Alex Tabarrok

Price Ceilings

by on February 27, 2015 at 7:25 am in Economics, Education | Permalink

This week we released two new sections of our principles of economics class, price ceilings and trade. Most textbooks discuss how price ceilings create shortages and deadweight loss. Modern Principles delves much deeper to explain how price controls impede the operation of the price system creating economic discoordination and a misallocation of resources.

The introductory video is short but it covers a lot of economics.

Smile! The Dentists Lose a Monopoly

by on February 26, 2015 at 7:20 am in Economics, Law, Medicine | Permalink

Yesterday, the Supreme Court ruled (6:3) in North Carolina State Board of Dental Examiners v. FTC that the attempt of the state board of dental examiners to exclude nondentists from the practice of teeth whitening violated the Sherman antitrust act.

mouth1The opinion, written by Justice Kennedy, is especially lucid. Here, from Kennedy, are the key facts:

Starting in 2006, the Board issued at least 47 cease-and desist letters on its official letterhead to nondentist teeth whitening service providers and product manufacturers. Many of those letters directed the recipient to cease “all activity constituting the practice of dentistry”; warned that the unlicensed practice of dentistry is a crime; and strongly implied (or expressly stated) that teeth whitening constitutes “the practice of dentistry.” App. 13, 15. In early 2007, the Board persuaded the North Carolina Board of Cosmetic Art Examiners to warn cosmetologists against providing teeth whitening services. Later that year, the Board sent letters to mall operators, stating that kiosk teeth whiteners were violating the Dental Practice Act and advising that the malls consider expelling violators from their premises.

These actions had the intended result. Nondentists ceased offering teeth whitening services in North Carolina.

The FTC then brought suit, arguing that the action was anti-competitive. The case raises constitutional issues because the states are allowed to violate the federal antitrust acts, as will inevitably happen in the ordinary use of their powers. The question then became whether the NC State Dental Board was invested with enough state authority to overcome the antitrust provisions. On the one hand, the principles of federalism say leave the states alone. On the other (Kennedy quoting Justice Stevens in Hoover v. Ronwin):

“The risk that private regulation of market entry, prices, or output may be designed to confer monopoly profits on members of an industry at the expense of the consuming public has been the central concern of . . . our antitrust jurisprudence.”

In my view, the majority deftly navigated the tradeoff. The court said that North Carolina can, without question, decide that teeth whitening is the practice of dentistry but they have to do so more or less explicitly–they can’t simply put the fox in charge of the hen-house by deferring the decision to the dentists.

In other words, the court raised the cost of rent-seeking. If the dentists want to monopolize the practice of teeth whitening they will have to make that case to the legislature and not rely on the unilateral actions of a board composed almost entirely of dentists and created for entirely different purposes.

As Kennedy put it in language reminiscent of bootleggers and baptists:

Limits on state-action immunity are most essential when the State seeks to delegate its regulatory power to active market participants, for established ethical standards may blend with private anticompetitive motives in a way difficult even for market participants to discern. Dual allegiances are not always apparent to an actor. In consequence, active market participants cannot be allowed to regulate their own markets free from antitrust accountability.

Addendum: I, along with a number of other GMU scholars, was part of an Institute for Justice BRIEF OF AMICI CURIAE SCHOLARS OF PUBLIC CHOICE ECONOMICS IN SUPPORT OF RESPONDENT. Congratulations are due to the excellent team at IJ, as the brief seems to have been influential.

By the way, the dissenting opinion (Alito, Scalia, Thomas) appears to accept the logic of our brief to an even greater extent, so much so that they shrug their shoulders at the rent seeking as business as usual (I especially enjoyed the dig at the FTC as also being subject to regulatory capture). Thus, the dissenters focused entirely on the federalism question. I respect that approach but I think that as federalism stands today, the majority’s balancing approach is likely to lead to better policy.

Here’s a stunning graph from the New York Fed’s Liberty Street Blog:

What it shows is that default rates on student debt decrease with higher balances or, to put it the other way, the students with the highest default rates are the ones with the least debt.

I wouldn’t have predicted that but here are some possible explanations. First, dropouts have less debt and also less income. But while the debt rises proportionally with years of education the income rises in less than proportion. As I said in Launching, students who drop out after 2 years get less than half of the gains from completing a four-year degree (the sheepskin effect). Thus the 40% or so of students who dropout see their debt rise faster than their income so burdens are higher and default rates increases.

