An economics without trade-offs

One reasonable definition of economics is the study of choice under conditions of scarcity, or choice under constraint.

When getting more of one good thing requires forgoing some other good thing, what do people do? How do they decide? 

Ganesh Ahirao (was Ganesh Nana; last name changed - I think because a historic error in NZ systems was finally more recently corrected) proposes an Economic Governance Act to replace core parts of the Public Finance Act.

Jack Tame asked how part of that would work. If the Minister of Finance were deciding how to spend the last billion dollars of available funding and were choosing between a hospital infrastructure project and a wetland restoration project, how would the Act guide that choice? 

Both projects would be supported under various parts of his proposed principles of responsible economic governance. The hospital would count under both the 'being a good ancestor' provision's 1(a)(ii), physical infrastructure and facilities, and under the 'social floor' provision's 1(b)(iii) access to health. The wetland project would count under 1(a)(i)'s 'healthy natural environment and associated eco-systems'.

There are seven objectives across the two domains, many of them with multiple parts. And there's no ranking. So how would the Minister decide? If the Act provides no guidance, what's the difference from the status quo? If it does have a concrete way of dealing with these trade-offs, where is it?

Ganesh didn't like the question, noting "What you're saying is the country can't afford both." 

The question very specifically asked about the last billion in public funding. 

Tame went on to ask what stops the next Muldoon if the fiscal responsibility provisions are stripped from the Act; Ganesh said that's 40 to 50 years ago and now irrelevant. 

And, somehow, the credit agencies would reward NZ for tearing up the fiscal responsibility provisions that have staved off a downgrade - so long as the government could make the case to the credit ratings agencies. 

A world without trade-offs. And a world where, somehow, money and borrowing costs never matter. It starts edging toward MMT.

A couple of other things seemed a bit puzzling in his framework.

Every environmental regulatory regime has to balance environmental harms against economic costs. Both are purposes in his proposed Bill. Which section tells the regulator how much weight to put on 2(2)’s productive and prosperous economy as compared to 2(3)’s kaitiaki role? And similarly for 4(1)(a)’s healthy natural environment against social licence in places that rely on that economic activity – or both of those against aspects of 4(1)(b)’s social floor that are funded through taxes raised on those activities? How does his system deal with trade-offs other than by denying they exist?

His Act provides no limitation clause comparable to the RSB's clause saying it creates no claims at law. Without that clause, could someone without a home sue the government for failing to provide one (part of the social floor) or for preventing his building one on his own land with his own money (zoning)? If suit is possible on the former, how could Treasury account the potential liability, or have we just given up on accounting?

The defensible version of an emphasis on broader outcomes reduces to Bill English's social investment approach. Run a broad CBA across long-term effects of current initiatives, and use that yardstick comprehensively across spending areas. That version takes trade-offs seriously. 

Around the traps

A few bits I've neglected to blog.

• My chat with Adam Jarvis on datacentres. 
• A follow-up chat with RCR on the same thing, as well as a couple of bits on the India Free Trade Agreement. 
• The RBNZ's Keeping Cash Local consultation was just atrocious. The Bank threatened commercial banks via a consultation document. OIAs showed that the Bank knew it did not have the power to  just go ahead and do what it threatened to do. There ought to be an inquiry on how that consultation document got out the door. My submission on the debacle. And my piece at Newsroom.
• Bit at The Post on some very fun AI textual analysis quantifying cultures of innovation going back over a thousand years. 
• The UK's Andy Burnham promises more localism, and the policy document looks decent! My piece at The Herald.
• Treasury knows the ethnicity of 97.5% of its staff; the remaining 1.5% didn't answer the question. By contrast, Treasury does not know what proportion of its staff have qualifications in economics. And it earned a big red "weak" grade on the quality of its economic analysis in the latest PIR. My piece in The Post. I also chatted with Sean Plunket about it. 
• And, over at Newsroom, a bit on the coming FSANZ rules that add more new NZ-Australia labelling requirements for alcohol. I thought that National had promised that we were going to stop doing this and shift instead to QR codes on store shelves to make it easier to enable imports and new grocer entry. 

Reader mailbag - prediction markets

In today's inbox:

Hello Eric,

My name is [redacted].  I read your article about prediction market regulation with interest.

As a student in 2013 I placed a single $60 bet which brought down iPredict from a run on the market related to Peter Dunne, which I intentionally caused based upon groupthink and illogical beliefs in the truthiness of the insider betting ring. I knew exactly what would happen when I joined and placed the well timed bet. I knew what I would prove, and let the energies of my opponents be redirected into their own damage.

iPredict is long gone, a decade ago, RIP. It was fun, but I guess if it had lived longer it could have competed with Kalshi and Polymarket. But now I live in the United States, and there are wildfires, and people are betting on wildfires on "prediction markets". How can you endorse this.

