In defence of simplistic models

This post on methodology is related to recent discussions about the role of maths in economics (Matt has a good summary with the relevant links here), but is actually response to a comment by Chris B over at SciBlogs to my initialpost on Labour’s proposed ban on non-resident ownership of houses. (Yes, this post is long overdue. Events have conspired to keep me away from blogging for a couple of weeks.) 

Chris says: 

You know, the more I think on it, the more dissatisfied I am with this thought exercise. If only because Seamus has seen fit to call it a “very simple model of the New Zealand housing market”. It realy isn’t . It’s simply a fictional market with certain highly abstract asserted properties. No more realistic or useful than the various maths exercises from my own university level economics classes.

Fair enough. I should have said a simple model to help think about the New Zealand housing market. The point of this post is to ask whether simplistic models can be useful. Note that such models are unrealistic by design. If I were writing an academic paper, I would have used a much more complicated model, and if writing a problem set for an undergraduate class, something only a bit more complicated. But this was a blog post, so the model was designed to be easily solveable in your head. (I hope that the maths exercises from Chris’ university-level economics classes were more involved than this one; if not he was severely short-changed by his university.)

In general, a simplistic model is designed to make one or two points by stripping away every piece of reality except a specific thing that you want to highlight. Some of the assumptions one makes in doing this are simply removing irrelevant reality in order to focus attention on the key aspect of the question at hand. Others are more like dogs that don’t bark in the night; seeing what happens when you assume away some aspect of reality highlights how important that aspect is. Chris lists a whole bunch of assumptions in my model. I won’t go into these in detail, but I would argue that they all fit into one of these two categories. Some, like the assumptions about homogeneous preferences and housing quality are just assuming away irrelevant reality. Others, like the assumption of inelastic supply are non-barking-dog assumptions. As I noted in my original post, when you relax this assumption, you make the case against bans on foreign ownership stronger. 

The realism or lack thereof of a model is therefore not a criterion for judging a model’s success. A simplistic model can be criticised for one of three reasons: 

a) the intuitive point that is laid bare when all other reality is stripped away is so obvious that the point doesn’t need to be made;

b) the model doesn’t actually illustrate the point being made; or

c) the point is actually wrong, and the model fails because it stripped away some highly relevant aspect of reality.

The third is not necessarily a criticism. If a model’s intuition can be changed by adding in some relevant piece of reality, the process of starting with a simple model and then relaxing the assumptions lays bare what the crucial step is for generating a particular conclusion and informs where one needs to look for empirical evidence supporting it.

Now, in my post, I was looking to make two points: The first was that the price of houses depends on the current and future expected stock of houses and the current and future expected demand for housing (i.e. the willingness of people to pay to live in houses); changing the rules on who is allowed to be non-occupier owners of houses should not change the price of housing absent a mechanism for the policy to affect demand for occupancy or the stock. The second point was that if speculation is pushing up the price of houses, it is only because house prices are expected to increase in the future; attempts to restrict speculation without dealing with the underlying drivers only delay the issue.

Now I don’t think you can say that my model fails on the ground of being too obvious, as so much public commentary on housing policy simply routinely ignores these two points. Whether the model is successful in illustrating the point is very much in the eye of the beholder. For the third criticism, I certainly can imagine relaxing assumptions to generate different conclusions and inform a debate about what is the more likely state of the world. Chris, however, would prefer to eschew the simplistic model altogether. In his words:

Plainly the exercise does not remotely resemble the New Zealand Housing market. Why, then, should we have any particular faith in our ability to extrapolate from the though exercise to what will happen in the real-world economy.

In what sense does the model not resemble the New Zealand housing market? The model has both renters and owner occupiers. It has owners of rental properties who earn investment income from the ownership. It has a future expected increase in the demand for housing, and in that world has landlords earning a below-market rate of return. All describe exactly, say, the Auckland housing market. Yes, the real-world economy has other things as well, but it is important to understand the simple models before adding complications. What is the alternative?  Chris’ conclusion is as follows:

Perhaps a better approach to arguing against the policy on economic grounds would be to identify other places where it has been implemented and talk about the impacts which have resulted. Potentially tricky to isolate the impacts of the policy from other confounding factors, but if it can be done, there’s the advantage of being able to present some empirical evidence against it. 

 Alternatively, perhaps we might drop the thought exercise entirely as extraneous and talk specifically about how we expect foreign buyers will react to future restrictions on their activities, consequences for investment decisions and the like.

Not so fast. How do social scientists isolate impacts from confounding factors? They use theory. That is, they have a model or competing models in mind that would be consistent with some observed correlations but not with others. And how can you learn anything about how foreign buyers will react to restrictions on their activities and what impact that reaction will have for the housing market, if you don’t have a view about how their behaviour relates to conditions in the housing market, how other people will respond to that reaction, etc.? 

In other words, careful empirical and behavioural analysis rests on models, and complicated models rest on simplistic ones. Non-careful analysis, in contrast, rests on unstated models, models that are potentially self-contradictory or rest on assumptions that have assumed away relevant reality but have never been made explicit. 

Parking Market Failures

Does any market failure argument justify parking minima? Many cities require that residential developments include some minimum number of off-street carparks. Can these be justified?

Well, I'm glad you asked, Agnito.

The best argument I've heard for these regulations is that on-street parking is rivalrous and non-excludable. If you have an apartment building with too few carparks, residents will park on the street or might keep flitting between a few different no-parking zones, staying one step ahead of the enforcement officers. A lot of people see paying for parking a bit like hiring other kinds of personal services: why pay for it when you can apply yourself and perhaps get it for free? And if you find the perfect parking spot, there's then a huge opportunity cost of leaving the space: people with really good parking spaces never give them up. Finding the perfect space can be a joy to be shared with others. Further, where excess congestion from everyone's free-riding on on-street parking gives incentive for the able-bodied to park in handicapped spaces (or in front of fire hydrants), disastrous consequences can ensue.

