And further on price elasticity

Seamus reminds us that we need to look at relative elasticities.

Brian Easton provides advice that the Law Commission deems "helpful". His advice is:

It is generally assumed that the demand for alcohol is largely price inelastic. However, it is believed that the main groups whose consumption is sensitive to changes in price are:

• the young;
• binge drinkers; and
• heavy drinkers.

Easton is right that alcohol consumption is relatively inelastic: around -0.44 for beer, which means that a 10% increase in price reduces consumption by 4.4%. But we tend to expect that the folks whose consumption produces greatest harms would also be the folks whose consumption is relatively least elastic. Price elasticity basically tells us how many substitute commodities there are out there for the consumer. If the individual views there as being no substitute for alcohol, his price elasticity will be very low; if he views a Coke as being a not too bad alternative, his price elasticity will be rather high. And, indeed, what numbers I've seen on it show that heavy drinkers are less price elastic than are moderate drinkers.

If we decide to be charitable, then Easton's just reminding us that even heavy drinkers are price sensitive. Which is true. But they're less price sensitive than moderate drinkers. Even if you accept the premise that there are some heavy drinkers who could be made happier by virtue of a tax increase that helps to keep them on the straight and narrow, moderate drinkers' consumption is more strongly affected. Suppose we have a 10% price increase. Moderate drinkers reduce their consumption by about 4.4%; heavy drinkers reduce their consumption by about 2.8%.

Now, how much does a heavy drinker benefit from a 2.8% reduction in consumption? How much is a moderate drinker harmed by a 4.4% reduction? And what are the relative proportions of both in the country? BERL said that 1/6 are "harmful" drinkers, which I still think is a gross overestimate of the true proportion. But let's take it for now. It then has to be the case that a single heavy drinker reducing his consumption by 2.8% is benefited by at least six times as much as a moderate drinker is harmed by a 4.4% reduction in his harmless drinking for the tax increase to potentially be efficiency-enhancing. If the true proportion is 1/10, change it to 10 times. Recall that for the wowsers, consumption of 2 pints per day is harmful; the midpoint of BERL's "high risk" category is 110 grams: 11 standard drinks, or about 5 pints. How big a price increase would be necessary to get the high tail consumers down to "moderate" levels? Well, they'd need to reduce their consumption by about 65%. If your price elasticity of demand is -0.28, then you need a 232% increase in price to reduce consumption by 65%. And of course for that level of a price increase, the moderate drinkers reduce their consumption pretty much to zero. All of these numbers are just back of the envelope, for now. But I don't think they're far out.

The LC cites a WHO study arguing that heavy drinkers are no less elastic than other drinkers. A quick check shows the WHO is looking at 2-3 studies while the above-linked one is a meta-study of more than a hundred, with results that are near identical to another meta-study of similar magnitude. The latter, forthcoming in the Journal of Economic Surveys, doesn't give a breakdown between heavy and light drinkers, but has near identical estimates of average elasticity. I give a heck of a lot more weight to a serious meta-study, and especially when two of them give near-identical results, then to a couple of pieces picked from the potential list. If there are more than a hundred studies, you can always find a few that give you numbers you like.

Looking more closely at the Law Commission's preferred WHO finding, ... wow. Terrible work.

While heavy drinkers are sometimes thought to be likely to be less affected by price, the Committee found that the evidence does not support this belief, with higher prices affecting the amounts consumed by frequent and heavy drinkers. This finding is supported by a large body of evidence which has shown an impact of prices on harms caused by alcohol, also indicating therefore that heavier drinking has been reduced (34). Natural experiments that have occurred recently in Europe as part of changes required as consequences of economic treaties have shown that as alcohol taxes and prices have been lowered, so sales and alcohol consumption have increased (37). In some jurisdictions in Europe, special taxes have been introduced for spirit-based sweet premixed drinks, in response to increases in young people’s drinking (38). These have led to reductions in sales and consumption of the specific drinks.

Nothing in the paragraph supports the WHO's argument. Nothing. Demand curves slope downwards, that's all they're saying. All groups are somewhat elastic in that demand drops when price increases. The question at hand is whether moderate drinkers reduce their consumption by more than do heavy drinkers, and they provide zero evidence supporting their opening claim. I cannot see how the Law Commission dismissed the findings of the meta-study based on this paragraph.

Shocking.

Oh Treasury, Why Hast Thou Forsaken Us?

Reading the Law Commission report on the review of alcohol taxation and regulation that Eric linked to yesterday, I noticed this sentence in the Treasury advice to the Commission:

Within existing constraints then, the best proxy for a progressive Pigouvian tax is an alcohol excise that equates to the net costs of the consumption of alcohol for society as a whole.

The constraints they refer to are the fact that the external costs of alcohol are typically higher for large users than for low users, so that ideally large users should pay a larger tax per drink than low users. Let’s leave aside the fact that a Pigouvian tax should be set to equal the marginal social cost not to equate tax revenue with the total social cost. My problem with this statement is that if one is constrained to apply the same tax to high-social cost and low-social cost users, the optimal policy needs to ask about the relative responsiveness of demand to price of the two groups. Let’s imagine that high-social-cost users have relatively inelastic demand and low-social-cost users have more elastic demand. Then a Pigouvian tax will have little effect in reducing the harmful consumption of the former group and a large effect in reducing the non-harmful consumption of the latter group. The optimal Pigouvian tax in this world would be much lower than one that equaled net social marginal costs. Indeed, in the extreme case where the high-social-cost users had demand that was completely unresponsive to price, the optimal Pigouvian tax would be zero!

Social science, done honestly

William Dickens has spent the last several years thinking hard about racial differences in IQ. The stylized facts didn't make much sense to him, taken together:

• Large differences in average intelligence by race (about 1 standard deviation)
• High estimates of heritability of intelligence and little discernible lasting effect of environment
• Rising intelligence over time (the Flynn Effect).

If variance in intelligence is largely explained by genetics, not by environment, how can we explain the Flynn Effect, which happens far more quickly than could be explained by any evolutionary story?

Dickens worked with Flynn to come up with a model that allows for complex interactions between genes and the environment that would fit the three stylized facts. The model works as follows, and is nicely described here. Kids with small initial differences in genetic endowments sort into more or less cognitively demanding environments. The ones in the more cognitively demanding environments reinforce their initial advantages. Because genes cause the initial environmental sortition, all then loads onto genetics in variance decomposition. But the observed differences are still a function of both genes and environment. And, if one group systematically has poorer access to cognitively demanding environments, then large group differences can be observed despite there being small underlying genetic differences. If the average environmental cognitive complexity increases for all groups over the period, we get the Flynn Effect.

Cute model and seems plausible. Bill then took the model to the data. Or, rather, took one implication of the model to the data: a full test would require some rather expensive experimentation. If the model holds, then a decomposition of variance into transient environmental effects, permanent environmental effects, and measurement error should show that at least some differences across siblings come down transient environmental effects. Instead, he found most of the environmental variance is permanent with the rest being measurement error (see slide 43 at the above link).

BUMMER! (Did I mention that one of the “advantages advantages” of tightly linking your theory to your empirical work by modeling is that you can be proved decisively wrong?)

Moreover, differences across identical twins in childhood are almost entirely measurement error. So if one twin randomly is assigned to a more cognitively demanding environment in childhood, we can't see any effect of it in the data.

And so Bill heads back to the drawing board, working on a new model where folks switch environments to match the one that meets their current level of cognitive ability, but where there's noise in the process and fewer opportunities for change as time goes on.

That's how social science, or any science, is supposed to be done. Hypothesis leads to test leads to starting over if the hypothesis is rejected. DeLong and Lang worry that all economic hypotheses might well be false because of publication bias; Ed Leamer worries that folks choose the method that gives them the results they want. Nice to see folks who work against both. And, entirely consistent with other observations on Bill, who visited here as an Erskine Fellow a couple of years back and who derived results on a scratch-pad while role-playing a low-intelligence half-ogre named Grissumpf in Bryan Caplan's excellent all-economist D&D campaign (I was a sage-assassin who threatened his way into sage school, charisma of 4). Good times.

Law Commission

The Law Commission released its report on the review of alcohol taxation and regulation. I've been teaching all day and so haven't yet had a chance to look through it thoroughly. I note though that the Law Commission thinks it appropriate to seek advice from Brian Easton as an independent authority on the social costs of alcohol to help resolve the differences between the BERL report and the Crampton/Burgess critique. Ahem. Will be interesting to read the rest of the paper.

Questioning education

Over at Inside Higher Ed, Mario Rizzo asks some pertinent questions about the push to have ever-increasing proportions of the population pass through universities.

