David Gerard

Author: David Gerard

Bad Day for Environmental Economics, And the Environment

Almost unnoticed, this week marks a terrible week for advocates of market solutions to environmental problems, including various cap-and-trade systems. The Wall Street Journal reports that new federal air pollution rules have resulted in the tanking of the sulfur dioxide market, rendering extant permits worthless.

Often referred to as “the grand policy experiment,” (also here), the SO2 market was considered a success, and thought of as a model for potential global system to reduce greenhouse gases.  As with so many cases in economics, a credible commitment matters.  The Journal sums it up nicely:

The market’s collapse shows how vulnerable market-based approaches to reducing air pollution are to government actions. That could scare off investors, who won’t commit to a market where the rules can change at any minute.

Indeed.

One of the great benefits of using market instruments to address environmental problems is that they can substantial lower the costs.  The law of demand says that as price goes up, people buy less.  As a result of the collapses of this market, we will likely pay more to get less in terms of environmental quality.  This may well undermine efforts to implement market solutions elsewhere.  If investors are convinced the regulatory environment is unstable or uncertain, they are unlikely to make large capital investments, and are more likely to take stopgap measures.

Let’s Mis-Behave

Economists are often chided for their “unrealistic” behavioral assumptions, specifically rational self-interest.  An obvious direction for research was to relax some of these assumptions, often with surprising results.  Indeed, the Nobel Prize in economics has gone to scholars such as Herb Simon and Daniel Kahneman for work that took a hard look at the rational man assumption.  But I would probably point to the blockbuster, almost freakish success of Freakonomics and Super-Freakonmomics, texts that sometimes venture into this realm, that put behavioral economics in the public eye.

George Lowenstein
George Lowenstein

Despite the success of behavioral economics and finance, we have to be careful how far we want to push it. “[I]t’s becoming clear that behavioral economics is being asked to solve problems it wasn’t meant to address,” says Carnegie Mellon’s George Lowenstein, one of the giants in the field. Writing a cautionary op-ed in today’s  New York Times, Lowenstein and his co-author give a number of examples where reliance on behavioral results can miss the forest through the trees.

A “gallons-per-mile” bill recently passed by the New York State Senate is intended to help drivers think more clearly about the fuel consumption of the vehicles they purchase; research has shown that gallons-per-mile is a more effective means of getting drivers to appreciate the realities of fuel consumption than the traditional miles-per-gallon.

But more and better information fails to get at the core of the problem: people drive large, energy-inefficient cars because gas is still relatively cheap. An increase in the gas tax that made the price of gas reflect its true costs would be a far more effective — though much more politically painful — way to reduce fuel consumption.

I think the LU economists are with Lowenstein on this one.  We believe that you need to be grounded with a clear understanding of the fundamentals in order to understand the strengths and weaknesses of the discipline.

Know Your LU Econ Bloggers

I came across a research note on how bloggers reveal their personality types through their word choices.

More neurotic bloggers used more words associated with negative emotions; extravert bloggers used more words pertaining to positive emotions; high scorers on agreeableness avoided swear words and used more words related to communality; and conscientious bloggers mentioned more words with achievement connotations. These were all as expected. More of a surprise was the lack of a link between the Big Five personality factor of ‘openness to experience’ and word categories related to intellectual or sensory experience. Instead openness was associated with more use of prepositions, more formal language and longer words.

I wasn’t really sure of what to make of that (did they misspell extrovert?), but fortunately, the comments section directed me to the www.typealyzer.com site — a site that allows me to take a look for myself.  A few clicks later and it turns out that we fall into the category, The Thinkers.

The logical and analytical type. [LU Econ Bloggers] are especially attuned to difficult creative and intellectual challenges and always look for something more complex to dig into. [LU Econ Bloggers] are great at finding subtle connections between things and imagine far-reaching implications. (emphasis added)

That sounds about right.  And it continues…

[LU Econ Bloggers] enjoy working with complex things using a lot of concepts and imaginative models of reality.

Wow, they sure have us pegged.

Since [LU Econ Bloggers] are not very good at seeing and understanding the needs of other people, they might come across as arrogant, impatient and insensitive to people that need some time to understand what they are talking about.

Well, you can’t win ’em all.

Didje See that Dean Pertl Article?

Speaking of careers in business, Dean of the Conservatory, Brian Pertl, poses the question, “What on earth could playing a Mozart symphony have to do with leading a budget proposal meeting?”

Plenty is his response at the Entrepreneur The Arts blog.

Coming on the heels of the successful Entrepreneurship in the Arts and Society class this past term, this is a very encouraging message indeed.  And especially so for those of us who believe in the mission and the viability of the liberal arts.