Having mandatory parking minima then avoids the free-riding on the on-street parking that could best be left for higher-turnover use. And where long-term on-street parking is discouraged only by time limits, it also encourages other socially wasteful forms of entrepreneurship.

The best response to this kind of argument is that it's massively second-best relative to the more efficient solution: price on-street parking. Do that properly and everything else sorts itself out.

Of course, in that world, Seinfeld wouldn't have been nearly as good. And where Gerry Brownlee wants to ban Auckland from using congestion charging, we might not be able to get first-best parking charges anyway.

For the record though: there is no real-world market failure sufficiently large to justify mandatory parking minimums. At least not in Auckland, best I can tell.

Coase and dorm-room noises

The University of Auckland's halls of residence warn that they might ban students from copulatory activites from 10 pm to 6 am, because of the costs their noise imposes on students in neighbouring rooms.

Ronald Coase reminds us of the reciprocal nature of externalities. Without the ban, active students impose costs on their neighbours. But by implementing the ban, the neighbours impose costs on those who would wish to undertake such activities. Which is best?

And so we have a situation identical to that which obtained in the Economics Department here at Canterbury when we moved to open-plan offices post-quake. No, we don't do that in the offices, despite the apparent productivity benefits. Rather, some of us type loudly and like talking with colleagues while others of us cannot abide noise while working. The Department is split over two buildings. In my building, we fence out the noise by adopting a "wear headphones" norm. This is fortunate both because I do take a few media calls from time to time, and because the Department's administrator is located in our building, and because I have the world's best keyboard. In the other building, they've adopted a shushing norm. I strongly prefer the norm in our building, but nothing stops people from choosing one building or the other as suits their fancy.

When I was an undergraduate in the University of Manitoba's University College dorms, I sadly was not the source of, well, any external noise cost. But rather than wish to shush others or seek to ban their fun out of envy or resentment, I played Bach's Brandenberg Concertos on infinite repeat, loudly, all night, every night. The Concertos still put me to sleep. But I was a Coasean, even though Manitoba's Economics Department didn't much emphasize Coasean approaches: I recognized that the costs to me of averting the costs of the noise were much lower than the costs I could possibly impose on everyone else from banning noisemaking.

Further, Bach was a general-purpose solution: it worked against sex noises, but also against the noise of drunken revelers coming home late from the campus bar. Ban all specific noises as much as you like, but there'll still be noise that happens. It's simply more efficient to encourage people who don't like distracting noises to fence it out with Bach.

I guess the point of all of this is that Auckland students should come to Canterbury instead.

Reserve prices, marginal utility, and management degrees

Sellers on trade-me set a reserve price: the minimum price at which they're willing to sell whatever they're auctioning off. In the absence of strategic play, a seller should set the reserve price at the lowest amount at which they're willing to sell the product: they should be trivially better off for having sold it than for not having sold it at that price. While they gain income that brings utility when they sell it, they forgo the flow of utility provided by continued ownership of the good.

Some things you might value at zero dollars, or negatively. That clunky thing that's taking up needed space: set a reserve price of $0 and hope somebody takes it away for free.

Let's then parse this TradeMe listing:

Replete with intermediate level Economics knowledge, this degree will help you realise that the reserve price and the marginal utility gained by the seller are worth exactly the same!

The seller is auctioning off his Bachelor of Commerce in Management, earned at the University of Canterbury.

I hope the seller means that he or she values the degree certificate at the $1 reserve price: owning the degree certificate provides its current owner with utility worth $1, and losing the certificate would make its owner $1 worse off. And so the reserve price is equal to the utility the degree certificate provides.

If the seller meant instead that he or she would gain marginal utility worth $1 by achieving the reserve bid, that can only be true if the value of owning the certificate were $0. That's plausible from the rest of the text, but hardly clear.

I've copied the whole ad below. I'm considering bidding. Then at Faculty meetings, we can truly state that at least one member of the Economics department owns a Management degree. If it ever comes up.

Original unused Bachelor of Commerce - $1 reserve! 

Major: Broken Dreams

• Current bid: $37.50
•  Reserve met 
• Closes: Thu 5 Sep, 8:59 pm
• Listing #: 632646059

Min next bid:  $Auto-bid

View full size photo

Limited edition print, this 2007 Bachelor of Commerce is barely used and in "like new" condition! Originally priced at nearly $30,000, this is now available at a fraction of the price, with only $1 dollar reserve!

Avoid the gruelling 3+ year sacrifice necessary to pull good grades and skip the rampant physical and mental diseases by buying your degree direct from Trademe. Replete with intermediate level Economics knowledge, this degree will help you realise that the reserve price and the marginal utility gained by the seller are worth exactly the same!

Revel in the accolades of your family as you become the first among them to attain advanced education, only to later avoid their sincere enquiries as to your job opportunities and general wellbeing. Marvel as employers overlook you time and time again, and let your youthful eagerness get beaten out of you with a sack of potatoes (the only food you could afford this week).

Eke out a living in the illustrious field of data entry or pick up a day job putting PostIts one-by-one on a wall - all without the guilt and shame that would exist if you actually made the mistake of getting the degree yourself. Finally, watch your fragile sense of self-worth crash like the Hindenburg; casting hopes and ambitions to the breeze, leaving you twisted, hollow and bitter.

The winning bid will receive ALL THIS and more in the original issued degree pictured above, with the one lucky individual having their name lovingly embossed in crayon over the previous owners. Don't delay, get your degree today!

Please read the questions and answers for this auction.

