Month: August 2004

The Gringos Will be Weeping

That is the subtitle of the film I saw last night in Mexico City. The title is “Un Dia sin Mexicanos” [A Day Without Mexicans]. The premise of this comedy is that all of the Hispanic residents of California suddenly disappear one day without any warning. Beds are empty, cars are left running, and so on. Not surprisingly, California falls apart.

There are few movies that accurately illustrate market economics and fewer yet that show a good understanding of the theory of comparative advantage. This is one of them, and it can be viewed as a truly libertarian film. I won’t offer any spoilers but the final message is cosmopolitan and explores the question of what it really means to be a Latino. Plus it offers rich insight into how the Mexicans feel they are viewed by Americans. The film does hit a few false notes and has some slow patches but much of it is quite hilarious. And most of the film is in English, if you ever (unlikely) have a chance to see it.

The movie is currently showing on more screens in Mexico City than any other, including “Yo, Robot”, starring Will Smith.

By the way, if you are wondering, the film was partially subsidized by the Mexican government.

Hot water (again)

I think my law students understood my first-class example about contracts, incentives and hot water. But Kevin Drum, Matt Yglesias and others are having some difficulties. No problem. I will make it simpler. Suppose we have a law that says that at the end of every year landlords must rebate their tenants $50 for every month of rent paid. Good for tenants, right? Perhaps in the very short run but in the near future we can expect to see rents rise by $50 per month and the old equilibrium will be restored in all essentials. Now suppose that instead of being required to rebate the $50 the landlords are required to spend the money on shoes for the tenants. Now both tenants and landlords are almost certainly worse off since the tenants would almost certainly have used the rebate to buy something other than shoes. The hot water example hardly differs.

Of course, we could add in some other features that might make the law a good idea. Suppose, for example, that hot water encourages bathing which reduces the transmission of disease. Tenants won’t take the external benefit of hot water into account and thus hot water will be underprovided – a hot water requirement or better yet a subsidy might be justified in this situation.

An alternative explanation for laws like this is that they are supported by people who want to keep the poor out of their neighborhood – this is an externality argument also but one quite different from that above. Whatever the explanation, note that these arguments are quite different than the naive one which assumes that the requirement transfers wealth from the landlord to the tenant. Contracts are multi-dimensional, force one part to change and the others will adjust. More bonus points: What implications does this have for the study of price controls?

As I told my students, understanding the basic analysis is the first-step on the path to wisdom, it is not the end of the path. But you have to understand the first step if you are going to reach the final destination.

Toll Roads and Externalities

A recent paper by Aaron Edlin and Pinar Karaca-Mandic has focused my attention on the potential of toll roads. The basic question is whether,

…driving entail[s] substantial accident externalities that tort law does not internalize? …If so, this implies that a one percent increase in aggregate driving increases aggregate accident costs by more than one percent.

This may seem obvious. Any error in tort judgments would reduce deterrence enough to make it suboptimal. But, argue Edlin and Karaca-Mandic, its not so simple;

The reverse, however, could hold. The riskiness of driving could decrease as aggregate driving increases, because such increases could worsen congestion and if people are forced to drive at lower speeds, accidents could become less severe or less frequent. As a consequence, a one percent increase in driving could increase aggregate accident costs by less than one percent, and could even decrease those costs.

Edlin and Karaca-Mandic find that

…traffic density increases accident costs substantially whether measured by insurance rates or insurer costs. …a typical extra driver raises others’ insurance rates (by increasing traffic density) by the most in high traffic density states. In California, a very high-traffic state, we estimate that a typical additional driver increases the total insurance premiums that others pay by roughly $2231 ±$549 each year.

What is the best way to internalize the externality? Gas taxes are, as Edlin and Karaca-Mandic point out, politically untenable. They propose

…requir[ing] insurance companies to quote premiums by the mile instead of per car per year? This simple change could reduce driving substantially by moving a fixed cost to the margin without raising the overall cost of driving.

