Month: August 2005

Why are companies seeking higher profit margins?

This is one of the great unresolved questions in the economic
history of America in the twentieth century. There are, broadly
speaking, three interpretations of what went on:

The first is the interpretation of a whole bunch of finance
economists starting from Adolf Berle and Gardiner Means writing in the
1930s, and including my brother-in-law Paul Mahoney. It is that a whole
bunch of changes in corporate law and financial practice in the early
twentieth century culminating in the New Deal shifted a great deal of
practical power away from "owners" and to "managers." Shareholders
collected their dividends, yes. On those rare occasions where companies
wanted to issue more stock managers were very solicitous of shareholder
concerns, yes. But most of the time managers did what they wanted,
chose their own successors, and set corporate policy with not that much
attention to maximizing company stock prices either in the short run or
the long run. And shareholders couldn’t do much of anything about that:
it was simply too costly and too hard to stage a successful proxy fight
to throw out the incumbent managers at the company annual meeting.

Now this does not mean that shareholders were "exploited." Managers
did care about the level of dividends and the price of the stock–it
was a big loss of face at the country club to report poor financial
numbers. But managers cared about other things as well–being pillars
of their community, indulging in natural benevolence toward their
subordinates, and avoiding nasty headlines in the local press, among

Now if you’re a finance economist, you see this system as
"inefficient": companies are wasting a lot of money by employing too
many people in jobs that are cushier than they have to be, and while
this is good for the workers of the company it also raises costs and
prices, and so the gains to workers are outweighed by the losses to
shareholders (who collect lower dividends) and consumers (who pay
higher prices). If you’re John Kenneth Galbraith, you see this
technostructure–this technocratic corporate elite of managerial
capitalism–as broadly a good thing, because managers are interested in
the fundamentals of production and human relations rather than in
prettying up their numbers for Wall Street road shows.

In any event, this system comes to an end in the 1980s as Wall
Street figures out how to successfully undertake hostile takeovers, and
as the threat of being subject to a hostile takeover pushes even those
managers who would have been very happy under the old system to pay
more attention to the bottom line as a way of boosting current stock
prices and making the benefits to outsiders’ undertaking a hostile
takeover much less.

That’s the first interpretation (in its two flavors).

The second interpretation is one that has been pushed by Larry
Summers and Andrei Shleifer. It notes that organizations run on
patterns of long-term trust and confidence, and that it is devastating
to an organization’s effectiveness for those at the top to break the
established implicit long-run bargains that the organization runs on.
Under this interpretation, the paternalistic-employer-and-civic-booster
model of the American corporation that dominated the first post-WWII
decades was an effective and efficient system of corporate
organization. Come the hostile takeover, however, the corporate raiders
can replace the old management that had made and kept the implicit
long-run bargains with new managers who have no attachment to them, and
are willing to do the bidding of the shareholders and the takeover
artists. This "breach of trust" moves us to a system of corporate
organization that is less efficient and effective for society as a
whole–workers who don’t trust their bosses won’t spend time learning
things that are important if you work for this particular company but
not in the larger job market, firms won’t invest in the community in an
attempt to make it a place where workers would like to stay, et cetera.
But this new form does expropriate a lot of the value of the firm that
was shared with workers-as-stakeholders, and transfer the value to the
bosses and the shareholders.

There is also a third interpretation: that the coming of the Volcker
disinflation, the dominance of central bankers, and the elevation of
price stability over full employment as a goal of governance was bound
to weaken American workers’ power enough to make the Kodak model
clearly less profitable than the more "Hard Times" alternative.

I find that I’m 30% a finance economist, 20% a Galbraithian, 20% a
follower of the Summers-Shleifer "breach of trust", and 30% a believer
that the high unemployment of the Volcker disinflation was the key in
its shift of power away from workers.

You will observe that I give 0% weight to the hypothesis that it was
a shift in culture–a rise in the belief that managers had "primary
responsibility to the shareholders"–that was responsible for the very
real change that you ask about. This is a professional deformation: for
27 years I have been trained to look first at changes in technologies,
resources, institutions, forms of organization, and incentives, and
only after all of these have failed to give answers to throw up my
hands and disappear in a "blaze of amateur sociology."

