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.

One more idea for Bush

Last week I presented twelve ideas for a domestic economic policy Republican vision for a Bush second term. I appreciate all those who wrote with additional ideas, or who suggested they might write in my name for President.

I will add one additional proposal:

13. Cut the number of pages in the daily Federal Register by half.

The American economy is drastically overregulated. But do not get me wrong here. I do not wish to gut important environmental regulations, many of which supply valuable public goods. To take one example, my benefits from the ban on low-quality gasoline probably exceed the costs I pay for all other regulations. Try spending a week in Mexico City in December if you are not convinced.

But I do wish to gut the median regulation issued by the Department of Agriculture, or by the Federal Communications Commission, to name two examples. Browse through a typical issue of the Federal Register to find other candidates for elimination.

It is fair to ask where I would make regulation stronger. First, I would do more to tax pollution. Taxes on purely productive activities should be correspondingly lower.

Animal cruelty also leaps to mind; currently we do very little to limit cruelty to animals in factory farms. I don’t take an extreme animal rights point of view, but animals do count for something. There are billions of them held in captivity, and our treatment of them counts as a great shame.

Lost in Translation

Here from a survey of translators are the top ten most difficult to translate words.


1 ilunga [Tshiluba word for a person who is ready to forgive any abuse for the first time; to tolerate it a second time; but never a third time. Note: Tshiluba is a Bantu language spoken in south-eastern Congo, and Zaire]

2 shlimazl [Yiddish for a chronically unlucky person]

3 radioukacz [Polish for a person who worked as a telegraphist for the resistance movements on the Soviet side of the Iron Curtain]

4 naa [Japanese word only used in the Kansai area of Japan, to emphasise statements or agree with someone]

5 altahmam [Arabic for a kind of deep sadness]

6 gezellig [Dutch for cosy]

7 saudade [Portuguese for a certain type of longing]

8 selathirupavar [Tamil for a certain type of truancy]

9 pochemuchka [Russian for a person who asks a lot of questions]

10 klloshar [Albanian for loser]


1 plenipotentiary

2 gobbledegook

3 serendipity

4 poppycock

5 googly

6 Spam

7 whimsy

8 bumf

9 chuffed

10 kitsch

My take: It’s rather common to hear that language determines thought and thus if a language has no words for a concept then that concept can’t really be understood by a speaker of that language. I find this theory difficult to believe (perhaps it was first proposed in a language other than English.) If the theory is true, however, I would like to learn the language where “spam” is untranslatable.

Dutch Auction IPO

googleHere is a nice graphic from the NYTimes explaining the Dutch auction IPO. I think Google’s IPO will be a success, it will raise more money for Google than a traditional IPO with its high transactions costs (which flow to the investment banks). Remember the standard to measure success is the cost per dollar of raised funds it is not whether the stock price hits a predefined target and not whether the stock pops. Indeed, Google’s stock price is unlikely to pop. The success of a traditional IPO is often counted by the size of the pop but that is ridiculous. A pop means the firm left money on the table – money which was transferred to a handful of insiders who were allocated stock at the low IPO price. A pop is thus the sign of a bad IPO not a good one. The Dutch auction method ensures that the initial price is a market price (thus Google’s price is unlikely to plummet either). There has been a lot of negative publicity about the Google IPO but my guess is that this was stirred up by the investment banks who are fearful that their halcyon days are ending.

Will John Kerry bring fiscal discipline?

No, but a Republican Congress might:

My AEI colleague Eric Engen and I [Kevin Hassett] just completed a detailed analysis of the Kerry spending proposals. To perform the analysis, we combed through Kerry’s web site and public statements to assemble a list of every spending promise he has made, and then dug through the public record to find third-party cost estimates for each of his proposals. When necessary, we adjusted the period for the existing score to the 10-year budget window using standard techniques. When we could not find such cost estimates, we relied on numbers that were supplied by the Kerry campaign. When the Kerry campaign did not provide cost estimates, we set the score for that promise to zero.

Even with that generous accounting, the Kerry spending promises add up to an extraordinary amount of money. Our best estimate is that Kerry’s proposals will add up to between $2 trillion and $2.1 trillion over the next ten years. Since the revenue from his tax proposals relative to the current baseline is actually negative, this implies that the Kerry proposal would increase the deficit by perhaps as much as $2.5 trillion over the next ten years.

On August 3, 2004, the Kerry campaign responded to criticisms such as this with a revised budget plan. The main difference between the first and second plans is that the campaign now claims to be able to save about $300 billion from eliminating corporate welfare. Even if we include this rather implausible savings in our estimate, the net increase in the deficit associated with Kerry’s proposals is on the order of $2.2 trillion.