To some extent insurance companies already do this. Nonetheless I’m not sure that this solves the problem. A friend of mine lives in Riverside, CA and commutes to LA at 3 am. He would get hit by the Edlin premium but is in fact reducing the externality. Even in LA he is really only a risk to himself at 3 am. Another option is toll roads. The problem is that currently most toll roads do not congestion price or differentiate by vehicle size (beyond trucks); a factor White [2002], for example, finds significantly affects accident costs. The transaction costs of internalizing this externality via toll roads may be too high. But technology, according to the Economist, is changing. Toll roads can now congestion price and change higher fees to SUV. The Economist notes that a Swiss toll system which charges for the distance driven

“.. seems to be an unmitigated success. To general surprise, it was up and running on time. And it achieved its main objective: reducing truck traffic across Switzerland, which increased by 7% during the late 1990s. In the year after the system’s debut in 2001, the number of trucks on Swiss roads fell by 5%. What is more, transport companies now try much harder to ensure that their trucks do not cross the Alps empty. Financially, things appear to work, too. Operating costs amount to only 6% of revenues, estimated at €575m last year.

Addendum: Tyler and Alex debated this issue you can follow the debate here.

Islamic economics

The Islamic Bank of Britain, the first sharia-compliant bank in that country will soon open its doors. Ironically, Islamic banks may do better in the West than in the present Muslim world. The natural alternative to interest-bearing loans is a profit-sharing contract but that only works if accounting standards are clear and the courts can enforce the contract. Consider, if Taghi lends Amir money based on interest it’s clear what Amir owes, but if Taghi gives Amir money for a share of a profit-making enterprise then he is at the mercy of Amir’s bookkeeper. Writing in the NYTimes, Virginia Postrel writes:

…Islamic banks learned the hard way that risk sharing does not work in countries where businesses keep false accounting records. “Many people came to borrow money with wonderful ideas, and they just walked away with the money,” Professor Kuran said. The banks could not reliably audit the books, and if they took a client to court, the business would just claim a loss.

Consequently, the banks all started charging what amounted to interest for loans…A minuscule portion – generally well under 5 percent – of the assets of Islamic banks consist of loans based on genuine profit and loss sharing,” writes Professor Kuran..

Substitutes for interest-bearing loans are not hard to find, however.

The most common way around the interest ban is known as murabaha. The bank buys a capital good, a computer, say, for a client, who agrees to buy it back, with a markup, at a particular time in the future. In effect, the markup represents interest.

Islamic banks also invest in debt securities and pay depositors returns that fluctuate with prevailing interest rates. They act like money market funds.

Postrel’s article is based on Timur Kuran’s book, Islam and Mammon. I haven’t read the book yet but I know Timur’s work and feel safe in recommending it to anyone interested in these important issues. Here is chapter one.

My favorite things Mexican

I am in Mexico, and you will be hearing more about this. Here are a few of my favorite things.

1. Favorite Mexican novel: Pedro Paramo, by Juan Rolfo. A hilarious and moving tale of visiting rural Mexico and encountering the dead. The true heir to Dante. I remain surprised by how many people do not know this marvelous work, though the English translation does not capture the humor well. Will you be turned off if I tell you this is a favorite of Susan Sontag’s?

2. Favorite Mexican music: Mexican rap is extraordinarily eclectic and creative. I would be hard pressed to pick a favorite group, but Control Machete is one place to start.

3. Favorite Mexican artist: Marcial Camilo Ayala, whom I am currently visiting in Cuernavaca. Here is one of my favorite pieces of his; here is one in black and white. If you pay in advance (less than you think), I am happy to help you get one.

4. Favorite Mexican food: Chicken with mole sauce, a’ la Puebla or Oaxaca. For real authenticity, make sure you crumble in the stale tortilla.

5. Favorite Mexican movie: You probably already know Y Tu Mama Tambien, Amores Perros, and El Mariachi. So I’ll recommend Luis Bunuel’s old version of Wuthering Heights, a truly strange adaptation that captures the spirit of the original novel remarkably well. You do not have to buy into Bunuel’s later, more pretentious work to like this one.

Addendum: My favorite Mexican dish might be Chiles Nogada.

The Olympics and Greek History

Here are two free 30 minute lectures from the Teaching Company.

The Olympics: From Ancient Greece to Athens, Parts 1 and 2.

From 776 BC onwards, the greatest champions among the Greeks began assembling every four years at Olympia in western Greece to assert their strength and physical prowess. Who were the most charismatic of the ancient Greek Olympic heroes? To truly understand the origins of the Olympics, why do we really need to begin with Homer? In these specially commissioned lectures, Professor McInerney takes you on a journey back to the Olympics of the ancient Greek world.

