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Recent Articles:

Paul Heyne and "The Moral Critics of Capitalism"
punctuality is inefficient, Q.E.D.
new deal for democrats' economics
new issue of Tax Watch
op-ed on new york's business climate
op-ed on california's business climate
Washington by the numbers
do deficits matter?
then and now
op-ed on presidential tax plans

Paul Heyne and "The Moral Critics of Capitalism"

by Andrew Chamberlain
Monday, February 14, 2005


If you were asked to give your last public lecture—to summarize the most important ideas of your lifetime—what would you talk about?

That was the theme of a series of public lectures held at the University of Washington in 2000. One of the participants was economist Paul Heyne, author of The Economic Way of Thinking and one of the legendary teachers of economics.

Audio of Prof. Heyne’s “Last Lecture,” titled “The Moral Critics of Capitalism,” has been added to the public archive of archive.org. The talk was given February 17, 2000 in Seattle.

Ironically this was in fact Prof. Heyne’s last public lecture, as he succombed to cancer just 2 months later.

Download the full talk (30 minutes) and Q&A session (20 minutes) here:

Full lecture (MP3—11.7MB).

Q&A session (MP3—9MB)

Filed under: Economics | Permalink | Feedback?



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punctuality is inefficient, Q.E.D.

by Andrew Chamberlain
Thursday, January 20, 2005


I eat lunch with colleagues occasionally. Over the years I’ve learned that a 12:30 lunch, in fact, means 12:40. And 12:40 means 12:50. And so on.

Time and again, otherwise smart and responsible people say one thing and do another. Why is this?

The answer is surprisingly simple: I hate waiting, but don’t hate you waiting.

Here’s the logic: You don’t know when I’ll show up, and waiting is costly. If you’re early you’ll have to wait. If you’re late you won’t. So you come late. I do the same thing. Presto, we’re both late.

Seems obvious enough. However when I make this argument to non-economists they’re unpersuaded, preferring an explanation for lateness based on lazyness and stupidity rather than as the unavoidable equilibrium of a social coordination game. So for their benefit, I’ll state it more formally here with some simple game theory.

The Lunch Model
Let’s meet for lunch at, say, 1:00pm. You try to guess my arrival time. Let’s say you think it’s normally distributed with a mean of 1:00pm and a standard deviation of, say, 10 minutes. That variation is plausible since random delays (think late busses) happen to the best of us.

Let’s assume “on time” means showing up within a standard deviation of 1:00pm. Also assume “early” and “late” mean showing up more than a standard deviation from 1:00pm—before 12:50pm and after 1:10pm respectively.

Here’s a picture of this distribution of my arrival times:

Distribution of times I might show up for a 1:00pm lunch.

Now since my times are distributed normally we know the chances of me being on time are P(on time) = 0.68. Also we know the chances of being early and late are P(early) = P(late) = 0.16.

Now assume time is valuable, so whoever’s early bears a time cost. We both have three options—show up early, late or on time—so let’s draw a 3×3 payoff matrix of the lunch game with waiting costs as the payoffs. Here it is:

Now, calculate the expected value of each option and pick the best. Do this by multiplying each payoff by its probability and summing for each option. Here’s the math:

E(early) = (-5)*(0.68) + (-10)*0.16) = -5

E(on time) = (-5)*(0.16) = -0.8

E(late) = 0

So your best—that is, least negative—option is to show up late. The math’s the same for me. So I show up late too. And our 1:00pm lunch becomes a 1:10 lunch. Q.E.D.

I leave it as an exercise to the reader to show we’ll both complain about each other’s lateness afterward.

Update: Several astute readers pointed out a flaw in the above “lunch model”. I’m always surprised by how seriously people take these obviously toungue-in-cheek models. Lighten up people, this is “where the dismal science gets groovy” not the American Economic Review!

In any case, for the econ nerds, here’s the problem and fix:

The distributions above represent my expectation of when you’ll arrive. In this stripped-down model where people naively assume other people will show up around noon, there’s technically no equilibrium.