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Thursday updates

Blogging has been light; I spent the last two days catching up with folks in Wellington and attending the National Drug Policy Summit run by the New Zealand Drug Foundation, about which I'll blog properly later. A few bits of interest in the meantime:

• Westpac notes that LVR limits can have short term effects on house price inflation, but only short-term effects.
  • Duh
  • There are sensible justifications for this kind of policy based on prudential regulation and avoiding any situations where banks take on too risky a loan portfolio and downside risk winds up being borne by the government. Justifications based on curbing house price increases don't make any sense to me, whether or not it's the RBNZ comms team or the Governor making them. In that sense, it's no damning of the policy that it only has transitory effects on house prices. But it still reinforces the NZ econ blogosphere's "it's just dumb trying to justify LVR on the basis of house prices being too high." consensus position.


• Scott Sumner praises Finance Minister Bill English. Agreed. Some credit could go to Minister English's truly excellent economics adviser as well. 


• The New Zealand Police have decided that despite GCSB's having acted illegally in the DotCom surveillance, they will not press charges because there was no intent to act illegally. But:

  Intent to break the law is not an element of the charge of illegally intercepting private communications.
  — Graeme Edgeler (@GraemeEdgeler) August 29, 2013

  The government, through the new GCSB and TICS legislation, is giving us an expansion of GCSB's scope with increased nominal oversight, but no expectation that GCSB would ever be prosecuted for doing anything that was in fact illegal. Lovely. Big slow clap here for everyone involved. Meanwhile, here's Ars Technica on some of this mess.


• The insurers here argue for something sensible, and something for which I've argued before: have EQC effectively cover a large excess in case of natural disasters, and otherwise stay out of the darned way.

So endeth the closing of the browser tabs, so closeth the day.

Update: note that Edgeler also argues that lack of intent to break the law could be a decent reason not to go ahead with prosecution in this kind of case and reminds us that criminal penalties are not the only form of accountability. That's all true; I hope that everyone who has illegally been spied upon knows that it has happened so that they can launch civil suits.

National drug policy summit

A few assorted observations from today's National Drug Policy Summit in Wellington:

1. Ross Bell and his team pulled together a reasonably diverse group. So it's fun.
2. As with many NZ conferences, and especially those with a policy focus or those addressing issues of interest to Maori, we broke unexpectedly (to me) into song. There were lyrics up on the projector, but I sure didn't know the tune.
3. I suspect that it is impossible for policy conferences addressing issues of ethnic or economic decile correlates to avoid spending 30-60 minutes finding a balance between noting how bad the current state of the world is for a disadvantaged group and how we don't want to problematise a disadvantaged group by pointing them out, presenting them as homogeneous, and so on. There should be a single-paragraph boilerplate that covers this for most policy issues. I wish it would be universally adopted.
4. Doug Sellman sought to clarify at the outset whether drugs like sugar were to be ruled out of the discussions.

Follow the hashtag #drugpol13 for further updates. I've been tweeting there a bit. The objective to is hash out some consensus document that might improve policy. I want to know whether their vision of harm reduction includes harm imposed on substance users from restrictions on their access. We'll see.

Honi Soit... revisited

The shame lies in the mind of the viewer.

The University of Sydney's student magazine, Honi Soit, this week had to gather up copies of the current issue. The front cover featured a set of pictures of, well...:

The front page of the University of Sydney rag, Honi Soit, featured a montage of graphic, unretouched vulvae - pubic hair et al - belonging to 18 students who stalk its hallowed halls.

There were black bars covering the middle of each picture, but apparently it was too translucent so the determined reader could peer through the censor's bar.

I saw a couple stories on this yesterday, mostly via @BexStevenson. And not a single one noted the delicious irony here. Recall what Honi Soit means. It comes from the Latin Norse French* phrase uttered by King Edward so long ago, or at least the story goes. Here's Hume's rendition:

A vulgar story prevails, but is not supported by any ancient authority, that at a court ball, Edward's mistress, commonly supposed to be the countess of Salisbury, dropped her garter; and the king, taking it up, observed some of the courtiers to smile, as if they thought that he had not obtained this favor merely by accident: upon which he called out, "Honi soit qui mal y pense,"—Evil to him that evil thinks; and as every incident of gallantry among those ancient warriors was magnified into a matter of great importance,[*] he instituted the order of the garter in memorial of this event, and gave these words as the motto of the order.

In this case as well, the shame lies in the eyes and mind of those taking offence at the magazine cover.

Previously: Seamus on Kapiti's logo...

Update: A few weeks ago, a reader at SciBlogs complained that Matt Nolan hadn't explained the acronym LVR in discussing Loan-to-Value Ratio regulation. Another commenter pointed out some disturbing alternative meanings of LVR, related to this post's topic.

* Je ne sais quoi est arrive ce matin quand j'ai ecrit ceci. Toute la phrase est francais; je ne suis pas familier avec le mot 'Honi', mais le restant est francais. Pardonnez moi!

Reader mailbag: LVR edition

A loyal reader writes, and I anonymise:

My [partner] is a [high ranking title] at [large professional services firm] and over drinks last night the young [professionals in this industry] (under 28, mostly single, still have student loans, gross income btw 60k and 90k, most 2/3 years’ experience max) were crapping themselves re the RB’s loan restrictions…really pissed about it. Most had planned to buy modest apartments this year using KS… centrally imposed adverse selection bars have costs! I said to go to Mum/Dad and/or finance houses, get a mortgage and then fold the other debt into after a year … impossible to police?

Yes, it is impossible to police. And that's a feature rather than a bug, if the point of the Loan-to-Value Ratio regulations is to increase the amount of collateral standing behind each home loan and thereby reduce systematic risk that could come from a housing downturn. If every one of these young professionals gets their parents to take on some of their mortgage risk by backing it with their own homes, which is effectively what they'd be doing if the parents take out a mortgage to front a 20% deposit, then the kids are less likely to default on the loan to the bank in case of downturn, though they may default on Mom and Dad, and the parents may be on the hook for some unexpected mortgage costs. But that has lower systemic risk. RBNZ noted it in their initial paper too: these workarounds are hardly unanticipated, and I don't think they're unwelcome. They work around the regulations in ways consistent with what the regulation should be trying to achieve.