How much of a difference did this shift–whatever caused
it–actually make? Here’s a graph from the National Income and Product
Accounts: net operating surplus of private enterprises as a share of
net domestic income. It shows (a) a large and steep fall in the rate of
profit at the end of the 1960s, (b) a partial jump back up in the
1980s. So figure that these changes in the 1980s, whatever caused them,
look to have boosted profits by about three percent of total income.

I will classify myself as 60% a finance economist, 5% a Galbraithian, 20% for "breach of trust," 5% to the Volcker disinflation, and 10% I will assign to "cultural change."  The advent of information technology matters as well, but arguably this falls under "finance economist."

Australia fact of the day

Until as late as the early 1950s a round-trip aeroplane ticket from Australia to England cost as much as a three-bedroom suburban home in Melbourne or Sydney.

That is from Bill Bryson’s Down Under, note that by the end of the 1950s the trip still cost as much as a new car, could take three days time, and encountered more or less constant turbulence.

My debate with Benjamin Barber on cultural diversity

You can find the video here.  This may be a more direct link.  Here is the Smithsonian summary:

Tyler Cowen and Benjamin Barber present two different perspectives on the role of market liberalization and cultural diversity and representation.

Tyler Cowen advocates working within a liberal market paradigm, using UNESCO as a ‘marketing tool’ for cultural representation and has a positive trade-enhancing vision towards culture.

Benjamin Barber critiques the structure of neo-liberal market expansion, pointing out the inherent structural inequities that maintain this system and do not allow equal representation of cultural groups, communities, and increasingly, nation-states.

Underrated economists, a continuing series

Adam Smith was not the only classical economist to understand economies of scale.  Edward Gibbon Wakefield had a well-worked out theory of the benefits of geographic clustering, along with a recipe for reform: force people to cluster together.

South Australia was a theory before it became a place. The theory owed most to the choice of place to Captain Charles Sturt. The gestation of the settlement in the seven years before the first colonists landed involved a blend of idealism and philanthropy, commercial speculation, comprise and muddle. The initial impetus of ideas came from Wakefield, whose theory of ‘systematic colonisation’ offered a partial solution to the perplexing economic and social conditions of Britain at the time. Wakefield’s views were not new, but he expressed them persuasively and they were well propagated by Robert Gouger who visited Wakefield in London’s Newgate Gaol in 1829 and discussed his theory of colonisation. In essence, ‘systematic colonisation’ required that all land should be sold at or above a fixed price and the proceeds should be used to provide free passage for a carefully selected labour force consisting of the young adult poor. The pace of emigration should depend on the volume of land sales, and a large degree of self government should be granted to the colonists in matters of land sales, emigration and revenue. As no convicts were to be admitted, no garrison troops would be needed; above all, such a colony should ‘be respectable’ and self-supporting.

The notion of concentration of settlement was added to the stock of theoretical ideals by an eighty year old radical political philosopher, Jeremy Bentham. He argued that the settlement should be founded on an entirely new principle entitled the vicinity-maximising-or-dispersion-preventing principle.

Read more here, and yes I am in Melbourne now.  To this day most Australians live on the southeast coast.  Here is material on Wakefield and New Zealand.  Bentham is also much underrated, but that is for another day…

Tips to avoid being mugged

I am back from Lima, my last stop in Peru, but these were on my mind while I was there: 

  1. Stride with confidence and purpose, even if you are utterly lost.
  2. Carry a glass bottle, a coke bottle is best (it must be non-alcoholic).  Occasionally, take a drink as you stride towards your "destination."  The bottle makes a handy weapon but, unless it comes to the worst, I do not advise that you use it (just give them your money).  The muggers, however, don’t know that.  Deterrence is your best defense.
  3. If you are lost or in trouble then ask someone for help.  But if some Joe on the street asks if you need help say, "no thanks," and continue to follow rule 1.  The selection effect makes all the difference.
  4. Do not walk in unknown areas, especially at night.

In my experience rule 4 works the best but it too has its opportunity cost.

What is wrong with neoclassical economics?

Michael at offers a lengthy and intelligent discussion of this ever-popular topic.  For the record, here are my views:

1. Most of the criticisms of neoclassical economics are correct.

2. The alternatives to neoclassical economics, if implemented on a large scale, would be worse.  Greater realism per se does not offer much insight.  Constructs such as "chaos theory" have not gone anywhere for economics.