At the risk of being accused of taking away the party punch bowl, readers should know that I stand to benefit a great deal if more Americans partook in the college experience since I teach large numbers of introductory and intermediate economics students for a living.

Despite this, he argues against President Obama's call for increased higher education. Worth noting:

• There are diminishing returns to aggregate educational attainment
• Education is costly
• The more low quality students are pushed through low quality schools, the greater the returns from attending prestigious schools to differentiate yourself
• A good portion of college is consumption for the students
• Richer countries have higher rates of tertiary completion, but causality is difficult to prove; there are notable counterexamples to received wisdom
• Education is a good, but so are other things: there are opportunity costs. As Rizzo asks,

  Does it make sense to sacrifice more and better carpenters or professional baseball players just to lead the world in college completions? Perhaps I am overplaying that hand. But there are many ways for individuals and societies to improve their human capital and productivity without relying on political forces to put more people through college.

Human capital is important, but higher education is only one way of getting it.

Nothing new under the sun

I thought I'd discovered a new word to describe an ongoing problem in the Crampton household. Turns out, someone else was there three years before me. It's still a good word though. Narcokleptic. Pertains especially to theft of blankets, leaving a cold Eric.

The word deserves wider usage. Enjoy!

Electricity Report: Who Paid the $4.3b?

The slides from my talk at the Institute for the Study of Competition and Regulation (ISCR) on the Wolak report into the electricity industry are now posted on ISCR’s website.
This is the study that produced newspaper reports like the following:

Power companies face public outrage after a Commerce Commission report said they had overcharged customers $4.3 billion.

I will blog a bit over the next few days on why I think the $4.3b is heavily overstated, but first it would be useful to correct a misunderstanding in the way that the study has been reported in the press.

In New Zealand, wholesale electricity prices are determined every 30 minutes in an auction market in which electricity generators submit offers for how much electricity they would be willing to supply at different prices at different injection points on the national grid, while buyers submit bids to buy electricity at the exit points on the grid. The computer-based market maker then sets the prices to equate supply and demand taking into account energy loss along the transmission network. In principle, generators can submit offer curves that are higher than their true willingness to supply (essentially pretend to be willing to supply less than they actually would like to) in order to push up the price. In the retail market, electricity retailers buy electricity from this wholesale market to sell to final consumers, usually at a price that is fixed for 12 months or more.

The Wolak study looks at the wholesale market, not the retail market. The $4.3b is an estimate of how much electricity generators have overcharged wholesale buyers. But who are those buyers. A small percentage are large industrial final users who purchase directly from the wholesale market at spot prices. But the overwhelming majority of purchases are by retail companies, who are mostly also the big generators. That is, the unfortunate purchasers that Wolak estimates have been overcharged $4.3b by the four large generator companies—Meridian, Genesis, Mighty River Power, and Contact—are, in fact, none other than Meridian, Genesis, Mighty River Power, and Contact!

A full study of the retail industry might reveal that there is pass through from wholesale overcharging to retail prices, but such a study has not been conducted, and it is by no means clear theoretically that such pass through would be profit maximising behaviour in a vertically integrated industry.

Temperature Trading

Over on iPredict, New Zealand's event stock market, they're running contracts on this year's global temperature anomaly as measured by the HadCRUT3GL series.

The first contract, TEMP.2009, pays out at $1 if the 2009 global temperature anomaly is higher than that of 2008. The 2008 global temperature anomaly was 0.324.

The second contract, TEMP.2009.HIGH, pays out at $1 if the 2009 global temperature anomaly is the highest ever. The largest anomaly in the series is 1998, when it hit 0.546.

Six months of data are now out. So half of what goes into making up this year's average is known. The average of the six months so far is 0.403. So, just on raw numbers it looks pretty unlikely that 2009 will be warmer than 1998 or colder than 2008. But we can do better than that. Throw the 160 year time series into STATA (or your favorite regression package) and run a simple forecasting model. The simple one I use regresses average temperature on a year trend, some lagged temperatures, and the temperature readings for January through June; I weight observations by the average number of temperature recording stations in the given year. From that, we can easily get a predicted temperature anomaly for 2009 and, more importantly, a measure of the year by year residuals. The residuals tell us how far the actual temperature varied from the model's predicted temperature.

With the residuals, I can look back over the history of the time series and count the number of instances that the model gave a prediction so far out that, if we had an error that large again this year, we'd either be warmer than 1998 or colder than 2008. Doing that, I find that there's no instance where the the model was sufficiently out to get us a temperature this year warmer than 1998, and only one instance where it was sufficiently out to get us a temperature this year colder than 2008. So the price of both contracts should reflect a smaller than 1% probability that we'll either be warmer than 1998 (price of TEMP.2009.HIGH should be < $0.01) or colder than 2008 (price of TEMP.2009 should be > $0.99).

Current trading price of TEMP.2009.HIGH is about $0.065; TEMP.2009 trades at $0.88. The former gives you a 7% return over the period to end-January next year; the latter, about 14% over the same period. If my model is right. I've consequently dumped a bit of money into both. Unfortunately, iPredict operates under regulation from the Securities Commission requiring that folks deposit no more than $1000 per 6 month period. So I can't put in any more.

One possibility is that there's an informed trader with access to better forecasting technologies that incorporate more than just the observed temperature series.

But I tend to think rather that we're being hit by the deposit limit. There's only a small subset of traders who

1. watch the market closely enough to note the low risk, long time horizon trades
2. who also don't watch it closely enough to prefer trading the contracts that are higher variance and end quickly
3. and who trust the market enough to make substantial deposits.

Why get a 14% return over 6 months when you can get a 50% return over a couple of weeks in some of the other contracts? Absent the deposit restrictions, that small subset of folks could move their retirement accounts over to iPredict and earn a decent return.

However, that doesn't explain the difference in pricing between TEMP.2009 and TEMP.2009.HIGH. One explanation is that TEMP.2009 only became such a sure thing with the release of the June temperature figures: prior to that, the price on that contract was close to right. If TEMP.2009 quickly moves to approximate (1-TEMP.2009.HIGH), then the liquidity preference story might not be far out.

Full disclosure: I have big positions on both contracts, and would have larger positions if I were allowed to deposit more. This should not be interpreted as investment advice.

What BoingBoing taught me today

• There's now a database with service records of soldiers from the Hundred Years' War. Robert Fogel did awesome work using data from the US Civil War showing just how much economic growth has improved our lives since the 1850s; I wonder what will come of this new dataset.


• You may have heard of the experiment from the 30s where the researcher raised a chimp infant alongside his own son. You may not have heard the "what happened next".

  The real reason he abruptly halted the study, then, was likely because of results that Kellogg never anticipated: his son Donald started imitating the chimp.
  
  For example, though Donald had learned to walk before Gua joined the Kellogg family, he regressed and started crawling more, in tune with Gua. He'd bite people, fetch small objects with his mouth, and chewed up a shoe. More importantly, his language skills were delayed. At 19 months, Donald's vocabulary consisted of three words. Instead of talking he would grunt and make chimp sounds.
  
  Gua got sent back to the Yerkes center in Florida, where she promptly died. And Donald? Not much is known of his life, but, at 43, he committed suicide.
  
  This study got a lot of press when it was published, but Kellogg ended up deeply regreting it -- not because of what it did to his son, but because it prevented him from being taken seriously as a scientist.

• Another dodgy use of copyright: this time, to keep folks from fighting their traffic tickets in the UK. Are speed camera photos really what folks had in mind when trying to protect the returns to intellectual innovation? I hope not.


• Bat shark repellent exists and is effective

And a victory for the little guy against the union

Three years ago, migrant farm workers at Mayfair Farms in Portage, Manitoba, Canada were deceived into joining a union. One of the workers got in trouble with the police for a non-work related problem. The United Food and Commercial Workers Union told the Mexican workers, most of whom did not speak English well let alone read it, that signing cards would get the UFCW to provide legal help for their buddy. They didn't know that signing the cards meant that they'd joined a union. They didn't want a union. Nothing required the union to provide documentation in a language that the workers could understand. The sordid tale is documented here, here, and here.

Now, the farm workers have finally been able to decertify the union.

A group of migrant farm workers in Portage la Prairie that once made history by accepting a collective agreement and forming a union have now managed to break their ties and de-certify their union.

On June 25, a representation vote was held, and 26 employees cast their ballots against union membership in a unanimous decision.

As a result, on July 9, the Manitoba Labour Board revoked the workers' union that was originally certified on June 26, 2007.