My correspondent wonders further about effects where some young professionals have recourse to Mom and Dad and others only to the finance companies. I expect here that it has strong equity effects, but the efficiency effects still work in the right direction. Borrowers on the secondary loan market will be paying higher interest rates and so we still see a reduction in demand for highly leveraged loans at the margin. The ones most hurt by the regulations are indeed the ones with least access to family or other capital. But equity isn't RBNZ's job, and those would be the riskiest borrowers in any case - the ones that RBNZ is deliberately trying to knock out of the market.

The bigger problem is the one Matt Nolan points to: RBNZ is grasping at all kinds of justifications for its regulations, and some of them either are way outside of anything RBNZ should be doing, or just don't make any darned sense. I can see some kind of case for it on systemic risk, but I would bet against the regs being justifiable on that basis. Default and bailout risk under OBR is lower than it was prior to OBR. And RBNZ simply should never ever be in the business of trying to protect investors from the risk that their investment might decrease in value. They don't have that kind of crystal ball.

And if the regs don't make sense on a reasonable rationale, we might start worrying rather more about the equity considerations.

Survey Says

More interesting than the "which economist am I most like" part of this rather nifty survey, based on responses to the IGM Economic Experts Panel, is their highlighting of where you differ substantially from the consensus of their expert panel.

My outlier views:

1. I disagreed that conventional economic reasoning suggests it would be good policy to let undergrads borrow at very low interest rates. Standard economic reasoning can give you good reason for wanting government-backing of student loans, but nothing in standard economic reasoning says that these loans should be provided at discounted interest rates. In my view anyway. I really cannot see any case for very low interest loans. Backed at market rates, fine. Subsidies for tuition in programmes with expected very high positive external effects? Can live with it. But at current tertiary enrollment rates, it's very implausible that any existing market failure requires low interest student loans. So I gave a "Strongly Disagree" on question (1).
2. I agreed with the panel that raising the minimum wage to $9 per hour would make it noticeably harder for low-skilled workers to find employment (Q11). Where the panel thought that the distortionary effects of this policy would be small enough to make the policy desirable, I disagreed (Q12). In particular, I thought indexing the minimum wage to the inflation rate was a particularly bad idea. Building in nominal wage rigidities is bad enough. Building in real wage rigidities is even worse. I note that prior and broader surveys of economists on the topic have favoured my position over the panel's. I also strongly expect that many answering "agree" here were running a political economy model expecting it to be impossible to use EITC as a more efficient way of improving outcomes. 
3. On Question 41, I expected it would have been better to have had Greece default early.
4. I was neutral on 47 & 48, regarding regulation of money-market mutual funds; I don't know the existing regs well enough to agree or disagree.
5. On Question 55, I expected that Germany would do better by failing to bail out Southern Europe than by giving them unconditional cash grants. 
6. On Question 72, I did not see it as a big drawback of a school voucher system that some students would fail to make an active choice. This could just be semantics: it could still be the main drawback, just not a very substantial one.
7. On Question 82, I disagreed that the long term full accounting on ARRA would have benefits in excess of costs.
8. On 85, I disagreed that it was a good idea to require US publicly listed corporations to allow shareholders a non-binding vote on executive compensation. But I haven't strong preferences on that one. 

Out of 105 questions, I'm not nearly as far away from the mainstream as I might have thought. I'm more skeptical about the merits of bailouts, whether national or corporate or banks, than many of the panel members. But I'm comfortable with that.

If it matters, the survey said I'm closest to Alan Auerbach.

Update: Donal ran the survey too.

Wednesday roundup

A few worthy items in the tabs:

• Matt Nolan over at TVHE rightly points out the rather large problems with the Reserve Bank of New Zealand's justification for its restriction on highly leveraged home loans - the Loan-to-Value Ratio regulation. It's fine to argue that the LVR regulations could reduce systemic risk: that's the RBNZ's job. But it isn't the RBNZ's job to protect potential homebuyers from price fluctuations; it's awfully strange for RBNZ to suggest that they could be providing such a benefit to first-home buyers by making it too hard for them to buy houses. I could as plausibly claim that I'm making everyone better off by banning them from listening to Coldplay because they're not likely to be "cool" for much longer.*

• Fairfax polling shows that Kiwis are pretty happy with the extension of powers to be granted to our spy agency this afternoon. National's likelihood of winning the next election hasn't dropped with any of the fooferah over the last couple of months; if anything, it's slightly up. ACT's chances of winning an electorate seat are down a bit; John Banks's likelihood of being ACT leader on nomination day is down a bit; ACT's predicted vote share is unchanged. ACT might be reading the tea leaves correctly on this one: few GCSB opponents would flip to ACT were ACT to switch its vote. Without a simultaneous change in leadership, it probably wouldn't be enough to bring enough civil libertarians over to get over the 5% threshold. Their main risk is that their support of the GCSB legislation leads to the creation of a liberal party. But, even then, the downside risk for ACT is small: Key is more likely to proffer an electorate seat to ACT than to a liberal party and there's little chance a liberal party would take 5% in 2014 given organisation costs and time.

• Now an older one, but my tabs stay open for a while. The Australian Christian Democrats have highlighted the inequality in incomes between same-sex and opposite-sex couples and promise to stop the oppression of "Mum and Dad taxpayers". Fitzroyalty points out the shoddiness of their numbers (language NSFW), but it's not implausible that same-sex couples would earn more on average than opposite-sex couples: they'd be likely to have both partners working if homosexual couples are less likely to have a child. I'm not sure quite how the Christian Democrats would equalise household incomes on this margin ... maybe banning gay couples from having children, giving more tax benefits to couples with children, then waving their hands about childless heterosexual couples? Another for the "which inequalities matter?" file.

