Category: Economics

Markets in everything

A woman [Yuolanda Taylor] who police say sold stones to rioters in a southwest Michigan city last year and used the money to pay her cable television bill has pleaded no contest to inciting a riot.

Police said Taylor toted rocks through a riot-wracked neighborhood, selling small ones for $1 each and bigger ones for $5. Prosecutors said the rocks were thrown at police.

Taylor told police she collected about $70 selling rocks, but quit when she got hit by one herself.

Here is the full story. Thanks to blogger John Wilson for the pointer.

The X,Y, and Z Prizes

The founders of the X Prize are going to offer new prizes “to meet the greatest challenges facing humanity in the 21st century.” But they have not yet settled on exactly what fields or what accomplishments and they are soliciting public input. I’ve already given my suggestion you can give yours here.

The sponsors offer some valuable thoughts on how to choose appropriate fields and prizes:

The X PRIZE competition focused on jumpstarting a private space industry has re-proven the principle – strongly proven in the early years of the 20th century for the aviation industry – that innovation can indeed be catalyzed. ….

Although the idea of using the X PRIZE concept work in other areas is at first glance a simple and attractive one, a great deal of up-front thought needs to go into what challenges/opportunities would be selected. One could argue that there were certain qualities about the challenges and opportunities in both the aviation field and the space field that lent themselves extremely well to a private sector competition of the sorts which have occurred. Variables to be looked at might include:

The maturity (or lack thereof) of the technology around which the competition would be based?
The maturity (or lack thereof) of the related industries from which a new industry would be born
The number of potential “competitors” potentially able to meet the challenge or at least the depth of the pool from which potential competitors could be drawn
The level of the specificity of the challenge
The financial resources potentially available to finance the potential competitors
The financial resources potentially available to finance the Prize itself
How potentially compelling and exciting is the field around which the challenge would be based
The amenability of the target area to a threshold change in public expectation
The replicability of the challenge to other areas?
The level of the presumed long-term benefit to business and society

The list of questions above is by no means exhaustive, but does give a sense of how the selection of a new challenge is not as first as simple as it may seem. It is absolutely key that the right challenges are selected – sufficiently exciting to compel hearts and minds, sufficiently ambitious to reach beyond what is already likely going to occur soon and to have a truly substantial impact, and sufficiently focused to have a good chance of succeeding within a reasonable timescale.

Nobel Prize update

Here is new information from the betting market. Ed Prescott has opened up a lead (then Barro, then Krugman), and Thomas Schelling has joined the list. Read my previous comments; the winner will be announced Monday.

As for tomorrow’s literature prize, John Updike, Margaret Atwood, and Philip Roth are the leaders.

Update: Here is the dark horse who won the literature prize, I am not a big fan.

Should the government subsidize mortgages?

Fannie Mae has $1 trillion in assets and owns or guarantees more than one-quarter of all American mortages. While the company is owned by private shareholders, its securities have an implicit guarantee from the federal government. In essence private debtholders, through the company, can fund mortgages at lower risk.

It now turns out that the company has engaged in questionable accounting and financial practices; the Wall Street Journal called them “stunning.”

Put aside the details of the current scandal, should Fannie Mae exist at all? Should we privatize the entity and move away from government guarantees?

There are two core arguments for government involvement in the mortgage market:

1. There are external social benefits to home ownership.

2. The mortgage market will otherwise be stunted by credit rationing.

On the first, while I enjoy suburban sprawl, I see no good reason to subsidize it.

How about credit rationing? Are there Americans who, in economic terms, should get homes but could not in a free market? A key assumption of most (Pareto-inefficient) credit rationing models is that you know your probability of loan repayment better than does your lender. (In that case lenders are afraid to extend a full menu of loans, for fear that the “lemons” will borrow the most.) I doubt if this informational asymmetry is true today. In most cases the lender, through statistical profiling, probably has a better predictive sense of the future than do self-deceiving borrowers. And for some skeptical empirical evidence on credit rationing, see this volume. Or just try reading your spam.

Even if some Pareto-inefficient credit rationing exists, I would rather wait for information technologies to alleviate the problem. The Fannie Mae behemoth involves financial risk for the taxpayer and sets a bad precedent for government involvement in capital markets.

The returns from innovation

In a recent NBER working paper – “Schumpeterian Profits in the American Economy: Theory and Measurement” – Yale economist William Nordhaus estimates that innovators capture a mere 2.2% of the total “surplus” from innovation. (The total surplus of innovation is, roughly speaking, the total value to society of innovation above the cost of producing innovations.) Nordhaus’s data are from the post-WWII period.