Heladio Martinez Perez, one of the seasonal employees at Mayfair Farms Portage Ltd. from Veracruz, Mexico, who was opposed to forming a union from the start, was overjoyed to see the employees were able to now sever their relationship with the union and end the collective agreement.

Perez said the employees did not originally want a union, but were misled into signing the initial agreement through a misunderstanding.

Congrats to the workers at Mayfair for breaking the union shackles! The UFCW treated them as pawns in their broader campaign to force through unionization of seasonal migrant labour, regardless of whether the workers wanted to be members. Nice to see the good guys win one.

Voter preferences and electricity generation

Seamus posted yesterday a political second-best argument in favour of maintaining public ownership of Meridian: while a first best would be private ownership, that's not a politically stable equilibrium because the median voter would demand regulations on a private owner even more inefficient than the initial public ownership.

I wondered in a comment there, and in a comment over at Anti-Dismal, whether the political second-best argument might well not justify a rather wide range of inefficient status quo positions. Paul takes me to task, but I think he's conflating my extension of Seamus's argument with my actual worry about potential use of the political second best argument against change.

I'm certainly not against political second best arguments in particular application. I tend to think, for example, that the New Zealand government has sufficiently proven its utter inability to avoid expropriating Telecom's investments in broadband infrastructure, through mandated sharing with competitors, that there's little chance of substantial private investment in fiber absent government making that investment directly.

Does the political second best argument hold in the power example? First, what do voters think about government ownership or regulation of electricity generation? Well, we have some data on this from the NZES. 40% of respondents want to have full government ownership of generation and distribution; 18% want "mixed" ownership (the current situation); 27% want a private but regulated industry, and 4.5% want a private industry (rest didn't know). So, it looks like voters are strongly against having a private, unregulated industry. That suggests that a private, unregulated industry is not a political equilibrium. Even the current "mixed" ownership situation isn't particularly stable.

Now, some interesting covariates. Probability of supporting full government ownership is significantly affected by:

• Economic thinking (-): a standard deviation increase in economic thinking reduces support for full government ownership by 8%
• Political ignorance (-): a standard deviation increase in political ignorance reduces support by 4%
• Listening to National Radio (+): 3.3%
• Being male (+): increases support 12%

Other covariates didn't matter much. Probability of supporting complete privatization is increasing in economic thinking, political ignorance, being female, not being a superannuitant, and being of asian ethnicity. By and large, the magnitudes of the coefficients is tiny (less than two percent increased probability) except in the case of asian ethnicity which increases the predicted probability by 6%. Economic thinking most strongly predicts support for a private but regulated system.

I'd expect a private but strongly regulated system to be an equilibrium; I can't see a private, unregulated system being a political equilibrium. If I could push a button that would privatize the electricity system while insulating it against stupid regulations, I'd push that button. Unfortunately, such buttons don't exist.

Now, is this a generalized argument in favour of any political status quo? I don't think so. I think there's reasonable evidence consistent with that privatization would result in a highly regulated system, and I can buy that such a system could be worse than what we now have. Paul says this may make me a Marxist, but I'd say rather Coasean.

I do worry that in some cases, building popular support for economically efficient policies requires government to be the first-mover in adopting currently unpopular moves and then building support for the shift by highlighting the successes of the reforms. Economists haven't a theory of the path to equilibrium, and much less a theory of the path from inefficient but politically stable equilibria to efficient stable equilibria that avoid worse-case outcomes. Hard problems.

In any case, if it takes substantial political capital to make any of these kinds of moves, why not start with ones that are more likely to lead to stable and desirable equilibria?

New Zealand: Free market agriculture on N - 1 dimensions

New Zealand abandoned agricultural subsidies in the 1980s. The transition wasn't easy, but the wide majority of farmers here prefer things as they are: no going back.

Compared to the rest of the world, we're paragons of virtue. So I was surprised to learn on moving here of Zespri's legislated near export monopoly on Kiwifruit. In short, any kiwi grower wanting to export anywhere other than to Australia has to go through the single-desk seller, Zespri. The National Business Review reports on a challenge to this monopoly from Turners & Growers:

Under the Kiwifruit Export Regulations 1999, Zespri has a monopoly over the export of kiwifruit from New Zealand, except to Australia.

This single desk selling system is widely accepted by kiwifruit growers because it controls the volumes of their produce in the global market, which leads to higher prices. Control over fruit volumes would be lost with deregulation of the industry, and growers fear that would undermine their returns.

However, Mr Gibbs said Zespri does a poor job selling the concept of New Zealand alongside the brand, which is more valuable than the label.

“It’s very simple. We don’t believe the Zespri brand is the only way to go. We believe the brand is New Zealand.”

Speaking from London, where he is on business, Mr Gibbs said the kiwifruit marketer has ignored the strength of the New Zealand Inc brand in some ways and should be further trading on this country’s clean and green reputation overseas.

Boy does this sound familiar to anybody raised on a farm in the Canadian prairies. As usual, the Canadian variant is far worse: there, the Canadian Wheat Board is the single-desk seller for all wheat grown west of Ontario, sold either within Canada or for export. The CWB claims that its position allows it to charge premium prices on the world market; Canada's market share in the world's traded wheat makes that rather implausible. As best I understand it, the Canadian system persists because lots of small farmers, inching towards retirement but holding onto a few acres and permit books, vote in favour of the CWB in the occasional plebiscite and vote for pro-monopoly candidates for the board; they're a minority by tonnage but a majority by body count. Organizations like the Western Canadian Wheat Growers push for an end to the CWB's monopoly, but haven't had great success as yet.

Back to New Zealand. The arguments sound pretty similar. Zespri argues it's able to command premium prices because of New Zealand's dominant position in kiwifruit production. Here, the claim is a bit more plausible because while wheat is durable and stores well, fruit doesn't. Italy is the world's largest producer, but we're in the opposite hemisphere. Chile's in the same growing season, but exports roughly half as much as does New Zealand. However, a report by Lew Evans and Co for Turners & Growers cites evidence from Treasury that New Zealand is not able to command any price premium in world markets. Turner's and Grower's statement of claim is compelling.

Absent really really strong evidence that a legislated export monopoly strongly benefits growers, how can the government justify banning a fruit grower here from selling his fruit to a willing purchaser?

One small aside: The New Zealanders in our Department tend to eat their kiwifruit skins and all, like a plum, rather than peeling them. Makes me wince every time.

Should Meridian be Privatised?

This story in yesterday’s Press suggested that the SOE, Meridian Energy, is being restructured in preparation for being privatised after the next election, although this has been denied by John Key.

The reaction of the regular “public finance” economist in me to the suggestion that an electricity company will be privatised is to cheer loudly: the government has no business owning shares in companies providing private goods while at the same time maintaining a large portfolio of debt. The “public choice” economist in me, however, hopes that Meridian and the other two SOE electricity generators (Mighty River Power and Genesis) will remain government owned.

The reason for this is that electricity politics is fraught in New Zealand. Economic efficiency requires that consumers pay the marginal cost of the most expensive unit of electricity produced, which will imply very large profits for owners of hydro power stations where the first units of electricity are very cheap to produce. And, unless we want to return to silly policies of the past in which the country wasted huge amounts of money building power stations whose only role is to supply electricity in very dry years, we will want customers to face higher prices in dry years in order to ration demand to available supply.

In New Zealand voters have a historical expectation that it is the government’s job to deliver them cheap power, with no blackouts, at the same price no matter how full are the southern lakes. In this environment, fluctuating power prices with high associated profits to the generators in dry years would only be politically sustainable if those high profits represent a dividend to the crown rather than to private interests. Yes, those high expected profits would be amortised into the price that the government would be able to sell Meridian and the other companies for, so that taxpayers would be enjoying the profits each year in the form of lower interest payments on the national debt, but this is not the popular perception.

Welfare reform for New Zealand

I'm greatly looking forward to reading Lindsay Mitchell's forthcoming report for the New Zealand Business Roundtable. One interesting suggestion, as reported in the National Business Review:

It also suggests the Work and Income Department could be privatised, loans could replace benefits, and that people could opt out of the public health and welfare systems in return for tax relief and accepting responsibility to fund their own needs.

I'll be interested to see how Lindsay proposes the last option work. It's well neigh impossible for the median voter to bind herself against the argument from pathos, so anyone opting out of the welfare or health system has an implicit option to jump back in should hard times eventuate. Consequently, any proposed system needs some pretty robust mechanisms to ensure that isn't necessary for folks to jump back.

As a first cut, I'd expect strong requirements for evidence of sufficient ongoing private health insurance as condition for exit from the public system; I'd also expect similar requirements for income protection insurance or ongoing evidence of substantial liquid reserves for exit from the welfare system. I wish these sorts of things weren't required, but time consistency isn't the median voter's strong suit. It'll be interesting to see what Lindsay here suggests.

