Category: Economics

SUV safety debate

A theme in writings about SUV’s (see here for a recent New Yorker article) is that consumers tend to overestimate SUV safety and grossly misunderstand the factors behind auto safety. The basic point is that safety comes from avoiding risky situations and quickly responding to danger. It turns out SUV’s tend to lull drivers into a false sense of safety and they respond more slowly to danger (e.g., SUV’s come to a complete stop much more slowly than many other popular types of cars). Because SUV’s are cosmetically altered trucks, they don’t have many basic safety features now standard in small cars or minivans, so you are more likely to die in an SUV accident than in another car (an anti-SUV site collects some Insurance industry reports). Consumer Reports has for many years argued that SUV’s are quite likely to tip over.

One response I’ve seen is to avidly defend consumer choice (see here for Car and Driver’s Brock Yate’s defense, or here for Peter Klein’s comment), or to minimize the SUV’s dangerous design. I think this misses a basic point. When events are infrequent (like fatal auto crashes), or when cause and effect are hard to link, people can opt to believe anything they want. All economics tells us is that markets are extremely good at responding to possibly erroneous consumer beliefs.

My take on this entire issue is that the central issue is liability. In general, you can’t hold someone accountable for the fatalities created by the use of a car with less then optimal safety features, any more than you can hold somebody accountable for the extra risk created by using a less than best bicycle, motorcycle or other device. In short, there is not much people can do about SUV safety because some people will always want to make the trade-off between safety and other product features.

Since the insurance industry is still willing to insure SUV’s, I wonder if the risk associated with them is tolerable given our current legal and economic standards. I invite knowledgable readers to email me information about how much more it costs to insure SUV vs. other vehicles.

Does the case for free trade require factor immobility?

Paul Craig Roberts has been claiming that the traditional case for free trade requires immobile factors of production. Michael Kinsley offers his [critical] understanding of the argument as well. I take the bottom line to be as follows. If labor can migrate, trade will not always benefit both countries, in all conceivable circumstances. Those laborers will move to the country with the strongest absolute advantage. This may lead to a brain drain at home, and perhaps crowding and lower wages in the recipient country. In other words, there are potential externalities from the migration of labor.

Another scenario is that American capital flows, say, to China, instead of Chinese labor coming to America. America will not experience overcrowding, nor will China have a brain drain. Still the real wages of some American workers might fall. Chinese labor will be concentrated in some sectors more than others. Certainly some American workers will be worse off, though economists will continue to insist that wealth as a whole will go up.

None of these arguments are new and they do not represent a novel critique of free trade. The first version of the argument suggests, at best, that we cannot currently move to complete free immigration. It does not dent the case for free trade. The second argument simply points out that wealth-improving policies do not benefit everyone.

The ever-insightful Daniel Drezner offers some further commentary on the new anti-free trade arguments. He also notes that the “factor mobility” scenario does not involve fundamentally new considerations from the “factor immobility” scenario.

The bottom line: We should take care to minimize the negative externalities from foreign trade and investment, and this is best done by well-functioning labor markets and sound macroeconomic policy. Basically Roberts is peddling snake oil. His argument boils down to old-style protectionism, dressed up in new rhetorical garb, not new substance.

By the way, as an economist, I sometimes receive irate emails telling me I have never had to compete with subsidized foreign workers. It is then suggested that if I faced such competition, I would not favor free trade. This description of the facts is not true. Most of my Ph.d. class at Harvard came from other countries, and many of them were heavily subsidized by their governments. I was not subsidized by the American government and yet I had to compete with these people for jobs.

Addendum: See further remarks by Joseph Salerno. See also Truck&Barter., which offers further links of value.