Although the debt to income ratio story is plausible it’s still surprising how many students default with low amounts of debt. Raymond, a commentator at the Liberty Street Blog, offers some additional hypotheses:

I work in financial aid at a large public community college. We pulled data on our defaulters and we found over 60% started with remedial coursework and borrowed their first and second terms. About 80% of the total data population suspended soon after the second term – thus the low amounts. Many were not students just out of high school, they were independent adults. Putting this altogether with the many years I’ve been in financial aid speaking with students I’ve come to a conclusion. 99% of the time when I have a student that has been suspended asking for loans and I mention private or alternative loans they immediately say they don’t have good credit. Bad credit seems to correlate with bad academics. Many seem concerned more with paying bills than paying education. Sometimes they are just out of jail and no one will hire them. Their probation requires they work or get a job which the later is nearly impossible. Other times we have people so deep in the hole in debt already that the student loans was a way to buy more time. The word is out if you have bad credit and are desperate for funds just go to a community college where tuition is low and borrow the maximum. We noticed in our data pull many students graduated from high school or received their GED up to 10 years ago or more! Want the defaults to go down – stop lending to students that have a significant number of remedial courses their 1st and 2nd terms at a college where tuition is already low.

Algorithm Aversion

by on February 22, 2015 at 7:40 am in Economics, Science | Permalink

People don’t like deferring to what I earlier called an opaque intelligence. In a paper titled Algorithm Aversion the authors write:

Research shows that evidence-based algorithms more accurately predict the future than do human forecasters. Yet, when forecasters are deciding whether to use a human forecaster or a statistical algorithm, they often choose the human forecaster. This phenomenon, which we call algorithm aversion, is costly, and it is important to understand its causes. We show that people are especially averse to algorithmic forecasters after seeing them perform, even when they see them outperform a human forecaster. This is because people more quickly lose confidence in algorithmic than human forecasters after seeing them make the same mistake. In five studies, participants either saw an algorithm make forecasts, a human make forecasts, both, or neither. They then decided whether to tie their incentives to the future predictions of the algorithm or the human. Participants who saw the algorithm perform were less confident in it, and less likely to choose it over an inferior human forecaster. This was true even among those who saw the algorithm outperform the human.

People who defer to the algorithm will outperform those who don’t, at least in the short run. In the long run, however, will reason atrophy when we defer, just as our map-reading skills have atrophied with GPS? Or will more of our limited resource of reason come to be better allocated according to comparative advantage?

The Rise of Opaque Intelligence

by on February 20, 2015 at 7:31 am in Economics, Science | Permalink

Many years ago I had a job picking up and delivering packages in Toronto. Once the boss told me to deliver package A then C then B when A and B were closer together and delivering ACB would lengthen the trip. I delivered ABC and when the boss found out he wasn’t happy because C needed their package a lot sooner than B and distance wasn’t the only variable to be optimized. I recall (probably inaccurately) the boss yelling:

Listen college boy, I’m not paying you to think. I’m paying you to do what I tell you to do.

It isn’t easy suppressing my judgment in favor of someone else’s judgment even if the other person has better judgment (ask my wife) but once it was explained to me I at least understood why my boss’s judgment made sense. More and more, however, we are being asked to suppress our judgment in favor of that of an artificial intelligence, a theme in Tyler’s Average is Over. As Tyler notes notes:

…there will be Luddites of a sort. “Here are all these new devices telling me what to do—but screw them; I’m a human being! I’m still going to buy bread every week and throw two-thirds of it out all the time.” It will be alienating in some ways. We won’t feel that comfortable with it. We’ll get a lot of better results, but it won’t feel like utopia.

I put this slightly differently, the problem isn’t artificial intelligence but opaque intelligence. Algorithms have now become so sophisticated that we human’s can’t really understand why they are telling us what they are telling us. The WSJ writes about driver’s using UPS’s super algorithm, Orion, to plan their delivery route:

Driver reaction to Orion is mixed. The experience can be frustrating for some who might not want to give up a degree of autonomy, or who might not follow Orion’s logic. For example, some drivers don’t understand why it makes sense to deliver a package in one neighborhood in the morning, and come back to the same area later in the day for another delivery. But Orion often can see a payoff, measured in small amounts of time and money that the average person might not see.

One driver, who declined to speak for attribution, said he has been on Orion since mid-2014 and dislikes it, because it strikes him as illogical.

Human drivers think Orion is illogical because they can’t grok Orion’s super-logic. Perhaps any sufficiently advanced logic is indistinguishable from stupidity.

Hat tip: Robin Hanson for discussion.

The US economy has been one of the most dynamic economies in the world but recent research suggests that US dynamism is in decline. The startup, job creation, and job destruction rates have all declined over the past three decades with a possible increase in the rate of decline in the past decade. The dynamism decline is robust, appearing in a variety of data. Moreover because startups and the movement of resources from low to high productivity firms are closely associated with improvements in productivity, the decline of dynamism may reduce real wages and the standard of living.

