Another Reason to Buy a House

Megan McArdle points out some reasons to buy a home--such as avoiding costs to moving and having the freedom to customize your space--but she forget a key issue: avoiding horrible landlords. While buying a house comes with the risk of getting a lemon, landlords can be the same way. They can be behind on repairs, rude, or lax on the law (which can cause many problems for you later). In one place I lived, a surprise investigation revealed that one of the rooms was not legally occupied since it lacked the proper amount of window space. A huge headache followed, eventually resulting in the occupant leaving the house.



There's something to be said for removing another person from the upkeep equation. While you lose the chance of professional specialization, you also remove the possibility of negligence which often accompanies a new (or even experienced) landlord. Many of these problems go away when you own your own home (sure, the plumbing still needs fixed, but now you're depending on the plumber instead of depending on the landlord who's depending on the plumber).

Santa the Slaver

In countless Christmas movies, we get the impression that the elves of Santa's workshop are happy, joyful people who do all their work for fun. It's part of the myth: who would want toys from a man who forces elfin creatures to do his bidding only to then give away all of their hard work to strangers and force them to start all over? The more you think about Santa, the more I realize those elves are his slaves.

(1) Santa has no income. Maybe all those fake Santas which crowd the malls bump up part of their paycheck to the big man (think of it like a franchise), but that wouldn't be enough to cover the cost of materials, let alone labor.

(2) There's no way that the North Pole is the elves' natural habitat. They don't have the fur needed comfortable survive there. Typically elves live in the forest. Now, obviously, Santa wants to be isolated from the humans which is why he lives in the North Pole. But there are plenty of other places he could be, places more hospitable for his elves (here's a map of the world based on how long it takes to get to a major city). The Amazon is quite isolated, as is the Sahara Desert. The Himalayas are warmer than the North Pole if you don't go too high. All are viable candidates. But Santa picked one of the most inhospitable places on the planet for one reason: to keep the elves indoors. If he was in the Amazon, in a place they were comfortable in, they might run outside instead of working. Not only did Santa kidnap them, he's trapped them in a work camp.

(3) But if they like to work, then it's ok, right? Well, if they like to work, why do they need Santa? Why not just stay in their natural habitat and send toys out into the world? Hauling cargo is work, too. Yes, they won't have Santa's magical powers to deliver them all on Christmas Eve, but so what? Unless you're talking about something that could spoil or die (which accounts for a tiny fraction of presents), they can be delivered weeks or even months in advance. It's more likely that after Santa kidnapped them, he lied, claiming the presents had to come out on the 24th and only the 24th, thus "justifying" the kidnapping.

(4) But what about all the shots from movies and television with the happy elves? For one, that's fantasy and you're mistaking what's fake for what's real. (Grow up, seriously.) Besides, Santa's an all powerful being (which brings up the question of why he doesn't make the toys himself): he brain-washes them.

An Item From Santa's Lap

Paul Krugman applauds the Senate health care bill for, among other things, forcing insurance companies to cover patients with pre-existing conditions. This has been a long standing point of reform: why should a family be forced to cover the expenses of a medical problem when they had no role to play in the development of the condition. It's not as if they're smokers suffering from lung cancer. And many families can't afford the very expensive treatments that come with such conditions. But insurance companies can and so, the argument goes, they should pay.

For one, I'm not sure they can, but there's a deeper point. A pre-existing condition is tragic, doubly so if burdened on a family who cannot afford to properly address the issue. But that does not translate into forcing someone else to shoulder the burden, whether the target is insurance companies, hospitals, or the U.S. government (though the last is most justified since, in theory, it works for all of us). Some believe that doesn't matter; covering such individuals is the right thing to do. But that misses the larger picture. Even if they could afford it and even if they could continue to afford it for the foreseeable future, it would be ethically wrong to force one group to shoulder the problems of another group. Yes, I know we do this a lot already, but that's hardly grounds to keep doing it.

Here's an analogy. Some people are born ugly, or stupid, or socially awkward. Such people have difficulty getting dates or maintaining friendship. While befriending a person with such a pre-existing condition just to be nice would be seen as an admirable act of kindness, no one would agree to a policy which forces people to befriend or date such individuals. It would be seen as unethical, even if the individual is not able to "afford" such loneliness (i.e. they are suicidal).

It's all well an good to ask for things but you have to think about where they come from.

Patent Number 5,547,091

When I shop for toothpaste, I prefer the caps with the flip top so I don't have to remove the cap when I brush my teeth. I usually forget to look since I tend to forgot to buy it in the first place but today I remembered. In my search for the flip-top cap, I discovered only one brand, Colgate, has them. Moments after I thought that was strange, I suspected the answer. A search at the PTO website confirmed my suspicions. It's patent number is 5,547,091. Here's the abstract:

A closure for a container having a dispensing nozzle include a central aperture to receive the nozzle. In one embodiment, the nozzle extends through the aperture and projects upwardly from the base cap. The base cap further includes a top wall inclined with respect to the central axis of the base cap to assist in dispensing of the contents of the container. A cap lid is hinged to the base cap by a snap hinge assembly.

The patent was issued on August 20, 1996. Thus, on 2016, the "who didn't replace the cap on the toothpaste" arguments will evolve into "who didn't shut the toothpaste" arguments. And we'll all be happier for it.

Darwin Zero

I found this post via Megan McArdle concerning the data surrounding climate change in the wake of "climategate." It's an interesting post but it's long. It's a case study on a temperature record station, Darwin Zero, and how climatologists adjust the raw data to something that is consistent across the past century. There's good reason to have adjustments (changes in station location, instruments, time of temperature recording, etc) but the adjustments to Darwin Zero are very...strange.


From the author:

Yikes again, double yikes! What on earth justifies that adjustment? How can they do that? We have five different records covering Darwin from 1941 on. They all agree almost exactly. Why adjust them at all? They’ve just added a huge artificial totally imaginary trend to the last half of the raw data! Now it looks like the IPCC diagram in Figure 1, all right … but a six degree per century trend? And in the shape of a regular stepped pyramid climbing to heaven? What’s up with that?

This doesn't mean that all adjustments are suspect or that climatologists are lying or even that these are falsifications (though you can bet I'd like to know the reasoning behind those adjustments). And over the years, I've become more sympathetic of climatologists' claims (decentralized researchers all saying about the same thing is a good litmus test for truth). But it does highlight the need for publicly available raw data and comprehensive explanations for all the adjustments. If the scientists really want to convince people, transparency is key.

Ten Red Balloons

DARPA's awarding $40,000 to the first person or team to find ten red balloons which were spread all over the country on December 5th. The goal is to learn how people organized in large teams use computers to socially network. What software will we see? Will there be spying? Attempts to misinform other teams? I'm not clear how they will measure all they want to measure, but the prospects look very interesting.

December 5th was the 40th anniversary of Arpanet, the Internet's precursor.

HT: Alex Tabarrok

Update: Here are the results.

The Paradox of Happiness

Disciplines are always most interesting when they cross with other disciplines and the economics of happiness is no exception. Talking to some of my friends the other day (one versed in anthropology and another in psychology), we noted how much people value a sense of genuine accomplishment and is probably why, in some cases, wealthy people aren't as happy as less wealthy people. (Setting aside the lower mortality rates in poorer societies.)

For example, the people of the indigenous tribe that must work every day to get a meal are going to be happier (assuming they are successful) than the middle management who, while isn't concerned about getting his next meal, has no sense of accomplishment and feels as though his life is wasted. (This, by the way, is how many mid-life crises take root.) Indeed, people who have the option to leave their tribe in favor of modern life tend not to take it (I know this is very common among the Amish, and I'm sure a similar story can be told for other groups).

However, I argue that the wealthier, accomplished person will be happier than the less wealthy accomplished person ("accomplished" being defined as the standard of the society...for example, getting a book published in the wealthier society versus bringing home a kill in the less wealthy one). Some expressed doubt to the claim, so here's my reasoning.

First definitions: p (probability of achieving an accomplishment); S (happiness from achieving survival); s (happiness from surviving); A (happiness from achieving something else); and a (happiness from that something else). This draws the distinction, for example, between the sense of achievement from a book published and the royalties received from getting a book published. Note I'm also assuming it's equally likely to achieve something in a rich society and in a poorer society. This is primarily to make the math easier.

A person would be indifferent between two societies if:

p(S+s) = p(A+a)+s,
where the right-handed side is the wealthier society (they get the benefits of survival without trying) and the left-handed side is the indigenous society. Simplifying reveals:

S-A = a+((1-p)/p)s
In other words, there must be a larger sense of accomplishment from surviving than from other accomplishments to make a person indifferent. To make a person prefer the less wealthy societies (which I strongly doubt), the premium (S-A) would have to be greater than a+((1-p)/p)s, which I doubt since both values are positive and a might well be quite large.