What is big may fall, what seems consensus may be false, and ultimately: I will be watching. I look forward to your next article about moral hazard.

My reply:

iPredict was always fun like that. Folks would convince themselves that a spike was due to an insider, and sometimes it was, but sometimes it wasn’t – whether a noob trader who placed a dollar-value order without checking the book, or someone just having a lark at low dollar stakes. But the markets proved remarkably accurate overall: trades at $0.75 turned into contracts paying out at $1 about 75% of the time. 

It’s been amazing to see what Kalshi’s been able to build in a world without deposit limits. 

The main concern I’d have on wildfire markets would be whether they’d encourage a very bad kind of insider trading. I don’t think Kalshi has any wildfire markets; their natural disaster markets are all on completely exogenous events. Polymarket has had those; best I’m aware, they’re not yet CFTC-authorised. 

I don’t know how material the risk is. I mean, a slightly less direct route would be to short insurers with exposure to that risk before starting fires. Similarly for a lot of the other ‘it will encourage them to do the bad thing’ risks: there are generally already very thick financial markets where options trading could get you similar results. I don’t think Trump needs prediction markets to cash in on Trump-induced oil price volatility. Brent crude futures are enough. 

At the same time a large punt on oil futures can have many causes, including “I will need a lot of oil in a few months”. A large and suspiciously-timed punt on a prediction market can lead to questions of who made the trade, identification of the trader (you have to do your KYC to trade at Kalshi), and then inquiries. 

I really wish Kalshi would set a market on “giant Wellington earthquake”. I could pay a friend in the US to take a position for me and treat it as insurance on otherwise uninsurable local earthquake risks. I’ve long wanted parametric insurance on a Wellington earthquake, and that is mathematically identical to a prediction market contract on it. Maybe someday!

Kalshi's Natural Disaster markets are here. You can trade on:

• How many major Atlantic hurricanes will there be this year?
• How many Atlantic hurricanes will there be this year?
• Number of tropical storms in the Atlantic this year
• How strong of an earthquake will occur worldwide before Sep 1, 2026?
• Will there be an 8 magnitude earthquake in California before 2027?
• 8.0 magnitude earthquake in Japan before 2030 [39%!]
• Number of tornadoes this month
• Major volcano eruption this year?

The California earthquake market has a 5% chance of the event, and just under $400,000 in volume. But the order book is still thin at reasonable prices. You could spend $400 and buy every contract in the book up to a $0.10 price, and get a $5100 payout if the event happens. Perhaps putting a giant buy order into the book would draw out liquidity. 

Spills

A new and more rational basis for ongoing choice of party leaders in a Parliamentary system.

Step one. Set a prediction market contract. "Pays $1 if the leader of the X Party is a Minister after the election." 

Step two. Set prediction market contracts: "Pays $1 if the leader of the X Party as at the date of election is {Name}."

Step three. Set conditional contracts. "Pays $1 if the leader of the X Party is a Minister after the election conditional on {Name} being Party Leader as at the date of election."

Step four. Set a decision rule. "The leader of the X Party changes to {Name} if {Name} shows a demonstrable sustained improvement in the Party Leader being a Minister after the election over the status quo, and superior to other {Name} options."

Works for both major and minor parties; their leader only becomes Minister (or Prime Minister) conditional on being in a winning coalition.

Punters from all parties could weigh in and put their money-votes on who they think would be most likely to improve each party's chances. 

A crazy ideological campaign to try to tank the other side's chances by picking a bad leader would draw in liquidity from outcomes-based traders - that's Hanson & Oprea (2009). The 'demonstrable sustained improvement' part is to give time for liquidity to come in in response to attacks - as well as guard against blips. 

No more dramas. No more press conferences. No need to try to attempt to count to whatever the required number of MPs might be to effect a spill and trust that nobody changes their mind along the way. Just watch the prices and let the leader be whoever maximises the Party's chances of being in a winning coalition. 

Probably only feasible in a country that's sensible enough to legalise prediction markets. 

Geloso on how to think like a good economist

I really like Vincent Geloso's slide deck on market processes, market failures, and government failures.

Over the past couple of months, Claude read through about four million words I've written to develop an "Eric skill". I can now give it documents that I don't have time to read, and it'll tell me what to watch for. 

When I gave it Geloso's slide deck, not because I didn't have time to read it but because I really liked it, the things it thought were inconsistent with the Eric Skill were errors on its part, and helped further refine the Eric skill to avoid those errors. Basically - look more carefully back through the corpus for the bits it thought were inconsistencies, and update the skill accordingly. 