Economic foundations of law

If tenants benefit from a law that says apartments must have hot water then surely a law that says tenants must have hot water and a dishwasher benefits them even more, right? What about a law that says tenants must have hot water, a dishwasher and cable tv? By now the students have cottoned on to the idea that the rent will increase. Once you realize that the law causes the rent to increase it’s no longer obvious if tenants benefit or if landlords are harmed.

We can work out what happens with sone numbers. Let’s suppose that after much bargaining the tenant and landlord have agreed upon the rent and the amenities – each party to the contract is profit maximizing, doing as well as they can given market conditions and the interests of the other. Now suppose that tenants value the hot water benefit at $100 and that it costs the landlord $150 to provide the hot water. At these prices the tenant does not buy the hot water. The law is passed; by how much does the rent increase? By at least $100 but no more than $150. The landlord knows for certain that he can increase the rent by $100 because this will make the tenant just as well off as he was before, which by assumption was an equilibrium price. Similarly, if the landlord could profitably raise the rent by more than his cost he would have done so already – the fact that he did not indicates that an increase of more than $150 would not be profitable

Thus the rent rises somewhere between $100 and $150, the precise amount to be determined by bargaining power. Suppose that the rent increases by $120. Then the tenant gets a benefit worth $100 at a price of $120 and is worse off by $20 and the landlord gets a benefit of $120 at a cost of $150 and so is worse off by $30. The law makes both the landlord and tenant worse off!

The lesson here is that a contract is multi-dimensional so if the government changes one dimension of a contract the other dimensions will adjust towards offsetting that change.

Bonus points: a) Suppose the tenant values the hot water at $150 and it cost the landlord $100. Does the regulation benefit the tenant and landlord now?. If so, what is odd about this example? b) Explain why the loss to the tenant and the loss to the landlord must add up to $50. How does this further illustrate the principle?

The dangers of IQ

By the title alone you know that IQ and the Wealth of Nations is going to be a controversial book. The book was recently reviewed, largely negatively but on scientific grounds without any charges of racism, in the Journal of Economic Literature (subs. required). What I didn’t know was that one of the authors, Professor Tatu Vanhanen, is the father of Finnish Prime Minister Matti Vanhanen. The professor’s words, therefore, have become a lightning rod for opponents of Matti Vahanen. So much so that the Finnish police considered whether to launch a criminal investigation of Professor Vanhanen for his comments on IQ, race, and the wealth of nations in a magazine interview. In the end, the police concluded that the Professor did not incite “racial hatred,” nevertheless I find the episode rather chilling.

Addendum: Here are some brave economists on this issue. Thanks to Gene Expression and Randall Parker for the pointer.

Henry Thoreau revisited

Henry Thoreau is perhaps the best-known anti-materialist thinker from the American tradition. But his life belied his formal doctrines:

The popular image of Thoreau is of the lone eccentric contemplating nature at Walden Pond. In fact, he spent only two years and two months there, and while he always preferred to be thinking and writing, he spent much of his life improving his father’s pencil business, surveying land, and otherwise earning money.

Here is the longer account, which is focused more on American attitudes toward materialism than Thoreau. Here are some of Thoreau’s passages on economy, read here also. Here is some biographical information. Alexander Pope was another author who damned commercial incentives while proving a master of them.

Guest Blogger: Eric Helland

We are very pleased to have Eric Helland guest blogging with us. Eric has just finished a year as a senior economist with the President’s Council of Economic Advisers. So now instead of writing pithy statements of economic wisdom for the President he will be writing them for you. A tradeoff perhaps of power for attention. Eric is now back at Claremont-Mckenna College in California. He is the co-author of many brilliant papers (see here) as well as the co-author of many other very good papers (see here). We are delighted to have him with us.

Hayek on gay marriage

Jonathan Rauch provides a “Hayekian” argument about gay marriage and institutional change. The argument is this:

“…that human societies’ complicated web of culture, traditions, and institutions embodies far more cultural knowledge than any one person could master. Like prices, the customs generated by societies over time may seem irrational or arbitrary. But the very fact that these customs have evolved and survived to come down to us implies that a practical logic may be embedded in them that might not be apparent from even a sophisticated analysis. And the web of custom cannot be torn apart and reordered at will, because once its internal logic is violated it may fall apart.

It was on this point that Hayek was particularly outspoken: Intellectuals and visionaries who seek to deconstruct and rationally rebuild social traditions will produce not a better order but chaos.”