Could regulation be increasing barriers to entry, raising the costs of reallocation, and slowing the diffusion of productivity innovations? To test the hypothesis that regulation is reducing dynamism Nathan Goldschlag and I combined data on dynamism with an industry level measure of regulation. Our measure of regulation is produced by an innovative technique that combs the Code of Federal Regulations (CFR) for restrictive terms or phrases such as “shall,” “must,” “may not,” “prohibited,” and “required”. The count of restrictive words in each section is then associated to industries via a machine learning algorithm that recognizes similarities between the language in that CFR section and industry language (e.g. a section of the text with words such as “pipeline” would be associated with the oil and gas industry). In this way, we can associate each industry with an index of regulation derived from the entire CFR.

The following figure shows the startup rate against the regulatory stringency index (both averaged by industry over the period 1999-2011). Contrary to expectation, there is a slight positive relationship; industries with greater regulatory stringency have higher startup rates. We find a similar relationship with job creation rates.

Startup Rate Against Regulation Stringency by Industry (1)

Of course, it could be the case that more dynamic industries attract greater regulation so the apparent positive relationship in our graph would not reflect a causal connection and could even be masking a negative causal connection. Thus, to further test the relationship, we statistically test whether increased regulatory stringency is associated with reduced dynamism within an industry over time (we give each industry a “fixed effect”). After subjecting the data to a number of different tests we find no statistically significant relationships between dynamism and regulatory stringency (see the paper for details).

One simple test divides manufacturing industries into those that experienced a large increase in regulation (+50% or more) during our time period and those where regulation hardly changed at all (+10%-to -10%). If regulation were the cause of changes in dynamism we would expect to see big differences between these groups. The figure below, however, shows that startup rates, for example, track similarly across the two types of groups suggesting that regulation is not a primary cause of declining startup rates (the same is true for job creation and destruction rates).

Manufacturing Startup Rates

It’s important to note that regulation could have large negative (or positive) effects without having a big effect on dynamism. A tax, for example, could reduce the size of the industry without have a big effect on the startup rate or how well the industry responds to shocks by reallocating labor from low to high productivity firms. In short, regulation can have significant effects on levels without necessarily having large effects on growth rates.

If regulation is not responsible for the decline in dynamism then what is? We offer some suggestive hypotheses in another paper. First, it could be the case that we are mis-measuring entrepreneurship. If entrepreneurship is measured as new firm creation, for example, we miss the entrepreneurship inherent in rebuilding and revitalizing larger and older firms. Since most workers work for larger and older firms, revitalizing these firms may be a more important use of entrepreneurship than starting new firms. In an increasingly global economy we may also miss some of the outsourcing of dynamism that has occurred in recent decades. Apple, for example, is measured in US data as a relatively stable firm but the Apple ecosystem from which Apple sources its product is a maelstrom of entry and exit as Apple hires and fires new firms with each new iteration of the iPhone.

Even if dynamism has declined is this necessarily a bad thing? We should not let word associations influence our evaluations of underlying realities. Dynamism as measured by, for example, job reallocation rates might equally well be called churn. Declining churn doesn’t sound as bad as declining dynamism. Moreover, combining the last two points, perhaps the reason for some of the declining dynamism as measured in the US statistics is that we have outsourced some of our churn. A very different way of describing the same data.

More generally, information technology may allow us to reduce churn while still allowing adaption and innovation. Creative destruction is necessary for a growing economy but if we can boost the ratio of creation to destruction that counts as an improvement in welfare.

Reallocation of labor and capital is an important force driving the American economy forward. We don’t fully understand, however, what the causes of declining dynamism are or exactly how our measures of dynamism relate to entrepreneurship, growth and improvements in the standard of living.

Addendum: Cross-posted at the Columbia Law School Blue Sky Blog.

Here is a Valentine’s Day puzzle: there have been five husband and wives awarded Nobel Prizes. Name them.

I will give you one hint. Four of the couples won for joint work. Only one of the couples each won a Nobel and that couple included a Nobel prize winner in economics.

Here is the second rose video which goes deeper into the meaning and operation of the invisible hand. One warning, however, don’t watch this video while drinking!

All MRUniversity videos are free to use in the classroom. To that end, we have put together a short guide for teachers that suggests some ideas for using the rose videos in class and how one might continue to deepen the lessons.

I, Rose

by on February 9, 2015 at 7:25 am in Economics, Education, Film | Permalink

Valentine’s Day is this week and what better way to celebrate than to appreciate the economics of roses!