Unemployment forecasts

iPredict, the New Zealand events market, has contracts on the Kiwi unemployment rate. Real money contracts, but trading open only to Kiwis.

The markets are pegging 5.8% unemployment for the June quarter, 6.5% for the September quarter and 6.9% for the December quarter. There's a 44% chance that unemployment turns the corner on or before March quarter 2010 with an additional 30% chance of a first decline in unemployment in June 2010.

Traders there also reckon that there's a 43% chance that the first OCR increase comes before 1 April 2010 and a 60% chance of an increase before July 2010.

On GDP growth rates, prices suggest that June 2009 quarter figures will show a decline, but that there's only a 50/50 chance of a negative showing in the September quarter and a 24% chance of negative results in December.

If the market prices are right, things will start turning around in New Zealand reasonably soon, though with employment lagging. If that seems out of line, and you're Kiwi, start trading!

Agglomeration: Saviour of New York, bane of New Zealand

Greg Mankiw points us to an insightful piece by Ed Glaeser, one of the smartest economists of this generation, on how human capital forms the ultimate resource for New York's reemergence. In short, agglomeration effects and human capital concentration together ensure that New York will ever be a hub for the generation of new ideas and industry, so long as city government doesn't do incredibly stupid things.

Further, New York will continue to have a comparative advantage at producing ideas. That advantage occurs because big cities are, at their heart, the absence of distance between people and firms. Talent, whether painterly or financial, gets magnified because of urban concentration. Cities thrive by connecting people. That’s why Bloomberg insisted on open offices at his company—cities writ small, places where people could constantly exchange information—despite techno-prophets’ repeated predictions that technology would make human proximity obsolete. Here was a firm on the cutting edge of information technology that chose to locate at the heart of a great city and did as much as possible to eliminate the physical barriers among its workers.

But what if you're on a small island of 4 million people at the far end of the world? "Move to New York" isn't on the government's preferred list of options, though the Kiwi diaspora is one of the larger ones out there.

Evidence against the feasibility of a desirable libertarian anarchy

Today's lecture in my Public Choice class will hit on anarchy, the state of nature, the emergence of government, and the feasibility of a desirable market-based anarchic structure.

On the latter point, a small bit of evidence from David Hume's History of England, the reign of Edward I (around 1297)

For this purpose, he [Pope Boniface VIII] issued very early in his pontificate a general bull, prohibiting all princes from levying without his consent any taxes upon the clergy, and all clergymen from submitting to such impositions; and he threatened both of them with the penalties of excommunication in case of disobedience. This important edict is said to have been procured by the solicitation of Robert de Winchelsey archbishop of Canterbury, who intended to employ it as a rampart against the violent extortions, which the church had felt from Edward, and the still greater, which that prince’s multiplied necessities gave them reason to apprehend. When a demand, therefore, was made on the clergy of a fifth of their moveables, a tax which was probably much more grievous than a fifth of their revenue, as their lands were mostly stocked with their cattle, and cultivated by their villains; the clergy took shelter under the bull of pope Boniface, and pleaded conscience in refusing compliance. The king came not immediately to extremities on this repulse; but after locking up all their granaries and barns, and prohibiting all rent to be paid them, he appointed a new synod, to confer with him upon his demand. The primate, not dismayed by these proofs of Edward’s resolution, here plainly told him, that the clergy owed obedience to two sovereigns, their spiritual and their temporal; but their duty bound them to a much stricter attachment to the former than to the latter: They could not comply with his commands, (for such, in some measure, the requests of the crown were then deemed) in contradiction to the express prohibition of the sovereign pontiff.

...Instead of applying to the pope for a relaxation of his bull, he [Edward] resolved immediately to employ the power in his hands; and he told the ecclesiastics, that, since they refused to support the civil government, they were unworthy to receive any benefit from it; and he would accordingly put them out of the protection of the laws. This vigorous measure was immediately carried into execution. Orders were issued to the judges to receive no cause brought before them by the clergy; to hear and decide all causes in which they were defendants: To do every man justice against them; to do them justice against no body. The ecclesiastics soon found themselves in the most miserable situation imaginable. They could not remain in their own houses or convents for want of subsistence: If they went abroad, in quest of maintenance, they were dismounted, robbed of their horses and cloaths, abused by every ruffian, and no redress could be obtained by them for the most violent injury. The primate himself was attacked on the highway, was stripped of his equipage and furniture, and was at last reduced to board himself with a single servant in the house of a country clergyman. The king, mean while, remained an indifferent spectator of all these violences; and without employing his officers in committing any immediate injury on the priests, which might have appeared invidious and oppressive, he took ample vengeance on them for their obstinate refusal of his demands. Though the archbishop issued a general sentence of excommunication against all who attacked the persons or property of ecclesiastics, it was not regarded: While Edward enjoyed the satisfaction of seeing the people become the voluntary instruments of his justice against them, and enure themselves to throw off that respect for the sacred order, by which they had so long been overawed and governed.

The spirits of the clergy were at last broken by this harsh treatment. Besides that the whole province of York, which lay nearest the danger that still hung over them from the Scots, voluntarily, from the first, voted a fifth of their moveables; the bishops of Salisbury, Ely, and some others, made a composition for the secular clergy within their dioceses; and they agreed, not to pay the fifth, which would have been an act of disobedience to Boniface’s bull, but to deposit a sum equivalent to some church appointed them; whence it was taken by the king’s officers. Many particular convents and clergymen made payment of a like sum, and received the king’s protection. Those who had not ready money, entered into recognizances for the payment. And there was scarcely found one ecclesiastic in the kingdom, who seemed willing to suffer, for the sake of religious privileges, this new species of martyrdom, the most tedious and languishing of any, the most mortifying to spiritual pride, and not rewarded by that crown of glory, which the church holds up, with such ostentation, to her devoted adherents.(emphasis added)

The Church of the late 1200s was perhaps best placed of any party to provide private law enforcement services to its members. But it was unable to protect the Clergy when Edward removed the State's protection.

Sure, technology has changed over the interval, and this is hardly decisive evidence about whether Caplan or Cowen is right today. But it is worrying.

Hume's History of England provides excellent bedtime reading. General rule for arts students: read more economics. General rule for economics students: read more history.

IQ and health

Further evidence that Gottfredson was right today comes from Razib at GNXP: differences in IQ explain a decent chunk of the heart disease related mortality between high and low socioeconomic status groups. In short, poor people are, on average, less intelligent than richer people, and that difference explains some of the differences in health status.

Authors of the study published in the European Heart Journal on 15 July...analysed data from a group of 4,289 former soldiers in the USA. They found that IQ explained more than 20% of the difference in mortality between people from socio-economically disadvantaged backgrounds compared to those from more advantaged backgrounds. Importantly, this was in addition to the classical, known risk factors for heart disease, such as smoking and obesity.
...
"The difference between the second and third analyses showed that IQ alone explained a further 23% of the differences in mortality between the higher and lower ends of the socio-economic spectrum, in addition to the other, known risk factors," said Dr Batty. “IQ wasn’t a magic bullet in this study, but this psychological variable had additional explanatory power on top of the classic variables such as smoking, high blood pressure, high blood glucose and obesity. It has partially explained the differences in death from heart disease and all causes."
...
...there could be three possible explanations for Dr Batty's findings: "(i) intelligence might lead to greater knowledge about how to pursue healthy behaviours; (ii) intelligence may "cause" socioeconomic position, i.e. more intelligence leads to more education, income, occupational prestige . . .; and (iii) intelligence may be a marker for something else, and it is that something else, early life exposures, for example, that leads to mortality."....

Nice.

I've longstanding complaints about the quality of work done in the public health field. First, utility is more than just health, something they typically ignore. Second, they are far to quick to chalk everything up to differences in socioeconomic status, and then make ridiculous policy claims, without stopping to consider that there might be underlying variables causing both differences in health and differences in economic outcomes. I'd discussed this a bit during my guest stint at EconLog in 2006, here.

Accents

It turns out I do have a Canadian accent.

Which American accent do you have? Canadian People from outside North America probably think you're from the States, but over here we wouldn't make such a mistake.

Click Here to Take This Quiz

I wonder what the quiz would do with the Kiwis. They need a few questions like

• Do these two words sound identical: "pawn", "porn"
• Do these two words rhyme: "morse", "sauce"

HT: Book of Joe.