3. Mainstream economics has improved greatly over the last twenty-five years (really!).  It is more policy-relevant and there is less worship of pure theory.  There is greater recognition of how various results can be context-dependent.  Experimental and case study methods are more prominent.  We pay attention to behavioral factors behind choice. Development and growth are more central as fields of investigation.  Some economists are even blogging, believe it or not.

4. The real problem is economists, not economics.  Love of ideas, love of learning, love of reading, and greater interest in other disciplines would remedy many current problems.  Admittedly that is a tall order.  But those are issues of time constraints and sometimes personal virtue, not method per se.

How to generate blog-related email

First, post "No need to write me about Crowded House or the other mostly mediocre indie bands from Down Under."  Second, post about the Iraq War on an econ blog.  All of your protests took me to be defending the war (or Bush’s execution of the war), which is not the case.  The key claims are a) one popular argument against the war is overrated, b) there are two other good (whether you agree with them or not) arguments against the war, and c) those two other good arguments are doomed to a certain amount of unpopularity, because they sound unpatriotic and defeatist.  This is one reason, for instance, why John Kerry never outlined an Iraq position satisfactory to the broader American public.  Thanks for all your emails, and sorry if I confused you.

Richard Posner on blogging

The charge by mainstream journalists that blogging lacks checks and balances is obtuse. The blogosphere has more checks and balances than the conventional media; only they are different. The model is Friedrich Hayek’s classic analysis of how the economic market pools enormous quantities of information efficiently despite its decentralized character, its lack of a master coordinator or regulator, and the very limited knowledge possessed by each of its participants.

In effect, the blogosphere is a collective enterprise – not 12 million separate enterprises, but one enterprise with 12 million reporters, feature writers and editorialists, yet with almost no costs. It’s as if The Associated Press or Reuters had millions of reporters, many of them experts, all working with no salary for free newspapers that carried no advertising.

How can the conventional news media hope to compete? Especially when the competition is not entirely fair. The bloggers are parasitical on the conventional media. They copy the news and opinion generated by the conventional media, often at considerable expense, without picking up any of the tab. The degree of parasitism is striking in the case of those blogs that provide their readers with links to newspaper articles. The links enable the audience to read the articles without buying the newspaper. The legitimate gripe of the conventional media is not that bloggers undermine the overall accuracy of news reporting, but that they are free riders who may in the long run undermine the ability of the conventional media to finance the very reporting on which bloggers depend.

Read more here. offers a critique.

My take: I expect the Internet to make mainstream media more centralized in key regards.  Ebay and Craigslist will cut out classified ads as a source of profitability for many mid-tier papers. Bloggers will make the leading papers more focal, and thus more important to read.  Can you understand the economics blogosphere if you do not read Paul Krugman?  It is fringe and niche media that will make national newspapers more viable.

Medicare at work

…[there are] striking variations in what Medicare pays for care in different states, or even neighboring Zip codes. In 2001, the typical Medicare patient in Los Angeles cost the government $3,152 more than a comparable patient in the District. A patient in Miami cost $3,615 more than one in Baltimore.

Those disparities cannot be explained by differences in local prices or rates of illness, said John E. Wennberg, a Dartmouth physician and an expert on geographical variations in medical care. Rather, higher spending is related to the number of specialists, hospital beds and technology available. "If you have twice as many docs in a community," said Wennberg, "you end up with twice as many office visits."

Yet most high-spending states rank near the bottom in quality of care, Medicare data show. Louisiana ranked 50th in quality yet first in Medicare spending in 2001, the most recent year available. New Hampshire was first in quality but 47th in spending.

Andrew Samwick has more, including the original links.

Why Horses are Better than Llamas

Brad DeLong has had several excellent posts recently on Jared Diamond’s Guns, Germs, Steel (see here and here).  Here is my thousand words from Lima’s National Museum of Archaeology, Anthropology and History.

What I believe this shows is how an Incan/Andean would ride a Llama, the peculiar postion being necessary because Llamas are not very strong and this is the best way to spread one’s weight across the Llama’s back.  The caption did read "Llama usado como transporte" but I could not find any other information.