Category: Economics

Tell us how "Knightian uncertainty can be made operational"…

Knightian uncertainty is not usually important when you are playing the first twenty (or is it these days thirty?) moves of a Ruy Lopez in grandmaster chess.  When Knightian uncertainty matters, we should observe market participants investing more in opportunities for serendipitous discovery.  This might, for instance, mean buying new books on a lark, traveling randomly around the world in search of insight, and in general mimicking wunderkind Ben Casnocha.

Do you think Knightian uncertainty is important in labor markets?  If so, go out and hire some people on the basis of rumors.

Norton A. Myers’s new and excellent Happy Accidents: Serendipity in Modern Medical Breakthroughs: When Scientists Find What They’re NOT Looking For is one of the best books I know of on science.

#18 in a series of 50.

[Please discuss the] relationship between age and productivity.

Economics has a real problem.  The smartest people, by the time they are forty (if that), have extremely lucrative opportunities for consulting.  They can earn hundreds or thousands of dollars an hour.  Most of them cash in, even if they continue to produce good work based on 80 percent of their core attention and capabilities.  We get a steady stream of young innovators, but we have few truly deep thinkers at the top of their game. 

On the other hand, the economics profession stays broader than it otherwise would be.  Non-lucrative fields, such as public choice, economic history, and cultural economics, keep their best thinkers to a greater degree, relative to econometrics and finance.  But perhaps these low-paying fields attract fewer really bright people in the first place.

#17 in a series of 50.

Ezra Klein tells me to go out there and tell people I support unions.  I do.  Alex likes unions too.  But we felt unions do not go far enough.  So we bypassed the capitalist altogether and started marginalrevolution.com.  (The sinister Jane Galt, on the other hand, rules over Winterspeak and Mindles with an iron fist and rakes in all that Amazon revenue for herself, surely they need to combine against her.)  MR is run solely by its laborers and when it comes to decision-making I can assure you there are no secret ballots. 

Labor-run firms are common in law, book agency, real estate, landscaping, and many other sectors; we even see them in airlines.  When labor in charge creates more value, labor starts its own firms or buys out the capitalist or buys greater control rights.  Growing capital markets make these evolutions easier all the time.  Cooperatives, which are governed by consumers, also are found.  Mutuals, non-profits, and yes unionized firms are common too.  I heart all of these organizational forms.  Keep in mind that if both workers and customers will be better off, yes it probably can happen; it is naive to think that liquidity problems are the major issues preventing workers from enjoying greater control rights.

In the short run, the mental model of the left-wing bloggers is a bunch of janitors trying to get better working conditions but opposed by employers.  In the longer run what is striking is the competition across different organizational forms.  It doesn’t always make sense to give labor residual control rights over capital goods, or the right to halt production. 

Forthcoming, the editor is the excellent Isaac Ehrlich, the board of editors is all-star: Daron Acemoglu, Gary Becker, Mark Bils, Geogre Borjas, Edward Glaeser, Claudia Goldin, Robert Hall, James Heckman, Robert Lucas, Kevin Murphy, Edward Prescott, Nancy Stokey.

A loyal MR reader asks about prospect theory.  I feel it is usually too experimental and too ad hoc, are those really the general biases out there in markets?  I was heartened to see the following good paper (non-gated here) on prospect theory and the stock market.  The abstract:

We study the asset pricing implications of Tversky and Kahneman’s
(1992) cumulative prospect theory, with particular focus on its
probability weighting component.  Our main result, derived from a novel
equilibrium with non-unique global optima, is that, in contrast to the
prediction of a standard expected utility model, a security’s own
skewness can be priced: a positively skewed security can be
"overpriced," and can earn a negative average excess return.  Our
results offer a unifying way of thinking about a number of seemingly
unrelated financial phenomena, such as the low average return on IPOs,
private equity, and distressed stocks; the diversification discount;
the low valuation of certain equity stubs; the pricing of
out-of-the-money options; and the lack of diversification in many
household portfolios.