Trademarks as Rent-seeking

The Real Beer Blog points to one of the more egregious recent rent-seeking uses of intellectual property protection in New Zealand. DB Breweries trademarked the name "Radler" for its Monteith's brand. Of course, Radler is a common international style; it's akin to trademarking "Pilsner" or "Ale".

And, this isn't the first time DB's gone this route. The ODT reports:

It also bid, unsuccessfully, to trademark its Summer Ale in 2007 to stop Lion Breweries selling Mac's Sun Dance Summer Ale and at the same time tried to stop Galbraith Brewery in Auckland from selling a summer ale it had been making for 12 years.

Lion produces a radler style under its Barefoot label in Australia but does not sell it here. It does not believe anyone should have exclusive use of the name of widespread beer styles.

Trademarks make sense as a way of preventing folks from eroding a firm's reputation. DB would rightfully get upset if another brewery tried to produce a "Monteith's" beer. But summer ales and radlers are fairly common styles. DB here seems to be trying to use IP law instead to raise its rivals' costs. It is no more likely that a drinker would confuse a Monteith's Summer Ale with Mac's Summer Ale than that they'd confuse a Monteith's Pilsner with anyone else's.

So now Green Man puts a sticker saying "Cyclist" over the "Radler" name on the label.

A business journal that recognizes bloggers' contributions

Nice piece in today's Wall Street Journal discussing the rise of economics blogs.

Americans trying to understand the nail-biting financial trauma of the past several months are flocking by the millions to a surprisingly lively source of enlightenment: blogs written by economists.

Such blogs are thriving in this recession, driven by intense interest from policymakers, investors, academics and people like Zina Poletz, a Minneapolis public-relations executive who says she had little interest in economics before the financial crisis intensified last fall. “I never thought I’d be sitting up late at night reading what [Federal Reserve chairman] Ben Bernanke thinks, but now I do,” she says.

For many people, economics has never seemed so captivating, or so relevant. The enormous appetite for information and guidance right now is hardly a surprise: Even those with a basic knowledge of supply and demand have struggled to keep tabs on the global downturn.

“My [economics] professors were always saying, ‘This is the most relevant class you could ever be in,’” says Christa Avampato, a product developer in New York City with an M.B.A. from the University of Virginia’s Darden School of Business. “But I think until the last 18 months I never really believed them.”

The result is a watershed moment for economics bloggers, ranging from academics to armchair economists, who are all too happy to help readers fill in the blanks—or find a place to vent their frustrations. Traffic to the top sites, such as Marginal Revolution, Freakonomics and the blogs from academics such as Paul Krugman, Greg Mankiw and Brad DeLong, surged anywhere from 80% to 250% from July to September 2008 as the financial crisis intensified, according to Compete.com, a Web site that measures Internet traffic. The most popular blogs can attract as many as 50,000 to 100,000 page views a day.

In the last several recruitment rounds at Canterbury, I've asked prospective hires which economics blogs they read. Some of my older colleagues think the question a bit from left-field, but I cannot imagine a better way for a young economist to stay on top of the current debates in the field as they're transpiring. If it's in print, it's already a couple of years out of date. And if you're just finishing up your PhD and you've never heard of the economics blogs, it's a pretty strong signal about the range of your interests.

The latest New Zealand top-20 blogs list includes three economics blogs: The Visible Hand at #18, your humble narrator at #19, and Peter Cresswell's Objectivist blog, NotPC, which sits at #3 and should also be counted as an economics blog. US readers: you got that right. A stridently Objectivist blog is the #3 ranked NZ blog. I don't think that Bernard Hickey's blog gets counted for some reason, but it's surely up there as well, and probably higher than either TVHE or me. Paul Walker's AntiDismal comes in at #25.

The economics blogs are relatively at least as popular in New Zealand as they are in the US. As yet, they've been far less influential in shaping the economic discourse, especially as it feeds into policy. Probably because the set of economists who blog in the US includes an awful lot of folks who get consulted about policy while the go-to folks for Treasury and RBNZ here, Arthur Grimes, Bob Buckle, Andrew Coleman and so on, don't blog and very likely don't read blogs. But the econ bloggers can occasionally make contributions at the margins of policy.

HT: Marginal Revolution

More NBR on the Hurly-BERLy

Today's print edition of the National Business Review covers the latest iterations of the debate between Matt and I on the one side and BERL on the other. Unfortunately, the story's not online; perhaps it'll be available as subscriber-only online content eventually to protect it from parasitic bloggers who do no independent investigative work.

A few choice excerpts:

The lead author of the controversial Business and Economic Research Ltd (Berl) report on the social costs of alcohol, Adrian Slack, and economists Dr Eric Crampton and Matthew Burgess have squared off in a bare-knuckle brawl of the theorists to gtry to prove whether alcohol costs New Zealand $4.8 billion or $662 million -- and the price of your favourite tipple may depend on who's right.
...
Mr Slack is standing firmly by all Berl's figures and has dismissed any criticisms of its report.

For starters, Mr Slack has reiterated that Berl was not commissioned to look at the benefits as well as costs of alcohol, which is why Berl has produced a figure that reflects the gross rather than net costs of alcohol to society.

But Dr Crampton and Mr Burgess contend Berl does consider benefits and that it is actually integral to its headline costs because private costs can only be counted as social costs if there are no offsetting private benefits.
...
So only the net social costs of alcoholic consumption were relevant for policy-making, which Berl chief economist Dr Ganesh Nana later conceded in a discussion with Jim Mora on National Radio.

The article goes on to list some of the points left to one side by BERL in its rebuttal.

Lion Nathan corporate affairs director Liz Read notes in the article that, as excise tax is paid by producers, it isn't necessarily passed through into retail prices so tax increases may not influence consumption. I think we have reasonable evidence in the literature of strong pass through, as we'd expect for goods that are relatively inelastic in demand. Tax incidence tells us that the producer bears the larger burden of a tax where demand is elastic but that the consumer bears it where demand is inelastic. The problem rather is that "harmful drinkers" are less price elastic, and so the burden falls disproportionately on moderate drinkers.

I hope they're not talking about me

The National Business Review, New Zealand's leading business journal, today pitches for subscriptions, promising subscriber-only online content (no link, as from the emailed pitch).

As you know, there has been endless discussion for a number of years about the crazy model adopted by newspapers in most parts of the free world in which they pay the enormous costs of running professional newsrooms only to give their content away free – while at the same time slashing newsroom numbers to save money as circulation and advertising revenues fall.

And to add to the madness it has been the aggregators that have profited the most from the supply of that free news copy. Worse still the model has spawned a huge band of amateur, untrained, unqualified bloggers who have swarmed over the internet pouring out columns of unsubstantiated “facts” and hysterical opinion.

Most of these “citizen journalists” don’t have access to decision makers and are infamous for their biased and inaccurate reporting on almost any subject under the sun (while invariably criticising professional news coverage whose original material they depend on to base their diatribes).

It is only a matter of time before the model collapses. The alternative is newsrooms decimated to the point of processing public relations handouts or unedited government propaganda from their fully staffed team of spin doctors.

I'm a fan of the NBR, and not only because they've been about the only outlet consistently covering the Hurly-BERLy. And, I'd far sooner pay for decent content than have it cease to exist. But it's a bit quick to blame the bloggers here. Bloggers aren't entirely parasitic on journalists; it's very much a two-way street. See here especially, but also here and here. In New Zealand, Kiwiblog's broken stories picked up without attribution by the mainstream.

Embrace Neurodiversity

From Tyler Cowen's discussion of autism:

In many areas of human neurodiversity, including autism, we still don't know the answers to many basic questions. There is still not even agreement on the basic definitions of autism, Asperger's, and related concepts. In the meantime we are applying lots of stereotypes and negative descriptions to autistics that we would not dream of using to describe racial or ethnic groups. It's high time that colleges and universities got out in the lead to fight these common prejudices. The rhetoric coming out of higher education needs to match up to the reality of higher education as a common avocation for autistic people.

...
It's a little tricky to talk or write about the autistics who may work in your institution. If you work at a college or university, there is a good chance you are interacting with people on the autism spectrum on a very regular basis. Maybe the reaction of the reader is to draw up a mental list of people in the workplace and start applying various stereotypes to them. Maybe you'll be on the lookout at the next dean's meeting for people who exhibit "autistic traits" and then gossip about those perceptions to your friends.

That's human nature, but I'm suggesting an alternative tack. Embrace individualism. Question your stereotypes. Maybe even look in the mirror. When you're done, it's likely that you'll see far more talent, in far more unorthodox varieties, than you expected.

HT: Arts & Letters Daily

Crashing boulders through the screen

Scott McLemee's always worth reading over at Inside Higher Ed. In today's discussion of the work of Isaac Rosenfield, he notes Scialabba's "What are intellectuals good for?"