Free trade and factor price equalization

I agree with the sophisticated points that Tyler makes above regarding free trade. The more basic point, however, is that contra Paul Craig Roberts and Charles Schumer, the theory of free trade does not rely on factor immobility. In fact, the theory shows that free trade and factor mobility have similar effects. Free trade in commodities tends to create factor-price equalization – i.e. the same prices for wages and capital of equal productivity everywhere in the world even when the factors themselves are immobile. But factor price equalization is exactly what would be produced by factor mobility. You can be against free trade or be for it but being against the theory in one form and against it in another is just wrong.

You are a better bargainer than you think

Negotiators tend to think they are more transparent than they truly are. They believe that their negotiating partners can discern their thoughts, and negotiating positions, when in fact the partners are clueless. See the experimental evidence from this recent paper by Leaf van Boven, Thomas Gilovich, and Victoria Medvec. There is good evidence that we send involuntary signals of our own trustworthiness. Still, we do not always have a good sense of how those signals are interpreted by others.

The basic result may stem from a kind of excess sympathy. The negotiator tries to put herself in the position of the “other mind,” but cannot eradicate the knowledge of her own bargaining position. So the model of the other mind contains more self-knowledge than is rationally justifiable. Related results have been found in other areas. Individuals overestimate how much others pick up on the cues from their facial expressions. Similarly, individuals who are laughing think they appear more expressive than they do to others. As for bloggers, well, they probably think that readers pick up more of the nuances of their writing than is the case.

The return of Horatio Alger

Paul Krugman published a December article in The Nation called “The Death of Horatio Alger.” He argued “America actually is more of a caste society than we like to think. And the caste lines have lately become a lot more rigid.”

Recent research by Kerwin Kofi Charles and Erik Hurst looks at intergenerational mobility in more detail. Here is a brief summary of the article, and here is a pdf of an earlier version of the paper.

The published version, “The Correlation of Wealth Across Generations,” in the December 2003 Journal of Political Economy, tells us the following:

1. “Age-adjusted parental wealth, by itself, explains less than 10 percent of the variation in age-adjusted child wealth.”

2. 20 percent of parents in the lowest quintile of the parent’s wealth distribution have children who end up in the top two quintiles of their generation. One-quarter of the parents in the highest wealth quintile end up with kids in the two lowest quintiles.

3. The age-adjusted intergenerational wealth elasticity is 0.37. What does this mean? If parents have wealth 50 percent over the mean in their generation, the wealth of their children will be 18 percent above the mean in the childrens’ generation.

4. Income levels account for about one-half of the parent-child wealth relationship. In other words, high income parents tend to produce high income children, to some extent. The children earn much of their wealth. Education and financial gifts account for very little of the correlation across parents and children.

5. Parents and children allocate their financial portfolios similarly, whether for reasons of genes or learned behavior. These common patterns of investment and savings are the second biggest factor behind the intergenerational wealth correlations we observe.

Note that the figures above do not include income from bequests. In this regard they underestimate some of the intergenerational correlation. On the other hand, large numbers of individuals do not receive bequests until they are at least in the 50s, so the figures measure the opportunities open to them in the earlier stages of their lives. And note that the data are recent, the wealth of the children is measured in 1999.

So what is the bottom line? Yes, there is some correlation in wealth across the generations. But most of that correlation (almost seventy percent) comes from continued hard work and savings. The authors do not examine Krugman’s claim that mobility once was greater, but it seems premature to suggest that the American dream is gone.

Addendum: offers some useful discussion and links, here is Daniel Drezner’s treatment, again replete with links.

Why do Japan and China keep on buying dollars?

The dollar has fallen about twenty percent against the Euro in the last year but China and Japan continue to accumulate large dollar surpluses. At the same time, many economists worry that they will dump their holdings, sending the dollar into a free fall.

Michael Dooley, Peter Garber, and David Folkerts-Landau suggest that this financial policy is no accident. They view the Chinese and Japanese as pursuing deliberate full employment policies. They buy and hold dollars, not as an investment, but rather to subsidize their own exports. Read this summary of the argument, or buy an NBER working paper here. Garber puts the point bluntly:

“The fundamental global imbalance is not in the exchange rate,” Garber told the IMF forum in November. “The fundamental global imbalance is in the enormous excess supply of labor in Asia now waiting to enter the modern global economy.”