In other words, we can think of stocks as a lottery ticket.  They offer a chance at the thrill of victory, and not just a mean-variance pair; this may help explain various pricing and return anomalies.  Am I convinced?  No.  Am I moved?  Yes.

#16 out of 50.

Idlehands points to this paper (QJE 2004) by John DiNardo and David Lee.  Neither author is a crazy right-winger, let’s hear their message:

Economic impacts of unionization on employers are difficult to estimate in the absence of large, representative data on establishments with union status information.  Estimates are also confounded by selection bias, because unions could organize at highly profitable enterprises that are more likely to grow and pay higher wages.  Using multiple establishment-level data sets that represent establishments that faced organizing drives in the United States during 1984-1999, this paper uses a regression discontinuity design to estimate the impact of unionization on business survival, employment, output, productivity, and wages.  Essentially, outcomes for employers where unions barely won the election (e. g., by one vote) are compared with those where the unions barely lost.  The analysis finds small impacts on all outcomes that we examine; estimates for wages are close to zero.  The evidence suggests that-at least in recent decades, the legal mandate that requires the employer to bargain with a certified union has had little economic impact on employers, because unions have been somewhat unsuccessful at securing significant wage gains.

Keep in mind what this means.  Once we control for endogeneity in where unions are formed, there may not be a union wage premium at all.  (A few posts ago I was telling you it was 10 to 20 percent, learn something new every day, etc.)  I learned also that when we look for the wage premium in establishment-level data, rather than household data, it usually isn’t there.  And that’s without considering the contribution and method of the authors.

I would like the highly intelligent left-wing part of the blogosphere to respond to this paper and to the Hirsch piece.  Here is an NBER version, here are other copies.  By the standards of labor economics, it does not suffice to note that the 1950s had both a more equal income distribution and more unions, or to call Western Europe a kinder, gentler place.  Those citations don’t sort out cause and effect, and in fact we do have more advanced ways of scrutinizing the data.

It is fair to say that these papers do not support the "right-wing scaremongering" scenarios about unions.  So a Kevin Drum might claim: "well, it can’t hurt to try more unions."  That still represents a significant downgrading of the original vision.  Unions are an emotional issue for the left, much as free trade and the fall of communism are so for the right.  Would it not be meaningful and rallying for the left to have the battle over collective bargaining once again?  But I am telling you all, there simply isn’t that much there.

By the way, here is Bloggingheads.tv with Megan and Matt on unions, can you imagine that?

I’ve spent the last few days perusing the economics of unions.  I’ve unearthed Barry T. Hirsch’s useful and serious piece, which looks at whether the Freeman-Medoff pro-union work from the 1980s has held up.  Here are a few select quotations from the article:

…while it is true that much of the negative relationship between unions and growth is not causal, slower growth is partly attributable to the lower profits and investment resulting from union rent seeking.

Empirical evidence on unions and productivity was rather sketchy in 1984; it remains less than clear-cut today.

…union firms reduce investment in physical and innovative capital, leading to slower growth in sales and employment and shrinkage of the union sector.

…empirical evidence for skill upgrading [through union participation] is weak.

The thesis that unions substantially increase productivity has not held up well.  Subsequent studies are as likely to find negative as positive union effects on productivity.

…employment declines have been concentrated in the unionized sectors of the economy.

…the empirical evidence finds that U.S. unions are associated with slower employment growth…

I am genuinely puzzled why the highly intelligent segment of the left-wing blogosphere is so attached to the legal encouragement of labor unions.

To some extent higher union wages translate into higher prices for consumer goods.  Over a five year time horizon I’ll guess at 50 percent pass through, adding that most of these goods are bought by other laborers.  Just to be flippant, for each dollar gained by a union member, I’ll guess that labor market "outsiders" lose 50 cents.