Now consider the scenario when p=1, or when you are comparing people in each society who have made achievements (either in survival or in something else). The equation becomes:

S-A = a
If we think of such individuals in each society as sharing common traits (intelligence, drive, etc), then this means that more capable people are less likely to prefer modern society compared to less capable people--it all depends on the additional satisfaction derived from achieving survival versus achieving something else. While I imagine this premium to be quite small, the fact that this (simple) model predicts "stronger" people are more likely to prefer an environment that is more dangerous seems to be quite the paradox.

The Value of the Original

The Original of Laura, the last novel of Vladimir Nabokov, was published last week. Normally, a new novel doesn't get a lot of media attention but this one's a little different: Nabokov didn't want it to be published. In fact, he wanted it burned.

It was in his last will and testament that all unfinished works of his should be destroyed. When Nabokov died in 1977, his family didn't carry out this wish. They were emotionally distraught and procrastinated the decision, putting the work in a bank vault. For thirty years, a battle of what The Times called "the demands of the literary world versus the posthumous rights of an author over his art" worn on. Eventually, the literary world won...sort of. The novel, apparently, isn't very good (at least in the state it's in).

According to the author's son, destroying the manuscript was something he never seriously considered. Such an attitude makes me nervous; not only did his son fail to follow an aspect of his last will and testament (as did his wife, who died in 1991), it has the potential to shrink the number of good novels.

Nabokov, like many writers, clearly didn't want works published that fail to live up their standards: even after death (the idea that you leave a part of yourself behind after you die is, I'm sure, a motivation for many writers). Suppose the standard attitude of posthumous publishing becomes "ignore last requests and publish anyway." I guarantee you, some aging authors will be less willing to even start a novel in fear that they won't be able to complete it before their death, even if it turns out they could. This can cost the literary world something very valuable. While suffering from tuberculosis, and certainly concerned he might die soon, Orwell worked on 1984, which was only published a year before his death. Mark Twain, Jane Austen, Charles Dickens, and Jules Verne (to name a few) also published several works near the end of their lives.

A Quick Logic Lesson

Earlier today, I published a post exploring the idea of America exiling its prisoners instead of incarcerating them (specifically to Madagascar). I don't seriously endorse the idea but given the burden our prison system is under, I thought it was interesting to explore. However, I decided that it needs to be thought about more carefully so I unpublished it and saved it for a later date.

In the brief time it was up, a commentator wrote (and I'm paraphrasing because I forgot to copy/paste) that Hitler wanted to send Jews to Madagascar (I think we chose the same island) and he/she hoped I wasn't planning something like that. That doesn't work.

The ethical problem with Hitler's plan was not that he wanted to exile a group from a country. It is that he wanted to treat a group of people differently from everyone else on immaterial grounds (ie, religion). Ignoring the nature of the crime for the moment, treating prisoners differently from non-prisoners is not unethical; we do it everyday when we send them to jail. The Hitler analogy is false.

Tea Party History

With the "Tea Party protests" so popular among some Americans as a way to defy big government, a history lesson from one of my favorite books seems appropriate.

Most believe that the original Boston Tea Party was a protest against taxes on tea. In reality, the Americans weren't drinking that much British tea; local merchants have been boycotting it for five years, relying on smuggled Dutch tea instead. So, the British decided to remove some of the taxes on British tea in an attempt to make it competitive with Dutch tea.

Loyal British merchants would be granted the right to sell this cheap tea, effectively running the American merchants out of business. That's what the tea party was all about and why those merchants threw their competition into the ocean. (Granted, this would grant a monopoly on British tea to Loyalists, but the problem with monopolies is they increase price and restrict outputs which wouldn't be an issue here, given it has to compete with Dutch tea.) The famed party wasn't a protest of tariffs, it was a protest for a lack of tariffs, as bootleggers supported Prohibition and drug dealers benefit from the DEA.

The Tea Party wasn't celebrated in the colonies, either. The systematic destruction of private property highlighted Massachusetts' reputation as a place for warmongers and Benjamin Franklin demanded that the protesters pay full restitution to the owners of the destroyed tea.

As much as I empathize with the concerns of the modern protesters, this probably isn't the thing you want to be referencing to get your point across.

Singles in DC

DC is apparently packed with single men and women, according to the Pew Research Center. With a national average of 52% (men) and 48% (women) married, the District sports a mere 28% (men) and 23% (women) married. The next lowest numbers are 47% (men) for Alaska and 43% (women) for Rhode Island. (These numbers are for the 15 and older crowd.)

One commentator believes this is due to the unique demographics of DC: very high black population (less likely to marry) and very high Democratic population (more likely to marry later). Another points to the 8.2% gay population as the culprit (along with the marry later point). These are certainly factors, but there's a much more obvious reason that I think carries the bulk of the explanation.

Married people tend to want to start families which generally means a bigger home and unless there's also a big raise, that means moving to the suburbs. In most states, moving to the suburbs can but not always means changing your state. But in DC, it always means leaving DC and heading to Maryland or Virgina (or West Virgina). So the states include both the city proper and the suburbs but DC includes only the city proper. Big difference.

The Economics of the Movie Ticket

A couple of days ago, Nicholas Tabarrok noted the strange economics of the film industry at MR. Movie theaters do not charge lower prices for movies that are unpopular. Similarly, highly anticipated movies have the same ticket price as movies that are proven flops. Why is that?

If the movie theater charged different prices for movies, it would need to hire individual ticket takers for multiple theater entrances at the multiplex--one for each theater that's seating at the time (otherwise people would just buy the cheapest ticket). This is a drastic increase in costs both in payment to the employees and to management, who must now organize a complex system of employees.

Instead, the theater simply adjusts how long a movie is being shown. Good movies are shown for a while, bad movies leave the theater quickly (making room for theaters showing the good movie). It's not as direct as individual pricing, but it's much more cost effective.

Information on the Margin

According to a study, New York City's new laws requiring calorie counts on fast food restaurants doesn't appearing to be having any net effect on food purchases. One would think this law would get people to steer clear of fast food, but it's easy to see why, in practice, this doesn't make any bit of difference.

Like smoking, the unhealthiness of fast food is common knowledge. Telling them exactly how many calories are in X, Y, and Z change anything because they're not seen as relevant (ignoring that a high calorie count isn't the same thing as being unhealthy). If you already know a Big Mac is bad for you, knowing it has 576, not 500, calories isn't going to change your decision.

It's too costly to calculate everything down to such fine nuance. Instead, people think in broad categories. Now, if estimated calorie count was off by a factor of 2 or 10, we'd see some real movement. But, on the margin, this information adds virtually nothing. People are good at estimating calories by themselves.

Not All Yale Students Are Hippies

Tanya and I are at some coffee shop in New Haven and I noticed on patron has a quote attributed to John Maynard Keynes on her laptop:

Capitalism is the extraordinary belief that the nastiest of men, for the nastiest of reasons, will somehow work for the benefit of all.

Apparently, this quote isn't from Keynes, but it's a good sentence nonetheless and reminds me of this quote from F.A. Hayek's The Fatal Conceit:

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.

(It occurs to me this person might think the quote is sarcastic but I hope not. That would ruin my title.)

Incentives to Inquire

Students don't like asking questions. For a while, I thought it was simply because they are shy and need to be enticed out of their shell (I still believe this, but less so now) so I require participation for the grade. An undergraduate friend of mine told me of another reason:

We know the professor only has so much material planned for a lecture. If we get it all done before time is up, they have to let us out early. But whenever anyone asks a question or asks to elaborate, that pushes the time we get to leave, back.

This is a problem. Most students don't understand the first time around or will forget if they don't talk about the subject matter. And there's a lost life lesson in the importance of speaking up. The reality is doubly a problem for my style since I make the lecture notes available online before each class.

It's tempting to solve this issue by just over-booking each lecture, but it makes you look disorganized. It also creates the risk of having material constantly spilling over to the next lecture until you get backed up at the end of the semester and your homework and exam assignments get out of whack.

So my solution I will be trying out in the future is to create one or two five-minute "widgets" at the end of each lecture. Short extensions on the topic we covered, but small enough that if we don't cover them I don't feel a big loss. When the semester begins, I let them know the rules: if we finish before we get the widgets, then I assume they have mastered the nuances of this lecture and we can further their understanding with applications (which will be now be on the exam). If we don't get to them, they won't be tested over them. Therefore, students are incentivized to ask questions, filling in the time by furthering their understanding of the material in order to avoid a larger exam. Since I have the power to veto questions, I can't imagine I'll be bogged down with filler inquiries in an attempt to game the system. I hope there aren't any unintended consequences I haven't thought of.

