Externalising the Internality

Back in August, I commented on a recommendation in the report of the Electricity Technical Advisory Group (ETAG) to force an asset swap between the two large SOE electricity generators, Meridian and Genesis. At the time, I thought that this swap was largely pointless (correcting a problem of market power that I don’t believe exists), but also would do little harm.

When the government announced plans for such a swap in December, it transpired that the particular asset swap would split up ownership of stations along a single waterway. The flow that is allowed through an upstream station can affect the production possibilities for downstream station. This is the classic kind of upstream/downstream issue that we use in undergraduate economics to illustrate production externalities. And the classic Coase-theorem-inspired solution to internalise the externality that we suggest in such cases is company mergers. To forcibly bring about the opposite would seem to be externalising the internality.

Recently, I discovered this paper, suggesting a number of reasons that asset swaps would actually worsen competition, even without any production externalities.

And now it transpires that Meridian have flipped and are now supporting the proposal. Does this mean that rather than increasing competition, Meridian and Genesis have found some way of using the new arrangement to extract some monopoly rents from the market? Or maybe the proposal has some general benefits that are not clear on the surface. I do wonder, however, if anyone has done any theoretical or empirical work to show a social benefit from an asset swap. If so, can anyone point me to it?

The depressing state of New Zealand politics

I really shouldn't be disappointed when politicians act in accordance with theory.

Public choice says that politicians are self interested and want to be re-elected. In an MMP system, that means that the big centre-right or centre-left party has to cobble together a coalition supported by 50%+1. We usually expect the minimum connected winning coalition - the smallest grouping of parties adjacent to each other in left-right space - to emerge. In 2008, Key put together a larger coalition than that, mostly, it seems, to give himself flexibility to ignore ACT, who might sometimes recommend that policies enacted by Helen Clark be rescinded. Even absent that kind of larger coalition, ACT is largely toothless: they know they won't go into coalition with anyone but National, National knows it, ACT knows National knows it and so on. So they have no bargaining power in coalition formation: they're promised productivity task forces that are promptly ignored and so on. ACT can't even get National to support a bill reversing a Labour-Green policy that National opposed when Labour enacted it and that National might reasonably have been expected to reverse in office.

If Key wants to maximize his chances of being Prime Minister after the next election, and ACT would neither bring down a National government nor go into coalition with Labour, then it's hard to fault his strategy. The polling wouldn't be good on changes to minimum wages as most folks don't understand economics; if the policy were enacted, more youth would blame National for small wage decreases than would credit National for getting jobs. So there's little political gain in dropping the youth minimum wage regardless of the economic case for it: no votes to be gained, and ACT doesn't much need appeasing.

I don't know how long ACT can survive as this kind of rump. Not many folks can point to any particular ACT achievements in government other than getting to take the blame for Auckland's amalgamation. Yeah, they're getting a productivity commission (after a productivity task force report was sent to the shredder, unread); yeah, they might eventually get a regulatory responsibility bill (which I'm now having a much harder time imagining both having the teeth to do anything useful AND being supported by Key: looks more like pick one or the other). And maybe they've behind the scenes stopped some really stupid policies; I'd believe it, but that's not the kind of thing they can campaign on. There seems little chance of ACT pulling above the 5% threshold for Parliamentary representation; Hide's seat in Epsom serves as lifeboat.

And, I don't think that just coming up with nifty new economic policies will push ACT over 5%; the problem more is in making credible that their policies ever would be enacted by a coalition. If ACT can't even get National to agree to go back to the status quo as of January 2008 on the youth minimum wage, why should we ever expect them to extract anything substantial from National? They're the dependable rump on the right, easily ignored, who'd never vote with Labour so why worry? It's the centrist parties that profit from bidding wars between the centre-right and centre-left. ACT has been up a bit lately in the polls, pulling from National's right tail. But those right wing voters have more influence staying in National and moving National's policy position than they have by increasing ACT's vote share. The policy position chosen by National at convention will be the median of its members, mediated a bit by a pull to centre. The more voters shift from National to ACT, the further left is the median National voter; as ACT won't credibly go anywhere else, it doesn't much move coalition policy. This of course will limit the number of voters ACT can draw from National's tail.

But ACT could have more serious influence on policy. Folks forget that a truly liberal party, in the European sense of the word, and which ACT has claimed to be, isn't a right wing party: it's to the right on economics and to the left on social issues. But ACT's forgotten the other side. It's time they remembered it.

Key can afford to ignore ACT because there's no chance of ACT going elsewhere after the 2011 election, if it returns in 2011. This has to change. And perhaps the best way of making that happen is for ACT to stop talking about economics and start talking about the parts of a liberal platform where they could make common cause with the Greens and the socially liberal side of Labour.

The Law Commission released a report arguing that New Zealand's laws on marijuana needed revision; Simon Power immediately ruled out any changes in drug policy. When a liberal party could have been jumping up and down with the Greens trying for a liberalization of our drug laws, I didn't hear anything from ACT, probably because caucus isn't as liberal as ACT's banner. Where has ACT been on the internet filter? On the use of asset forfeiture legislation? On copyright reform? They may well have policies on all of these (and, on asset forfeiture, the wrong one), but they've not been priorities. Instead, I only see them on economic issues that increasingly seem doomed and on Tiebout-competition-destroying and subsidiarity-ignoring city amalgamations.