A rose isn’t just a symbol of love it’s a symbol of global cooperation coordinated by the invisible hand. In The Price System, the just released section of our principles of microeconomics course, we feature two rose videos (along with videos on the great economic problem, speculation, prediction markets and more). Here’s the first; I, Rose. Tomorrow, A Price is a Signal Wrapped up in an Incentive. Enjoy.

Unions for Online Education

by on February 6, 2015 at 12:31 pm in Economics, Education | Permalink

The Washington Post reports on a new campaign by the Service Employees International Union, the 2nd largest and fastest growing union in the United States, to greatly raise the wages of university teaching adjuncts:

Now, a union that’s been rapidly organizing adjuncts around the country thinks that number [wages, AT] should quintuple. Last night, on a conference call with organizers across the country, the SEIU decided to extend the franchise with a similar aspirational benchmark: A “new minimum compensation standard” of $15,000. Per course. Including benefits.

…At the moment, the $15,000 number sounds even more outlandish than $15 did when fast food workers started asking for twice the federal minimum wage. But organizers argue that if you’re teaching a full load of three courses per semester, that comes out to $90,000 in total compensation per year — just the kind of upper-middle-class salary they think people with advanced degrees should be able to expect. (Most adjuncts teach part-time, which would put them at $50,000 or $75,000 per year.)

Tullock’s Questions?

by on February 5, 2015 at 7:20 am in Economics, History | Permalink

Gordon Tullock was famous for asking a lot of questions. Some odd, some uncomfortable, some on the spot and some in his work. For example, Gordon would often ask, Why don’t we invade Brazil? Meaning why did countries stop invading other countries and setting up colonies? It’s a good question. I am interested in collecting more of Tullock’s questions. Please respond with any questions Gordon asked you or questions that you find him asking in his work. Thanks!

Tullock

The most recent issue of the Fletcher Security Review features a paper by Alex Nowrasteh and myself on Privateers! Their History and Future. One of the interesting side notes is that Americans supported privateering not just because it was effective but also because America’s greatest patriots, the founding generation, were deeply skeptical about standing armies and navies. Today, the right-wing, uber-patriotic brand of Americanism is pro-military and pro-empire. In contrast, the founders would regard the empire as deeply un-American. Quoting from the paper:

The founders feared standing armies as a threat to liberty. At the constitutional convention, for example, James Madison argued that “A standing military force, with an overgrown Executive will not long be safe companions to liberty. The means of defence against foreign danger have been always the instruments of tyranny at home.” For the founders, the defense of the country was best left to citizens who would take up arms in times of national peril, form militias, overcome the peril, and then to return to their lives.

As a result, the ideal military for the founders was small and circumspect (remember also that the second amendment was in part about the fear of standing armies, hence the support of the militia). The 1856 Treaty of Paris banned privateering but the United States refused to sign. Secretary of State William Marcy explained why in a great statement of patriotic American anti-militarism:

The United States consider powerful navies and large standing armies as permanent establishments to be detrimental to national prosperity and dangerous to civil liberty. The expense of keeping them up is burdensome to the people; they are in some degree a menace to peace among nations. A large force ever ready to be devoted to the purposes of war is a temptation to rush into it. The policy of the United States has ever been, and never more than now, adverse to such establishments, and they can never be brought to acquiesce in any change in International Law which may render it necessary for them to maintain a powerful navy or large standing army in time of peace.

Today the patriotic brand of anti-militarism, the brand that sees skepticism about the military and the promotion of peace and commerce as specifically American, is largely forgotten. President Eisenhower’s farewell address to the nation was perhaps the last remnant in modern memory. It’s a tradition, however, that true patriots must remember.

Should economists shy away from teaching hard topics for fear of offending someone’s moral sensibilities? Should we restrict ourselves to the market for ice cream? The tagline of our textbook, Modern Principles, is See the Invisible Hand: Understand Your World. We take understand your world seriously and we teach topics that other textbooks do not such as the economics of network goods like Facebook or the economics of tying and bundling which students see regularly when they purchase cell phones and minutes and Cable TV.

The world, however, is not always a pleasant place and so we also discuss modern slavery and how the concept of the elasticity of supply can help us to evaluate programs like slave redemption. It’s important to teach this material with seriousness, it’s not an idle exercise in “freakonomics,” and it’s possible to misstep but we think students need to see economics as a vital discipline that can be used to make the world a better place, even if only one small step at a time.

Here is Tyler on elasticity and the economics of slave redemption. This is from the elasticity section of our course at MRUniversity, released today along with taxes and subsidies. You can also find a lengthier treatment with more details in Modern Principles.

