics.

How about the Dictionary of Free-Market Economics? Nope. How about A Primer on Modern Themes in Free Market Economics and Policy? Though it includes lots of policy prescriptions for moving toward a free market, there’s no actual definition.

So much for that. Let’s try an indirect approach.

Wikipedia—though it has no entry for free-market economics either—defines “free market” as follows:

A free market (or free-trade) economy is an idealized form of a market economy in which buyers and sellers are permitted to carry out transactions based on mutual agreement on price without government intervention in the form of taxes, subsidies, regulation, or government ownership of goods or services.

Now, one might conclude that free-market economics is simply the study of the free market. And from that, it might seem reasonable to conclude that free-market economics is therefore another branch of economics—one that studies markets without state intervention.

But you’d be wrong. That’s simply not what people mean when they use the term free-market economics.

Much like suppy-side economics, in practice the term is used to describe a political viewpoint about economic policy, not a field within economics. Free-market economics isn’t so much economics as it is an ideological predisposition for a particular set of social arrangements favoring markets over government.

Now, being sympathetic with laissez-faire is one thing. But calling it a branch of social science is another. It seems pretty clear that explicit ideological predispositions like those embodied in the term free-market economics have no place in the social sciences.

The goal of economics is to provide a true account of social phenomena. To some extent, that requires economists to accept a scholarly responsibility to pursue truth in as unbiased a fashion as possible. Labeling one’s self a free-market economist seems to be an explicit rejection of that scholarly responsibility.

If free-market economics means anything, it means some questions and answers about social phenomena—especially those involving government action—are simply off the table, for ideological reasons. I think everyone can agree that’s an unscientific approach. It’s pretty clear that “free-market” economics is a case of a mislabled political program, and isn’t technically economic science at all.

Of course, one might object that since no science is completely free of ideology, denouncing free-market economics for having explicit ideological biases misses the mark. And on some level that’s true—ideological predispositions do guide the types of questions all scientists find interesting, and they undoubtedly temper everyone’s research instincts.

But whatever the subconscious influence of ideology, economists—and academics more generally—have a professional responsibility to actively steer clear of their own ideological biases, insofar as they interfere with the truth-seeking enterprise of science.

As people who study markets and have a rich understanding of the failings of government intervention in the economy, it seems natural that some economists will aesthetically favor free markets. I’m usually one of them. And in our capacities as citizens in a representative democracy, or as policymakers formulating economic policy, those views are appropriate and necessary.

But as social scientists, there is an ethical responsibility to at least keep them in the closet. Importing ideological predispositions into our work in an attempt to cloak them in a veneer of scientific validity is bad methodology. And it works to discredit the entire intellectual program.

Economics has already got a bad rap. Critics of economics have long questioned the status of economics as a science—accusing it of being mere “politics in disguise” in the words of iconic author Hazel Henderson.

Unfortunately, the day economics devolves into ideological advocacy of a political program—even if that program is the best among alternatives—they will be right, and that will be a shame.

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the price of deregulation: subsidies

by Andrew Chamberlain
Thursday, May 27, 2004


One good thing about deregulation is that it clears out economic dead wood. When regulations are lifted, companies start competing and either get efficient or lose their shirts. Over time, economic losers go away and low-cost producers thrive. And society gets things done better.

At least that’s the theory.

In practice, economic losers don’t go away so easily. Once deregulation frees-up markets, politicians often rush in with heavy subsidies to losing companies. People like stability, and subsidies promote that.

These subsidies can be huge, and they’re an often-overlooked “cost” of deregulation. After accounting for the cost of subsidies to taxpayers, actual gains from deregulation can be dramatically lower.

A common example is airlines. Even after deregulation in the 1970s, airlines continued to enjoy a seat at the federal trough during rough times. According the Congressional Research Service, between 1918 and 1998 the feds spent about $155 billion on commercial airline subsidies—guaranteed loans, airport subsidies, direct hand-outs, you name it. And the trend isn’t slowing. By some estimates, they’ve tacked on another $15 billion just since September 11, 2001. (Download the study in PDF here).

That’s a lot of cash down the drain. Historically, these subsidies have gone hand-in-hand with deregulation, leading some to argue they’re simply a “price” we pay to enjoy deregulation’s gains.