What would he spend the money on? According to our analysis, roughly half of this additional spending is attributable to Senator Kerry’s health care proposals that would add more than $900 billion in federal outlays. Education expenditure accounts for nearly one quarter of Kerry’s new spending, with almost $500 billion added over ten years. A $400 billion expansion of military personnel and benefits for veterans comprises most of the remainder of Kerry’s spending plans, with the balance distributed among numerous social programs and increases in international aid.

I have not been through these numbers, but Kerry has not exactly been running on a platform of spending cuts. Most of all, I’d like to see a further analysis, weighting each number by the probability it will pass into law.

Thanks to TCS for the link.

Do Not Pass Go…

Crime doesn’t pay, but criminals just might.

That is what more and more local governments are hoping, as they grapple with soaring prison populations and budget pressures.

To help cover the costs of incarceration, corrections officers and politicians are more frequently billing inmates for their room and board, an idea popular with voters.

Here in suburban Macomb County, 25 miles north of Detroit, Sheriff Mark Hackel has one of the most successful of these programs in the nation. Last year, the sheriff’s department collected nearly $1.5 million in what are being called “pay to stay” fees from many of the 22,000 people who spent time in the county jail.

Inmates are billed for room and board on a sliding scale of $8 to $56 a day, depending on ability to pay [TC: hey, that’s price discrimination!]. When they are released, the sheriff’s office will go to court to collect the unpaid bills, seizing cars or putting some inmates back in jail. The wife of one inmate, a Chrysler truck factory worker who is serving half a year for drunk driving, dropped off a check for $7,212 this week to cover part of his bill, the largest single amount ever collected by the sheriff.

I’m not comfortable with this notion, since I don’t think government prisons should move toward becoming profit centers. And ex post, elasticity of demand is not very high. But now more than half of the states are collecting fees of some kind from their prisons. It is noted, however, that Martha Stewart will not be paying for her time in jail.

Here is the full story.

That’s [Not] All Right

Elvis Presley is on the charts again but the owners of That’s All Right are worried because as of January 1 2005, Presley’s 50 year old classic enters the public domain in Europe.

Under current EU law, sound recordings are classified as “performance” and copyrighted for a period of 50 years. This is not to be confused with compositions, which remain in copyright for the artist’s lifetime plus 70 years…

Nevertheless what this law does mean is that, from January, anyone may store, share, swap or commercially release That’s All Right without recourse to RCA, who currently own rights to the track as part of their back catalogue. …

Faced for the first time with losing significant back catalogue profits, the industry is lobbying to change the law. …[But]for every one recording that has the power to reach number three in the commercial charts fifty years after its original release, there are hundreds if not thousands of tracks that do not.

Although these recordings no longer have any commercial value to their rights holders, they are of tremendous value in terms of our cultural heritage. But the mechanisms of copyright law mean that, should the European Parliament choose to heed the music industry, keeping Elvis out of the public domain for a further 45 years or even more, the King will drag down with him this huge body of commercially worthless but culturally significant work.

Works of no commercial value will be orphaned, languishing in forgotten store cupboards at record company headquarters when they could be enjoying a digital rebirth in the public domain.

A solution to this problem is already in use for patents. Renewal fees. Renewal fees for copyright extension would allow Disney, RCA and those few others with very valuable property rights to maintain those rights while at the same time the vast majority of “commercially worthless but culturally significant work” would flow into the public domain.

Note that I am not arguing that we should extend the rights of Disney, I stand with my betters in seeing little benefit to doing so, but if political pressures force policy in that direction we need not lock everything up in order to protect the few cash cows. A renewal system should be politically viable because the fees can be made low enough so as not to greatly concern Disney or RCA, yet high enough so that most works will flow to the public domain. Owners of profitable works will benefit and owners of non-profitable works will not be harmed.

Aside: Suzanne Scotchmer has an important but difficult paper arguing that renewal fees can be optimal. Here is another clever idea to improve the patent system. As usual email me if you can’t access the link.

What has Virginia come to?

A Virginia mother was sentenced yesterday to 10 days in jail for defying a court order not to smoke in front of her children.

Tamara Silvius, 44, who has said she smokes about a pack of cigarettes a day, was led from a Caroline County courtroom in handcuffs. But the judge allowed her to post a $500 bond to stay out of jail while she appeals the ruling.

“It should never have come to this,” Silvius said in a telephone interview, after spending four hours in jail before being released. “. . . I hope and pray my two little kids don’t think they had their mama sent to jail.”

The sentence is the latest development in a bitter and long-running battle between Silvius and her ex-husband, Steven Silvius, over custody of their children, ages 10 and 8…

Tamara Silvius already had violated the court order once. At Thanksgiving, while driving her children to South Carolina, Silvius, wanting to smoke as she drove, tacked up plastic between the front and back seats and secured it with duct tape. In January, she was found guilty of violating the order in that instance and was given a 10-day suspended sentence.

Here is the full story.