Scialabba does not simply repeat standard complaints about the decline of free-range public intellectuals and the rise of transgressive professorial jargonization. (That is a familiar story, even perhaps too familiar.) Scialabba points, rather, to the role played by a “new variety or mutation” of thinker in the “modern, efficient machinery of persuasion” necessary to hold highly developed societies together. Scialabba calls this type “the anti-public intellectual, whose function is not criticism, not defense of the public against private or state power, but the opposite.… As a result of the intellectuals’ incorporation en masse into the ‘power elite,’ it now requires far more training, leisure, and resources to penetrate the screen of corporate or government propaganda….”

And so the critic must redouble his efforts at challenging the arts of public manipulation, however Sisyphean those effort may be. The boulder will crash through the screen every so often, with enough luck and a good aim.

Reading McLemee always winds up adding to the stack of books I hope to read while on sabbatical next year.

What do alcohol and electricity have in common?

I have been spending most of the past two weeks reading the Wolak report for the Commerce Commission into electricity pricing, in preparation for a presentation on the report next Monday at the Institute for the Study of Competition and Regulation in Wellington. This was the report that found that electricity generators had earned $4.3b from exercising market power since 2001.

I'll blog a bit next week on my take on the report, but an immediate reaction was a bit of deja vu after following Eric and Matt's work on the Berl report. In both cases, we have a public institution commissioning an independent report that produces an implausibly high number that is then put out into the public domain. Both reports were subject to external review prior to being released. And both have some questionable aspects to say the least that did not seem to be spotted by the external reviewers.

I wonder if a better approach to publically commissioned reviews of this nature would be to change the order: Release a preliminary version of the report, seek public comment, and then submit both the draft and the public feedback for external review.

Elasticity of sin

The rational addiction model predicts that the consumption behaviour of addicts in response to price signals will be, well, rational. The model predicts that the price elasticity of demand may well be low in the short term but that it's higher in the long term. It also predicts that addicts will adjust their consumption behaviour in advance of a well-known upcoming price increase. These predictions bear up in the data. But, addicts' demand elasticity will remain less elastic than for moderate consumers. Consequently, tax instruments applied to try and curb addicts will impose high deadweight costs on moderate consumers.

The interesting twist is that, the stronger is the evidence for rational addiction - in other words, the more closely the demand elasticities match for the two groups - the more likely it is that a tax increase will reduce addicts' consumption at a reasonable cost in terms of deadweight losses imposed on moderate consumers. However, if the rational addiction model really holds, then such taxes are not welfare improving absent the specification of a highly paternalistic social welfare function. So, alcohol taxes work to stop "harmful" consumers' drinking when those consumers don't really need the help.

On the flip side, if the rational addiction model fails to hold and the real story is a behavioural one about weakness of will and self-control, then "harmful consumers" might prefer that something be done to help them quit. However, in that case, we're outside of the rational addiction model and the price elasticity of demand will be near zero: in other words, taxation is no longer an effective mechanism for reducing their demand. In the state of the world where the rational addiction model does not hold, alcohol taxes will not make addicts better off even though those addicts would prefer that their consumption be reduced. Instead, the alcohol tax just imposes deadweight costs on moderate consumers.

Long story short: if alcohol taxes work to curb addicts' consumption, then we probably don't need them because that consumption is more likely to be rational. If addicts really are irrational and need help to curb their consumption, then alcohol taxes won't work to solve the problem.

On the latter point, a recent NBER working paper gives some evidence on short run demand elasticities across cohorts of drinkers. They use a finite mixture model to allow heterogeneity across latent groups. They then find that short run demand from heavier drinkers is indistinguishable from zero. They consequently argue:

[I]n the case of potentially harmful goods, sin taxes are levied in part to reduce the potential harms, external and internal, of consumption. For these drinkers, under several behavioral economic theories of addiction, taxes could increase welfare by serving as a precommitment device that serves to bolster weak self-control. However, our results suggest that the heavier drinkers are least likely to respond to the higher taxes, thus neither the externality nor 'internality’ justification for higher alcohol taxes is supported by our results.

I'd like to know what their approach would say about longer run demand elasticities. I continue to hold the view that the rational addiction model explains a lot about the real world. I'm also happy to accept that demand elasticity among high demanders is lower than that among low demanders; consequently, I worry that excise tax increases, even if effective in curbing some "harmful consumption", induces disproportionately large deadweight costs on moderate consumers.

What did I miss?

A week ago, the RBNZ worried a lot that the banks were shafting customers by not passing along the Reserve Bank's interest rate cuts. Of course, banks do have to compete for deposit funds; it's not like they can underwrite mortgages based on overnight borrowing at the RBNZ.

This week, the RBNZ instead is worried that recovery in the New Zealand housing sector may presage a return to our old "borrow and spend" ways: in other words, we need to do something to encourage more saving and less borrowing. What is it that affects that...ah, right. The interest rate. So a week ago the RBNZ berated banks for interest rates being too high; today, Bollard berates consumers for responding to interest rates being too low. Which is it? I suppose that new information could have come into the system in the interval about housing sector recovery, but it would suggest that perhaps folks oughtn't have been so quick to criticize the banks in the first place.

Matt on BERL

My coauthor, Matt Burgess, gave a short interview on Wellington's Newstalk ZB over the weekend; audio file is here.

Morning updates [updated]

The Royal Canadian Mint still doesn't know what happened to $15 million in gold. Having exhausted plausible theories, like bad accounting, some now turn to more implausible heist accounts: folks dissolving gold in acid and thereby sneaking it past the metal detectors. The Mint assures us that their detectors can detect this kind of dissolved gold. But they still don't know what happened to the gold. I guess I'm not cut out for heists; last thing I'd think to do with gold is dissolve it in acid.

On folate in bread: the bootleggers and baptists story is seeming less plausible to me than that the reg is just part of some boilerplate treaty agreement on food regs, treaty language imported from elsewhere, and that nobody thought too hard about that bread is exceedingly unlikely to be traded across wide oceans. How hard would it be to strike out a line or two from a bigger treaty where there is no real trade issue though?
Update Some stories suggest the issue is flour, which would make more sense. Flour can travel by ship.

Cross-tasman trade in bread?

One of the things that worries me least is whether or not my bread is fortified with Folic Acid. For some things, I'd go to the barricades. This seems one of the more minor regulatory impositions; however, I can imagine it being very costly for small bakeries.

What I'm puzzled about is the National government's willingness to go carry through with the prior Labour government's policy in this area. They cite cross-Tasman trade agreements with Australia. Now, I can see the case for regulatory harmonization in some areas, weighing appropriately concerns about reduced Tiebout competition, but who trades bread across the ocean?! If efficiencies of scale in bread-making were so large relative to transportation costs, I'd expect there to be one or two big bakeries serving all of New Zealand. Instead, they're everywhere! Coupland's, the big South Island bakery, doesn't seem to ship bread even up to the North Island, never mind to Australia.

Whenever I see things like this, I start thinking about Bootleggers and Baptists. This is all of course just speculation, but folic acid supplementation really seems like the kind of thing that can be done at very low per-unit costs by the very big bakeries but at much higher per-unit costs by the little guys. There are fixed costs in redoing your recipes and testing things out. So it seems a possibility for the kind of regulation designed to raise rivals' costs. So, there's the bootleggers. The Baptists, as often the case, are the public health folks demanding that somebody think about the children.

National's candidate explanation makes no discernible sense, unless there's a massive trans-Tasman trade in bread that nobody's told me about. Bread is about the least likely thing to ship across the ocean though: low value per unit weight so bad for shipping by air, and highly perishable so bad for shipping by sea. So I'd be a bit surprised if the trade regulations were the real story. Purely speculation, but might it be the case that big bakeries have already incurred the fixed costs of rejigging production lines and are keen not to see that investment sunk without it similarly being imposed on the little guys? I see no exemption in the regs for small bakers unless they want to go purely organic.

Or maybe my paranoid goggles are on again now that semester's started and I'm again teaching Public Choice.

Utility is more than health

The excellent Glen Whitman points us to an LA Times article showing that, while mice on a calorie restricted diet live longer, they also are less happy than the control group of mice kept on a full diet.

This points to a generalized problem in the public health literature. Far too many public health folks are willing to assume that health is the maximand and not utility. Consequently, they want to tax or regulate anything that's both fun and potentially damaging to health.

Still, this is the important issue, is it not? If eating less increases your lifespan but decreases your happiness, then there’s a very real trade-off between quantity and quality of life. Which means the author’s conclusion that even people with a healthy weight “should probably be eating less” is simply unjustified -- unless we make some fairly heroic assumptions about what’s loaded into that key word “should.”