On Racism and Income In America

During a heated discussion with my girlfriend the other day, I brought up the graph below from a post I saw on Marginal Revolution. It's summary data from an adoption study when primarily Korean children were adopted by American families of various incomes between 1970 and 1980. Now in their 20s and 30s, the graph summarizes their parents income (presumably at the time of adoption, hopefully adjusted for inflation) along the x-axis and the child's average income along the y-axis.


This, I said, is a very interesting study: adopted kids did about the same (on average) regardless of who brought them up. But when they are the natural kids of the parents, they do better on average. Since it's reasonable to say other effects are constant across incomes (such as how parents treat an adopted child), the data suggests that genetics play a critical role in determining income and that the wealthy are not wealthy simply because their parents were. (Note there is still a high level of income mobility in the data: 10K a year parents averaged almost 40K a year kids; 200K a year parents averaged only about 78K a year kids...though the latter point could be argued by wealthier kids opting for jobs with fewer financial awards and more non-pecuniary benefits.)

Tanya didn't agree on a few levels, for one arguing that it suggests low black incomes are low because blacks are stupid. But the study doesn't say that environmental factors don't influence future prospects (though I am admittedly surprised to see how uncorrelated adopted incomes were with their parents) nor was it a perfect study. Since adoption agencies are ethically bound to make sure the couple could provide for the child before adoption, the selection bias would overestimate the success at the lower levels of income.

Tanya was also concerned about effects embedded in the adoption. Since the kids were Korean, they were clearly adopted. Thus, she argues, issues of racism and the stigma of being adopted washed out and overshadowed any advantage wealthier kids had. Sure, this exists, but I'm not convinced these factors are so strong it would wash away all environmental advantages. Yes, the children grew up in the 70s and 80s, where racial tension was likely stronger compared to now, but such tension tends to lean toward the Afro-American and (to a lesser degree) Hispanic populations, not Southeast Asians.

Really, I have don't know how much racism is in America. Most people don't know. Of course, it still exists and minorities will have first hand experience with it. But that doesn't mean it's common. Similarly, most white people I know (myself included), are good people and most scared of a misunderstanding being mistaken for racism. That does not mean most white are not racists. And surveys done on the issue are going to have major credibility issues about the honesty of people's responses. I can say with confidence that black incomes are rising, interracial couples are more common, and companies are very concerned with being thought of as inclusive; at least things seem to be getting better.

The Burden of the Pre-existing Condition

If you were born with Asperger syndrome, should people be forced to date you? Most of you would probably say "no." It's a good answer: why should people be punished for something that isn't their fault? So why do so many believe health insurance companies should be required to accept applicants with pre-existing conditions? (Before you respond with "I don't want to date someone who doesn't want to date me," remember Asperger syndrome severely limits your ability to read social cues; you won't be able to tell they are with you only by force.)

It's not even that insurance companies won't cover pre-existing conditions. It's that they won't cover them at a particular price: a low price. In the end there are those randomly burdened with a condition that's expensive to care for and they don't want to pay for it (at least all of it). But that does not translate into forcing someone else to cover the costs.

And no, insurance companies are not sitting on lots of excess cash. Record profits are not the same thing as high profits (and even if they were, proposing a permanent change based on temporary conditions is very reckless way to make policy). Because they are barely profitable, forcing their costs up with such reforms will force prices up and making it too expensive for someone who could otherwise get it. Now we are forcing our neighbor to carry the burden of our condition. Where's the justice in that?

The Value of Life

Ask most people how much they value their life and they will inevitably say "an infinite amount." That's what my girlfriend told me the other day (generated from a conversation I've forgotten the origins of). "This cannot possibly be true," I said. "You take risks."

Mathematically, here's how it works. The expected cost of any activity under uncertainty is the likelihood of the event times the cost if the event occurred. A fifty percent chance of losing $200 means that the expected cost is $100. For any activity there is a probability you will die, or lose that life you value at an infinite amount. Thus, it's an infinite cost no matter what you multiply it by, no matter how risky the activity is. Since you have to do something to stay alive, you should always choose the least risky activity, no matter how much you might value the alternative because of the costs of that activity are infinite.

That people value their life only because they value what they can do with it doesn't change the math. In life, there are always options. You can watch TV or skydive: both are valuable to you and while the former might be more fun after 8 hours of TV a day, it is still too costly. But people still skydive.

They also show their finite value of their own life in other ways. People speed, jaywalk, ignore check engine lights, confront rude people (who might kill them out of anger), forget to check smoke detectors, travel to foreign countries, and eat unhealthy food. When we change our estimations of how dangerous (or safe) an activity is, we change our behavior. But if we valued our life infinitely, that shouldn't change anything (as the costs would come out the same regardless of the probability of death). Clearly, the costs to risking your life are lower than you might think.

Milk, Cheese, and the Myth of Retail Collusion

This week's Economist told the story of falling wholesale milk prices which are bringing EU farmers to call for lower milk production quotas. Some farmers blame supermarkets for the lower prices, noting that they sell milk at about the same price but buy it from farmers at a significantly reduced price.

Falling consumer demand (especially given the recession) isn't the explanation EU farmers give, and it certainly doesn't seem to explain the inconsistency at the supermarket. But the Economist linked them, though they didn't say how. The short version is: it's all about the cheese.

Cheese demand has fallen a lot, especially within the EU. Unlike milk, people buy a lot less cheese when their incomes fall. But cheese is made from milk and in the wholesale market, all cheese is milk (since cheese-makers are buying it to turn into cheese). In other words, grocers who want milk for milk compete with cheese-makers who want milk for cheese. But people want less cheese so there's less demand for wholesale milk.

Just as more cheese-makers bid up the price of milk (and a growing China bids up the price for gas down the street), fewer cheese-makers means there's downward pressure on prices. Grocers, then, are getting their milk on the cheap. But the market for milk-at-the-store changed very little. So we see grocers getting cheap milk, selling it at about the same price, and it's all thanks to consumer demand, not colluding grocers.

Collusion and Commons

I hope my micro students can answer the following:

How is collusion between firms like a tragedy of the commons? In answering this question, make sure to define tragedy of the commons, reference positive and negative externalities, and summarize the incentives of individual firms.

On the Economics of Sidewalks

Today on the Kojo Nnamdi Show, DC residents debated the pros and cons of adding sidewalks to northwest neighborhoods that still lack them. Well, it was mostly pros, from making walking easier to complying with Americans With Disabilities act. The cons were concerned with losing what country-feel they had in the metro area and that few people actually use sidewalks that are installed.

But no one mentioned another problem with adding sidewalks, not surprising because the pros are unlikely aware of it and the cons wouldn't want to admit it: adding sidewalks increase foot traffic and make life harder on those that live there. In economic jargon, sidewalk traffic externalizes costs on surrounding residents.

Sidewalks make walking cheaper and so, no doubt, you'll get more foot traffic. That means more dog walkers, and the increased risk of the dog walker not cleaning up after her animal when he does his business. That means more children running around, and the higher likelihood of noise and damage from particularly active kids. It means more people lingering in a driveway, trampling lawns or flowers, and risk seeing you while being intimate with loved ones (sometimes you forget to close the drapes).

It sounds so selfish, but why should local residents bear the cost of other's enjoyment? The common theme when people called in is that they moved to those areas because the lack of sidewalks made it feel more rural. They were looking for one thing: isolation.

Note: For the record, I'm in favor of the sidewalks only because, in my estimation, the costs externalized onto residents with the sidewalks are likely lower than the costs which must be suffered by people because there are no sidewalks to use.

The Good, the Bad, and Healthcare

Critics of government backed health care seem schizophrenic: on one hand, they argue government run health care will be really awful. On the other hand, they argue it will crowd out private health care if the two compete. How can it be so bad no one will want it but so good everyone will abandon all other options?

The two seem to be mutually exclusive and on some level they are. For example, the post office competes with FedEx all the time for package delivers. Sometimes people use one, sometimes the other. No doubt that the existence of competition improved the government system, though how much better is not obvious.

There is an area, though, where the government system is quite low quality but people still attend it: public schools. Ignore your personal experiences for the moment. People complain a lot more about public schools than they do about private ones. And while I seem to remember some data that, like FedEx, private schools improve their government counterpart, again the degree is difficult to pin down.