The smallness of this figure is astounding. If it is anywhere close to being an accurate estimate, the implication is that “society” pays a paltry $2.20 for every $100 worth of welfare it enjoys from innovating activities.

That’s from Don Boudreaux at Cafe Hayek. To some extent fame incentives alleviate underinvestment in new ideas. To some extent I advocate favorable tax and legal treatment for innovation.

Markets in everything

How about non-matching socks? LittleMissMatched.com sells you paired socks with different colors and designs. “That way, you would never have to worry about losing a sock,” says one company spokesperson [exam question: does this violate an axiom of choice theory, if so which one?]. The company, by the way, considers schoolyard bullies to be one of its greatest opponents. Here is the full story, New York Times password required.

It is not the case that each sock is strictly unique; the company is encouraging its (intransitive?) young customers to trade socks with each other, to obtain matching pairs.

Health Insurance and Health Costs

Tyler asks Why is private health insurance such a disaster? in particular he wants to know, Why does private health insurance perform so badly in holding down costs?

There are actually two issues. Tyler mostly questions the traditional arguments that insurance increases costs. I won’t deal with all of his arguments (today!) but consider the following:

The tax-free nature of employer-supplied insurance benefits encourages wantonness. (TC: Why? You can subsidize the purchase of apples, that doesn’t mean apples will be produced inefficiently or at “excess cost” for that level of apple output.)

True, but the phrase “for that level of output” contains a whole bag of tricks because subsidies will change the output level both in quantity and quality terms. Assume that there are two drugs, a cheap one at $10 and an expensive one at $20. You think the expensive drug is worth $5 more than the cheap one. With no subsidy you buy the cheap drug. With a 75% subsidy the cheap drug is $2.50 and the expensive one is $5 and the difference is now only $2.50 – you now buy the expensive drug. Thus there is no necessary production inefficiency but costs double.

So it is true that 3rd party payment will increase total costs. I think some of the other arguments that Tyler questions are also correct but these arguments do have another problem – one Tyler does not mention. To the extent that third party payment is not increasing, the increase in demand will cause a one-time increase in the level of prices/expenditures. What we see in the United States and worldwide, however, is a sustained increase in relative prices and expenditures and for that you need some factor that is also sustained – that factor is technological advancement. In real terms technological advancement lowers prices but when you combine that with an elastic demand for medical care nominal prices and expenditures increase. (When Christian Barnard performed the first open-heart surgery in 1967 he reduced the real cost of treating heart disease but increased expenditures on open-heart surgery).

In other words, health insurance companies don’t hold down costs because their customers don’t want them to. In this sense, I don’t think private health insurance is a disaster. The problem, if there is one, is in ourselves.

The Ig Nobel Prize in Economics

This year’s Ig Nobel prize in economics goes to the Vatican for outsourcing prayer.

A prize to Tyler, probably more Ig than Nobel, for flagging more than one future winner in Marginal Revolution including the aforementioned prize in economics and the prize in psychology for research on gorilla vision.

If you don’t yet know about the gorilla vision research, I encourage you view this Java video of a basketball game and try to count the total number of times that the people wearing white pass the basketball. Do not count the passes made by the people wearing black. When you’re done read Tyler’s post. As this award indicates some Ig Nobels are given for important research.

Should we privatize Social Security?

Brad DeLong argues that we should privatize social security. His ingenious analysis suggests that privatization could help overcome market failures of insufficient savings and insufficient investment in equities (the “equity premium paradox”). Turning the usual debates on their head, he argues that market fans should have no reason to support privatization, but interventionists might. Note that Brad was replying to earlier posts by Matt Yglesias and Atrios, both worth reading in their own right on the issue.

I agree with most of Brad’s analysis (though the equity premium matter is complex and poorly understood), but I am less sanguine about the privatization idea. I wish to privatize many things, but forced savings is not one of them.

Most of all, I am worried about the fiscal implications of this privatization. Current plans need not, in the long run, cost us any money, as Arnold Kling reminds us. But they do require a big tax increase in the short to medium run. In essence the proposed reforms stop collecting “pay as you go” contributions and move everyone possible toward private accounts. But during the transition an influx of money is still needed to pay off the current elderly, therefore the tax increase. And we are talking trillions here, not just small change.

Of course these taxes must come sooner or later, given that privatization is simply shifting future claimants out of the public sector expenditure nexus. So if we raised taxes today, to finance a transition, and cut them twenty years from now, social security privatization would be revenue-neutral in this regard (of course it could influence revenues along other dimensions).