Garber estimates that there are 200 million underemployed Chinese who must be integrated into the global economy over the next 20 years. “This is an entire continent worth of people, a new labor force equivalent to the labor force of the EU or North America,” he explains. “The speed of employment of this group is what will in the end determine the real exchange rate.”

Garber likens the global labor imbalance to the collision of two previously independent planets — one capitalist and one socialist. “Suddenly they were pushed together to form one large market,” he says. The best way to restore equilibrium is for the former socialist economies to pursue export-led growth — and for the United States to act as a buffer and absorb the world’s exports.

Brad DeLong says he doesn’t believe the argument because the U.S. trade deficit is too large relative to the American economy. Brad predicts a revaluation of the Asian currencies within three years. Garber predicts that the new arrangement can last until another 200 million migrating Chinese find jobs. Either scenario would be better for the U.S. economy than some of the scare stories suggest. A weaker dollar in Asia would help correct the U.S. trade imbalance and it is unlikely that the Chinese would allow the yuan to rise so rapidly that the dollar would plummet. And if the current arrangement can continue, so much the better. The bottom line is this: the world economy, in real terms, is drawing on a massive “free lunch,” namely migrating Chinese labor.

Movie Cramming

So many great films to see, so little time. Return of the King, Mystic River, Monster, House of Sand and Fog – all are Oscar contenders and all are showing now. Roger Ebert rates Monster as the best film of 2003 despite the fact that it opened – in NY and LA only – on December 24. Of the last 25 Best Picture Oscar winners, 12 were released in December and only 3 were released in the first half of the year. Why?

I think the main reason is the pull of the Academy Awards – this year the awards are on Feb. 29 and voting occurs in late January and early February. The studios figure, probably correctly, that Oscar voters have poor memories so a film that opens late in the year has a better chance of winning than one that opens early. (The theory is a little hard to test because of the self-fulfilling prophecy problem but I think there is some truth to it.)

The unfortunate result is to reduce total movie revenues. We and the studios would probably be better off if the good movies were spread throughout the year, giving us more time to see each one, but such a situation is not stable because opening late gives a movie an advantage even if that advantage tends to disappear when all the studios act similarly (the prisoner’s dilemma).

Can the problem be fixed? The Academy could ask for ratings several times a year although this would require rating on absolute scale (like 1 to 10) rather than just voting for the best film. A graduated tax based on release date would do it in theory but I’m not optimistic about the practice. What I’d really like to see is other organizations such as the LA Film Critics go to a fiscal-year award cycle and make their awards in July. I know, it’s an idea only an economist (or an accountant) would like.

Is it better to be a small nation?

Of the ten richest countries in the world in terms of GDP per head, only two have more than 5m people: the United States…and Switzerland, with 7m. A further two have populations over 1m: Norway, with 4m and Singapore, with 3m. The remaining half-dozen have fewer than 1m people.

The Size of Nations, a new book by Alberto Alesina and Enrico Spolaore, addresses why some small countries have done so well. Here is a related working paper by Alesina, here are some related working papers by Spolaore. As some of the larger empires of the past break up, questions of national size increase in importance. More than half the world’s countries have fewer than six million people, roughly the population of the state of Massachusetts.

The Economist offers the following summary:

The book argues that the best size for countries is the result of a trade-off between the benefits of scale and the costs of heterogeneity; and that openness to trade alters this trade-off. The gains from being big are considerable. Large countries can afford proportionately smaller government (although they often don’t). Essential running costs can be spread over many taxpayers. Embassies, armies and road networks are all likely to cost less per head in populous countries. Defence in particular is cheaper for giants. “It is only safe to be small in a peaceful world,” say the authors (who, unusually for economists, offer two stimulating chapters on conflict, war and the size of nations).