How is this possible? How are public schools so popular but so bad? There's lots of possible reasons but one reason sticks out: it's really cheap. In fact, baring fees and supplies, it's free. Those costs are then burdened onto everyone else and the public subsidizes a low quality service. There is some value to public schools, of course, which is why people still send their kids there. Everyone else, including private schools, indirectly pays for a product they either don't value that much or compete with. So is the nature of taxes.

Health care risks walking down the same path. In fact, it already has. Medicare and Medicaid, by law, buy hospital services at about 20% less than the cost to the hospital. It is one of the reasons why everyday objects, like Tylenol, run several dollars a pill. Hospitals have to make up the difference somewhere. Adopting this policy for everyone follows depressingly close to Bastiat's take on government: "Government is the great fiction through which everybody endeavors to live at the expense of everybody else." A great fiction indeed.

Fundamental Mistakes

Never before have I seen so many basic errors in such a short amount of time when Douglas Rushkoff went on the Colbert Report to promote his book, Life, Inc. The errors are too numerous to address each one, but two stand out as particularly sloppy.

First he claims that pursuing supposedly noneconomic avenues, such as having friends or taking walks, are drains on the GNP. "[Corporations] crowd out every kind of activity." Instead, people are forced to "support the economy with consumption we don't want or need." Most firm would love it if that were true. If they could control people's lives, they wouldn't have to work so hard to stay competitive. But trade, as my students recently learned, is mutually beneficial. What world does Rushkoff live in where people are forced to buy things they don't want?

In an attempt to criticize measuring wealth through spending, he argued that "if everyone got cancer tonight, that's good for the economy" because people would spend more money. But no one actually familiar with how economists measure wealth would make such a juvenile confusion. GDP and GNP are proxies, convenient estimations because capturing everything is impractical or impossible. We are fully aware that there is more to wealth than what we can count and changes like the one Rushkoff sarcastically propose are nothing more than playing voodoo with the numbers.

In Praise of Passive Investment

As regulators ponder making it harder for speculators to invest in oil, University of Maryland law professor Michael Greenberg backed such acts against "passive" investing on WTOP radio yesterday. He correctly identifies them as having "no interest in actively controlling these assets, just hoping to make a buck when their prices rise."

I wonder when Greenberg will take arms against other forms of passive investing:
-The university which offers financial aid to smarter or more driven students, betting that their attendance will yield more donations long after they graduate.
-The company which helps pay for its employee's education, hoping the employee will remain with the company even after a minimum staying period.
-The firm which gives its employees on-the-job-training, familiarizing them with a system they could apple elsewhere.
-The patron of the arts who supports a starving artist in the hopes they will be a success later.

In each case, the person hasn't actually become valuable yet, just like the oil that investors jump on (or off of). Speculators (who bet the price will rise) will buy oil now and cash out when it's more valuable. Passive investors in human capital do the same thing.

Voting Three Times A Day

Robert Kenner's new movie, Food, Inc., argues that food is too cheap and, thanks to health-related issues from diabetes, will end up being more expensive in the long run. While Kenner is lacking in his rationality (it's hard to make the argument that it's bad to give people more options in the form of cheaper food) he recognizes that consumers are the key to the problem. When he appeared on The Daily Show last week, he reminded Jon Stewart that the consumer "votes three times a day." If consumers want healthier food, they will demand it and producers will provide. They will have to if they want to stay in business. But most Americans aren't demanding these things, even those who know all the messy origins. At the end of the day, people vote for fat and that's their choice.

iPods Are Not Cylons

While cleverly defending copyright law, identifying those against it as having a "bias to the collective," Mark Helprin on this week's EconTalk falls victim to his own collectivist leanings. He argues that many people succumb to "perverse adaptation." People adapt to technology instead of technology adapting to them. Helprin invokes images of commuters staring at their blackberries and consumers demanding things faster and faster as examples.

Human beings require time for reflection...We require stillness and the ability to absorb things rather than just being hooked up to a machine and made into bundles of tropisms. [Emphasis added]

But those who don't are not dead. We do not require these things. We may require them to accomplish certain goals, goals Helprin places high value on, but we do not require them in the absolute sense. We choose to not do them. Technology does not leap in our lap and hook into us like a drone from the Matrix. Those people who Helprin paints as so grey are people who always wanted to move faster; technology simply allows them to do it. It's not that technology has enslaved us. Helprin simply believes that if people don't like the same things he does, there's something wrong with them. Such an attitude is the hallmark of the collective mindset.

Pay Grades in the Extralegal Sector

In Peter Leeson's new book, The Invisible Hook, Leeson notes the pay grade was quite flat (pirate captains were paid twice as much as the lowest member of the crew, compared to merchant captains of that same era which were paid five or six times as much). He argues it's to encourage solidarity, discouraging envy and encouraging unanimous approval to continue on their plundering ways (a skewed system would encourage those at the top to stop and those at the bottom to keep going, thus creating tension).

But the same could be said of drug dealers, who have a very skewed pay scale. As Steven Levitt and Stephen Dubner note, the top drug dealers earns about 100 times that of the lowest earner. But gangs of this sort don't show the lack of harmony or disloyalty that should be plagued by Leeson's explanation. So how do we reconcile these two different worlds?

The key difference between a pirate ship and a drug-dealing gang is the level of entanglement with their surroundings. A pirate ship is basically a floating island and because it's so isolated, it's relatively easy for anyone to see how the game is played. A gang, on the other hand, is entangled with the larger surroundings. There's a lot of activity members don't see and many critical relations with those outside the gang that most don't have. In other words, the lowly sailor is a closer substitute to his captain than a lowly drug dealer is to his top boss. While a rebellious sailor might be able to handle captaining competently, a rebellious drug dealer would likely not have the same level of success. This also explains why pirates elected their captain while dealers autocratically promote from below (thus why the higher ups are paid so much: to encourage lower ranks to work harder on the chance they can be promoted).

Franchise Laws of the Automaker Apocalypse

Imagine for a moment that television studios by law had to continue making shows they would normally cancel. Or fast food chains had to make menu items that few people buy. Imagine we still lived in a world of New Coke, Arch Deluxe, and Cavemen. Well wake up because when it comes to cars, that's the world we live in.

As Mike Munger and Russ Roberts discuss in the latest EconTalk, car franchises long ago lobbied local governments to pass laws handing dealers a string of advantages over the corporate office. In the vast majority of states, two dealers can't sell the same model within fifty miles of each other (stories that the franchises are too densely packed aren't true), corporate must make a strong effort to advertise each brand, only dealers can unilaterally terminate the dealership agreement (unless the dealer does a very poor job selling), and corporate must keep supplying the dealership with a minimum number of cars. Dealerships did this because each franchise is based around one model of car. But it also means that any model GM, Chrysler, or Ford make is a model they can never get rid of (though they can re-imagine it).

There's lots of problems the American automobile industry has (and the podcast goes into more detail) but I found these laws most shocking. They also explain a lot (such as why foreign makers focus on a few good brands). Paradoxically, it was the domestic dealers that brought down the Big Three; the only way out of these dead-end dealerships is bankruptcy.

How Obama Got People to Be Less Afraid of Being Republican

Robin Hanson proposes that Obama's election makes the public more conservative. No, the story isn't that Americans are secretly racist and have suddenly come to terms with their racism. Quote psychology experiments,

People were more willing to express potentially prejudiced attitudes when their past behavior had given them a bit of credentials as a nonpredjudiced person.

Bizarrely, Hanson cites recent polls that Americans are more in favor of gun control, less in favor of legalized abortion, and fewer people believing global warming is the result of human activity as evidence of this theory. What does racial issues such as affirmative action have to do with climatology?

People care what others think of them, even if those others are strangers. We care about it so much, we say we believe things we don't believe. If we value the truth on an issue low enough, ewe even fool ourselves into believing things we'd normally conclude are false. (Bryan Caplan calls this rationally irrationality.) In essence, we are paid (in the form of social capital) to conform.

The reason why we care so much about we others think of us is that we care what others think. We like to associate with people who are like us, a trend easily seen in grade school, high school, college, and beyond. This isn't merely shared interest but political opinion and values; constantly arguing with someone about politics gets exhausting for most people. It also makes it easier to talk to people since there's more common ground and you don't have to police your offhand comments or jokes.

There are lots of issues, though, and it's inefficient to list off your opinion on all of them. This is why we use labels (to the annoyance of some), such as Democratic, Republican, Libertarian, Populist, Christian, Muslim, Atheist, Jew, Protectionist, Free-trader, etc. In a single word, we convey a body of opinions to potential friends or mates. This is why it is normal for dating sites to post a person's political affiliation: it's a cheap way to convey important information.