In Defense of the Company Town

by on January 27, 2015 at 7:25 am in Economics, History | Permalink

In my EconTalk with Russ Roberts on proprietary cities I only mentioned company towns in passing. Even the great Milton Friedman got company towns wrong, however, so it’s worthwhile spending a little time to dispel some myths.

Take company stores. Why did mining companies often own the town store? The standard answer: to squeeze every nickel from the workers so they would “owe their soul to the company store.” But that lyrical argument makes no sense and the truth is actually closer to the opposite.

The mining towns were isolated geographically but they weren’t isolated from the national labor market. The number of workers in these towns moved up and down in response to the price of coal and the workers often traveled long-distances to work in the mines, sometimes from other states or other countries. The company towns were isolated not because the workers couldn’t get out but because few people wanted to live where coal was abundant. As a result, workers had to be enticed to travel to and to live in these towns. Oil rigs are similarly isolated today and once on board the workers have nowhere to go but the company restaurant, the company theater and the company gym but that hardly means that the workers are exploited.

Since the mine workers weren’t isolated from the national labor market they had to be paid wages consistent with wages elsewhere and indeed on an hourly basis wages in mining were higher than in manufacturing (not surprising since these jobs were riskier). Moreover, workers weren’t dumb and so–just like workers today–they would consider the price of housing and the price of goods in these towns so see how far their wages would take them. All of this suggests that workers would not be fooled by high wages and really high prices at the company store that nullified those wages. And indeed, prices at company stores were not especially high and were similar to prices at independent stores in similar locations.

It was possible to find examples of a good at a particular company store which had a markedly higher price than at a particular independent store but this was cherry picking, (I am reminded of the exam question about two rival supermarkets both of which advertise “the average consumer at our store would pay 20% more if they shopped at our competitor.” The question asks how it can be possible that both stores are telling the truth.) Comparing identical baskets, prices at company stores were not higher than at similar independent stores.

I said that the traditional story actually gets things backward. We can see how by asking why the companies owned the stores. First, independent stores had to bear a lot of risk because they would be selling in a local economy that was dependent on a single mine. That risk was better born by the mining firm itself because it knew more about coal and fluctuations in the price of coal, its own plans, the time the mine would be expected to be open and so forth. Thus, it was cheaper for the mines to own the stores than for independents to own the stores.

Second, if an independent store did open they would have a monopoly and would want to charge a monopoly price but–and this is key–the higher the price charged by the independent store the higher the wages the coal mine would have to pay to compensate the workers. Thus monopoly independents would be bad for the workers but they would also be bad for the owners of the mine. If the mine owned the store, however, they would have a greater incentive than the independent store to lower prices because that meant they could save on wages. Overall, both workers and mine owners would be better off with company stores (A classic example of the double marginalization problem).

Similar arguments apply to company owned housing. On the one hand, this did mean that during a lengthy strike the firm could evict the workers from their housing. On the other hand, would you want to buy a house in an isolated town dependent on a single industry? Would you want to own a major asset that was likely to fall in price at the same time that you were likely to lose your job? Probably not. Rental housing meant that workers had the freedom to leave town easily when better work opportunities were available elsewhere – i.e., it meant that the workers were less isolated from the national labor market than they would be if they owned their homes and were tied down to a single place and a single employer. Moreover, the fact that the housing was company owned meant lower prices than if the housing was owned by an independent monopoly developer, the most relevant alternative (again because of the double marginalization problem).

The bottom line is that far from being an example of the abuse of monopoly power, the company town was an effort to constrain monopoly power.

References: The best source for an accurate view of the company towns in the mining industry is Price Fishback’s Soft Coal, Hard Choices: The Economic Welfare of Bituminous Coal Miners, 1890-1930. The book is based on a series of papers (JSTOR).

The company towns built by the mines weren’t especially pretty but some of the other company towns, especially those which employed high-skilled workers, were professionally designed by the leading architects of the day and they came with parks, playgrounds, retail areas, public transportation, churches and a variety of services. In essence, these company towns were doing what Google does today, competing for workers with amenities. Margaret Crawford’s book, Building the Workingman’s Paradise, is an interesting history showing how company towns pioneered a number of architectural and planning innovations that later found there way into many post World War II home developments.

Based on my paper, Lessons from Gurgaon, India’s Private City (with Shruti Rajagopalan) I discuss private cities with Russ Roberts over at EconTalk this week.

I think the conversation went well but I haven’t heard it yet so let me also take the time to point you to my favorite recent EconTalk, Russ interviewing Greg Page, the former CEO of Cargill, the largest privately-held company in America. Their discussion covers the global food supply, false definitions of national food security, the role of prices, comparative advantage and more. It’s a great discussion.