If that’s the case, is the price worth it? Well, even if we assume losses from subsidies always go along with deregulation—what I call the “post-deregulation welfare” effect—compared to the benefits, they’re peanuts.

Take the case of airlines. Just between 1976 and 1990 the estimated savings from deregulation were $5 billion to $10 billion per year. Taking the low estimate, that’s $70 billion in savings over just 14 years—and that’s just lower ticket prices. Add in better routes, safety, customer service, innovation, and 14 more years of low prices to the present, and that total’s much larger.

So, is “post-deregulation welfare” inevitable? That’s debatable. But one thing isn’t: even with wasteful subsidies to laggard companies, the cost/benefit balance still tips in favor of deregulated markets.

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who cares about regulation?

by Andrew Chamberlain
Thursday, May 27, 2004


The big problem with regulation isn’t that it’s inefficient. It’s that it’s boring.

Most regular people don’t notice—or care about—how regulations impact daily life.

Partly, this is economists’ fault. Many of us have forgotten that ideas—just like goods in the marketplace—need marketing. With just a little improved story-telling, economists can make a big difference in helping people see why regulation matters in practical, concrete terms.

To pick an easy one: Once upon a time, air travel was an expensive luxury. Then in 1978, airlines got deregulated and everything changed. Ticket prices fell 40 percent. Suddenly, we witnessed something incredible: for the first time, low- and middle-income Americans could afford to see the world—something historically only available to the rich.

Sure it leaves out a lot. But that’s what make it a powerful story. It contains no math. It doesn’t use the word “efficiency”. And it helps people who don’t care about economics see why regulation matters.

There are lots of economists who tell these stories well. Within the field of regulatory economics, three of the best are Randall Kroszner, Alfred Khan, and Bruce Yandle.

What makes them good? Understanding regulation, like most hard problems in economics, takes experience as well as theory. The world of regulation is a tangled thicket of bureaucrats, lobbyists, and public-interest moralizers. These economists did time in Washington, working in senior policy positions next to the actual people who write regulations, and came back alive—tempered by the experience and full of insights.

Some samples:

From Bruce Yandle—formerly of the President’s Council on Wage and Price Stability in the 1970s—see his famous essay “Bootleggers and Baptists” (PDF) from the May 1983 issue of Regulation magazine.

From Alfred Kahn—the so-called “father of airline deregulation” during the Carter administration—see his entry on “airline deregulation” from the Concise Encyclopedia of Economics.

And from Randall Kroszner—formerly of President Bush’s Council of Economic Advisors—check out this 2003 interview with the Federal Reserve Bank of Richmond’s Region Focus magazine.

From Kroszner on the incentive to regulate:

When you spend much of your career working in a certain industry, you begin to see more nuances … That may be why you find so many people who, in general, are free-market advocates but when it comes to their industry, they are willing to say we need this regulation or barrier.

In some cases they may be right—there may, in fact, be a market failure. But the real question is: Should the government take action? I don’t believe that markets work perfectly all the time. Virtually all markets are imperfect in some way. But what is the relevant alternative? The alternative can be much, much worse.

I am a great believer in the power and importance of free markets for advancing human good. But it’s not because those markets work perfectly—it’s because I can’t think of a better alternative.

Sure, deregulation makes markets more efficient. But is that something that resonates with most people? Probably not.

The far more interesting story is that better markets mean life’s basics get done cheaply. And that means more time for the good stuff in life, like leisure, self-development, creativity and—of course—fun.

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why do gas prices rise quickly, but fall slowly?

by Andrew Chamberlain
Thursday, May 27, 2004


The first lesson in economics is that prices move based on supply and demand. But the second lesson is that they don’t always do it well.

Sometimes prices are “sticky,” and don’t quickly respond to changing market conditions.

A common example is gas prices. From the The Economist’s online econ glossary:

Petrol-pump prices do not change every time the oil price changes… Sticky prices are slow to change in response to changes in supply or demand. As a result there is, at least temporarily, disequilibrium in the market.

Stickiness is easy to see in the data. Below is a chart of California gas prices from 1996-2000. The pink line is wholesale prices, and the blue is retail. Note how quickly retail prices rise when wholesale prices jump, and how slowly they come down when they fall—a classic case of asymmetric price adjustment.