But it's not perfect. Some issues are more important to some people than others and individuals are more diverse than the label's official or perceived hierarchy of priorities. We want to connect with people that share what we care about, starting with top priorities. People will then adopt most of the views of one group, including views they don't believe, to signal that they believe things that they find very important and distinguish themselves from the group that seems (rightly or wrongly) to disagree with them, even if they secretly agree with that group on less important issues. When an event convinces people that most agree with what you find to be really important, you will more accurately express your view of the less important things since you are less afraid of being mistaken for some other group.

To illustrate, consider two parties: D (Democratic) and R (Republican). Also consider two issues: A (being for racial equality) and B (being for less gun control). ~A means, then, that a group is perceived as being against racial equality and ~B means that a group is perceived as being against less gun control (or in favor for more gun control). Before Obama, one could argue that the public views the parties as so:

D (A, ~B)
R (~A, B)

Consider a person who has the preference of (A, B), but cares much more about A than B. In other words, he'd rather spend time with a person who's restricting gun ownership and is racially tolerate than a racist gun nut. U(A, ~B) > U(~A, B) (U stands for utility, economic lingo for satisfaction.) Thus, he will adopt policies of both racial tolerance and gun control to better signal that he's a Democrat, making it more likely he'll spend time with his preferred type of person. He might even start believing B, since he'll have to argue the point at parties and it's easier to argue something if you fool yourself into believing it's true. (This is where the rational irrationality comes in.)

But suddenly, Obama is elected president and it starts to look less like ~B is a staple of group R. If so many Americans were racist, it's hard to believe a black man could win (especially since he got 52.9%). Thus, the public perceives racism as being uncommon enough that it isn't a defining attribute of a major political party. At worst, the public's opinion on the stance is uncertain and the perception changes to this:

D (A, ~B)
R (?, B)

Now back to our hypothetical (A, B). No longer concerned with openly believing B will attract ~A people, he expresses his B opinion (or overturns his previous ~B opinion). He is no longer afraid of being mistaken for R.

In practice, there are more than two issues and people might still call themselves Democrats out of habit, fear of losing current friends, or because there's still enough about the party they like. But, in time, more will be willing to. In the meantime, expressing the secondary opinion will be more common. So, here's the punchline: Obama's election made Americans, and by extension moderate Republicans, seem less racist. Thus more people are willing to be seem as (or mistaken for) a Republican.

Control Breeds Suspicion?

Here's some data from the General Social Survey about how much confidence Americans have in various institutions. These are the averages between 1972 and 2006:

Institution	Percent With "A Great Deal" of Confidence
Organized labor	12.50%
Congress	13.70%
Television	13.80%
Press	16.90%
Executive branch	17.20%
Major companies	25.30%
Banks and financial institutions	27.10%
Organized religion	29.40%
Education	31.10%
Supreme Court	33.00%
Military	38.50%
Scientific community	43.10%
Medicine	48.30%

A few interesting things stand out in this survey, most of all the four government institutions: Congress, Executive branch, Supreme Court, and Military. It seems that the more direct control the public has over the institution, the less confidence they have in it. My initial guess is that more direct control means more attempts to grab the voters directly, meaning less believability of claims of neutrality. This would also explain why the press is ranked very low and the two highest are science and medicine--like the judges and soldiers, people see doctors and scientists as being coldly rational necessary for their job. Robin Hanson, though, would have a different opinion as to why people have so much confidence in medicine: we're afraid to be suspicious of them.

The Profit Motive of Eureka

Yesterday on Morning Joe, Joe Scarborough mixed up his economics. While expressing disgust that a 4% of the world "taking" 25% of its resource output, he proposed that if

....we control the next wave of energy, we will own the 21st Century...in America we have eight of the top ten research universities on the planet. Why not tap into that and really have a focused effort to create the next wave of energy resources....

Those in the developed world do not take resources; they buy them. And they can afford so much because they produce so much, notably the technology that Scarborough wishes to see. Since private investors and inventors are creating the next waves of technology, his insistence of an American focused effort can only mean some sort of central government planning. This deadly pair--economic nationalism and government centralization--is truly wasteful. Technology becomes harder to produce under such large bureaucracies, especially when you restrain where in the world you can draw your inputs for discovery from.

There is a big push for new technology and it's been that way since the dawn of human civilization. Only in the past few hundred years has government been laissez-faire enough to let it truly flourish. And look how far we've come so quickly! Technology creates resources far more than it consumes them. It is our greatest source of genuine growth and with so much wealth up for grabs, it instantaneously creates a vast network of entrepreneurs far more focused than Scarborough could ever imagine.

Too Cool For Grammar School

One of my mother's pet peeves is improper grammar, most potently using the phrase "I should have went" instead of the correct phrase "I should have gone." A couple of day ago, she read me an opinion piece by someone who shared her frustration, arguing grammar mistakes (even in casual conversation) demonstrate sloppy thinking, laziness, and a disrespect for the English language. I conceded that for instances such as job interviews, this makes sense: good grammar signals intelligence and etiquette. But something about the story didn't sit well with me and I let it go.

Later, I realized bad grammar is also an example of countersignaling. When you can send multiple signals, you are best to eschew weak signals and stick with strong ones, demonstrating that you are not be confused with those who are merely adequate (as average candidates will send the weak signals in case the strong ones aren't as strong as they think). This is why you don't put that part time job from high school on your post-college resume.

Good grammar is a weak signal (with the exception of, perhaps, English professors). By making (purposely or not) common grammar mistakes, people can show they are so qualified, they don't need obsess over the nuances of the English language. This, of course, does not work with rare mistakes. "I is interested in working with you" will not get you the job.

All That We Are

NPR's The Diane Rehm Show today discussed the advantages of having a Hispanic woman (Sonia Sotomayor) on the Supreme Court. Because she'll be able to draw on a "wider palette" of experience, they say, she'll be a valuable asset and necessary resource.

Just because she had different experiences doesn't mean she has more, and certainly not ones more applicable to cases. Just because she'll be more empathic to women's issues or Hispanic culture doesn't mean she'll be more fair or that the court as a whole will be more fair. Yes, she can add something others can't, but in that endeavor aspects of a case can become more important than they should be. No net gain is obvious.

We are all merely the sum of our experiences so any fair judge would recognize that. This is what expert testimony is for. By expecting the justices to capture all that we are by their demographics alone, we hurt ourselves. Prioritizing gender or race (or sexual preference, or religion, or the presence of a disability, etc) requires us to narrow our field of search. It could well deny us someone far more accomplished, and fair, than whoever is left after we apply whatever parameters we happen to be prioritizing at the time.

Waxman-Markey-Dobbs

The DC area gets policy advertisements, ones I never remember getting when I lived in Iowa or Wisconsin. Perhaps that's just because of population density, but I have feeling the "company" of this company town has a lot to do with it. Lately I hear a lot about the Waxman-Markey bill, a bill supporting cap and trade for carbon emissions. If cap and trade is better or worse than a carbon tax is debatable and I'm not sure on my position, but the arguments put forth looks like they were authored by Lou Dobbs.

China's making energy efficient lightbulbs and has other "green" industries, jobs they "took" from Americans. According to the ad, the bill will let us take those jobs back. If this the best argument for the bill (and it might be; Tyler Cowen reveals the benefits are hard to find), then we got a big problem. As Don Boudreaux likes to say, costs are not benefits. By forcing the costs of production higher (reflected by the fact that firms will produce these things in the more expensive US without additional gain), the economy becomes poorer, not wealthier. If jobs were wealth, the best thing the government could do is not eliminate trade, but eliminate technology.

My Students On Opportunity Costs

In the first exam for my international economic policy class, I asked my students the following infamous question:

You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost $40. On any given day, you would be willing to pay up to $50 to see Dylan. Assume there are no other costs of seeing either performer. Based on this information, what is the opportunity cost of seeing Eric Clapton?

Only a quarter of them answered it correctly (note this is slightly better than the quarter from the survey because my multiple choice had a "none of the above" option). But there were complaints that the question was confusing, particularly on the topic of if you already bought the ticket or not. So for the final, I repeated the question with a few tweaks:

You won a free ticket to Germany (which has no resale value). A plane for France is leaving at the same time and is your next-best alternative activity. You value the ticket to France at $600 and could buy it for $550. Assume there are no other costs of visiting either country. What is the opportunity cost of going to Germany?

I'm pleased to say that the class did much better but given that I repeated the same question, reworded it to make it clearer, and discussed the question in the wake of the first exam, that's expected. That 52% still got it wrong is not. I doubt it's me (though it could be) and recalling that so many economists got the original question incorrect, maybe there's something about opportunity costs that's more counter-intuitive than we give credit.