Indeed. I've argued the point at length in the New Zealand Medical Journal, but especially here.

Too often, researchers couch paternalistic arguments in allegations of market failure to give the cloak of scientific efficiency to their prescriptions. Doing so is just bad economics. A more honest approach would first specify that the authors want to tell everyone how to live their lives, then present the set of Pigovean instruments as an efficient way of inducing the consumption choices they view as better than that which people would otherwise choose for themselves.

Be not ashamed of your paternalism: embrace it! But, if others disagree, don’t blame shadowy special interests for the failure of your policy prescriptions; rather, concede that most people really don’t like it when others try to tell them how to live, even if following the advice would lead to slightly longer (but less interesting) lives.

Update: Brad Taylor weighs in nicely.

Rejoinder to BERL

On Monday, BERL released a statement rejecting criticism of their study. We have completed our reply, available here. Let's hit the highlights.

BERL levies three main critiques of our work. Let's take them in turn.

Reply Number One:

They say that we misinterpret their brief and consequently fault them for things that were never within their remit: specifically, that they do not include the benefits of alcohol.

It is certainly true that benefits were not within the RFP. We noted as much throughout our report, and in our executive summary. However, counting benefits as being precisely equal to zero is what allows BERL to count private costs as social costs. As BERL correctly notes at page 173 of their report:

When measuring the social cost of harmful AOD use, known private costs should generally be excluded…because private costs are offset by private benefits, so there is no net social cost

They there cite Collins and Lapsley, their primary source, as warning against the counting of private costs. They then go on:

In the case of harmful drug use, however, individual decisions are not necessarily made on a rational basis, that is, a decision where the consumer equates their costs and benefits. We argue that the consequences of irrational consumption decisions lead to private costs that are borne by the rest of society, and hence should be included as social costs… We assume that it is irrational to drink alcohol to a harmful level and that harmful alcohol use has zero private benefit.

Without that assumption, BERL could not count private costs as socially relevant. Their entire method hinges critically on that they have decided to assume zero gross benefits to drinkers of their drinking. So while benefits were outside of the RFP, they have taken a very strong position on the absence of benefits: a position without support in the economic literature. It consequently is fair game to critique BERL for counting the benefits as being equal to zero. And we do not understand how BERL can say with a straight face "we cannot accept criticism for not covering issues that were outside the project's brief" when their entire method is built on their having brought it into the project's brief.

If benefits are outside the remit, the proper approach is to consider only external costs. At minimum, BERL should have apportioned its cost tally between private and external costs. Instead, they termed all costs as social costs.

Reply Number Two

BERL notes two errors in our original document. Adrian Slack pointed these out to me at the NZAE meetings, I checked into it, and emailed him the day before he posted his rebuttal informing him that we were adjusting our costs upwards slightly to correct for this. We planned on incorporating the fix to a revised version of our paper, but once BERL's rebuttal went up, I instead quickly issued our errata here. Correcting the errors Adrian pointed out added $36 million to our measure of external costs; at the same time, we added in $197 million in excise-equivalent duties collected by the Customs Service and left out of our initial analysis. We now find net external benefits rather than costs, but would say rather that external costs roughly match external benefits.

Interestingly, in re-reading the section from BERL's source, Rayner, on the employment costs of harmful alcohol use, we also find that Rayner provides a strong argument against BERL's multiplier. Again, BERL multiplies all forgone wages by 1.87: the ratio of GDP to wages. Rayner says that total wages are an upper bound estimate of labour costs; the lower bound estimate is transitional costs in replacing a worker. BERL goes 1.87 times above their cited source's upper bound estimate.

We're reasonably pleased that a rather complicated reverse-engineering job on BERL's report resulted in objections amounting to only $36 million.

Reply Number Three

BERL argues we use assumptions with a cost-deflating bias motivated by world view.

The first striking bit of evidence against us? That we're willing to consider that maybe, just maybe, prisoners and hard core alcoholics would have labour market characteristics somewhat worse than the average Kiwi even if alcohol had never been invented. We don't assume anything here: we go to the relevant literature, find some reasonable relevant estimates of comorbidity of alcoholism and other mental health disorders and of the labour market characteristics of prisoners prior to incarceration, and adjust the figures accordingly. The adjustment has little effect on our overall figures in the grand scheme of things: it knocks about $69 million off of the total cost figures and much less than that off of the external cost figure (since most wage costs are internal). But we thought it was something that should be checked.

Second, we count only as external costs of forgone labour ten percent of the total forgone wages. In this category, BERL begins by obfuscating about computers not running themselves if you're home hung-over. If you go through BERL's numbers, like we have, you'll find that the vast bulk of their forgone labour costs come from unemployment, followed by reduction in workforce through premature mortality. In the first case, BERL's argument about complementarities is a total nonsense. In the second, firms will bear transitional costs of hiring and retraining. BERL's numbers require that these costs equal the forgone worker's total wages times 1.87. Hiring costs are not 187% of annual salaries. Absenteeism, reduced productivity, and injury-related wage costs amount to about 13% of BERL's tabulated total paid labour costs. It's only in those cases where the complementarities story can start making sense as being a substantial fraction of the overall wage bill. Again, recall that BERL's cited source, Rayner, argues for a multiplier of no more than 1.0. We apply a multiplier of 1.1, and apportion the 0.1 as an external cost. Note also that even counting that ten percent as external is more than a little controversial; others question whether there can be any externality at all.

Finally, BERL asserts that alcohol reduces human capital formation. We cited some evidence to the contrary in our report; BERL cites nothing. Frankly, BERL's turning to this issue, and complementarities, smells like ex post rationalization of a dodgy multiplier. In the initial report, this is all that BERL provides to justify its multiplier:

The value to society of lost output is considerably larger than lost earnings alone, for example, in addition to lost wages there is also lost profit. As such, the earnings profiles were scaled up to reflect the difference between wages and residual value added. The resulting output profiles were based on the assumption that the average GDP per FTE (BERL Forecast Database) is 1.87 times the average wage income (StatsNZ). These output profiles by age, gender and workforce status are used in the calculations below.

BERL specifically viewed the 1.87 multiplier as reflecting residual value added. We went to the empirical literature, found estimates of 1.05-1.1 for value added, and applied the upper bound of that range. It seems that, in BERL's view, actually thinking to consult the empirical evidence counts as a cost-deflating downwards bias.

BERL concludes by rehashing their favorite trope: world-view and rationality. Never mind that we have, ad nauseum, shown that none of our results hinge on assuming perfect information, perfect foresight, or perfect rationality. The prior link is the most exhaustive coverage, but the same issue has been covered here and here as well. And I re-iterated it at the NZEA conference with both Nana and Slack in attendance. Instead of providing any reason why the analyses above are wrong, BERL instead reiterates the perfect rationality tropes and throws in personal attacks by suggesting that we think drink driving and murder are perfectly ok. Is this really how senior economists at an established consultancy are going to defend their report?

In the same section, BERL laments our lack of citation on a claim that alcohol saves more lives than it costs.

The ‘result’ that “alcohol saves many more lives than it takes” is an assertion that requires evidence. And the idea that addiction has rational foundations clearly indicates a model view of a consumer that would be at variance with others' views, including those of some economists. Such a value judgement would not have been appropriate for an independent study such as ours.

On that point, as noted in our report (at page 37), we're drawing again on one of BERL's preferred sources, Collins and Lapsley, who at page 38 of their report (Table 11) present figures from Chikritzhs, Stockwell et al (2002) finding that across all categories of drinking, alcohol saved about 2363 lives in Australia in 1998; even among high-risk drinkers, where total lives lost outweigh total lives saved, 557 individuals were estimated to have had their lives saved. If there's any citation issue here, it's that we should have noted that Collins and Lapsley here were citing the work of Chikritzhs et al.

Our full reply, linked to at the top of this post, has a few other bits of interest, including a summary of issues we have raised that BERL thus far has utterly failed to address. Do read the whole thing.

The murderer's utility

Paul Walker nicely summarizes the David Friedman argument on the law and economics of counting the criminal's utility.

I agree with his analysis entirely when I'm wearing my economist's hat. When doing economics, as economists, we have to set the moral questions to one side. Wertfreiheit.