Don’t forget, former Fed Chair Alan Greenspan was a clarinet student at Julliard before dropping out to tour with Stan Getz. Is that why they called him Maestro?

Don’t Feel Like You *Have* To Become a CEO

News from the research front that (some) economics majors are going places. To wit, “the share of graduates who were Economics majors who were CEOs in 2004 was greater than that for any other major, including Business Administration and Engineering.”

Here’s the paper, appropriately titled “Economics: A Good Choice of Major for Future CEOs,” and here’s from the abstract:

We find evidence that Economics is a good choice of major for those aspiring to become a CEO. Economics ranked third with 9% of the CEOs of the S&P 500 companies in 2004 being undergraduate Economics majors, behind Business Administration and Engineering majors, each of which accounted for 20% of the CEOs. When adjusting for size of the pool of graduates, those with undergraduate degrees in Economics are shown to have had a greater likelihood of becoming an S&P 500 CEO than any other major. That is, the share of graduates who were Economics majors who were CEOs in 2004 was greater than that for any other major, including Business Administration and Engineering. The findings also show that a higher percentage of CEOs who were Economics majors subsequently completed a graduate degree – often an MBA – than did their counterparts with Business Administration and Engineering degrees.

I nicked that from Marginal Revolution, and I’m certain there will be plenty of snarky commentary over there about it.

Some other interesting data over there. For example, the total number of business majors is split pretty evenly between males and females, but economics is 70% male. Of course, females now make up 60% of the undergraduate population.

Partial Financial Regulation

The New Yorker’s James Surowiecki claims the financial reform bill pending in Congress has some real teeth, yet somehow it exempts a major chuck of the consumer credit market — auto dealers.

There are close to eight hundred and fifty billion dollars’ worth of auto loans outstanding in the U.S.—about as much as our total credit-card debt—and car dealers broker about eighty per cent of them. Since the central task of the new consumer financial-protection agency is to oversee the market for consumer credit, which has become something of a cesspool in recent years, it would have been natural for car dealers to fall under its jurisdiction. Instead, the dealers won a special exemption: the agency can’t touch them.

Now that’s an interesting.

Do you buy his explanation for why car dealers succeeded in dodging where others failed? Not everyone agrees.

Gambling on the Economy

I saw an interesting bit over at Bloomberg Businessweek about how to think about the trajectory.  It’s colorful, gangsta-esque title is “Krugman or Paulson: Who You Gonna Bet On?” On the one hand, you have Paul Krugman warning of a depression without very tall cash-on-the-barrelhead government spending monetary outlays.  On the other, you have billionaire Henry Paulson literally putting his money on a recovery:

Paulson’s latest 13f filing with the Securities & Exchange Commission indicates nearly $2.995 billion of Bank of America common stock and $2.052 billion of Citigroup common. Despite healthy advances from their spring 2009 lows, banks may have more room to run, particularly if Paulson is correct in the estimate he made to investors that housing prices will rise as much as 10 percent next year.

Since his initial forays in banks, Paulson has ventured into riskier assets like casino stocks and vacant residential land in the utterly busted Florida and Southern California markets. As a private hedge fund manager, Paulson is not obliged to provide a complete picture of his investments; long positions could be hedged with shorts and derivatives that he does not have to divulge. But nothing in either his statements or reports about what he’s buying suggests he is anything less than upbeat about the economy right now.

I’m not sure that’s a fair comparison, because Paulson is simply betting on certain sectors, some of which benefit handsomely from government policies.  So his bets don’t necessarily represent a “stimulus v. no stimulus” type of comparison.

What is it about people wanting to bet Krugman? Last year, in what New York Magazine hailed as “the nerdiest bet ever,” Greg Mankiw threw down and bet Krugman about the administration’s GDP forecast.

Paul Krugman suggests that my skepticism about the administration’s growth forecast over the next few years is somehow “evil.” Well, Paul, if you are so confident in this forecast, would you like to place a wager on it and take advantage of my wickedness?

Who knew economists could be so catty?

Safety First

“The safer they make the cars, the more risks the driver is willing to take. It’s called the Peltzman effect.” — Some CSI Episode

The basic idea is so simple that it’s hardly controversial.  If you reduce the cost of doing something, you would expect more of it.  The classic Sam Peltzman paper has to do with making cars safer, which reduces the costs (in terms of potential injury or fatality) and hence increases “driver intensity,” as Peltzman puts it.  The startling result is that the behavioral changes completely offset the technological improvements, though this does not have to be so.