The Blessed Death of Newspapers

Gideon Yago appeared on MSNBC arguing "there's no question we need the newspapers," going so far to suggest that the government subsidize the failing medium. Commentators joked that the death of the printed word marks a golden age for corrupt politician.

Yago mistakes the death of one medium with the death of all media. The reason newspapers are doing poorly is because other sources, notably the Internet, do the job so much better. New technology changes things, but people still want investigative journalism. The method changes but the content will ultimately be the same, because preferences on content haven't changed. The fourth estate is not limited to the screaming Jamesons and inquisitive Lois Lanes of the comic book world. The legions of writers and bloggers that parade the Internet do it, too, but in a form superior to newspapers in virtually every way. Yago might as well said the end of the horse drawn carriage is the end of travel. Quite the opposite, actually.

Exam Question

I hope my international economics students can answer the following:

Consider the recent movie X-Men Origins: Wolverine and then answer the following:

a. Using the graph illustrating the market for the movie, indicate the areas of rent, consumer surplus, and deadweight loss. (3 points)

b. What characteristic does this product have which explains why the marginal cost is zero? (One word would suffice…provided it’s the right word, of course.) (1 point)

c. If the movie could be illegally downloaded, who along the demand curve should download it to maximize efficiency? (You may indicate your answer on the graph, but make sure you clearly distinguish it from other things you’ve indicated on the graph.) (2 points)

d. Many people who saw this movie were disappointed. What type of asymmetric information problem does this represent? Why do you say so? (Think about when the problem occurred in relation to when the transaction occurred.) (2 points)

e. Suppose people had perfect information about the quality of the movie (assume the demand curve before this point reflected estimated benefit which, as noted in (d), is too high). Recalling your answer in part (c), would the optimal number of illegal downloads increase, decrease, or stay the same? Why? (2 points)

Tabarrok At TED

My dissertation chair, Alex Tabarrok, gives an inspiring talk at TED on growth and the future. Watch, won't you?

Wealth in Sweden

An episode of the Daily Show last week paints Sweden as a wealthy country thanks to it's government interventions. Sweden is certainly wealthy by international standards, but is it wealthier than the US? The simple data say yes, but reality is more complicated.

Sweden's GDP per capita is $52,789 compared with the US's $46,859, but that's in nominal dollars and doesn't adjust for how much you can buy with the money.

When we adjust, the Sweden's wealth changes radically: GDP per capita falls to $37,245: a 30% drop! (The United States numbers don't change since these are in dollar amounts.) In other words, while the Swedes get paid more than Americans, everything they buy costs much more and, on net, they are poorer.

Note this underestimates the wealth difference. Technology spillovers from America to Sweden is much larger than the reverse but these wealth effects from technology (which are quite large) aren't included in the data. Much of the Swede's wealth comes from technological innovation abroad not social safety nets, though nailing down exact numbers is quite difficult.

A Third Way: Healthcare

A friend of mine works multiple part time jobs and has a pre-existing medical condition. Not surprisingly, he supports government subsidized (though not free) health care for people like him: working full time but without benefits. Companies don't want to provide benefits and often fire a full time person to hire a pair of part time people: same work and pay, but no costs of benefits. But this firing/hiring trend is common in every recession: it seems strange to create a permanent agency to solve a temporary problem. Still, the multiple part-time jobs is a permanent fixture in the economy and is worth thinking about.

My knowledge of tax law is somewhat lacking, but my understanding is that firms give benefits instead of an equivalent amount in cash because (a) tax laws make benefits cheaper and (b) people prefer that warm feeling of someone watching out for them over cold hard cash. Besides, matters of mortality is not something people like to think about so there's benefit in having someone else handle it. But part time workers aren't paid enough for the worker to be willing to take such an income hit in exchange for benefits. Moreover, tax laws wouldn't motivate the employer and minimum wage laws would prevent people from working for just benefits.

It seems we're stuck. Either provide subsidized health care and suffer all the inefficiencies that come with moral hazard or let the working poor suffer and with it the costs of delayed care.

But suppose we re-wrote the tax laws so firms would get tax breaks for benefits of part time workers and created an exception for the minimum wage laws (or just got rid of them) allowing people to be paid an equivalent amount in benefits. That way someone working multiple jobs would have one job where they're paid exclusively (or partly) in benefits and other jobs they get cash normally.

There's surely additional complexities because I'm not familiar with all the details of the tax code. But it has the advantage of giving people access to greater health care without running into the strong case of moral hazard that spawns comes from universal health care. The only hitch is that a lot of politicians hung their hat on universal health as the only reasonable solution so a compromise in the tax code probably won't be enough satisfy their constituents.

I Think I'm Getting Soft In My Old Age

I've decided to offer my students some extra credit. Here it is:

This extra credit is worth three points, added to your final grade (for perspective, this is the equivalent of 60 points added to a homework assignment). You must answer it in 75 words or less. If you use anything more than that, even by one word, than it will be worth zero points. Your answer must be typed with few spelling or grammatical errors (if it needs to be stapled, you did something wrong).

“It is through exchange that difference becomes a blessing, not a curse.”
—Jonathon Sacks, The Dignity of Difference, 2002

This quote opens our syllabus and captures a subtle theme of the course. What’s the theme? (There are probably multiple answers to this question.) In answering this question, you better off using information from at least one of the following podcasts, preferably two. Indicate via footnote which podcast(s) you use; these references do not count to your word limit. You might want to listen to more than you intend to use; some of these podcasts are better for answering this question than others.

Leamer on Outsourcing and Globalization
Brook on Vermeer's Hat and the Dawn of Global Trade
Bernstein on the History of Trade
Munger on Middlemen
Boudreaux on the Economics of "Buy Local"

This assignment is due on May 4, 2009.

Fifteen Lawyers On a Dead Man's Chest

Pirates portrayed in popular media were not the kind of heroes we make them out to be today. Like the modern Somali pirates, they disrupted trade and threatened fortunes. They murdered, raped, and stole. They burned ships and killed innocent people. Centuries ago, pirates would occasionally be acting on the behalf of a government, acting as a Crown thug rather than the rugged rogue we think of them as. Perhaps their only endearing quality is that some were made up of sailors dodging the English draft.

Cyber piracy is different story entirely, highlighted by the Pirate Bay Trial. Internet pirates download and/or view copyrighted material without paying for it. Studios argue that they are stealing media and more than one commercial depicts it as the same as swiping a CD from a store. But that's not quite true.

Granted, it is possible that downloading illegally is effectively the same as taking a hard copy. Taking a hard copy is always denying the company revenue, even if you would never buy it because your theft denies someone else from buying that particular CD. But downloading a file copies it, leaving the original in tact. Your consumption of it does not deny someone else from consuming it. The company loses revenue only if you pirated instead of paying for it. If you were never going to buy it (you value it less than the price but more than zero), the studio/actors/retail store/etc lose nothing. There are no distorted incentives and no real theft.

In an ideal world, only those who download for few are those who wouldn't have paid in the first place. But I know of no way to reasonably get to that world for it requires each consumer to honestly determine what they are willing to pay for, act accordingly, and, when appropriate, resist the romantic call of a pirate's life.

On Solow On Posner On the Economy

Nobel Laurette Robert Solow wrote a review of Richard Posner's new book about the economy. In a surprising move, Posner blames market failure--not government failure--for the recent problems. In an unsurprising move, Solow agrees with him. I don't.

Both point out that the market is not perfect and there's no denying it. You'll be hard pressed to find any economist who thinks businesses, and even whole markets, make mistakes. But the temporary or systematic failure of a firm, or the temporary failure of many firms (i.e. the market) does not mean there are inherent problems with the system. On the motivations of engaging in investments investors knew little about, Solow writes

Why did I do such a risky and, as it turned out, stupid thing? Well, it had worked in the past, and made a lot of money for many people. If I had backed off, others would probably have continued to make money for a while. I would have looked like a fool, and very likely an unemployed fool.

Add "until now." And lots of banks didn't do it: Pittsburgh National, Wells Fargo, JP Morgan Chase, and Bank of America (the last one did, but only after the crisis begun). Now they look like geniuses. Believing firms are so mindless, myopic, and systematically prone to being duped violates basic economic principles of rationality.

Imperfections and information asymmetries always exist. People understand that and people adapt to it. They don't adapt instantly and they don't do it perfectly, but they adapt as well as they can. Solow and Posner seem to agree unless we're talking about regulators. One cannot point to information asymmetry as a key problem and then call for non experts to correct it.