Large countries are able not only to spend more efficiently; they can also raise taxes in more cost-effective ways. Income taxes are more efficient than customs duties, but require a bigger initial bureaucracy. Large countries have bigger internal markets, allowing more specialisation and returns to scale. And they can redistribute resources geographically, providing insurance when one part of the country is hit by disaster or recession and shifting income from rich regions to poor ones.

So why don’t all countries merge into one large superstate? Well, smallness has its benefits too:

…large countries are also likely to have a diverse population whose varying preferences and demands a government may find hard to meet: America, Brazil and India are cases in point. A study of local government in the United States suggests that Americans are willing to put up with the higher running costs of small municipalities and school districts in exchange for living in communities with little variation in income, race or ethnicity. This could imply that people also prefer to live in more homogeneous countries. With the main exception of America, successful big countries (such as Japan) have relatively homogeneous populations.

The authors argue that a worldwide regime of free trade will make the optimal size of nations smaller. If you can trade with other nations, there is no need to be large to ensure an open internal marketplace. So rising globalization should make secession easier to endure, which indeed seems to be the case.

My take: I am less convinced of the benefits of smallness. Think of small countries as having greater scope for experimentation, and thus a higher variance of outcomes. They also pop in and out of existence at a higher rate. Brazil will always be Brazil, but the fortunes of Croatia have varied over the years. If we look at the small countries that continue to exist, there is positive selection bias. We should expect them to do better than average, as the failures disappear, unlike with the less politically fluid larger countries. The observed superior performance of small countries does not mean that ex ante you should prefer to live in San Marino. In a small country, you face some very real chance that your system will fail, and that you will cease to exist, possibly under unfavorable terms. Especially if you are risk-averse, there is much to be said for the security of living in a larger nation.

Facts about gift-giving

A recent Australian article cites some facts about gift-giving:

1. 28 per cent of surveyed respondents admitted that they “recycle gifts.”

2. Women give Christmas gifts to more people than do men. The average difference is 12.5 versus eight.

3. Women devote more time to selecting the appropriate gift, 2.4 hours per recipient versus 2.1 hours for male gift shoppers. [I will surmise, without any systematic data, that the real difference is far greater.]

4. Women are more successful in finding desired gifts. 10 per cent of women’s gifts were returned to the shop, as opposed to 16 per cent for gifts given by men.

A good theory of gift giving should account for the greater popularity of gifts among females. I could not help but notice that during my recent honeymoon, my wife bought gifts for many of her friends. I bought family-related gifts, but did not buy a gift for a single friend.

The linked article notes one theory of gifts, called the search theory:

…gift giving makes sense in cases where the giver’s knowledge of where to find something the recipient wants is greater than the recipient’s own knowledge. Or if the giver is in a position to get it cheaper. So the rule is that the giver gives a gift only when her “search costs” for the gift are lower than those of the recipient.

This emphasis on the hassle involved in finding suitable presents helps explain why, even though it’s regarded as poor form to give money, parents are more likely to resort to money as their children get older. The parents’ search costs rise as they become less certain what their kids would like, whereas the kids’ search costs fall as they become more independent. This theory also helps explain why people who go on trips return with presents. Their gifts tend to be things that are dearer or harder to find at home. Even so, it’s hard to believe the theory accounts for more than a fraction of gifts.

The search theory explains some of observed practice, but not why women devote more attention to gift-giving. Perhaps women, having lower average wages, also have lower average search costs. More likely, women find it more worthwhile to invest in a tight network of extended family and close friends. Men might find it more worthwhile to invest in a goal-oriented mentality, which will discourage large amounts of time spent shopping. When it comes to shopping more generally, gifts or not, men take less time, are more decisive, more prone to impulse purchases, and less likely to look at the price tag. Read this account of gender differences in shopping. Buying gifts may require an attention to shopping detail that men simply do not have in the first place.