* I don't know when Coldplay peaked. I make it a rule not to listen to any bands whose name are just two random words stuck together. Cold + play, Nickle + back, Silver + chair. Maybe I'm missing some good stuff, but it's a heuristic that's served me well on average. My Spotify starred items are here. No Coldplay, Nickleback, or Silverchair.

Policy synergies

Last week, I suggested that any government worried about productivity and health costs of things might wish to encourage that there be more sex. It seems to be good for earnings. 

Today, Tim Wilson at The IPA points me to an Australian public health advocate's wish that sitting for more than two hours consecutively be banned. Professor Jonathan Shaw there is worried about diabetes risk. Sitting for extended periods may increase diabetes risk:

"We need changes to occupational health and safety regulations so it is not allowed for people to sit for two hours at a time without a break," he said.

"I think everything should be on the table - taxation levers, town planning, even the layout of office spaces needs to be reconsidered to tackle the growing personal and community impact of chronic disease," he says.

Perhaps we could combine both findings. Instead of banning sitting or taking these kinds of hard paternalistic lines, we could perhaps imagine encouragement of discreet workplace venues that might...

Ok, I'm just going to end with the </reductio> tag and leave it at that. But if someone successfully combines the two in an interesting defense in employment court, I'd love a pointer to the judicial decision in the comments.

Ratings warning

I've done a fair bit of NZ cheerleading. Sadly, I have to warn of a potential downgrade of New Zealand immigration from a "buy" to a "hold".

Jason Sorens has moved, at reasonable personal cost, to New Hampshire, in pursuit of the free life and in support of the Free State project.

I also understand why libertarians who are promoting the cause in their own careers would see a career change and a move to New Hampshire as a step back. But most of what I have done as an academic does not promote liberty directly, and I have come to question seriously the “trickle-down” model of social change widely adopted by libertarian organizations. The idea, following Hayek’s essay, “Socialism and the Intellectuals,” is that creating new academic research showing the benefits of liberty will filter down through journalists and other “secondhand dealers in ideas” to the general public, eventually resulting in a freer society. But academic economics has long leaned free-market, and journalists don’t seem to understand the key insights of that discipline. If anything, the general public’s views are worsening in key respects. People under 30 are more likely to favor socialism than capitalism. The enterprise of educating the public via secondhand dealers in ideas seems doomed on a national scale, but it could work on a small scale.

Eric Crampton says libertarians should move to New Zealand. If only we were all lucky enough to have employers willing to sponsor our emigration there! They won’t just let you move without a job, after all. In my view, New Zealand and Switzerland are the only places in the world with a long-term better prospect for liberty than the United States, and I understand why some libertarians might move to those places. But they aren’t realistic options for most of us.

I fully agree with Eric that libertarians need to put their money (and bodies) where their mouths are. If they view liberty as important, either as a means to the ends that one enjoys personally or as a moral imperative for society, then it should be valuable enough to move for. Is enjoying significantly greater liberty worth a smaller car, a smaller house, a less fancy phone, slightly slower Internet, no cable TV, Chinese rather than Swedish or American furniture, making dinners at home rather than going out, or all of the above? If you think that gross injustice exists, don’t you have a duty to do something that plausibly could stop it? American society falls far short in protecting the rights and dignity of all its members. We have a real opportunity to change that situation in one place, and we are changing it.

Alas, things here have gone downhill a bit since 2011. I haven't started appending #Emigrate hashtags to NZ news tweets because it sure isn't obvious where one could go. But the reasons for coming here aren't as strong as they were.

On lots of margins, New Zealand remains excellent. Most of what I'd written on the merits of moving to New Zealand continues to apply. On a fair few margins, we remain the Outside of the Asylum. Other great stuff: New Zealand has moved from a prohibition regime for new party drugs towards a regulatory regime allowing the sale to adults of products that pass a safety check. Alas, we've not followed Washington State and Colorado.

Factors affecting today's ratings warning? Most substantially, the GCSB / TICS legislation. At the same time as pressure is growing within the United States to make their internet spy agency, the NSA, a little less spooky, New Zealand's giving new powers to its spy agency, the GCSB.

Where we'd had a market opportunity to be the "Outside the Asylum" destination for American tech entrepreneurs looking to establish cloud services in which customers could have some expectation of privacy, we instead seem to be determined to be every bit as bad as America. I'd worried about this back in May; Ian Apperley's since tried putting some numbers on the cost. Susan Chalmers from InternetNZ has similar worries. I haven't fisked Apperly's figures, which seem predicated on a reasonably optimistic view of the New Zealand counterfactual. I'm not even sure we really can quantify things: there was some possibility that we could have drawn in substantial American tech investment, but I couldn't possibly tell you what that probability was. But imagine you had a lotto ticket that only paid out if you got all 7 numbers right. Five of the numbers have just come up in your favour. Do you tear up the ticket before finding out what the last two numbers are? Entries on Slashdot and Boing Boing about how we're turning GCSB into a low-rent client of the NSA are a great way of ripping up that lotto ticket.

And think that New Zealand would be above the petty thuggery that the UK today imposed on Glenn Greenwald's partner? We can hope so, but there were a couple of worrying stories last year about hassles for people thought to be Kim DotCom's friends.

There are also a few longer standing issues that have contributed to today's ratings warning.