That is not to say regulation never has its place, but the issue is one of costs and benefits. What is less costly to society: the costs of establishing and maintaining the regulation plus the good opportunities regulation renders impossible or the occasional, but vary painful, market corrections that come with no regulation. The answer is not obvious, especially when you consider that people will adapt to the rules. There are many ways around regulation (creating a false sense of security), many ways to game the system (making regulation more costly), and many reasons to embrace prudence when you know one's going to save you if you screw up. The essential mechanism of market self-correction doesn't go away when errors get big, though the additional time it takes to fix itself (increased by uncertainty in the political climate) might fool even famous judges and Nobel Laurettes that it disappears completely.

On Coase and Income

I hope my international economic policy students can answer this:

Economist Ronald Coase argued that in cases where one person involuntarily harms another through their actions, (also known as a negative externality, such as a factory emitting smog on a community), that the group who should change their action is the one who is the least cost avoider (for example is it less costly for the factory to move than the community). How does income inequality create a negative externality? In the case of income inequality, who is the least cost avoider? Justify your answer.

Thin Film of Life

This one ranks high as my favorite YouTube video:

Consider the words Carl Sagan used: "a thin film of life." Exactly how thin are we talking about? I did a simple calculation and it's quite humbling.

Suppose we consider the thickness of the film of human life on Earth to range from the Dead Sea to Mount Everest (the lowest and highest point on land, respectively). That comes to 9,226 meters. The average diameter of the planet is 12,742,000 meters: a ratio of 1:1,381. In other words, if we inflated a beach ball four feet across (large by beach ball standards) and painted it, the thickness of the paint would encompass the whole of human civilizations: every monument, empire, family, and philosophy (save satellites and other space artifacts, of course). A thin film, indeed.

On Reputation

Recently (in no small part to EconTalk's new book club starting with the Theory of Moral Sentiments) I've been given thought to if people should speak bad of others and if a person owns their reputation. The impulse seems to be that of course they do. It is their reputation, isn't it? Do they not have a right to know if someone speaks ill of them and to prevent harm to their reputation?

But calling it "my" or "her" or "their" reputation is really a semantic shorthand, much like "my" job or "my" girlfriend. We do not say it to convey possession, but rather relation. It is fundamentally not the same thing as my book, my computer, or my wallet.

The fact that a person's reputation can be harmed (and thus the person herself) should not be considered, either. A firm can (and is) harmed by their competition, but no one says McDonald's owns Burger King. Similarly, a critic who gives a negative review of a movie is thus not controlled by the movie's studio. Just because something can harm you, doesn't mean you own it.

Your reputation is the sum of what others think about you. To say you own your reputation is to say you own others' thoughts which is clearly nonsense. You don't own your reputation. Others do.

This is not a green light to spread lies. Lying is a violation of implicit contract between the listener and the talker--regardless of if a reputation is actually harmed (I'm told many things about many people I don't believe). But if reputation is harmed through expression of fact (including opinion presented as opinion), it's hard to claim the subject of conversation has a case of being wronged.

Smith advocated against harming another's reputation but has a valid function. People get bad reputations for reasons, most of which are justified. Spreading opinions can prevent disasters for others later (again, assuming there are no lies involved). Far from being malicious, speaking bad of someone actually helps people.

Quota Question

I hope my international economic policy students can answer the following:

Sketch a standard supply and demand graph, illustrating the market for imported cars from Japan. Suppose the government set a consumption quota on imported cars from Japan well below the equilibrium quantity. Identify the areas of deadweight loss and the price of imported cars from Japan. Also indicate the area of rent and indicate who (as specifically as possible) the rent goes to.

Striving for Specificity

In homework three, I give my students a little history lesson:

According to amendments to the Clean Air Act of 1970, new coal power plants have to install scrubbers to reduce the carbon and ash of their emissions. Environmental groups called this amendment a great victory for clean air. The scrubbers, which are about as large as the power plant itself, consume a great deal of power (10% the plant generates) and are very expensive to operate. There are two basic types of coal in the United States that could be mined for such power plants: “dirty” coal (which has a high carbon and ash content, mined in the east) and “clean” coal (which has a low carbon and ash content, mined in the west). The latter is slightly more expensive, but does not need to be scrubbed (and is in fact cleaner than scrubbed emissions from dirty coal).

The punchline to all of this is that power plants buy dirty coal instead of clean coal since scrubbers have to be installed regardless. In the end, we get dirtier air (scrubbed dirty coal is dirtier than unscrubbed clean coal), the opposite of what the Clean Air Act was suppose to do. In a podcast about this topic, Bruce Yandle notes that environmentalists, scrubber makers, dirty coal miners, and railroad companies (who specialized in that kind of coal transport) celebrated at the regulation. Strange bedfellows, indeed.

A student notes that the rule should be that all power plants purchase clean coal. It's certainly a step in the right direction, but not likely to be a good, lasting solution. Whenever you discover a law encourages people to do X when Y is more efficient, the proper response is not to require people to do Y. Just because it's specific, doesn't mean it's going to be smart. Institutional and technological change might make X better later, or a third option, Z, better than Y. The goal is not to force people down a particular road but to encourage them to the road that's most efficient at any given time. In other words, taxing the emissions (with all that calculation problems that brings along) is a much smarter solution. It not only deters the essence of what we dislike, it encourages new ways to solve the problem. Striving for specificity, no matter how smart it might seem in the short run, is ultimately a recipe for centralization and encourages the delusion that "just the right static requirements" are better than the competing efforts of countless millions.

Hands and Heads

Here's the latest PhD comic, published yesterday:

The author, notably, did not consult an economist on the issue of sustainability, just foresters. And in doing so, we miss half of the evidence of what's going on when it comes to long term economic development. We are told people are just mouths and stomachs: they just consume and more people or development means more consumption. End of story. But people are also hands and heads: we produce and (most critically) we invent.

Which is the bigger factor? The evidence suggests that, certainly, in the short run consumption matters more. More consumption raises the price of goods (meaning they are more scarce). But the long run results (the sustainability concern) favors production. Goods (adjusted for inflation) keep getting cheaper. That short run boast in prices generates the incentive to ration, find substitutes, and ultimately develop new technology. People say it's different now, especially with energy (one of our most fundamental inputs). We've reached some peak that we can never return from. Armageddon is always just around the corner.

Humanity faced an energy shortage since our conception as a species. We sought it in plants, rivers, wind, fire, and a menagerie of animals. We built waterwheels, windmills, stoves, ships, sails, yokes, collars, carts, and harnesses in pursuit of of more efficient sources of energy. We dug mines all over the planet. Wood begot peat begot coal begot oil begot gas begot uranium. Now we seek it from the inner depths of out planet (geothermal) to the distant reaches of space (solar) and one theme permeates this unending quest of one of our most precious of resources: energy is cheaper. What new trend could have possibly emerged that makes them think it's suddenly different now?

Next time, Mr. Cham, I suggest you ask someone versed in both consumption and production. Next time, ask an economist.

Corn Laws and the Ironies of History

In the 1840s, England's Corn Laws (corn being a generic term for wheat, barely, and rye) were under a hot debate. The Laws issued a series of tariffs ensuring bread prices stay two to three times higher than they were 100 years ago. But as the Industrial Revolution pushed forward, mill owners knew cheaper food was crucial to feed their employees. There thus arose a battle between the landed aristocracy, arguing mercantilism and questioning this "new" economy, and manufacturers, citing Adam Smith and the logic of free trade. Thankfully the latter, led by Richard Cobden, won the day.

Manufacturing, once a great advocate of free trade, now in the West is its enemy. And if Lou Dobbs, a vocal opponent of free trade on the grounds that it hurts factories, lived a century and a half ago, he would be raging against the very sector he so persistently defends today.

Fixed Exchange Rates

I hope my 385 students can answer the following:

True or False:
If a currency with a fixed exchange rate is undervalued, its central bank will have to buy the domestic currency to maintain the fixed rate.

What Vegas Can Teach You About the Recession

In last week's EconTalk, economist Allan Meltzer argued one of the main reason for our current financial mess is the Fed's policy of too big to fail. If a large financial institution collapses, it will harm countless other institutions and hamstring the the market as a whole. By preventing disaster and saving these companies, the Fed saves the economy. Knowing that in the worse case scenario someone will help you out, these banks then took riskier chances than they otherwise would. Thus the mess we're in now. In a world of superheroes, there are more extreme athletes.

Some are skeptical of this relationship, made evident by the fact that this is not at the forefront of the popular debate (the much more vague and non-scientific "animal spirits" is). But suppose you went to a conference in Las Vegas and your company agreed to reimburse you for any gambling losses you suffered during the trip. It's obvious that you would gamble more. And you would take bigger risks. Why wouldn't you?