Notice we haven’t even counted negative effects on the rate of future economic growth, or for that matter costs to employers.

We already don’t have workers, viewed as a class, coming out ahead.

I would be curious to hear the numbers assumed by those who wish to encourage labor markets by law.  I would be curious to hear how much they think, over say a ten-year time horizon, wages deviate from labor productivity.

Inquiring minds wish to know.

Many of you say paternalism is to protect the very stupid.  Would you support Would-Have-Banned stores with an min IQ rule?  If so, what would that IQ be?

That’s Robin Hanson, advocating stores devoted to selling banned products.

We’re all taught that in a competitive industry price will equal marginal cost.  Well, what is a competitive industry?  There are lots of Chinese restaurants in or near Fairfax, and with a few noble exceptions they have more or less the same menu.  Each could serve an extra diner at essentially zero marginal cost, yet the price of the food is not zero.  Not even marginal meals are given away for free, except perhaps to the staff.  If price is equal to marginal cost, we have to ask equal to which marginal cost?  The marginal cost of one more Kung Pao Chicken?  The marginal cost of being known for giving some meals away?  The marginal cost of possibly setting off destructive price competition with rivals?  The concept of marginal cost relies on a definition of time horizon, strategic assumptions, and the counterfactual against which real world action is being compared.  Yikes.

Armen Alchian and Fischer Black are the guys to read on what cost really means (Buchanan and the Austrians only get you so far).  If you really want to get dizzy read Lester Telser on when there is a core, and wonder whether the industry you have in mind meets his screwy but essentially correct standards for MC, AC, and no coherent equilibrium.  It’s not just the airlines.  So when is price equal to marginal cost, average cost, or some blend of the two?  And which definitions of average and marginal cost? 

What about "reality"?  Toss a bone to social frictions, then ask for some micro-studies of how "competitive" industries price in the short run.  Use interviews and ethnography to supplement the formal models.  In practical terms, you might end up with some understanding of a) why prices can be sticky in apparently competitive industries, and b) why few businessmen — including high IQ types — will admit to pricing at marginal cost or even understand what that means.

The bottom line: I’ll say that MC is flat if truly all inputs are replicated.  But that’s never the case, so MC is usually zero under one set of counterfactuals and sloping upward dramatically under another set.  That’s not the end of the world, live with it.

The second bottom line: When it comes to teaching the students, just tell them that marginal cost slopes upward at some point.  After all, sooner or later they all stop studying.

The third bottom line: #13 out of 50.

Steve Levitt wonders.  My view: in a given WSJ issue, there will be a small number of wonderful bits, and a whole lot most people don’t care about, like the notices of the debentures.  A free web site would make it too easy to cherry-pick the interesting content, strip it down, and reproduce it and circulate it without the ads.  Even if WSJ could enforce a price on the unbundled content, bundling can facilitate price discrimination, especially when the diversity of valuations of bits is high.

The FT, which also has a gated web site, is similar; their best article on a given day is wonderful, but I don’t read most of what they offer.  Many mornings I won’t even open up the second section, who cares about European debentures? 

When your newspaper is more like a "thicket," the best packaged version of that paper is the paper’s website itself and useful unbundling is difficult.  Note that the so-called chaff business notices in the WSJ are in fact intensely interesting to the few people they immediately affect.  That makes it possible to charge for such news, even though it doesn’t contribute to producing a thicket of content for most readers.  We return to the potential dangers of unbundling, and the possibility of picking apart the WSJ until it isn’t a newspaper any more.  An upfront charge makes sure the value is reaped before most of the paper is discarded.

Ezra Klein has an interesting post on union elections, favoring greater unionization; Jane Galt is not persuaded. [Addendum: Mark Thoma has more.] 

I propose a deal.  I’ll agree that unions, in the best natural experiments we have, boost wages by about 10 to 20 percent.  On the other hand, will Ezra (and others) agree that unions are mostly detrimental to the rate of economic growth?