• New Zealand's version of civil asset forfeiture kicks back seized funds to drug enforcement. We're certainly not as bad as the US on this one, and there's strong likelihood that the policy gets fixed before really bad stuff happens. But downside risks are substantial. 
• Our revised censorship legislation is fully "Inside the Asylum" stuff. See here and here. Justice Minister Judith Collins says it's all about the kiddie porn, but the definition of "objectionable materials" includes marijuana growing guides and a bunch of pornographic materials involving homosexuality that were deemed objectionable in the 70s and continue to be banned. A pile of comic books are banned. An online vendor, Fishpond, copped $4,200 in fines for distributing a couple of movies that are widely available in the United States. Our whole film classification regime is nuts. You have to pay $1000 to get a ruling from the film classification office on whether a movie meets the NZ guidelines. This kills legal distribution of long-tail films here. At the same time, failing to get a film classified can risk your getting years in jail if the Censor's Office then deems it objectionable. 
• The Christchurch earthquake was February 2011. Since then, the rebuild has been substantially hindered by regime and regulatory uncertainty caused by the government - both local and national, and the various acronyms now running the place. More worrying, very substantial problems both in the earthquake insurance scheme and in the regulatory regime around unsafe buildings have yet to be resolved for future earthquakes. This contributes to a ratings downgrade because, if you move to a part of New Zealand likely to be hit by substantial quakes while you're here, there are pretty substantial, foreseeable, preventable things that are going to happen despite their being substantial, foreseeable, and preventable:
• Buildings with unreinforced masonry will fall down and kill people. Deaths from earthquakes are pretty much unavoidable. But the combination in New Zealand of a zero-faulty liability regime for unsafe buildings combined with a regulatory regime giving building owners decades to get them up to scratch mean that, in the event of a quake, many people will die whose deaths could have been avoided at relatively low cost. And even if you've brought your property up to spec, you can still have problems if the absence of either liability or regulation encourages your neighbour to fail to take due caution. 
• You will have been compelled to pay for Earthquake Commission insurance with your private property insurance. The ability of EQC and private insurers to fob responsibility off on one another, combined with EQC's demonstrated incompetence in dealing with the volume of claims inherent in any large event, combined with the reinsurers' and government's need to constrain the total cost of claims regardless of whatever they promised to provide you in the insurance contracts you signed, mean you can't avoid having things drawn out for years and still wind up with less than your due. If you think that a government-run insurance company will not have every incentive to pretend that new damage is really a pre-existing condition, well, you haven't been paying attention to Christchurch.
• With no change to underlying riskiness, the government may decide after an earthquake event that the risk of rockfall facing your house in the event of additional earthquakes is too great for you to bear, even if you think the risk is eminently bearable and even if it would be cheaper to put in place earthworks or fencing to mitigate that risk. Or they could just faff about for two and a half years without telling you whether you're allowed to live in your house.

If the GCSB and TICS legislation pass without substantial amendment, I'm moving New Zealand from a "buy" to a "hold". If worries about surveillance state issues weigh heavily in your utility function, and you're considering emigration from America because of it, parts of Europe are in much better shape than we are. Most importantly for those who consider the NSA mess to be a reason for leaving the US, it now looks like, whatever America does on surveillance, New Zealand will basically follow along. Maybe with fewer resources, maybe a bit less enthusiastically. But if you think that surveillance in America will get worse before it gets better, you should expect New Zealand to follow in lock-step.

But on plenty of margins we remain much more free than the United States. Our airports remain exceptionally sane: I can show up at the airport 20 minute before a domestic flight and, so long as I'm not checking luggage, just walk on up to the gate and board. Home brewing and distillation are legal. Prostitution is legal. Same-sex civil unions have been legal for years and the first full same-sex marriages were celebrated today.

And, even with the new GCSB legislation, I doubt we'll be worse on surveillance than America. We'll just all have to be far more diligent about secure computing.

The Social Costs of Abstinence

Suppose that the correlation between one's sex life and earnings were actually causal, and worked from sex to income rather than the other way round. What correlation? This one:

Having an active sex life may make you happier, healthier and wealthier.
A new study reveals that people who had sex four or more times a week earned more money than their counterparts who weren't as lucky.
"People need to love and be loved (sexually and non-sexually) by others. In the absence of these elements, many people become susceptible to loneliness, social anxiety, and depression that could affect their working life," study author Nick Drydakis, an economics lecturer at Angila Ruskin University in Cambridge, England, said to CBSNews.com by email.
The discussion paper was published in July by the Institute for the Study of Labor,an economic research institution, in Germany.
Drydakis said he was interested in the topic because of previous studies linking sexual activity with extroversion traits (including being sociable, outgoing and energetic) and good health. In addition, good health has been linked to higher wages. A 2009 Brazilian study also showed a connection between higher wages and a more active sex life.

We can imagine some causal mechanisms that could run from sex to income. Happier people could be more productive at work. Or the cardiovascular benefits could yield better health and then consequently greater productivity. The authors do use a two-stage estimation procedure to try to isolate causality: they try to instrument for sexual activity, so it's at least more plausibly causal than much of what goes on in the public health literature.

If we follow the standard line in public health of assuming correlations are causal and in the "right" direction, and of ascribing as social all things private, we have to then worry about the social costs of abstinence. Those having too little sex earn less and so must be less productive. Those productivity costs reduce output and reduce tax revenue. And if it's working through a health channel, they also impose costs on the public health system.

The policy consequences are left as an exercise for the reader. But note that if you're recommending subsidies, you might need to offset the STD costs on the public health system via complementary regulations around health testing and public disclosure of who has what. This may seem like a violation of privacy, but can we really make rational decisions without perfect information?

[The should-be-obvious caveat: entire post subsumed within a "reductio" tag.]

Keeping it 18

New Zealand's reduction in the alcohol purchase age from 20 to 18 did not substantially worsen outcomes for youths. Alcohol consumption did not increase among 18 and 19 year olds subsequent to the change. Consumption, binge drinking, and accident rates among 15-17 year olds seems to have fallen since the reduction in the purchase age as well.