Cadavers for rent

In most of the world socialist ideas are practically passe, but in Africa they are still killing. In a few short years, Zimbabwe under Robert Mugabe has gone from being the breadbasket of Africa to being on the verge of mass starvation. Only a handful of stalwarts warned of the dangers when in the 20th century large parts of the world descended into economic insanity and political barbarism. At the beginning of the 21st century, virtually the entire world knows of the dangers and Zimbabwe yet descends.

Read Samantha Power’s Atlantic article How to Kill a Country for the full tragedy. I will quote only one semi-amusing aspect that illustrates, once again, some of the absurd consequences of price controls.

[Mugabe] fixed the price of a loaf of bread at half the bakers’ break-even price, and levied astronomical fines on any baker who charged more. Bakers stopped making bread until somebody noticed that sesame bread, a “luxury item,” wasn’t price-controlled; by sprinkling a few sesame seeds on their standard loaves, bakers were able to get back in business. A pair of mortuary workers were arrested recently for running a profitable “rent-a-cadaver” business: because Mugabe had decreed that drivers in funeral processions would get privileged access to the trickle of fuel coming into the country, these entrepreneurs had begun leasing bodies to Zimbabwean drivers.

House of Sand and Fog and Preferred Children

Economists like to say that behavior reveals preferences. I just finished watching House of Sand and Fog, which reveals a most discomforting preference, albeit in extreme form. Be warned: I’m going spoil the plot, so don’t read any further, unless you’ve seen the film or don’t care to.

The movie is about a woman (Jennifer Connelly) who loses her home as a result of tax delinquency. An Iranian immigrant (Ben Kingsley) buys the home at auction, hoping that the difference between the auction price and the market price will pay for his son’s college tuition. The woman and the Iranian immigrant get into a violent confrontation, resulting in the accidental shooting of the man’s teen age son. Here’s where revealed preference comes into play: When the Iranian man sees that his son has not survived being shot, he kills his wife and himself. The character does not believe life is worth living if his son is dead… however, his newly wed daughter is still alive!! Conclusion: The character believes life is only worth living for his son, not his daughter.

Just another case of twisted movie logic? Maybe not. I’d venture that this is an extreme case of favoring sons over daughters. Steven Landsburg discusses some strong evidence that this is the case, even in contemporary America – census data shows that couples with female children are 5% more likely to divorce. In Viet Nam, having a female child increases the chance of divorce by 25%!! A lot of people seem to believe daughters are not worth sticking around for, and Kingsley’s character takes this to an extreme.

Readers are invited to email me extreme or strange examples of films, or other popular culture, showing characters favoring sons over daughters.

Mexican tax reform fails

Reforming Mexico’s tax system, which is rampant with corruption and inefficiency, has been a pillar of Fox’s agenda since he was elected in 2000. Mexico raises less revenue through taxation than nearly any other Latin American country, just 12 percent of its $600 billion gross domestic product. Fox has argued that improving tax collection is essential to increasing government investment in such key areas as education, health and welfare programs to alleviate the poverty that afflicts more than half of Mexico’s 100 million people.

The failed plan would have levied a six percent tax on food and medicine, a highly unpopular notion. More generally, the VAT would have been lowered but applied with fewer exemptions. Here is a summary of why the plan failed politically. Now the Fox reformist agenda is considered dead.

The big loser, of course, is Fox. But the reforms were by no means a complete positive. Fox claimed he needed the additional revenue to help the poor, but then why tax food and medicine? If Mexico wishes to raise more revenue, why not simply eliminate VAT exceptions?

Mexico’s low tax collections have been the country’s blessing and curse for many decades. The Mexican economy has been one of the most dynamic of the twentieth century, growing at an average rate of more than five percent per annum. The fiscally starved government, however, has become almost completely corrupt. One reason is that public sector salaries are so low. The time probably has come to improve the quality of the public sector, it now seems that Fox is not the politician to bring the country there. In his three years in office he has yet to win a single major legislative victory.

