General Interest

Category: General Interest

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.

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.

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?

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.

Henry George Rises from the Dead

Who is Henry George? you might ask. A good question. A simple answer would be a 19th century printer who believed that a single tax on land would be an effective social liberator. As students of Urban Economics might recall, George argued that rises in land value (as distinct from the structures put on land) come largely from social rather than private investments; thus, such rises should be taxed and used to meet various public purposes.

In today’s Financial Times, Martin Wolf opines that we (at least policy makers in the US and UK) provide both cheap capital and insufficient taxation on these “unearned” increments in land value. Furthermore, he believes that such value increments should be taxed if we seek to avoid credit cycles of the sort we have recently experienced. One might view existent policies as the opposite of “think global, act local” since the resulting credit booms and busts (based on securitized loan packages sold to an integrated, world financial system) have spread well beyond their their initial homes. “Freemarketeer” Wolf, acting as a reincarnated “socialist” Henry George, sees the need to halt these land and credit cycles with a land increment tax.

As noted in my comment on Michael Spence’s opinion piece, also in today’s FT, in the previous LU Econblog entry, it’s not clear to me how political logic will help us to break these destructive cycles.

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.

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.

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.

Regulatory Wishful Thinking or Long Live Pigou

Professor Gerard has posted numerous articles on regulatory policy, some of which rest on the theme that regulators will be captured by the industries they are assigned to regulate. Simon Johnson, in today’s Economix blog, focuses on both oil and financial regulation. He argues that living wills, that is strategies businesses might design to deal with their own failures, are not the solution for either industry. He notes that oil companies other than BP had similar plans for managing the risks of a major oil spill in the Gulf of Mexico. In fact, many had hired the same consultant to write their plans. Such plans demonstrated limited knowledge of the Gulf as well as limited preparedness. Stated differently, they had very little incentive to write constructive plans.

If we want private companies to respond to potential catastrophes or even continuous negative externalities, we need public policy that encourages them to do just that. Of course, such public action requires that our legislators and the Executive branch need to both address the societal tradeoffs our nation must face and face-down the lobbyists who seek to postpone such action. Perhaps our policy makers should be tested to see if they support the manifesto for the Pigou Club or a bit smaller challenge, if they know Pigou’s contribution to welfare economics.

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.

Can You Think of a Radical Idea to End Poverty?

What’s the best idea out there to reduce poverty and improve urban life? Well, Paul Romer thinks a big part of the answer is his charter city idea. What’s the charter city idea, you ask? I’m not sure, actually. Professor Finkler has been on me to read about it, and I may finally take him up on it, as the new issue of The Atlantic has a feature piece, “The Politically Incorrect Guide to Ending Poverty.”

How’s that for a provocative title?

The article of course profiles Romer, who is by any account a fascinating character.

In the 1990s, Paul Romer revolutionized economics. In the aughts, he became rich as a software entrepreneur. Now he’s trying to help the poorest countries grow rich—by convincing them to establish foreign-run “charter cities” within their borders. Romer’s idea is unconventional, even neo-colonial—the best analogy is Britain’s historic lease of Hong Kong. And against all odds, he just might make it happen.

We’ll see.

In addition to charter cities and making Aplia happen, Romer is also the hero of David Warsh’s Knowledge and the Wealth of Nations: A Story of Economic Discovery. The first half of the book is a short course in the history of economic thought; the second is an accounting of Romer’s role in launching endogenous growth theory. Both halfs are well worth reading.

Eyes on the Demise

James Hamilton at Econbrowser has a post, similar to one here, about difficulties regulating amidst rapid innovation. The cases of note were the disastrous Gulf spill on the one hand, and the disastrous financial meltdown on the other.

With the help of modern technology, we can now keep an eye on both.

As I’m sure you’ve seen, BP has a live feed up to its gusher, providing a continuous video feed from a mile under the sea.

Where did they get that idea, I wonder?

Perhaps from NPR Planet Money’s round-the-clock coverage of their own “toxic asset” via Toxie Cam. Here’s just a taste of some screenshots from their thrilling live feed:

And here’s the back story:

We bought Toxie for $1,000 earlier this year. Every month, we get a check. It’s a small piece of the payments people are making on their mortgages. And every month, more houses get foreclosed on and sold off by the bank. When enough houses get sold off by the bank, Toxie will be dead.

She’s not dead yet — but things are looking grim.

Last month, we got $72.41; so far, we’ve received a total of $449.

This month, our payment was zero dollars and zero cents. We could still get another payment next month — maybe.

So, it looks like the toxic asset really was toxic, with a payout of less than 50 cents on the dollar. On the other hand, that seems to be about what my 401K has been doing.

At any rate, video technology is clearly making the world a better place.

Joga Bonito

It’s June again, and that means it’s time to figure out exactly who you are going to pick to win this year’s FIFSA World Cup. What’s that? You’re busy with finals? With packing up and leaving campus? With finding a job and shopping for Ramen noodles? Who has time to research the top teams?

analyst Why, the investment banks, of course.

According to the Financial Times, Danske Bank, JP Morgan, UBS, Evolution, Goldman Sachs, have all put their top personnel on the matter and made their predictions. Well, Goldman only picked the semi-finalists because, you know, they don’t want to take any unnecessary risks.

It looks like la Brasilia is the big favorite this year, with a JP Morgan giving a hat tip to the English.

How do they do it?, you ask. Here’s one case:

Danske are using six factors (income level, population size, football history and tradition, current form of national team, presence of ‘superstars,’ and home field advantage) to gauge the teams relative strength… Then they simulate the Cup schedule.

That’s right, linear regression. OLS. What can’t it do?

For those of you US football fans out there, the yanks are better than even odds to advance past the group play, and about 90:1 to win it all right now. Spain is actually the gambling favorite to win it all right now at 4:1, with the Brazilians just behind at 9:2.

The New Republic has a blog.

Interested in a Political Career — How Tall Are You?

Slate has an amusing piece on what political coverage would look like if political scientists wrote it. Here’s just a taste:

Democrats hope that passing health care and financial regulatory reform will give them enough momentum to win in November. Unfortunately, there’s little relationship between legislative victories and electoral victories. Also, what the hell is “momentum”?

Prospects for an energy bill, meanwhile, are looking grim, since Obama has spent all his political capital. He used to have a lot. Now it’s gone. Why winning legislative battles builds momentum but saps political capital, I have no idea. Just go with it.

In related news, things are heating up in Oshkosh.

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