Stefan Boes and Steven Stillman's paper using regression discontinuity design and difference-in-difference measures on the alcohol purchase age, previewed here, is now up as an IZA working paper. Their abstract:

This paper examines the impact of a reduction in the legal drinking age in New Zealand from 20 to 18 on alcohol use, and alcohol-related hospitalisations and vehicular accidents among teenagers. We use both a difference-in-differences approach and a regression discontinuity design (RDD) to examine the impact of the law change. Our main findings are that lowering the legal drinking age did not appear to have led to, on average, an increase in alcohol consumption or binge drinking among 15-17 or 18-19 year-olds. However, there is evidence that the law change led to a significant increase in alcohol-related hospital admission rates for 18-19 year-olds, as well as for 15-17 year-olds. While these increases are large in relative magnitude, they are small in the absolute number of affected teenagers. Finally, we find no evidence for an increase in alcohol-related vehicular accidents at the time of the law change for any teenagers. In an important methodological contribution, we show that one approach commonly used to estimate the impact of changing the legal drinking age on outcomes, an RDD that compares individuals just younger than the drinking age to those just older, has the potential to give misleading results. Overall, our results support the argument that the legal drinking age can be lowered without leading to large increases in detrimental outcomes for youth.

The difference-in-difference measures in particular show lowered consumption among 15-17 year olds.

Finer-grained data on traffic accidents showed no increase with the purchase age reduction. There were more youth hospital admissions for alcohol use disorders subsequent to the law change. But while the increase is large in percentage terms, the baseline risk is low. Boes and Stillman estimate an additional 2.2 to 3.4 alcohol use disorder hospital admissions per month among 15-17 year olds, 2.1 to 2.6 per month among 18-19 year olds, and 1.0 to 1.5 per month among 20-21 year olds in the period immediately following the law change. They note that seasonal variation in admission for flu and asthma are three and twenty times larger than the variation attributed to the reduction in the alcohol purchase age.

They also make an important point on method, and I thank Steven for having explained this one to me slowly; hopefully I've understood it properly. Now recall that they found no effect of the law change on traffic accidents: changing the alcohol purchase age from 20 to 18 did not increase the accident rate among youths. Nevertheless, results from a regression discontinuity design comparing accident rates among kids just under the alcohol purchase age with those just over the alcohol purchase age shows an increase in accidents on reaching the alcohol purchase age after the law change. Why could there be an effect in RDD but not overall? Either the RDD is picking up the effect of the alcohol purchase age on the cohort of inexperienced drinkers who change their behaviour on reaching 18 and experience worsened outcomes, or it's picking up a particular changed behaviour around the time of the birthday. We would have overestimated the effects on traffic accidents for 18-19 year olds by extrapolating from the discontinuity around the 18th birthday.

But, we only know this because New Zealand actually had the policy change so we can compare actual outcomes with those estimated by the RDD. Now, suppose you're in a country that hasn't reduced its drinking age and you want to estimate what the effect of decreasing the drinking age might be. If you ran an RDD looking at the effect of reaching the age of majority on traffic accidents, took the break around the birthday as being the effect of being able to drink, then extrapolated that effect back across the cohort of younger drinkers who would be eligible to drink under a different minimum legal drinking age, you could pretty easily be overestimating the likely effect of a real change in the alcohol purchase age. The RDD picks up the effect of reaching the legal drinking age rather than the effect that would obtain by lowering the legal drinking age.

They conclude:

Overall, our results support the argument being made by groups like Amethyst Initiative and Choose Responsibility (see http://www.choose responsibility.org/proposal/) that the legal drinking age can be lowered without leading to large increases in detrimental outcomes for youth. The current age limit of 21 in the US is higher than in Canada, Mexico and most western European countries. The arguments against lowering the drinking age typically include the idea that even, if a new steady-state with a lower drinking age might be beneficial, the transition to that new steady-state might be very costly. The evidence in our paper from a country with drinking habits very similar to the US suggests that this does not have to be the case.

It is pretty tough to maintain a position that youth drinking is any kind of worsening problem in New Zealand.

Earlier this month, Auckland University's Youth Survey came out. Binge drinking rates among high school students have almost halved since 2001. The NZ Herald highlighted a few other trends from the survey hardly consistent with any kind of growing youth crisis. David Farrar linked up the current survey numbers with prior year figures to show decreases in all measures of youth alcohol consumption.

Weak instruments are weak

More than a decade ago, back in the advanced econometrics course at George Mason, Thomas Stratmann taught us about the weak instruments problem. Looks like one of these was worse than I'd thought.

Suppose you wanted to know whether education affected earnings. And you saw that people with more education had higher incomes. But suppose that you also thought that people who were smarter (or more conscientious) would earn more regardless of education AND that those same people were more likely to select into more education. You then have an endogeneity problem: just running a wage regression with education on the right hand side doesn't really give you the effect of education on earnings. It tells you how much more those with more education earn compared to those with less education, but it's a total effect rather than a partial: it includes all the effect of selecting into more education as well as the effect of the education.

So, then, what to do? You need something that will affect the amount of education that somebody gets that isn't itself a predictor of income. Something exogenous to income that affects education. If you have that, you can use an instrumental variables approach to try to estimate the effect of education on income via the effect of the exogenous instrument on education.

And the typical early example is the old Angrist and Krueger measure of quarter of birth as instrument for education. Compulsory schooling laws in the US meant you couldn't quit school until you were some minimum age. Quarter of birth could then affect how much schooling you got: those who turned 16 early in the school year could drop out earlier than those who turned 16 later in the school year.

Then Prof Stratmann told us about the weak instruments problem. Quarter of birth is only really weakly correlated with education - it explains very little of actual differences in education levels. And so bad stuff can happen in the estimation.