There are many reasons for stickiness—“menu costs”, contracts that lock-in prices, firms’ unwillingness to irritate customers with constant price changes, etc. But a common one that’s false is that price stickiness like in the above chart is evidence of monopoly pricing power by firms.

It’s an easy mistake to make. From the chart, it’s clear that when wholesale prices rise, gas stations jack up retail prices immediately. But when they fall, retail prices don’t drop as fast. Firms keep prices high, and profit margins fatten. Looks a lot like a case of monopoly pricing to gouge consumers. Right?

Not so fast. A new job-market paper from Matt Lewis, a Ph.D. candidate at U.C. Berkeley, shows that this asymmetrical price adjustment has nothing to do with market power. Instead, it’s caused by consumers, and the way they act differently when prices are rising vs. falling. [Download the paper here (PDF)]

The paper builds a “reference price search model”, in which consumers don’t search much for better prices when they’re falling, but search a lot when they’re rising. When consumers search, markets are more efficient. And when they don’t, markets are less efficient. So when wholesale gas prices fall, gas stations drop prices just enough to keep people from searching much. That makes markets sloppy, and retail prices get pushed down more slowly than up.

It’s a great paper, and it makes intuitive sense—as one professor quipped in a recent listserv discussion, “This phenomenon is no more surprising than the fact that no one ever gets a second opinion when a doctor delivers good news.”

This pricing phenomenon is very widespread, and the paper is one of the first attempts to model it at a micro level. Lewis finds pretty good empirical support for it, too. Email him here.

So, gas prices are on the rise now… if you’re in the Washington, D.C. area, try this tool to make your own search for cheap gas more efficient.

Filed under: Economics | Permalink | Feedback?



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advertising as antitrust defense

by Andrew Chamberlain
Thursday, May 27, 2004


Times sure have changed.

The above image is a two-page spread from the July 1976 National Geographic, featuring Union Oil’s infamous “What a way to run a monopoly!” ad.

The ad copy’s the best part. Reading it today, it’s shockingly gruff and confrontational—an anachronism pre-dating the rise of the “social responsibility of business” doctrine that dominates today’s business schools.

Here’s the copy:

You’re looking at some of the brands and names of companies that sell gasoline. Some people say oil companies are a monopoly. If so, it’s the world’s most inept “monopoly.”

This “monopoly” is so inept that it offers the world’s richest country some of the world’s most inexpensive gasoline.

This “monopoly” is so inept that it lets everybody and his brother horn in on the action. Did you know that of the thousands of American oil companies, none has larger than an 8.5% share of the national gasoline market?

In fact, this “monopoly” is so inept that you probably wouldn’t recognize that it is a monopoly because it looks so much like a competitive marketing system.

People who call us a monopoly obviously don’t know what they’re talking about.

For all its awkwardness, it’s sure got a high truth-to-word ratio.

Almost enough to make you nostalgic—well, maybe not.

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commerce and capitalism

by Andrew Chamberlain
Thursday, May 27, 2004


Do art and commerce mix?

Conventional wisdom says they don’t. Art and commerce are seen as polar opposites—commerce aims at profit, while art aims at beauty. As a result, commercial practices are viewed suspiciously in the arts world, and are assumed to have a corrupting effect on artistic integrity.

As usual, conventional wisdom is wrong. The St. Petersburg Times has just run an excellent two-part story exploring the intimate—and symbiotic—relationship between commerce and art in, of all places, 19th century Russia:

From the Times:

The piece is based on Ph.D. work by Andrei Shabanov, who’s associated with the art history program at the European University at St. Petersburg.

Read part one here. Read part two here.

More on GMU economist Tyler Cowen’s well-known work on commerce and art here. Read a sample chapter of his In Praise of Commercial Culture—a good introduction to the way economists think about art and commerce—here.

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manufacturing decline as self-fulfillment

by Andrew Chamberlain
Monday, March 29, 2004


Is the U.S. economy’s shift toward services—and away from manufacturing—a move up Maslow’s hierarchy of needs?

A a recently-published paper from psychologists Leaf van Boven and Thomas Gilovich at least suggests that. (read a summary here).