Productivity and unemployment

I am growing increasingly annoyed with people who argue that the dark side of productivity growth is unemployment. The Economist, which ought to know better, says we are overproductive. CNN Money discusses the problem of productivity, the President blames productivity growth for unemployment. Even someone as sophisticated as Brad DeLong writes “with productivity surging, it’s hard to be pessimistic about GDP growth, but it’s easy to be pessimistic about unemployment” which seems to suggest that if only productivity growth were lower, employment would be higher.

And yet the “dark side” of productivity is merely another form of the Luddite fallacy – the idea that new technology destroys jobs. If the Luddite fallacy were true we would all be out of work because productivity has been increasing for two centuries. Sure, some say, that may be true in the long run but what about the short run? Even in the short run there is no necessary connection between productivity growth and job loss. In the computer industry, for example, productivity growth has led to falling prices and a bigger not smaller industry. If demand is inelastic then productivity growth can create short-term unemployment, especially at the level of the industry experiencing the growth – less likely but not impossible is that productivity growth leads to short-term economy-wide unemployment.

The more typical case, however, is that productivity growth leads to higher real wages and lower unemployment. Indeed, in the now fairly standard real business cycle models a boom is caused by a positive productivity shock and a recession by a negative shock. Empirical evidence supports the idea that positive productivity shocks lead to lower unemployment.

Why then do we see in very recent data a correlation between productivity growth and unemployment? One reason may be reverse causation. When firms fire workers they tend to fire the least productive first leading to an increase in average productivity. Workers may also work harder when unemployment threatens (an efficiency wage explanation). Thus, an increase in unemployment can cause an increase in productivity per hour. But in such a situation diminished productivity would certainly not lead to higher employment!

Bottom line in my opinion is this: productivity growth and unemployment are mostly unrelated. If productivity growth were currently lower we would have lower real wages and unemployment would be just as high. As a rule – and as a rule to follow – productivity growth is an unalloyed blessing.

The new German economic reforms

Earlier in December Germany passed some much-needed economic reforms. Germany hopes to avoid its growing reputation as the “sick man of Europe.” It has been plagued by slow growth and double-digit unemployment for decades now. The key measures of the reform included the following:

1. An $18.9 billion tax cut, adding $11 billion to a previously planned cut. Note that this is a tax cut, not a spending cut.

2. A weakening of job protection rules, especially for firms of less than ten people. This is the best element of the package.

3. Stronger financial incentives for the jobless to take work. That being said, most of these changes are small adjustments in the numbers rather than a real kick in the pants.

4. Consolidation of some unemployment and social help benefits. Nowhere do I see this described as a real spending cut, although perhaps it will eliminate some costs of administration in the long run.

5. Restrictions on various tax exemptions and a greater unification of the tax code. Read: some small tax increases. This includes an explicit tax increase on tobacco, an elimination of tax deductibility for some commuting expenses, and a tax amnesty designed to raise a burst of revenue. Of course the long-term implications of amnesty encourage more tax cheating.

Here is (not very useful) summary in English of the new policies. Here is a longer and more detailed German treatment, also read this from the FAZ as well.

My take: These measures are better than nothing but they address only a small fraction of the German problem. Looking at who voted for them — the Social Democrats — is enough to illustrate their weakness. That being said, Germany appears to be in the midst of a mild recovery of expectations, so if these reforms get the credit all to the better. It might make further improvements possible.

Perusing the German articles is revealing, whether or not you read German. The country has policies called the “Werbungskostenpauschbetrag,” “Vermoegensbeteiligung,” and of course the “Bewirtungsaufwendungen.” As Mark Twain might have suspected, simply pronouncing and spelling out these words is likely to put a dent in your growth rate.