If so, the utilitarian evaluation will boil down to the choice of discount rate, keeping in mind that under the left-wing account the gains follow mostly from redistribution more than from wealth creation.

Admittedly the empirical literature on unions and economic growth is murky.  But it does seem that in non-socialist societies, more unionization lowers the growth rate.  (In socialist societies, it may be that economy-wide unions internalize some poliitical externalities and lead to better policy, a’la Mancur Olson.)  These papers are easy enough to criticize, so I’ll admit I am more convinced by simple theory here than by any empirics.  Unionization raises the cost of many growth-enhancing business decisions, such as layoffs or implementing technical progress.

Union supporters?  Do we have an epistemic deal about how you are willing to lower the growth rate?  And can we pull your true discount rate from the Stern/global warming debates?  (I recall Jane once writing that a zero discount rate would require her to revise everything she believed, but I think the opposite is sooner true.)

Oh, did I mention that the union wage premium, especially for private sector employees, has been declining and may be disappearing altogether?

And no, I will not be moved by sarcastic attempted reductios which pretend that enslaving the workers would raise the growth rate too.  Figure out yourself what is wrong with that.

Addendum: Johan Richter asked for: "Your preferred policy towards unions," so I’m calling this #12 out of 50.  My preferred policy is laissez-faire, noting I have never been a right-wing, union basher, Morgan Reynolds sort of guy.  But I see encouraging unions through the law as a relatively short-sighted solution to the problems of labor and the desire to raise living standards.

A loyal MR reader asks:

What is currency and what are the potential implications of a
completely digital currency that could have unlimited meta information
attached to it? [Some obvious implications would be tracking
transactions and the government’s ability to enforce taxes, etc., some
more esoteric stuff would be attaching conditions much like covenants,
say that a particular payment could only be used to buy products that
were carbon neutral, possibly down the road having policy implications.]

Higher taxes and carbon offsets we’ve already covered.  More generally, the use of "covenant currency," as I shall call it, would raise prices.  Restricted money simply isn’t worth as much.  It also would lead to a secondary market in currency.  Say you paid with me with money that can only be used to buy corn from Africa.  I’ll try to resell that money to the people who were going to buy corn in Africa anyway.  Of course the supply of targeted covenant money for that end may exceed the demand for it, and then price will adjust; think of this as an extreme form of legal tender laws.

Would it ever be efficient to use covenant money?  I doubt it.  It is a tax — on the holding and use of cash balances — when a simple transfer would do.  Use regular money for your transactions and, if you wish, send some cash to the corn sellers of Africa.

Inflation is also a tax on cash balances, and few people think that is the right or the best fiscal way to finance subsidies to various worthy groups.

#11 in a series of 50.

A loyal MR reader asks:

What are your thoughts on the new dynamic optimal public finance policy models being built and simulated?  Will they yield any new insights applicable for the real world, or are they a fad?

Real insights maybe, real measurements for sure.  I take this paper by Mankiw to be a paradigmatic example.  Through this body of literature we learn, or confirm our previous intuitions, that:

1. Cutting U.S. income tax rates is not, in general, self-financing.  We also get a rough idea of how much revenue we can make up in the long run.

2. Many forms of corporate and capital income taxation are, in the long or even medium run, inefficient.

3. Ideally we should move to a consumption tax.  (NB: Moving outside the models, I am scared that this kind of tax reform will just turn into another tax increase.  We’ll add a VAT to income taxation rather than shift to the VAT.  Yikes.)

These results are the bread and butter of applied public finance.  You can complain all you want about the assumptions, the artificiality, and the use of intuition to throw out unacceptable calibrations, but at the end of the day there is not a better way to do the work. 

A fad, perhaps, but there is nothing wrong with that.  The Beatles were a fad too.

By the way, here is an interesting paper on a different frontier in public finance, namely field experiments.

#10 in a series of 50.