So we've known for a while that quarter of birth might not be a great instrument. But it would still get used. Bound, Jaeger and Baker complained about it in 1995; I think we went through their critique in our 1999 metrics class. Jaeger got angry in 2009 when quarter of birth was still being cited as a decent instrument.

Fast-forward to today's news from the Freakonomics blog: Buckles and Hungerman have shown that season of birth is endogenous. (gated, ungated) Ka-boom.

Season of birth is associated with later outcomes; what drives this association remains unclear. We consider a new explanation: variation in maternal characteristics. We document large changes in maternal characteristics for births throughout the year; winter births are disproportionately realized by teenagers and the unmarried. Family background controls explain nearly half of season-of-birth’s relation to adult outcomes. Seasonality in maternal characteristics is driven by women trying to conceive; we find no seasonality among unwanted births. Prior seasonality-in-fertility research focuses on conditions at conception; here, expected conditions at birth drive variation in maternal characteristics, while conditions at conception are unimportant.

If different types of parents select different seasons in which to have kids, then there goes the exclusion restriction: IV just plum don't work right if the instrument affects outcomes via channels other than the one specified. I think that Dubner at Freakonomics understates the importance here when he says the finding's interesting because so many studies have found an association between birth month and later outcomes: the importance is rather that we have something much more serious than a weak instruments problem when using quarter of birth to get around endogeneity problems in estimating the effect of schooling on income.

@KevinMilligan points out that folks have moved toward regression discontinuity design for this kind of work anyway.

@colbycosh Certaily hurts QofBirth IVs, but most stuff now uses tight discontinuities. Season of birth effects no prob if trend smoothly.
— Kevin Milligan (@kevinmilligan) August 12, 2013

Agreed! But I still wonder whether loud cries of "WE TOLD YOU SO!" were coming from Jaeger, Bound or Baker's offices when the Buckles and Hungerman paper came out....

Update: I'm going to give the last word on this one to Dr. Phil:

Finding a solid IV is a grueling task. Make it a little more fun by turning it into a scavenger hunt for the kids.
— Dr.Phil of Economics (@DrPhilofEconomi) August 13, 2013

In which we welcome Shamubeel Eaqub and revisit an old chestnut

The excellent Shamubeel Eaqub is now blogging as part of the team over at TheVisible Hand of Economics. Shamubeel has been a regular commenter at TVHE and is often quoted in the media; it is great to see him now blogging. Eric linked to Shamubeel’s first post yesterday in his Monday round-up.

Shamubeel was commenting on this story about National’s latest housing policy, in which “the number of first home buyers eligible for KiwiSaver deposit subsidies will double”, but buyers “will have to save a bigger deposit before they qualify for Government assistance”. Again, I find myself asking, What is it about housing policy that leads to people forgetting basic economic principles? The two quotes that jumped out at me were the following:

"Key said the requirement for a bigger deposit was necessary to avoid throwing fuel on an already overheated housing market in Auckland."

And David Shearer’s

"I am also determined to reduce speculation-driven demand in our housing market. Labour will restrict sales to overseas speculators and clamp down on speculators here through a capital gains tax on houses bought over and above their own home."

So Shearer  wants to make housing more affordable partly through taxing it and partly through a policy that restricts the nationality of who can own a rental property but won’t affect the number of people wanting to live in houses or the number of houses available for living. I have discussed these ideas before (here and here) so won't belabour the point. But now Key wants to join the party by promising to make housing more affordable by simultaneously shifting the demand curve to the right and then shifting it back to the left to prevent price increases! For sheer internal inconsistency, you have to say that National’s policy takes the cake here.

To be fair to both parties, both are also offering solutions to act on the supply side as well. And both parties think the other’s policy is crazy, so they have that right as well. But it wouldn't it be great if we could get beyond these silly games and have the political discourse focus on real policies?

Monday roundup

I love that the NZ economics blogosphere is now large enough that I can now simply outsource parts of my thinking to others. Today's worthies:

Donal explains the changes to broadband pricing regulation over at Economics NZ. First some background: mobile call pricing has come down substantially consequent to a new competitor's entry. Next, some background on the current broadband regulatory structure and how prices are set for regulated access to Chorus's infrastructure. Donal promises more to come.

Bill Kaye-Blake notes historical pamphlets worrying about the indolence of the peasantry were they ever to accumulate too many resources, and draws the logical extension to current "cost of alcohol" kinds of studies calling it a cost to the state if one chooses inebriated leisure over labour. Work is a bad and leisure is a good!

James Zucollo notes that Netflix doesn't believe your star ratings. Instead it recommends films based on what you actually watch. Expressive preferences differ from revealed preference. That's why economists trust the latter over the former whenever available, and are skeptical about surveys even when revealed preference measures aren't available.

Finally, Shamubeel Eaqub blogs at TVHE on National's policy in support of first-home buyers. Recall that RBNZ is initiating LVR regulations to prevent banks from taking on too many highly leveraged mortgages; they think that banks' asset sheets take on too much housing price risk. This will necessarily fall hardest on first-home buyers who cannot use the proceeds of the sale of their first home as deposit towards their next home. The National Party's proposed plan lets Kiwisaver participants use more of their dedicated retirement savings towards their first home. While this will push up housing prices where housing supply is pretty inelastic, it shouldn't heighten any of the risks that RBNZ is worried about under LVR: it's still a real deposit, and so it's less likely that banks wind up in the negative on foreclosing. The part that's a problem is instead the expansion of the Welcome home Loans Scheme, under which the government apparently underwrites loans for home buyers, who have to come up with only a 10% deposit. I can't see how this part doesn't cut against RBNZ's LVR policy except inasmuch as it's somewhat limited in total coverage: the Fairfax story says they're expanding from 850 loans per year to 2500.