Anyway, the slide deck's here.

The main updates to the Eric skill consequent to its reading Geloso's slides:

What changed: four additions, all sourced from Eric's own corpus, not from Geloso's slides.

• §1, endogenous excludability (line 15) — the one drawn most directly from existing material: his public-goods lectures (ECON 336, 224, 653; the public-economics notes) already state "excludability is a function of technology," with the scrambled-TV, congestion-charging, radio-tied-good, and Buchanan-club-goods examples verbatim. This closes a real gap where the skill under-represented his own teaching. Highest confidence.
• §1, statogenic failure (line 29) — generalises his gas-ban and RMA/housing positions into a standing diagnostic. High confidence on substance.
• §1, price-theory-and-discovery-as-one-investigation (line 13) — folded into the price-theory substrate as complementary layers, not a rival Austrian register, per Eric's explicit instruction this session.
• §4, item 18, interventionist ratchet — the one most worth the red pen; it's the least directly attested in his existing wording, so it's my synthesis of his second-order-dynamics habit rather than a phrasing lifted from the corpus

Age of wonders.  

Let them build: electricity and datacentres edition

New Zealand's electricity companies know how to stick a pipe into the ground in the Taupo Volcanic Zone and generate electricity. They've been doing it for decades, and there is enormous untapped potential. 

America's hyperscalers are currently willing to pay a large premium for immediacy. They are sticking expensive off-grid generators beside datacentres that would have to wait years for a connection. 

If NZ could be the place where decisions on whether a power company is allowed to stick a pipe into the ground are made in weeks/months rather than years, and a similarly fast decision on whether a datacentre is allowed, tens to hundreds of billions of dollars could drop here in a very big hurry. 

My column at Newsroom this week suggested NZ should consider being that place. And that the window of opportunity will not be open forever. 

[As always, I didn't pick the headline]

Just fix industrial allocations

New Zealand's Emissions Trading Scheme includes industrial allocations of carbon credits aimed at avoiding inefficient carbon leakage.

But the formula is wrong. 

Imagine that you're a domestic firm producing stuff that generates CO2 emissions. You correctly have to surrender NZU - one for each tonne of emissions. But if competitors in foreign markets do not face a carbon charge, there's a problem. They'll undercut you because their costs are lower, you'll scale down or shut down in response, the other outfit scales up, and their unpriced emissions go up.

It can easily result in a net increase in global emissions.

So, what to do about it - if you want the ETS to solely be about net emissions?

Identify firms in that situation. Look at the intensity of carbon emissions in their foreign competitors' products. Then, do the following.

Take the local firm's production in base year. Multiply it by the GHG-intensity of the foreign producers' products. Then give the firm that many NZU as an industrial allocation.

Simple example. 

Suppose that the NZ company produces 100,000 units of widgets. Each widget produced abroad by relevant competitors creates one tonne of CO2-e. So give the NZ firm 100,000 NZU regardless of its own GHG emissions. 

If the firm is more carbon-efficient than international competitors, it will on-sell surplus NZU. It will also have strong incentive to invest in decarbonisation-tech so long as the cost of reducing emissions is less than the going carbon price. Why? Because that means it can sell more valuable NZU for others to use. 

If the firm is less carbon-efficient than international competitors, it will have to purchase NZU to make up the difference. That will increase its costs, and that is perfectly fine. It will have strong incentive to invest in decarbonisation-tech so long as the cost of reducing emissions is less than the going carbon price, because that's cheaper than buying units. And if it cannot do so cost effectively, and international competitors take their markets, that's fine - at least as far as the ETS is concerned. It is, in that case, carbon efficient for the local firm to scale down or shut-down. That kind of carbon leakage is a-ok because net global emissions go down. 

You would regularly rebase the measure of international carbon intensity, so that firms would have incentive to keep up with what's going on in the rest of the world. 

But that isn't what the ETS does. Instead, the ETS allocates NZU based on the local firm's own emissions, on a schedule that declines over time. And you can easily then wind up in spots where a local firm that is more carbon-efficient than international competitors loses business to those international firms that do not face a carbon price, shuts down, and net emissions go up. Because the local firm winds up facing a carbon price at the margin that leaves them less competitive than overseas firms that do not face a carbon price. 

Fixing it isn't simple; running the figures on international carbon intensity could be tricky. And the thing will have to update as emission budgets reduce: either provide firms with the cash-equivalent of the NZU allocation so they can purchase credits from carbon foresters, put in a CBAM to reduce the distortion on imports, or a mix of the two. 

But the alternative is firm-by-firm bailouts. This week it's cement. Who knows who it'll be next time.

I'd had a chat with Heather at Newstalk on this earlier this week.