This is similar to the “rebound effect,” where improving energy efficiency or fuel economy, for example, causes people to set their thermostats more aggressively or to drive more miles (that is, because the marginal costs go down).

The Peltzman effect has crept into my RSS feed twice in the past week.  From this morning’s Marginal Revolution:

The NHTSA had volunteers drive a test track in cars with automatic lane departure correction, and then interviewed the drivers for their impressions. Although the report does not describe the undoubted look of horror on the examiner’s face while interviewing one female, 20-something subject, it does relay the gist of her comments.

After she praised the ability of the car to self-correct when she drifted from her lane, she noted that she would love to have this feature in her own car. Then, after a night of drinking in the city, she would not have to sleep at a friend’s house before returning to her rural home.

Well, that certainly makes me feel safer.

One of the classic jokes associated with the Peltzman effect is that NHTSA should put a spear extending out of the steering column, making the driver exercise extra caution so as not to be impaled. In that vein, the good folks at Organizations & Markets alerted me to this cartoon:

Pretty funny.

Peltzman is one of the most prominent empirical economists ever.  Certainly, having an “effect” named after you is a pretty big deal.  Some of the more astute of you also recall Peltzman from the Stigler-Peltzman capture theory. Love him or hate him, he is an interesting character.  I recommend this interview at EconTalk.

800 Years of Ineptitude

For today’s recommended reading, The New York Times profiles Carmen Reinhart and Kenneth Rogoff, authors of This Time Is Different: Eight Centuries of Financial Folly.

You may recall this title from our summer reading recommendations that we posted a few weeks ago.  You can find a paper approximation of the book here and a summary of its principal findings here.

Both of these economists seem to be pretty interesting characters and the article is a fun read.

Whatever Works

The misery accompanying the U.S. recession / depression manifests itself firstly, I think, through the job market.  There seems to be an increasing perception that policymakers in Washington and at the Fed aren’t taking the unemployment situation seriously enough. Nonetheless, jobs are certainly on the minds of people who have them and, even moreso, people who don’t have them. We learned yesterday that the declining unemployment rate is actually bad news. Why? Well, in order to be counted as unemployed, a person has to be seeking employment, and consequently so-called discouraged workers, people who are no longer looking for work, do not count as unemployed.  And would-be workers are pretty darned discouraged.

This gives us a fundamental measurement problem, how can we determine how bad the employment situation really is?  One common way to tackle it has been to track the total adult population in the workforce.

EmpPop

As you can see, the picture isn’t a pretty one. Continue reading Whatever Works

To Spend or Not To Spend…

Most economists haven’t really been thinking about this issue, they haven’t really focused on it. It’s not their specialty. Most economists today, they haven’t really been thinking about this kind of multiplier issue… I don’t think most economists are focused on this, or that they’re familiar with the empirical evidence. I don’t think they’ve really worked on the theory. So I don’t know, maybe they have some opinion that they got from graduate school or something. — Robert Barro in The Atlantic Monthly

Even if by accident, you’ve probably noticed that there is an on-going debate on whether a massive government spending campaign is needed to “prime the pump” to stimulate the economy (the Keynesian route), or whether fiscal discipline (austerity) is in order. Last week, most members of the G-20 (but not the US) came down on the side of austerity.

As a trained economist, I know the basic institutional details and understand the basic arguments, but as Barro suggests, I have no great insight on the empirics or which side of the debate is likely to be correct.

Certainly, the primary mouthpiece for the pro-spend crowd is recent Nobel Prize winner, Paul Krugman.  In a recent column, he tears into those who promote “austerity”:

So the next time you hear serious-sounding people explaining the need for fiscal austerity, try to parse their argument. Almost surely, you’ll discover that what sounds like hardheaded realism actually rests on a foundation of fantasy, on the belief that invisible vigilantes will punish us if we’re bad and the confidence fairy will reward us if we’re good.

Of course, not all economists agree with Krugman’s assessment. In addition to our friend Hayek, Robert Barro is pretty clearly on the austerity side. This interview with Barro is a good place to see a sketch of the battle lines in the debate, and certainly indicates that he and Krugman are not on particularly friendly terms.  This week, Harvard professor Alberto Alesina is getting some press for his advocacy of austerity measures. And, as for the regime uncertainty argument that Krugman caricatures, I would recommend Robert Higgs as the central proponent of that idea.

As for me, I am not sure exactly what I learned in grad school that prepares me to take a side in this debate. What I find interesting is that most people who engage me in a discussion seem to think the Keynsian spending route is the way to go, and many of these folks invoke Krugman on this point as if Krugman is the voice of the profession. As today’s Krugman piece indicates, he seems to think that many in the profession are moving in quite the opposite direction. It’s not clear to me whether this boils down to pre-conceived ideology or not, but that is certainly his claim.