Here’s why. If I assume you’ll show up at noon, I should show up at 12:10. But I know you’re rational and will make the same calculation and will show up at 12:10 also. So the distribution shifts right, and I repeat the calculation and decide to show up at 12:20. And you do the same thing, and so on. These iterations continue and we never show up.

That’s obviously nonsense. So how do we complete the model? We make choices of arrival times to aim at continuous, and add in a “social penalty” for late arrival.

A more rigorous model wouldn’t have a simple payoff matrix with 3 choices of “early, ontime, late.” Instead players would choose arrival times to aim at on a continuous scale (see Glen Whitman for more on this here). That’s realistic, although it complicates the math considerably because payoffs will be continuous functions rather than a simple 3×3 matrix.

Next, we have to add in a “socal penalty” for being late—a cost incurred the later players arrive compared to the agreed upon time—something I mentioned briefly in a note at the end of the original post.

Think of the social penalty as the expected value of the lost income due to other’s reduced willingness to deal with you due to their irritation at your lateness. I won’t speculate on philosophically why people impose a social cost on latecomers—for the model we just need to know it’s there, not why—and take it as exogenous based on culture. The socal penalty would be a simple function of minutes late compared to the agreed-upon time (not the other player’s arrival time!) with y’ > 0 and y’’ > 0.

In this model we’ll get a very realistic equilibrium: Showing up early is costly due to time costs of waiting, and showing up very late is also costly because of the rising social penalty.

That implies there exists an equilibrium that minimizes costs between the two. Which is exactly what we see.

Update 2: Here’s an insightful March 2004 post from Marginal Revolution on the game theoretic approach to lateness and punctuality. Does this confirm or refute the “lunch model”?

Filed under: Economics | Permalink | Feedback?



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new deal for democrats' economics

by Andrew Chamberlain
Monday, December 20, 2004


I’ve got a new commentary up on the Tax Foundation’s site. Topic: three ways Democrats can improve their economic policy—and broaden their moderate appeal—without abandoning core progressive ideals.

Excerpt:

From the Democratic National Party’s 2004 platform: “We believe the private sector, not government, is the engine of economic growth and job creation … We want a tax code that rewards work and creates wealth.”

Clear as day, even the Democratic platform praises low taxes and economic growth. Why? These policies expand wealth and tax revenues that make other Democratic priorities possible.

In that spirit, here are three ways DNC leadership can mainstream their economic policy without dumping progressive ideals:

Get behind tax reform. There’s plenty in the tax code to infuriate Democrats as well as Republicans. For one, it systematically diverts income from “blue” Democratic states into the hands of “red” Republican states.

Surprised? The reason is simple. Blue states on average have higher incomes than red states. Thanks to progressive income tax rates blue states pay a disproportionately large share of federal taxes, while getting a disproportionately small share of spending in return—as low as 57 cents per tax dollar in some states.

The solution? Surprisingly, flatter tax rates.

Democrats supporting flat taxes may sound crazy, but it isn’t. Even the progressive stronghold of Massachusetts has boasted flat taxes since 1779 when John Adams wrote them into the state constitution.

Massachusetts learned a tax lesson the DNC should take note of. Hurting the rich doesn’t help the poor. Helping the poor does. And there are more direct ways to do that than soaking the rich with high marginal tax rates that punish work and investment.

If done right, tax reform can silence criticisms of Democrats as tax hikers, help blue-state constituents, and steal some Republican fire in the process.

Stop fighting Social Security reform. Embrace it as a civil rights issue. Thanks to differences in life expectancy and earnings, African Americans receive dramatically less from Social Security than whites with comparable incomes.

The current system essentially transfers dollars from young African American workers to white retirees—up to $10,000 per person over a lifetime according to the Rand Corporation. Is it any surprise black voters favor private Social Security accounts in polls?

Even with private accounts there will be a need for a minimum-benefit safety net. By getting behind Social Security reform Democrats can recast themselves as the party of civil rights, win over moderate fiscal conservatives, and preserve their heralded retirement safety net in the process.

Stop pitting rich against poor and business against workers. Like it or not, every American wants to someday run a business and strike it rich. Rich vs. poor rhetoric is a pointless jab at those aspirations.