The study finds people are happier when they buy services—or “experiences”—rather than goods. That may mean shifts toward services are predictable in rich countries, as consumers easily satisfy basic needs and start aiming at self-actualization instead.

From the authors:

“We have shown that, for a variety of reasons, experiential purchases make people happier than material purchases . . . Our research suggests that individuals will live happier lives if they invest in experiences more than material possessions.

So why do services beat goods? The authors give three reasons:

1. Experiences are more open to positive reinterpretation later than goods—we tend to be nostalgic for even our worst vacations, for example;

2. Experiences are more central to our identities—life is literally the sum of past experiences, not past purchases; and

3. Experiences have greater “social value.” Sharing them helps us form more satisfying relationships that lead to happiness—think of the difference between a bar-room story about about your European backpacking adventure vs. your new Sony flat-screen.

Keep that in mind next time you hear complaints that our shift toward services represents a “hollowing out” of the U.S. economy.

[Link via Mahalanobis.]

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growing new property rights

by Andrew Chamberlain
Sunday, March 28, 2004


Who owns space?

For now, no one. But if recent stories about a Russian entrepreneur trying to beam ads across the night sky from orbit are true, that will change.

Why? A basic result from property-rights economics is that as the value of common property resources increases, more carefully-delineated property rights over them will be formed and enforced.

In this case, a technological change allowing ads in space boosts the value of orbit. As entrepreneurs try to capture that value, defacto property rights will emerge.

So will some interesting legal disputes—which leads to a second result from property-rights economics: property rights disputes are inevitable in a market economy.

The reason is that property is ambiguous. It’s composed of a complex bundle of attributes. Some are observable and valuable, some aren’t. And when property rights get legally delineated—either by contract or court decision—not all attributes will be specified. Only attributes that are both observable and valuable at the time of delineation will be assigned ownership.

Disputes break out when the value of an unspecified attribute goes up—often caused by new technology. And when it does, it’s not clear who owns it. People will compete to capture that value.

An example will clarify: You rent a plot of land with an old wooden fence on it. At the time you sign the contract there’s no mention of the fence because it’s worthless. Now, months later, imagine some new use for that particular kind of wood is discovered. Suddenly, the fence is worth delineating. And unless you and your landlord can cut a private deal, you’ve got a legal dispute.

Economist Harold Demsetz first outlined this theory of property-rights formation in a famous 1967 article in the American Economic Review. It’s a fun read—he examines how beaver populations in Native American communities transformed from common property to private property when the value of beaver pelts rose as access to European markets opened up.

The definitive statement of this “property rights” approach to economics comes from economist Yoram Barzel, who’s Economic Analysis of Property Rights (1997) is a readable introduction with lots of quirky applications—from why salt’s free in restaurants to how rules against contracting prolonged slavery in the U.S.

More on property-rights here. An application to car break-ins here.

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the economy as persuasion

by Andrew Chamberlain
Thursday, March 25, 2004


Is conversation an “economic” activity?

Most would say no. We tend to think of things like trade, investment and work as “economic,” but not things like relationships, religion or art.

That’s a false dichotomy. In an important sense, all social activity is economic activity—it’s based on people trying to forward the projects that interest them.

But another symmetry between them—popularized by polymath economist Deirdre McCloskey—is that they’re all fundamentally driven by persuasion.

Consider conversation. Here’s how it works: first, we establish common ground—that’s our medium of exchange. Next, we swap ideas, recombining and expanding them. At the end, there are more and better ideas than were in either of our heads to begin with.

To an economist, that looks a lot like trade.

Similarly, to linguists trade looks a lot like conversation. The link between them? Both are an attempt to mutually reconcile goals through persuasion.

McCloskey’s claim that persuasion matters in the economy may seem bizarre, but it’s old news in business schools. Marketing and management theory—the micro microeconomics—are dominated by psychological principles of persuasion. More importantly, so are day-to-day practices in the actual companies that make up markets.

So who cares? Well, if economists want a micro-level understanding of markets, a good first step might be a better understanding of how the people in those markets go about their daily business. B-school research on persuasion can help here.

See here for a typical example of persuasive techniques in marketing and business, and here for the academic theories behind them.

More on McCloskey here and here.