I guess I will leave it at that.

UPDATE: Keynes v. Hayek in print. Commentary here.

A Prescription for Innovation

A Sign of the Times

ANYONE who thinks it would be easy to get rich selling marijuana in a state where it’s legal should spend an hour with Ravi Respeto, manager of the Farmacy, an upscale dispensary here that offers Strawberry Haze, Hawaiian Skunk and other strains of Cannabis sativa at up to $16 a gram.

The illicit drug market seems to me to be an excellent place to think about the nature of markets and competition (e.g., how much does it dampen demand? How do suppliers emerge and compete? What is the effect of a major bust on industry-wide prices and profits?). And, as we all know, many of those folks make very tall dollars.

But what what would if those drugs were suddenly legal? As the above quotation, taken from a New York Times article on medical marijuana in Colorado, suggests, competition has a funny way of making it hard to make money. So, I suspect that liberalization of drug laws will make for a fascinating route to explore market processes, including the role of innovation and entrepreneurship in these markets. There is also a an excellent piece from The New Yorker on “how medical marijuana is transforming the pot industry” in California.

We’ll be on the lookout for how this all shakes out.

Political Economy of Regulation, Final Exam Question

With new financial regulations (potentially, yes, potentially) imminent, today’s question is why Congress is delegating so much of the authority to regulators to craft the actual rules of governance:

Consumer and financial lobbyists alike are marshalling the troops on K Street to impact the decisions regulators make in setting new rules after Congress finished writing the Dodd-Frank Act on Friday. The 2,000-page financial overhaul bill is expected to face a final vote this week, but despite its length, it leaves many specific directives to regulators. Regulators are left with the freedom to decide what kinds of trading are included in the prohibition against banks’ investment of their own money and “how much money banks have to set aside against unexpected losses.”

Now, the first question is, why would Congress delegate so much authority? Is it in deference to regulators’ superior knowledge? Or do you think it has something to do with not taking responsibility? Or do you have another explanation?

The second question has to do with the relationship between industry and regulators. If you believe in the capture theory (and many of you do), what type of explanation would you give for delegation? And, what sort of outcomes might you expect from this round of legislative reform?

Wait, the term is over? What?

US v. Ghana at Cinema, Saturday 1 p.m.

The Intrepid Professor Finkler has secured the Cinema in the Warch Campus Center to watch today’s US footballers take an Africa’s final hope, Ghana. The winner will move on to play Uruguay.

I have been puzzled as to why this year’s World Cup has had such a somnambulous effect on me. Is it the heavy prescription narcotics? Is it the gentle buzz of the vuvuzlas? Or perhaps it’s that the teams just aren’t putting the ball in the net?

It does seem that goals this year are even tougher to come by than usual, though that does not (necessarily) mean the games are more boring. It might mean tighter games down the stretch and even more exultation when the ball does go in the net.

Whatever the reason, we hope to see you in the Cinema for popcorn and football and possibly an impromptu game theoretic discussion of goalie strategy versus a penalty kick.

Carrots or Sticks?

Are You A Motivated Self-Starter?
Looking for a motivated self-starter

I’ve seen this video from RSA Animate making the rounds at some of my favorite blog sites.  It’s from Dan Pink, and it gives an 11-minute, Johnny-on-the-spot animated primer on what motivates us.  It’s not actually animation, more like watching someone pretend to animate something, with real cartoon-like pictures being the result. Watching it is quite mesmerizing, and it’s probably more interesting than whatever you’d otherwise be doing for the next few minutes.

The big take home message is that higher-powered incentives don’t necessarily translate into better performance, specifically when “big brain” tasks are involved. Research indicates that people like autonomy in what they are doing and gain non-pecuniary satisfaction from a sense of accomplishment.   Open source success stories like Linux and Wikipedia seem to bear this out.  On the other hand, there seems to be a fundamental tension between an organization’s objective function and individual autonomy.  If they aren’t aligned well, then we wouldn’t expect much innovation that benefits the firm.

So, let’s think about this some more, and meanwhile, enjoy the cool cartoons.  Here is the full collection.

Free or Best Offer

The last time I had a yard sale, the point was more to get rid of the stuff in my basement than to raise revenues.  After a couple of hours of slow moving, I changed my price policy to “Free or Best Offer.”  Although a rational choice model probably wouldn’t see this as doing very well financially, several people dropped wads of cash on us as they hauled away bags full of stuff from children clothes to mismatched coffee mugs to old VHS tapes.  Now why would they pay anything, I wondered?  Guilt?  Soon after, a friend of mine involved in community theater told me of a similar “pay what you think it’s worth” pricing scheme that they often run, which is basically “free or best offer.”

