Tuesday 9 September 2014

Negative value added: education edition

Remember the story of the West German auto exec who, after touring the Trabant plant, wept because the value of the steel and other inputs going in exceeded the value of the car coming out? The Trabant plant was destroying value.

That's how I felt on reading the New Zealand Qualifications Authority standard on economics. Or at least this bit. They are making the students dumber by teaching them things that are not so.

Here's the particularly offensive bit:
3.  Market failure refers to situations when a market fails to deliver an efficient or equitable outcome. Efficiency occurs when Social Marginal Cost equals Social Marginal Benefit. Equity occurs if a situation or outcome is considered to be fair. The different market failures relate to: consumption externalities, production externalities, public goods, imperfect information, inequitable income distribution. 
4.  Government interventions refer to interventions in a market by central or local government. For example, these may include, for each market failure, a selection from:
  • subsidies, taxes, regulations, property rights and government provision (consumption externalities) 
  • subsidies, taxes, regulations, property rights and government provision (production externalities) 
  • government provision (public goods) 
  • regulation (imperfect information) 
  • progressive taxes, welfare benefits, collective provision and minimum wage (inequitable income distribution). 
This just isn't so!

Pick up any reasonable intermediate microeconomics text. Market failure occurs when the conditions underlying the first welfare theorem fail to hold. That doesn't necessarily mean that there's anything the government can or should do to fix things, but it opens up the possibility that there could be interventions that improve outcomes. The kinds of things in the first four bullet points are pretty standard textbook analysis, though we'd need to caution that the failures are necessary but not sufficient basis for intervention.

The last bullet point is right out. Draw the standard Edgeworth Box and derive the contract curve. Any of the infinite number of points on that curve are consistent with market efficiency (the First Welfare Theorem), but only some of the points will be consistent with particular views of equity.

If the government decides that one point on the curve is preferred, for equity reasons, to the one that would be achieved by markets, it can push things in that direction through appropriate redistributive measures. That's the Second Welfare Theorem. But we would never describe equity-based interventions as correcting a market failure. If we were on the contract curve, where marginal rates of substitution and marginal rates of transformation all lined up nicely, but we just didn't like that point for some reason, that just isn't a market failure. And I would have given a failing grade to a student who would have described it as such. Heck, I ran multichoice questions specifically checking against this kind of fallacy. NZQA is teaching students how to get a failing mark on intermediate micro exam questions.

Even worse, were we to take the Second Welfare Theorem as justification for equity-related interventions, the Theorem does require that least-inefficient means be used to get to the preferred point on the contract curve: typically, lump-sum redistribution of initial endowments. In the real world, you aim for the least distortionary taxes available: maybe land value taxation, maybe progressive consumption taxes. But you sure as heck don't go for minimum wages. That's a good way of ensuring that you never get back to the contract curve, or that you stay farther away from it than you could have using alternative measures like wage subsidies (or, to be consistent with theory, lump-sum transfers).

Why does this matter? There are decent theoretical reasons for interventions addressing First Welfare Theorem considerations. They're sciency. And, if designed properly with appropriate side-payments, they can in theory make at least one person better off while making nobody worse off. But there just aren't such justifications for equity-based policies - they're based on aesthetic considerations. It would be like having an engineering class move on from efficiency considerations in engine design to say that it's also an efficiency failure if the engine is painted blue instead of red.

Somebody please fix NZQA so that the economics standard isn't teaching kids how to fail their intermediate micro exams?

Update: in comments, Granite26 very correctly notes:
In your red vs blue engine example, it might be more correct to say 'uses too much fuel regardless of the efficiency with which it is converted to horsepower'. We should all be riding Mopeds, you know
Update 2: Paul Walker points me to the source on the Trabant story.


  1. You're kidding. I actually think I might cry.

  2. That "weeping" tag is there for a reason.

  3. I'm not sure that the course on the whole is actually destroying value. If we accept that lack of economic thinking among voters makes democracy worse, then I'd expect that the net effect of the course is improved economic thinking and therefore added value.

  4. I haven't evaluated the rest of the course. This part of it is value-destroying.

    Consider too that a very badly taught high school econ curriculum can both mislead students AND put them off taking econ at Uni.

  5. Amazing. Could not be more wrong. Equity has nothing to do with market failure. Economists are famous for having little to say on equity.

  6. In your red vs blue engine example, it might be more correct to say 'uses too much fuel regardless of the efficiency with which it is converted to horsepower'. We should all be riding Mopeds, you know.

  7. You're right. That's exactly what I should have written.

  8. Your links are pretty depressing. But the age breakdown may not be cause for too much pessimism. After the first Quebec referendum, the conventional wisdom was that it was only a question of time as young voters were more separatist than older voters. It turned out that that was an age effect, not a generational effect. As those young separatists grew older, their views mellowed somewhat.

  9. Hey Seamus,

    I'm not too sure about this one. I pulled the Scottish economic statistics up (http://www.scotland.gov.uk/Topics/Economy/Statistics) and Scotland's economy has been in a bad state since 2008. Whereas New Zealand came out of the GFC in 2010, Scotland has been mired in the slump up until this year.

    That's 6 years of national economic under-performance. I can't help but wonder whether being part of the United Kingdom and having the pound as its currency means Scotland's export competitiveness is being determined by the strong English economy which is setting the pound's exchange rate.

    Krugman's article talks about problems of independence AND retaining the pound. Independence and ditching the pound for a floating exchange rate might just be the ticket for rebalancing Scotland's export price competitiveness and revitalising their economy.


  10. James. I think your conclusion depends on the following:
    1. Scotland's relatively poor performance since the GFC is purely because it is an optimal currency area and so looser monetary policy is all that it needs to perform better; because
    2. The only way to achieve a separate currency is to separate from the U.K.
    3. The benefits of inflating out of the crisis will be so large that the other costs associated with operating a separate currency to the Disunited Kingdom will not outweigh them.
    4. There is no other way of achieving the relative price changes implied by depreciation.

    I can buy point 2. I think 1 is highly unlikely. All the literature on how much international borders restrict trade relative to what gravity models of distance would imply suggests to me that 3 is even more unlikely. And even the stickiest models of sticky prices don't suggest that relative prices stay unchanged forever, even under a fixed exchange rate.

  11. James. I've been thinking about Point 2 some more. Why is it that a country could not have more than one currency if it comprised more than one optimal currency area. I think the question is moot because borders are so hugely important, that optimal currency areas are never smaller than individual nation states. So point 1 is trumps all.