Now, if the conclusion of a serious study found that murderers' enjoyment of crime were greater than the cost imposed on victims, in other words that allowing murder is Kaldor-Hicks efficient, I'd then take off my economist's hat and put on my amateur moral philosopher's hat and say that murder should nevertheless be illegal because it infringes the victim's rights and because, as amateur moral philosopher, I really don't mind discounting the utility of rights-violators all the way down to zero. But I would be taking off my economist's hat when doing so. If economics gives us the efficiency-based case against murder, as I rather expect it would, so much the better. But if it doesn't, it's far better to present the economics straight up, and then present the value judgments separately, than to pervert the economic analysis by doing things like, oh, declaring at the outset that the murderer gets no utility and that a total discounting of the murderer's utility is consistent with good economic practice.

Aside: wertfreiheit is one of my favorite economics words. Methodenstreit is another. I may currently be engaging in methodenstreit with BERL over wertfreiheit. I like that. Is it strange that I always hear the Sepultura lyrics as "War of Methodology" rather than "War for Territory"?

Zombies and Epiphenomenalism

NCIB ROFL gives a nice daily roundup of amusing articles published in the PubMed database. Highlights include medical articles on optimal methods for extracting the zipper-entrapped penis an ergonomics article on the force required to drag sheep over various surfaces.

Perhaps there's no equivalent in the humanities because it would be too easy. Here's the latest from Dialogue, a Canadian philosophy journal. Andrew Bailey's work on Zombies and Epiphenomenalism. doi:10.1017/S0012217309090076

ABSTRACT: This paper examines the relationship between the claim that zombies are logically/metaphysically possible and the position that phenomenal consciousness is epiphenomenal. It is often taken that the former entails the latter, and that therefore any implausibility in the notion of conscious epiphenomenalism calls into question the genuine possibility of zombies. Four ways in which the zombist might respond are examined, and I argue that two — those most commonly encountered — are inadequate, but the others — one of which is rarely formulated and the other new — are more forceful. The upshot, nevertheless, is that the zombist may indeed face an unwelcome commitment to conscious epiphenomenalism.

If there actually are zombies, an unwelcome commitment to conscious epiphenomenalism is the least of our worries.

I had a look because of the intriguing title, but the article goes into some interesting work on theory of mind. I was unaware that the metaphysical possibility of zombies had been raised as a counterexample against physicalist theories of mind. Bailey concludes:

Finally, however, to the degree that the notion of causal gaps (or causal agents that are neither physical nor phenomenal) can be made plausible, it might be possible for the zombist to evade even this commitment and sever the link between the zombie hypothesis and phenomenal epiphenomenalism entirely.

This last move will be attractive to — perhaps even necessary for — the zombist, given the widespread wariness that exists, among physicalists and anti-physicalists alike, about phenomenal epiphenomenalism. Yet it has as yet been little explored, and remains highly speculative. Perhaps this is the front on which the next battle of the “zombie wars” is to be fought.

I'll have to ask the philosophers at the staff club to fill me in on the zombie wars.

A word after the final word on rationality

Eric has generously given me co-blogger status on Offsetting Behaviour so I can weigh in on the subject of irrational consumers and one’s world view.

The background for this was the session of the NZAE meetings last week when the BERL report on the costs of alcohol was presented. There we heard again the suggestion the question of whether the costs drinkers impose on themselves should be included as costs in a cost-benefit calculation is simply a matter of one’s “world view”. That is, the suggestion is that if you believe that consumers are the best judges of their own well-being then, by definition, any costs consumers impose on themselves are offset by equal or greater benefits and so can be excluded, but if you believe that some consumers make decisions that they will come to regret, these consumers incur non-offset costs that should be included.

Now, my world view is for the most part closer to the first than the second, although I don’t hold dogmatically to this view. That is, I believe that although consumers can and do make mistakes, they mostly are better judges of their own well being than are government officials, or at least are entitled from a personal-liberty perspective to make their own mistakes. Call that “world view 1”. But for the purposes of discussion, let us assume “world view 2”, which is the empirical and ethical assumption that people can make mistakes that can and should be averted by government policy. The question I want to address is how, or indeed if, that world view can be incorporated into cost benefit analysis (or just cost analysis).

It is probably useful to review first just what cost-benefit analysis is. Cost-benefit analysis is one of many approaches to answering two valuation questions: How can we compare bundles of different goods for a single individual to get a sense of whether alternative policies would make that individual better or worse off? and, How do we make comparisons across individuals to decide whether a policy that makes some consumers better off and some worse off is socially desirable?

Cost-benefit analysis is an approach that tries to make as much use as possible of the information contained in prices and individual decisions. For an economist with world view 1, the first valuation question is relatively easy: A rational consumer will consume a good up to the point where the marginal benefit equals the price, and so the price represents the value to that consumer. For goods traded in markets, this gives us a quick and easy way of observing that value. For goods that are not so traded, we ask the conceptual question: How much money would the consumer be prepared to pay to have one outcome compared to another? This can be hard to measure, but at least is conceptually clear. But what if you have world view 2? In this case, you cannot assume that price represents value at the margin, and so have to start making subjective assessments about the value the consumer would place on a good were he not making irrational decisions. That in itself is not a fatal problem. As with the example of non-traded goods above, we need to make subjective decisions all the time in cost-benefit analysis. But what does a dollar measure of cost and benefits mean for an irrational consumer in world view 2? For a drinker who consumes a later-to-be-regretted excess, we can only ask the conceptual question of how much he would, in principle, be willing to spend to reduce the amount he had drunk (i.e. a dollar measure of the costs his excess drinking imposes on himself) if dollars have some meaning as a measure of value for that consumer. If an irrational consumer would choose to spend additional income on things other than alcohol that would make him worse off, then, income is not a measure of value for that consumer at all. It would seem that to use dollar values to calculate the costs of alcohol that irrational drinkers impose on themselves, you can’t adopt world view 2; rather, you need something like world view 1.5—that consumers who are not fully rational in their decisions over the consumption of alcohol and drugs are fully rational for all other allocations. Only with this near-rationality are we able to continue to assume that there is useful value information contained in prices.

Now, it can reasonably be argued that addictive substances are quite different from other goods, and so a world view that assumes rationality except in that narrow sphere might be perfectly sensible. So let’s now consider the other valuation question, and ask whether adding up dollar costs across individuals makes sense with less-than-fully-rational consumers. With fully rational consumers, the idea of adding up dollar costs and benefits rests on the practical idea that dollars (unlike some subjective measure of well-being like “utility”) can be transferred between consumers, and on an ethical notion called the compensation principle. This says that a policy can be justified if, in principle, the consumers who gain from the policy could make a monetary compensation to those who lose in such a way that everyone is made better off by the policy. When, for example, Sir Geoffrey Palmer quotes “the headline figures in the Berl report of $5.296 billion in social costs of alcohol (and drugs), versus the alcohol excise tax take of $795 million, as a basis for his preferred policy option of significantly raising excise taxes to cover the shortfall”, he is invoking the compensation principle.

To illustrate, consider the situation of a rational drinker facing a price of $10 per drink, and imposing an external cost of $10 per drink on other people. Further imagine that demand is highly insensitive to price, but this is not known to the policy maker. In this case, we could put a $10 dollar tax per drink on the alcohol. Tax revenue would now equal $10 times the number of drinks purchased, which would exactly equal the external costs. We would now know that the benefit to the consumer was in fact greater than the external costs imposed, shown by the fact that the consumer is willing to pay the price of $20. If demand were sensitive to price, there would be some reduction in alcohol consumption—a reduction in those drinks for which the gross benefit to the drinker were less than the resource plus external cost of the drink, exactly what we would like according to the compensation principle.

In contrast, consider the same situation of an irrational drinker with price-insensitive demand who faces a price of $10 per drink but receives no benefit at all from the alcohol. This drinker is also imposing a cost of $10 per drink on society ($10 of resources used to make the drink with no offsetting benefits to the drinker), but that cost is entirely borne by himself. We could place a tax of $10 per drink on this drinker, but all that would do is increase the costs to the drinker by the same amount that it provided compensation to “society”. The story does not change significantly if demand is price sensitive. In this fanciful example, the appropriate tax would be the one that pushed the price of a drink so high that the drinker would reduce his consumption to zero (since he receives no benefit from the drink). That is, the appropriate tax would be one derived from his (irrational) demand curve for alcohol, not from any calculation of the dollar value of the costs he imposes on himself.

Contrary to Sir Geoffrey’s statement above, therefore, a comparison of the dollar value of the social costs of alcohol to the value of tax revenue received makes no sense if the social costs include costs imposed on himself by the drinker.

In short, the point here is that one is free to take a world view that people are sometimes not fully rational or informed, and to devise paternalistic policies based on that world view. But don’t use a false precision of dollar values, and don't use the technical apparatus of a valuation technique that depends on an assumption of rationality for its internal consistency.