Are Democrats fooling anyone when they say taxes on companies—the source of America’s jobs—won’t hurt individuals? Likewise when they divide America into groups by income—as if our incomes don’t shift over a lifetime—and instigate fights.

You don’t have to punish the wealthy to create opportunities for the poor. Policies that promote economic growth can be win-win. The Democratic platform nods to the virtues of free enterprise held dearly by mainstream Americans, and party leadership should recruit candidates who reflect that.

This February the DNC needs to steer toward the political center, not pander to the “morality” vote. Their platform already outlines a low-tax and pro-growth agenda. Why not support candidates that mean it?

The full piece is here.

Filed under: Economics | Permalink | Feedback?



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new issue of Tax Watch

by Andrew Chamberlain
Thursday, October 28, 2004


It’s hard work making tax policy interesting. Here’s my latest attempt at it. The second issue of Tax Watch is out, posted below using FlashPaper. Have fun:



Filed under: Miscellaneous | Permalink | Feedback?



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op-ed on new york's business climate

by Andrew Chamberlain
Tuesday, October 26, 2004


Landed an op-ed in the Buffalo News last week on New York’s business tax climate. It’s basically the same story as California (below):

New York’s high-tax reputation has recently made New York companies an unusually ripe target for competing states.

French drug giant Sanofi-Aventis recently pledged to move hundreds of jobs from midtown Manhattan to lower-tax Bridgewater, N.J. Film and television producers have been fleeing New York for Illinois, Louisiana and even North Carolina for years. Even the story of Rudy Giuliani was filmed in Montreal, where lower taxes mean lower production costs. Unfortunately when it comes to tax competition, most states get it wrong. The temptation is to lure sexy employers like sports teams and corporate headquarters with short-term tax incentives. But this strategy almost always backfires—a lesson Gov. George Pataki should remember as he responds to job threats.

Consider officials in Mohawk Valley, who lured a major aircraft repair company with a $5.5 million incentive package back in 1999 in exchange for 500 new jobs by 2006. The company is long gone. It went bankrupt without paying back a penny just 20 months after opening its doors, leaving taxpayers with the bill.

Short-term tax lures seem like a politically attractive way to create jobs. But those expensive giveaways send a damning message about a state’s tax friendliness. To new companies, they signal that only special bonuses can make the state’s flawed taxes attractive. And to existing companies they’re an economic face-slap, treating current employers as dupes who’ll pick up the tab for newcomers.

The real way to lure long-term jobs? Streamline New York’s tax code to be permanently business-friendly to all companies.

Don’t buy the argument that neutral and low taxes helps states compete for jobs? Ask Ireland.

Filed under: Economics | Permalink | Feedback?



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op-ed on california's business climate

by Andrew Chamberlain
Tuesday, October 19, 2004


I’ve got a piece with Scott Hodge in today’s San Francisco Examiner. The topic? How California’s lousy tax code has companies fleeing for neighboring states. Here’s the full piece:

Revise state tax climate
By Scott A. Hodge & Andrew Chamberlain

Despite campaign rhetoric about “Benedict Arnold CEOs” sending jobs overseas, Californians are sweating about a jobs threat much closer to home: low-tax U.S. states poaching California’s businesses.

The threat of tax competition between states for jobs is old hat to state lawmakers. Within America’s 50-state free-trade zone, every change in a state’s tax code affects its competitiveness with its neighbors.

But California’s recent budget woes and high tax rates have made the state an unusually ripe target for opportunistic governors. Nevada recently posted ads to lure California employers, and Gov. Arnold Schwarzenegger retaliated with pro-business promises. But in today’s economy, Nevada isn’t the only jobs threat.

Unfortunately when it comes to tax competition, most states get it wrong. The temptation is to lure sexy employers like sports teams and corporate headquarters with short-term tax boondoggles. But this strategy almost always backfires—a lesson Schwarzenegger should remember as he responds to job threats.