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the marketplace as organism

by Andrew Chamberlain
Wednesday, March 24, 2004


Journal of Bioeconomics

The always-provocative Journal of Bionomics—a relatively new field linking biology, psychology, and economics—has a special issue out on biology and social behavior.

Here’s a PDF of the intro by celebrated UCLA economist Jack Hirshleifer.

Be sure to check out Gordon P. Getty’s paper (PDF here), where he outlines “total return economics” or TRE—a biological approach to growth theory and the national income accounts.

It’s math-heavy, so here’s the bottom line: TRE supports Robert Solow’s claim that all growth comes from productivity increases—not savings per se. That means policymakers are probably wasting their time trying to boost growth by prodding consumers to save more.

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not your father's economics

by Andrew Chamberlain
Tuesday, March 23, 2004


Some of the sexiest research in economics today is coming out of a field called behavioral decision research.

What is it? Here’s how Carnegie Mellon University describes their excellent program:

“Behavioral decision research (BDR) is an interdisciplinary field that draws on insights from psychology and economics to provide a descriptively more realistic picture of human decision making.

“BDR shares with economics the idea that human behavior can be understood as a purposeful attempt to achieve well-being. It shares with psychology the ideas that social contexts shape thought, that people have limited information-processing capacity, and that systematic deviations from “rational choice” can be predicted.

“The combination of these perspectives leads BDR to focus on ways that real-world decision making deviates from the stylized assumptions of economics—and on ways in which performance might be improved.”

Go browse some working papers here and here.

As we’ve seen with the development of the field of law & economics during the last four decades, knowing a little economics and a lot of anything else produces very creative and interesting stuff.

Go check out CMU’s program—sounds like a fun place for grad work if you fit that description.

[Thanks to James Wilson for the pointer.]

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do not enter

by Andrew Chamberlain
Tuesday, March 23, 2004


Imagine walking into the department of licensing to open a sandwich shop.

After filling out 10 forms and waiting 47 days in line, the guy behind the counter forks over a bill—for half your annual income.

Sounds crazy, right?

Unfortunately, that’s about average for most countries. At least that’s according to a a World Bank survey of legal “entry costs” in 85 countries. On average, 10 procedures, 47 days, and half of annual per capita income is required to register a start-up.

Some places are beyond bad. It takes 152 days for a business license in Madagascar. In the Dominican Republic, license fees are five times annual income—plus 21 bureaucratic steps.

With barriers like that, it’s a wonder anybody gets out of bed. No surprise: the authors find countries who penalize entrepreneurship see less of it—the law of demand in action.

But the real question is, Does regulating start-ups do any good? Don’t high costs of entry pay for social goods like better health and clean water?

From the authors:

“In a cross section of countries, we do not find that stricter regulation of entry is associated with higher quality products, better pollution records or health oucomes, or keener competition.”

So much for that. However, there is one thing increased regulation does get you:

”...[S]tricter regulation of entry is associated with sharply higher levels of corruption, and a greater relative size of the unofficial economy.” (emphasis mine).

Public choice model, 1; public interest model, 0.

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the Robin Hood paradox

by Andrew Chamberlain
Sunday, March 21, 2004


Three basic values in western culture are property rights, the rule of law, and political individualism. So it’s interesting that wealth redistrution—which seems at odds with all three—has been popular in western societies.

On some level, redistribution has an intuitive appeal. The Robin Hood tale of taking from the rich and giving to the poor resonates with most of us, and runs deep in western culture. The “heroic underdog” is a ubiquitous character in literature, art and music. Why? Partly because we see ourselves in his struggle to succeed over unfortunate circumstances.

Helping the “little guy” get ahead has deep emotional appeal for most people, and reflects our desire for a fluid and non-hierarchical society where anyone can advance. Equality of opportunity is a fundamental western ideal, and wealth and income redistribution seem to appeal to that sense of fairness and opportunity.

But where does this intuition come from? One answer might be that our earliest moral intuitions are forged as children in families. Sociologically, households are small communities with reputational incentives and extensive knowledge of others. In that environment, communitarian norms work best. As a result, common property, centralized resource distribution, authoritarian decision-making, and the notion of equality-as-fairness are typical features of life in households with children. As children mature and integrate into a more complex and largely anonymous commercial society outside the home, it’s hard to shake those early communitarian instincts.