It occurred to me that it might not be a bad way to low marginal cost items with low or highly-uncertain demand where the idea is to make a sale.  Obviously, this isn’t an original insight, as there are many cases where firms bolster revenues through some sort of two-part tariff scheme. In the theater case, they were going to do the production, so, ceteris paribus, I would think they would prefer to have some crowd rather than no crowd (especially if they have concessions). In my yard sale case, my costs increased if I didn’t get rid of the stuff.

That's Not Tyler Cowen

Now, there seem to be a number of restaurants implementing this sort of pricing logic, yet this pricing logic doesn’t seem to work for restaurants, does it? If the reasons aren’t obvious, check out this interview with economics pop star, Tyler Cowen, over at Salon.com.

Meanwhile, I recommend you get out there and take advantage while these places are still in business.  Consumers often benefit tremendously from competition like this — many of my favorite restaurants weren’t in business very long at all.  While they were in business, I sure enjoyed eating there.  In this case, however, even if you pay them what you think it’s worth, I don’t think they are going to be around for long.

The State of Federal Regulation

With the financial meltdown and the increasingly-disturbing oil spill, the efficacy of federal regulation is very much in question.  The New Yorker‘s James Surowiecki sees it as a “good government gone bad” problem.

These failures weren’t accidents. They were the all too predictable result of the deregulationary fervor that has gripped Washington in recent years, pushing the message that most regulation is unnecessary at best and downright harmful at worst. The result is that agencies have often been led by people skeptical of their own duties. This gave us the worst of both worlds: too little supervision encouraged corporate recklessness, while the existence of these agencies encouraged public complacency.

I’m pretty sure he uses the word “deregulation” incorrectly here, at least in a conventional sense. His argument is more along the lines that enforcement of (some) regulations has become more relaxed. Of course, economists of the public choice stripe would probably point to the coziness between regulators and the regulated as a predictable result of the political process.

Drawing partly on Daniel Carpenter’s epic new book, Surowiecki points to the FDA as an example of a “consistently effective.” Of course, many economists have pointed at FDA as an example of an agency that exercises too much caution.

Whether that is accurate or not, Megan McArdle has an interesting article in the most recent Atlantic Monthly discussing why the number of drugs coming to market has been going down.  The McArdle piece is especially discouraging with the backdrop of a New York Times piece on the failure of the human genome project to reveal breakthroughs in treatment.

And then there’s this just in.

Out with the Old, In with the Older

Here are a few links for you as we bid farewell to the 2010 Lawrence economics graduates and brace ourselves for the alumni revelers descending upon campus for Reunion Weekend. As Neil Young might say, economics never sleeps.*

As you have probably noticed, we have more than a passing interest in the oil spill around here.  One of the interests has to do with the liability versus regulation question, and on that front, Resources for the Future (RFF) has background information on oil spill liability law. Mark Cohen at RFF did some of the seminal work on the enforcement of environmental laws, focusing on oil spills, so this is definitely a good place to look.

Another piece has to do with the long-term corporate viability of BP itself – is this spill just a speed bump on the route to long-run profitability? Or will the company be taken over? Or will it go into bankruptcy and attempt to expunge its environmental liability? Or maybe it will agree to a takeover and then go into bankruptcy and expunge its liability and then be taken over (Can they do that? See above).  New York Times writer Andrew Sorkin explores these issues. The current stock price is down to $31 from a 52-week high of $63.  That means that more than half of the company’s “worth” has been wiped out. Ouch.

So, things aren’t going that well over in the old economy.  How about the new economy? If there is anyone with a worse public image than BP right now, it might just be a mysterious cabal that is putting the architecture in place to unleash a malicious computer virus on the world’s computers. Well, we really don’t know who is behind it or why. Mark Bowden at The Atlantic has a fascinating article on the Conficker virus. This case may well fit into William Baumol’s famous definition of entrepreneurship (cited here) that includes “destructive entrepreneurship.” I guess we’ll have to wait and find out.

On a happier innovation front, the most recent EconTalk discusses the fashion industry, where “there is limited protection for innovative designs and as a result, copying is rampant. Despite the ease of copying, innovation is quite strong in the industry and there is a great deal of competition.” Schumpeter was a famously natty fellow.  I wonder what the fashion world thinks of creative destruction?

I imagine without class in session, the summer blogging will slow to a crawl. If you come across anything interesting, feel free to send it my way.

*Then again, probably not.