Consider Columbus, Ohio, a city addicted to money-losing tax bonanzas. Local officials lured a moving company with a five-year package of tax goodies back in 2000. Four years later? The company not only failed to add 100 jobs as promised, but actually fired 98 employees, sending lawmakers into a panic to yank the final year of tax breaks.

What went wrong? Short-term tax lures are a politically attractive way to “create” jobs. But those expensive giveaways send a damning message about a state’s tax friendliness. To new companies, they signal that only special bonuses can make the state’s flawed taxes attractive. And to existing companies they’re an economic face-slap, treating current employers as dupes who’ll pick up the tab for newcomers.

The real way to lure long-term jobs? Streamline California’s tax code to be permanently business-friendly to all companies.

The Tax Foundation recently released its guidebook on business tax-friendliness, the “State Business Tax Climate Index.” It ranks the business tax climates of the 50 states, rewarding tax codes that are neutral, have low and flat rates, are simple and transparent, avoid double taxation, and have statutory restraints that keep tax burdens low.

The 10 most business-friendly states this year are South Dakota, Florida, Alaska, Texas, New Hampshire, Nevada, Wyoming, Colorado, Washington and Oregon—a list that includes several of California’s neighbors.

This year California ranked 38th in the nation, putting California at a competitive disadvantage with nearly every state in the West.

The main culprit? High tax rates. For corporations looking to relocate, California’s 8.8 percent corporate income tax is the highest in the West, and only 10 states have a higher rate.

However, many small businesses—sole proprietorships, partnerships and so on—pay individual income taxes rather than corporate taxes. California’s top rate of 9.3 percent kicks in for just over $39,000 of income for singles, $78,000 for couples. At those income levels, no state has a higher rate. And on top of that is California sales tax, the nation’s highest at 7.25 percent.

Overall, California’s tax code isn’t exactly a welcome mat for employers.

California companies can’t be blamed for accepting tax boondoggles from competing states. Blame lawmakers in Sacramento who’ve steadily marched toward high tax rates in recent years with no concern for state competitiveness.

There is a way out for California: tell Gov. Schwarzenegger to lead the way toward a more neutral and job-friendly tax code. If you do, the jobs will stay.

Filed under: Economics | Permalink | Feedback?



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Washington by the numbers

by Andrew Chamberlain
Tuesday, October 5, 2004


Economics isn’t everything. Especially when it comes to voting.

It’s tempting to judge incumbents by a few economic indicators that shifted under their watch. What happened to national income? Are there more jobs or fewer? The numbers seem to speak for themselves—and tell us who to blame or praise.

But not quite.

There’s a temptation to score-keep on the White House, attributing every statistical tick to something the President did or failed to do. But as economists endlessly point out, the big driver of our material well-being isn’t the Oval Office at all. It’s the army of regular Joes sweating it out in the marketplace: the store owner keeping the books in order, the importer making a killing on cheap parts, the poor kid who gets a degree and a pay raise.

Those are the stories beneath the aggregates. But like most of economics, they’re invisible. So we ignore them. And generation after generation we fall prey to the same seductive myth: that members of Congress and the White House pull the strings on the U.S. economy from on high. When in fact, most of any particular Washingtonian’s annual work product is—thankfully—an economic wash.

So much for caveats. Now with the above warning in mind, let’s have a look at the numbers on the economy over the last four years.

From economist John Irons at OMB Watch (along with numbers I’ve added):

Employment:
January 2001: 132,388,000
August 2004: 131,475,000

Unemployment Rate
January 2001: 4.2 percent
August 2004: 5.4 percent

Real Gross Domestic Product:
2001 Q1: $9,875 billion
2004 Q2: 10,784 billion
Average annual increase 2.6% (FYI, that’s not great)

Stock Market—Dow Jones Average:
Jan. 2, 2001: 10,646
Oct. 1, 2004: 10,193

Deficit
Fiscal year 2000: +$236 billion—Surplus
Fiscal year 2004: – $422 billion—Deficit

Poverty Rate
2000: 11.3%
2003: 12.5%

Median Household Income (in inflation adjusted 2003 dollars)
2000: $44,853
2003: $43,318

To be fair, this leaves out some good news on taxes:

Tax Freedom Day (day we work until to pay taxes)
2000: May 2
2004: April 11 (lowest since 1967)

Top Marginal Income Tax Rate
2000: 39.6 percent
2004: 35 percent

The verdict? If voters vote with their wallets this November, it’s bad news overall for the President—regardless of the degree to which he’s actually responsible for these numbers.

