Speedy pork makes Hungarians proud

$4 million to sponsor a driver in Formula One next year. Eszther at CrookedTimber.org offers the full story. This example may seem extreme, but it reflects the real rationale for much of what government does. People simply like the idea of their government providing some good or service. The fact of government provision enters their utility function above and beyond the effectiveness of the policy at procuring stated ends. In other words, we want a government that we can be proud of and feel good about. Unfortunately we often seek this end without proper regard for the associated social costs, in this case alternative uses of the $4 million. Hungary is not a rich country.

Other times we simply favor the process of a government taking some course of action. So much of life is about favoring a certain kind of process, for its own sake, regardless of the outcome. Talking with friends is fun no matter what does or does not come of it. We all daydream for similar reasons. This same attitude, applied to government policy, often leads to wasteful and disastrous outcomes. We like the idea of “the government promoting national reputation,” again without much regard for whether the ends are effectively achieved. Once again, behavior that is rational for the individual can be very costly for the collective.

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.

Competition, Ignorance and Football

Michael Lewis’ “Moneyball” shows how Bill James revolutionized baseball by statistically analyzing players and teams. Josh Levin in slate.com asks why this hasn’t quite taken off in other sports like football. The key point is that it’s easy to isolate to isolate the relationship between certain behaviors in baseball and scoring points. In football, it’s a lot harder – people’s actions on the football field are all interrelated, making analysis difficult. Thus, a dependable statistical analysis of football has yet to emerge.

This might be an interesting curiosity about the difference between baseball and other sports, but I think there’s a broader point about competition and knowledge. The success of statistics in baseball created the opportunity for entreprenuerial behavior by some baseball managers. The introduction of statistics into baseball allowed a few team owners to impose high costs on those who refused to believe that statistics was valuable in sports. This was made possible by baseball’s rules – everything centers around a few events (at bats, outs, runs) and it’s easy to attribute individual performance to these events.

One might conjecture that some businesses are like baseball – inputs and outcomes are discrete and easy to measure. In those kinds of industries, the creation of knowledge is a low cost activity and those who have the knowledge can easily compete against others, forcing them to accept your analysis of the situation.

Other industries are like football – messy and hard to relate inputs to outpus. In this case, it would be hard to do what Billy Beane did in baseball. I’d guess that success in such industries is characterized by “judgment” – the intuitive understanding of how the industry works built from years of experience. If you don’t have that, then you’re probably relegated to following “gurus.” Seems like a nice explanation of management fads – organizing people is probably a messy business where everything is interconnected, and it’s hard to come up with easy to implement rules. Thus, a lot of management behavior revolves around business fads. Readers are encouraged to email me interesting examples of industries or economic activities that are very “baseball”-like or “football”-like.

Do we overvalue the difficult?

Experimental subjects consistently value a poem or artwork more highly when they are told it took a long time to produce. See this study by four psychologists. The increase in perceived value is strongest when quality is difficult to judge by other means. Furthermore other research suggests that we value artworks more highly, the more time and trouble it took us to understand them.

What does this mean for the arts? We will tend to overvalue difficult works of high culture, most likely. We also will undervalue that which is accessible. In other words, Seinfeld is better than you think.

The authors note that Jackson Pollock, in his lifetime, was attacked for producing paintings that “anyone could have done.” In reality Pollock’s paintings were the result of a painstaking process, difficult for anyone else to mimic. He often was defended on these grounds. A single painting could require months of hard work. So if you don’t like Pollock, perhaps now you will think more of it.

And this blog, well, this blog just takes forever to write…

10th anniversary for NAFTA

The first of January will mark ten years of NAFTA. There is little doubt it has helped the United States and Canada, but how about Mexico?

Foreign investment in Mexico has increased dramatically. It now stands at $12 billion a year, more than India receives. Exports have grown by a factor of three, up to $161 billion. Mexico’s per capita income has risen 24%, to $4000 a year. All these trends were underway before NAFTA, but NAFTA continued and cemented them. It also is believed that the $40 billion Clinton bailout never would have happened without NAFTA. Finally Mexico has made significant steps toward democratic rule and now holds elections with relative freedom of political entry.