You could point out that the companies are worse off than those that didn't take the housing gamble (such as JP Morgan Chase, Pittsburgh National, Wells Fargo). But they are better off than if the Fed hadn't intervened at all. If the company compensates you only half or a third of what you lost from gambling, you would still gamble more but not as much as full compensation. Regardless, this policy would immediately prove to be a terrible idea. But that's the rule in place at the Fed now.

The Economics of Alien Conquest

My cousin, Brendon, and his girlfriend, Jenna, were in town this weekend. Both of them read my blog and Jenna told me I'm clearly knowledgeable about what I'm talking about, but still wrong. That response in itself deserves a post, which I may or may not get around to. Still, it would be fun to deviate a bit away from controversial topics and I thought of alien invasion. If aliens invaded, what would be their motivation?

Natural resources is a favorite Hollywood staple. Aliens will destroy our planet to take our stuff, likely minerals (Independence Day comes to mind but the physical land might be valuable, too (in The Day the Earth Stood Still, alien invaders attempted to terraformed our planet).

This is quite possibly the least likely reason aliens would go through the trouble of global conquest. The universe is filled with minerals and other resources that no one's using and are much easier to get to than stuff on an occupied planet. Maybe other extraterrestrials make harvesting Vega asteroids difficult, but even in the boundaries of our solar system there's still quite a lot to draw on.

Unless aliens are after biomass (i.e. living things). Perhaps there's some technology or feeding requirement that requires biomass (or they just want us as slaves), and Earth is the best place to get it. Lots of biomass with little ability to defend it. In that case, the best strategy probably wouldn't be a messy mass attack on the resource you're trying to harvest. Aliens would likely be much more insidious with probably a pathogen--killing everyone or knocking us all out while leaving the bodies around for collection later.

Racism is a likely motivation. This pops up in a lot of Sci-Fi television shows (Star Trek, Stargate, Babylon 5). A similar train of thought is a concern for humanity and a fear of what will happen if we're allowed to continue to live. Given many humans mistakenly fall into one of these two categories, I'd like it's a reasonable motivation for aliens to kill us.

Technology is a justification that's rarely explored. This is understandable but not for the reasons you probably think. Most assume that if aliens know how to travel faster than light, they are clearly more advanced than us on all other levels. That is far from certain, especially since an alien brain will probably not be wired the same way as a human one. As Richard Dawkins suggests, it is entirely possible there's a group of extraterrestrial life who intuitively understand the theory of relativity but have difficulties grasping principles of air resistance and other "slow" speed phenomena.

But it would be rather clear that the easiest way to get technology is to trade for it, not to take it by force. If such aliens were interested in our technology, they would more likely be peaceful. The one exception to this rule is if they discover it's easier to kill us than to learn a single human language. That would certainly be a sad state of affairs for us.

Then there's the possibility that aliens need to build a intergalactic superhighway along a path that intersects with Earth's orbit. That's a bit unlikely given how big space is ("Really big," according to Douglas Adams) but it could still be true. And if galactic eminent domain is as potent as our terrestrial version, then considered us conquered.

Politics As Usual

Alex Tabarrok ran some numbers, breaking the stimulus plan down by state. Below is the relation of infrastructure spending per person versus the unemployment rate. The red line is the best fit line for all the data points. Note it's sloping down.

The basic logic of a stimulus package is that government will create jobs, people spend the money, which creates more jobs, which allow people to spend the money again, etc, increasing money's "velocity." But here we see the states with the least unemployment get the most money and with the most unemployment get the least money (with some outliers). I can think of three explanations. Here they are in decreasing likelihood.

Shut up. This relationship is because congress members are using the package to send money to their home district/state. Those with the most political clout/understanding get the most money. This package really isn't about helping the whole economy but about boasting one region at the expense of another in order to get re-elected.

Oops. The government made a mistake. Some numbers got mixed up and checks are being sent to the wrong states. Granted, it's a pretty big mistake and one must wonder how an institution which make such mistakes will rationally plan us out of this mess.

Holier Than Thou. We missed something and the U.S. government knows what's going on but this graph doesn't capture all we need to know. If it did, everything will fit together very logically. This is possible, but no where near as likely as the other two.

Most Interesting Sentence I Read Today

From this week's Economist:

Indeed, some say the Few learnt [Irving] Fisher too well: from 2001 to 2004, to contain the deflationary shock waves of the tech-stock collapse, it kept interest rates low and thus helped to inflate a new bubble, in property.

A concise reminder that artificially fixing one sector one sector of the economy has unintended consequences in other sectors. One must wonder where the new holes will appear in the aftermath of the $787 billion stimulus package.

Krugman on the Virtues of Protectionism

When I read Paul Krugman, I first think "that's crazy! He's insane." Then I read it again and that usually (but not always) becomes "that's interesting, but it still wrong." Reading Krugman's February 1st article (spawning a nifty debate here, then here, then here) led me to the typical reaction.

I'm still reading through the responses, but Krugman's basic argument is that fiscal stimulus benefits other countries in addition to the one doing the stimulating (for now, let us assume Keynesian economics works the way Keynesian insist it does). The country being directly stimulated imports from other countries, which help their economy. But these economies share none of the debt generated by the stimulus package. Thus the funding country gets a smaller benefit than they should and we have too few economic recovery acts. Short term protectionism internalizes the benefits to those that are paying for it, thus we get more such packages when we need them.

It's a clear argument but to see why it doesn't work, let's follow the money. Suppose the exporting foreign country is Japan. They now have (say) American dollars. What do they do with this crazy American money? They can't spend it in their country. There are two things they can do with it.

(1) They can import from America. This means that money Keynesians want to stay in the US will come back. It's just adding another step. Instead of Government to Domestic Market, it's Government to Foreign Market to Domestic Market.

(2) They can invest in America. Instead of buying goods, they buy companies (or just capital). Again, the money comes back into the economy, but now there are two steps before it enters domestic consumption (Foreign market to Domestic Company to Domestic Market). Again, it's a wash.

You could argue time is an issue but money moves pretty quickly, especially in the era of Internet and telecommunication satellites. And, because the government's buying international, it's going to get a better deal which will help in the long run (when this huge debt will have to pay off). It's hard to imagine that extra delay is really such a huge problem.

An implicit assumption of Krugman's argument is that exports are inherently good for an economy and imports are not. But that's completely wrong. While Krugman might paint my argument as grounded in theology and not economics, the case for free trade is so strong, and for protectionism so weak, such interpretations are closer to being grounded in laws of economics as irrefutable as gravity or motion.

Economics, the Law, and Treasure Hunting

Last week, deep-sea explorers announced they found the shipwreck of the original HMS Victory which sank in 1744. This is certainly a victory for the decedents of her captain (as the location of the ship demonstrates it sank due to a storm, not mistakes on the captain's part). But that is not the interesting part of the rest of us: it's the treasure.

Well, the legal battle for the treasure is what's interesting as the treasure is mostly large bronze cannons of historic significance. There also might be as much as four tons of gold, but that's just a theory. Due to the decay of the site, we're a long way off from a good estimation of value.

But that hasn't stopped the British government from claiming "dibs," though the site's in international waters. Lost for over 250 years, the government argues they never explicitly gave up sovereignty of the ship and its contents.

If it really is the HMS Victory, "her remains are sovereign immune," the British Ministry of Defense (MOD) said in a statement on its blog Monday.

"The wreck remains the property of the Crown. We have not waived our rights to it. This means that no intrusive action may be taken without the express consent of the United Kingdom."

They also want a cut of what's found, though the exact size is under negotiation (but you can bet it'll be a sizable one).

Safe to say, it creates a mess for the people who found the ship to sort out. It also cuts on their profit margin. This is where law and economics can help. The boringly named field of law and economics uses economics to better form the law so it encourages efficiency.

In this case, the law allowing a country to claim sovereignty on a wreck someone else found makes it less profitable for other people to find and recover wrecks. Thus more ships sit at the bottom of the ocean, slowly decaying into nothing. There are few examples so illustrative of waste as that one. Granted, there's a good argument for claiming sovereignty on a ship that sank last week. It takes time to find wrecks and if somebody just stumbles upon it in the meantime and gets to claim it all, that would have its own unintended consequences on how willing people are to use ships (or even build them in the first place). But that argument doesn't spill over to a quarter of a millennium. This looks a lot more like theft then maintaining sovereignty. I hope the British government aren't looking for any other important ships, of their own sake.

Stimulus Package May Prove Flaccid

A friend showed me this video:



Brilliant.

HT: Mike Mills