Filed under: Economics | Permalink | Feedback?



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do deficits matter?

by Andrew Chamberlain
Monday, September 20, 2004


Just like people, governments that spend more than they collect go into debt.

This year the federal government will overspend by $422 billion. That has budget hawks biting their nails and criticizing the Bush administration’s profligate spending and huge tax cuts.

Why care about deficits? In theory, like a spendthrift approaching bankruptcy, big budget deficits threaten future prosperity. That’s because when governments run deficits they must borrow to make up the difference. That means they compete with companies, home buyers, and others for scarce funds, which can bid up interest rates. That makes it more expensive to start new companies and invest in new equipment, and that can slow productivity growth—the engine of rising living standards.

So much for theory. What about the evidence?

The historical relationship between deficits and interest rates is murky. Partly this is because lots of things in the economy affect interest rates besides how much government borrows. Some academic studies find a slight relationship between them (see here), while others find none at all (see pp. 69-129 here). Often, the two variables move in opposite directions altogether (see here).

The bottom line? At some level, deficits are clearly harmful. But they must be very large to do so.

So how large is “large”? Over the last 42 years the average deficit has been about 2.1 percent of GDP, with a standard deviation of about 1.9 percent (see here for data). Given this, a statistically reasonable criteria for calling a deficit “large” might be: one that’s two standard deviations from the average, or about 5.9 percent of GDP or larger.

According to the Congressional Budget Office, this year’s deficit will hit 3.6 percent of national income—far from the 4-5 percent deficits of the 1980s and 1990s and hardly cause for panic.

So much for fears about the current deficit. Although with booming Social Security, Medicare and Medicaid liabilities on the horizon, it may be time to panic soon enough.

Filed under: Economics | Permalink | Feedback?



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then and now

by Andrew Chamberlain
Thursday, September 16, 2004


Some famous tax beginnings—and where they’ve ended up:

Up in Smoke: The first federal tobacco tax was passed July 1, 1862, and raised $8,592,000 in 1864. By 2003, federal tobacco taxes raised $8.2 billion, a 948-fold increase. At $4 per pack, that’s enough to build 14 full-size replicas of the famous Leaning Tower of Pisa out of cigarette packs. Laid end to end, those cigarettes would stretch from the Earth to the Moon, nine times.

Fueling Taxes: The first state gas tax—one cent per gallon—was passed in Oregon on February 15, 1919, and raised $443,000 the following year. Today, Oregon’s gas tax is 24 cents per gallon, with 2002 collections of $396 million, an 893-fold increase. At today prices that’s enough to buy the gas needed to drive a Honda Accord at 60 miles per hour for twelve and half years—long enough to circle the earth about 265 times.

License to Tax: The first law requiring auto license plates passed in New York on April 25, 1901, and the $1 fee brought in $1,082 the following year. By 2001 motor vehicle registration fees raised $583 million, a stunning 539,000-fold increase. At $2 per mile, that’s enough for a one-mile New York City cab ride for every man, woman and child in the United States—tip not included.

Update: Several emails have asked if the above figures are adjusted for inflation. They’re not—the point was to give a sense of the magnitude of current tax collections, not analyze tax burdens over time. In any case, here are the inflation adjusted figures in 2003 dollars:

Tobacco tax: Collections grew from $100,041,793 to $8.2 billion between 1864 and 2003, an 81-fold increase.

Gas tax: Collections grew from $4,709,582 to $405,025,013 between 1919 and 2002, an 85-fold increase.

License tax: Collections grew from $23,322 to $605,714,285 between 1901 and 2001, a 25,970-fold increase.

Filed under: Economics | Permalink | Feedback?



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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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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.”]

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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.]

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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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