Why then so many complaints from Mexico? First and most importantly, many Mexican exporters have been devastated by competition from the Chinese, who pay much lower wages. To be sure, this is a real problem, but for Mexico to be the high-wage competitor itself says something about how far the country has come.

Second, many Mexican farmers are upset at competition from American pork and corn. Most of these farmers are not mechanized in any way. They push a plow through their fields with a burro or ox. It is hard to imagine how preserving these sectors could benefit Mexico’s future development. I am all for easing the relevant adjustment costs, but trying to keep these jobs would be no different than banning the car to protect the proverbial horse and buggy. The only difference is that many of these farmers don’t even use techniques from the horse and buggy age.

Keep in mind that free trade in food will be a windfall for Mexico’s urban poor. Furthermore many indigenous farmers grow food for their own consumption, not for sale to outside markets. Cheap American imports can’t make them worse off, since they can always continue their current time allocation if they wish. More likely, they will start buying more cheap foodstuffs and look for a different line of work.

NAFTA was far from a perfect treaty, but let us offer three cheers in its favor. It may well go down as the most lasting legacy from the Clinton administration.

A recent World Bank report confirms this positive view: “without NAFTA Mexican exports would have been around 25 percent lower than the actual numbers, foreign direct investment would have been around 40 percent less and the country’s per capita income in 2002 would have been up to 5 percent lower.” Here is a summary of the report.

By the way, did you know the Mexicans are the world’s biggest drinkers of Coca-Cola in per capita terms, exceeding even Americans?

The earlier figures in the post, as well as the Coca-Cola information, come from Business Week.

How much do Freddie and Fannie Mae save homeowners?

Freddie Mac and Fannie Mae receive numerous state privileges, including tax-exempt status for their securities. Many investors believe that the U.S. government would guarantee the debts of the agencies, should a crisis arise. Not surprisingly, there has been recent talk of making the agencies operate on a level playing field.

The agencies, in response, argue that they have lowered the cost of homeownership significantly. But by how much?

Wayne Passmore of the Board of Governors did a study, here is one summary. Here is the bottom line:

The report says that because of their government-sponsored status, Fannie Mae and Freddie Mac were able to borrow at lower interest rates than private sector firms by an average of about 40 basis points from 1998 through the end of this year. However, most of this benefit is passed on to stockholders not to homeowners, the report says. The effect of these two enterprises buying and repackaging mortgages has reduced interest rates by only about seven basis points.

“The GSEs’ implicit subsidy does not appear to have substantially increased homeownership or homebuilding because the estimated effect of the GSEs on mortgage rates is small,” Passmore reports.

Furthermore it is estimated that the legal subsidies account for as much as 81 percent of the value of the traded companies. Not surprisingly, the agecies have been critical of the study.

My take: A common sense understanding of tax incidence favors Passmore’s conclusions. Humongous is the right word to use in describing American capital markets. If you let one entity borrow at lower rates, there are two primary options. First, that entity makes profit without lowering overall rates much. Second, and less likely, that entity becomes big enough to lower mortgage rates by some amount. But to the extent the entity becomes large, there is a significant tax or guarantee cost associated with its size. In other words, the government would be pushing down real interest rates by subsidizing capital accumulation, which cannot generally be done at low cost.

Marriage Brokers

An article in the current issue of Legal Affairs focuses on professional match makers and the difficulties inherent in the business. It’s been estimated that there at least 6000 matches each year and the fee can be about $2000.

How good are the matches? According to the article, a preliminary study conducted by the Department of Justice suggests that mail order brides might suffer less abuse than other wives. However, match makers sometimes fail to inform prospective wives of a future husband’s history of abusive behavior, which has resulted in some cases of abuse and state regulation of the industry.

Of course, regulation of the industry seems plausible – mail order brides don’t have the social networks that enable home-grown brides to learn about their future partner, and they might be susceptible to abuse because they don’t know their new country as well. But there are other ways of dealing with this. Like job applicants, match makers could perform basic screening of candidates – a check of the person’s criminal record might be useful. Match makers who failed to do some basic screening could be held liable for some damages, a proposal to be debated by the legal bloggers. A match maker subject to these professional norms might find better matches than the old fashioned match makers.