Unfortunately, the communitarian norms that make wealth redistribution attractive and possible in families fail in large societies, for the same reason central economic planning fails—they require impossible amounts of personal knowledge of reputations and specific circumstances. Economist F. A. Hayek famously made this argument in the September 1945 American Economic Review in the context of state economic planning. But it seems to apply to cultural norms as well.

Limitations on human cognition introduce “scale problems” with the sort of knowledge that makes communitarian norms work—reputations, others’ needs, etc. As a result, patterns of interaction in social systems don’t scale “linearly”—they change in fundamental ways when communities grow beyond a certain point. They become radically more complex as members rely more on one-time transactions, market prices, and anonymous middlemen to satisfy social needs. Big societies aren’t just scaled-up replicas of small ones. They are fundamentally different.

What this suggests is that there may be good reasons wealth redistribution never goes away politically.

We live in large societies, but we long for small ones. And it may have nothing to do with greed, envy and political opportunism after all.

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we're running out of oil?

by Andrew Chamberlain
Saturday, March 20, 2004


Let’s do a thought experiment. Say the world’s proven oil reserves are 400 million barrels. And say world oil consumption is 20 million barrels a year, growing at 5 percent annually.

Question: when will earth’s oil reserves be 100 percent depleted?

OK, timeout. Before you scratch your head and break out the scratch paper, I should warn you—the answer isn’t 14.2 years. Or 20.4 years. Or any other number of years.

It’s never.

That answer strikes most non-economists as an astonishing—and possibly immoral—claim. So let me explain. Consider the following example:

Imagine it’s your 10th birthday, and you really like pistachio nuts. For a present, your folks give you an entire room full of pistachios—a 4-foot-deep sea of tasty, salted treats.

Sounds delicious. At first, they’re easy to eat. Pick one up, eat it, and throw back the shells. But over time, pistachios get harder to find. As you eat, there are fewer nuts, and more shells. Eventually you get frusterated, spending more and more time sifting through the godamn shells looking for a single pistachio.

This continues until, finally, you give up altogether. It’s just too costly to find those last pistachios. You decide it’s cheaper to go to the kitchen for a different snack, and abandon the pistachio room forever—even though you haven’t “run out” of pistachios in any absolute sense.

OK, now back to oil markets.

Just like pistachios, as we deplete easily-drilled oil reserves, oil gets harder and harder to extract. As it does, market prices rise to reflect this. These rising prices encourage people to 1) conserve oil, and 2) find substitutes. And the process continues until the price of oil rises to the point where it equals the price of the next-best substitute—whatever that is—and we stop using it. We never actually “run out” of oil in any technical sense.

Now, that’s a simple but powerful story. Of course, it doesn’t settle every question about oil use. For example, it says nothing about oil’s impact on the environment, what technology we’ll switch to when supplies get low, or whether dependence on imported oil is corrupting America’s foreign policy.

But what it does do is important. It provides a useful mental framework when thinking about neo-Malthusian diatribes like this, in which authors worry about everyone’s lack of foresight but their own—and yet refuse to put their money where their mouth is by placing bets in commodities futures markets.

And that’s what economics is supposed to do. Pass it on.

[The pistachio example is originally from economist Russell Roberts. Thanks to Micha Ghertner for the pointer.]

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the [cultural] wealth of nations

by Andrew Chamberlain
Friday, March 19, 2004


A basic result from ecology is that species aren’t evenly distributed across the planet. They cluster in resource-rich areas, and thin out in resource-poor ones. In nature, diversity and wealth are closely tied.

Now, a new study in Nature argues that cultural diversity in human societies follows the same sort of distribution—rich areas are culturally diverse, poor areas are homogeneous. (See a summary here).

But one big difference is the source of wealth. For species, it comes from natural resources. For humans, it comes from expanding trade and markets.

That means we’d expect places with more extensive markets—like Manhattan—to have more cultural diversity than places with thinner markets—like Butte, Montana. Which is exactly what we do see.

Interestingly, one way of viewing the study is as a restatement of Adam Smith’s famous insight that the division of labor is limited by the extent of the market, to include the realm of cultural specialization.

Overall, I’d say that’s bad news for those who argue globalization necessarily leads to cultural homogenization.

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