Now you can see my fear. If we move to privatize social security, I predict that higher taxes today will mean still higher taxes tomorrow, not an eventual tax cut. People would grow to tolerate the higher taxes, and our ever-diligent Congress would find new ways to spend the money (don’t trust any promises to the contrary — remember when they told us that social security numbers would never be used for purposes of personal identification?).

I think of social security as having two parts: a welfare system for old people, plus a regime of forced savings for the young. The Bush plan cuts back on the welfare angle, but also would put the forced savings in the private sector.

If we were starting from scratch, I could imagine that a fully vested system of private accounts could make sense. But given where we are, I would like to see social security evolve into a system of welfare for the elderly, and junk the forced savings aspect. Keep in mind those “private” accounts will be regulated rather than truly private in the libertarian sense. They will channel benefits to government-approved providers, thus leading to bureaucracy, regulation, and costly commissions. And if anyone’s account goes bust, do you really think there will be no secondary safety net to bail them out? What if the whole market went bust for about ten years’ time?

One of the original virtues of social security was its minimum administrative costs and its relatively “clean” fiscal nature. Let’s not lose their properties of the system just to privatize something — forced savings — that should be a matter of voluntary choice in the first place.

So let’s push for means-tested benefits, and hope that social security slowly but surely shrinks and evolves to a welfare system for the needy elderly. It should not be a stranglehold over every mainstream employment relationship.

It may sound like a strange world where Brad DeLong endorses social security privatization and I oppose it. But given the other views we hold, this is where we each ought to end up.

Charter Schools

Caroline Hoxby is mad, and rightly so. In August, the American Federation of Teachers released a study attacking charter schools because charter school students performed worse than their public school “peers.” The study got huge media attention, including a front page article and editiorial in the NYTimes, despite the fact that it is not a very good study – lagging far behind its peers in the academic literature.

The main problem is that the study doesn’t do a very good job at comparing peers. The most credible studies look at the achievement differences between randomly assigned students (as did the study on private schools in Colombia I discussed earlier). When charter schools are over-subscribed (which often occurs – a sure sign that parents think they are superior to more traditional public schools) students are sometimes selected by lottery. Using data on randomly assigned students in Chicago, Hoxby and co-author Jonah Rockoff find significant achievement gains for the charter school students (paper, executive summary). (Surprise! When given the opportunity, parents can pick good schools.).

Another problem with the AFT study is that it uses a relatively small sample, about 3% of charter students in the fourth and eight grades. In another paper, Hoxby examined tests from 99% of 4th grade charter students. It’s not possible to use a randomized study when you look at nearly all charter school students so instead Hoxby compares charter students to students in the nearest regular public school and the nearest regular public school with a similar racial composition. For the latter comparison she found that charter students were 5% more likely to to be proficient in reading and 2.8% more likely to be proficient in math – small but meaningful improvements. And in places where the regular public schools are especially bad, like Washington DC, charter students were about 36% more likely than their peers to be proficient in reading and math!

Despite the fact that Hoxby’s studies are of far higher quality than those of the ATF and other groups you don’t see her work trumpeted across the front page of the NYTimes. And it’s not as if Hoxby isn’t well known, she is a Harvard professor whom several years ago The Economist listed as one of the best young economists in the world. As Brad DeLong might ask in another context, Why can’t we have a better media?

I have drawn from an op-ed by Hoxby in the Wall Street Journal from Wed. Sept. 29, 04 (sorry I don’t have the link).

Subsidy Spam

Here is a piece of spam email that I received recently.

The new revised edition of the Canadian Subsidy Directory 2004 is now available. The new edition is the most complete and affordable reference for anyone looking for financial support. It is deemed to be the perfect tool for new or existing businesses, individual ventures, foundations and associations….

The Canadian Subsidy Directory is the most comprehensive tool to start up a business, improve existent activities, set up a business plan, or obtain assistance from experts in fields such as: Industry, transport, agriculture, communications, municipal infrastructure, education, import-export, labor, construction and renovation, the service sector, hi-tech industries, research and development, joint ventures, arts, cinema, theatre, music and recording industry, the self employed, contests, and new talents.

Sadly, I have no doubt that this all true. (I am also sure a similar product exists for the U.S.)

What’s in a Name?

Once, Mrs Joan Robinson, my radical teacher at Cambridge University, and Professor Gus Ranis of Yale University, a ‘neo-liberal’ economist, were observed agreeing with each other that Korea had been a great success.

The paradox was resolved when it turned out that Mrs Robinson was talking about North Korea and Professor Ranis about South Korea!

That is taken from an interview with Jagdish Bhagwati, who I might add is another plausible contender for an economics Nobel Prize.

Thanks to www.politicaltheory.info for the link.