Rauch characterizes this as the traditionalist objection to legalizing gay marriage: who knows what could happen if you change traditional marriage.

Yet Rauch argues that Hayek was not against all institutional change. He was primarily concerned with institutional change aimed at creating utopias. Since gay marriage is not utopian, argues Rauch, a Hayekian has little to fear.

Rauch, however, inadvertently makes a case against both a constitutional amendment banning gay marriage and a court decision allowing it nationwide. Hayek is making a case for gradual institutional change: Neither a nationwide ban nor outright legalization. Letting states experiment would allow us to see just what the consequences of changing the marriage laws are. Moreover the Tiebout hypothesis at least mitigates concerns about jurisdictional differences.

Institutional gradualism would seem to be Hayek’s revealed preference on the subject of marriage. Hayek’s first wife would not give him a divorce, so in 1950 he came to the United State to establish residency in Arkansas; at the time one of the only states with no-fault divorce laws that would allow him to divorce his first wife and wed his second cousin.

Is education good for growth?

It has long been received wisdom that education spurs economic growth. The education variable pops up as significant in many cross-country regressions. And many of the East Asian countries have had high investment in education and high rates of economic growth.

So how might a skeptical take on this matter look? Here is one pithy excerpt:

…there is actually a striking global correspondence between the world economic slowdown since 1973 and ever-increasing levels of educational spending. Comparisons between countries also confound the idea that more education translates into more growth. For example, South Korea is often given as an example of a country that made education a priority since the 1960s and saw significant economic growth. But as Professor Alison Wolf from King’s College London points out, Egypt has also prioritised investing in education, but its growth record has been poor (4). Between 1970 and 1998 Egypt’s primary enrolment rates grew to more than 90 per cent, secondary schooling levels went from 32 per cent to 75 per cent, and university education doubled – yet over the same period Egypt moved from being the world’s forty-seventh poorest country to being the forty-eighth.

A retort might be that education isn’t the sole determinant of growth – other factors may offset its positive economic role – but it remains a necessary one. But this argument doesn’t stand up either. The rapid growth of Hong Kong, another of the East Asian tigers, wasn’t accompanied by substantial investment in education. Its expansion of secondary and university education came later, as more prosperous Hong Kong parents used some of their newfound wealth to give their children a better education than they had had.

William Easterly doubts the evidence:

‘African countries with rapid growth in human capital [the fashionable term for people’s work abilities, especially levels of education] over the 1960 to 1987 period – countries like Angola, Mozambique, Ghana, Zambia, Madagascar, Sudan, and Senegal – were nevertheless growth disasters. Countries like Japan, with modest growth in human capital, were growth miracles. Other East Asian miracles like Singapore, Korea, China, and Indonesia did have rapid growth in human capital, but equal to or less than that of the African growth disasters. To take one comparison, Zambia had slightly faster expansion in human capital than Korea, but Zambia’s growth rate was seven percentage points lower.

‘…Eastern Europe and the former Soviet Union compare favourably with Western Europe and North America in years of schooling attained. Yet we now know that [gross domestic product] per worker was only a small fraction of Western European and North American levels. For example, the 97 per cent secondary enrolment ratio of the United States is only slightly higher than Ukraine’s 92 per cent, but the United States has nine times the per capita income of Ukraine’ (6).

My main worry concerns the hoary distinction between correlation and causation. The consumption component of education is commonly underrated. Rich countries spend more on education for the same reason that they consume more leisure. See my previous MR post on education and economic growth.

The glory of Athens

Politicians often refer to our Judeo-Christian heritage but in math, science, philosophy, and especially politics we owe much more to our Greco-Roman heritage. Consider; democracy, republicanism, and the rights of citizenship, these idea owe virtually nothing to the Judeo-Christian tradition and everything to Greece and Rome.

I am reminded of this by rereading Pericles’ Funeral Oration. Here, from nearly 2500 years ago, is Pericles, in the midst of war in a ceremony to honor the dead he speaks to Athens, and also perhaps to us, about liberty and war.

If we turn to our military policy, there also we differ from our antagonists. We throw open our city to the world, and never by alien acts exclude foreigners from any opportunity of learning or observing, although the eyes of an enemy may occasionally profit by our liberality; trusting less in system and policy than to the native spirit of our citizens; while in education, where our rivals from their very cradles by a painful discipline seek after manliness, at Athens we live exactly as we please, and yet are just as ready to encounter every legitimate danger.