Imagine that after the 2011 elections neither Labour nor National has enough votes to go it alone. Labour plus the Greens plus Maori plus ACT could form government; National could do it with ACT or Maori. That's not implausible. ACT puts out a slate of economic policies for National; a slate of civil liberties policies for Labour/Green, choosing the ones that the Greens would find most enticing. A liberal agenda is advanced in either case. It's not like Labour is hopeless on civil liberties either: I am far more a fan of Labour's civil unions bill and prostitution law reform than I am of anything National's done or, increasingly, than I am of anything I expect National to be likely to do. For all that Labour screwed up on the economics side, a not unreasonable case could be made that a liberal agenda made more progress under nine years of Helen Clark than has been made with a liberal party in a National government.

After an election giving National the choice, would National really choose not to bring ACT into the government if its slate of economic policies were roughly in keeping with the kinds of things that National voters tend to like? Just make former National Party leader Don Brash's productivity commission report the basis for ACT's proposals. But by being willing to go into coalition with Labour on a civil liberties platform where they'd make common cause with the Greens: drug reform, internet filter, civil asset forfeiture, perhaps even copyright reform, ACT could have a decent chance of holding National to some reasonable economic reforms: size of government (giving room for changes in taxation), welfare, regulatory burden, RMA.

ACT needs to be able to make credible threats. Focusing on civil liberties would help.

I could easily be wrong: maybe the Regulatory Responsibility Bill has a really great chance of being implemented in a form that would do a lot of good. I can believe that National would be more friendly towards legislation that constrains future action than legislation that annoys voters today; it's probably ACT's best chance of achieving anything on the economics side. If they can quietly make useful structural changes in a National government, then there's less need for the kind of positioning I'm advocating. But everything I've seen thus far from Key makes me pessimistic; I'd expect National to write in enough escape hatches that it, and Labour, would not be terribly constrained. OIRA in the United States hasn't been particularly effective in constraining bad legislation and budget caps there similarly have proven ineffective when every year can be deemed an emergency year requiring the cap be increased or ignored. Quasi-constitutional constraints are great, but they have a hard time being effective in a Parliamentary system if the majority party doesn't particularly wish to be constrained and if voters aren't particularly constitutionally minded.

The biggest risk in liberal positioning would be in alienating the hard conservatives in ACT's base. But how many of those would be willing to trade a much better chance of advancing the economic issues they care about in exchange for some moves on social policy? And, for those who haven't the stomach for the deal and leave, how many younger folks would ACT bring in on a civil liberties ticket? I hope ACT's doing some polling.

Versalko's Millions

Lots of folks chattering about the Kiwi banker who embezzled millions from a few bank clients and spent over $3 million on a couple of prostitutes in a combination of fee for service and extortion payments. Most folks seem puzzled by how he could spend, if you knock out the extortion money, $2 million over 9 years on such services.

I'm more puzzled about why this strategy didn't occur to Monty Brewster. Recall the terms:

Brewster suddenly finds that his recently deceased long-lost great-uncle was an eccentric multi-millionaire who was also his only living relative, and includes him in his will. Under the terms of the will, Brewster is challenged to spend $30 million within 30 days in order to inherit $300 million. There are some important conditions attached: at the end of the 30 days, he may not own any assets that are not already his, and he must get value for the services of anyone he hires. Furthermore, he may donate only 5% to charity and lose another 5% by gambling, and he may not waste the money by buying expensive goods and then destroying them or giving them away. Finally, he is not allowed to tell anyone about the nature of this challenge.

Not own any assets at the end of the spending? Check.
Must get value for service? Who's to say he didn't! Check.
Not charity and not gambling? Check.
Not buying and destroying expensive goods? Check.

Just claim to have very bizarre, hard to satisfy, and consequently expensive, tastes. If the terms of the will said you can't do anything illegal, hire the Concord to take you someplace it's legal.

On the other hand, getting the "None of the Above" election result was probably pretty satisfying too....

Minimum wage disappointments

David Farrar rightly takes the National government to task for its failure to support Roger Douglas's minimum wage legislation.

It will be remarkable to see National MPs argue against a bill, which just 18 months ago they were in favour of. As their MPs get up to explain, why they are voting against, I doubt any of them would really believe what they are saying.

The Government gets criticised, often unfairly, for refusing to break pre-election promises that are a handbrake on greater economic growth. I think it is commendable that the Government places a premium on honouring its major commitments.

But when there was no pre-election promise, when in fact their stance was 100% in favour of a lower minimum wage for teenagers, the u-turn by the National Party is legitimate fuel for those who say the Government’s record is not matching its rhetoric.

Now, I could understand it if English had asked Treasury to run a quick extension of the Hyslop and Stillman paper to check for effects post the 2008 minimum wage changes and they'd found my preliminary analysis was missing something. It very plausibly could be missing something, but there's a prima facie case there to answer.

Instead, the scuttlebutt I've heard is that National did some polling and it looked bad.

Of course the polling would look bad. The median voter is, not to put too fine a point on it, utterly incompetent to make on the spot decisions about appropriate economic policy. Last year I noted some results from the 2005 New Zealand Election Survey:

While economists will disagree vehemently about the magnitude of the effects, most economists would agree that minimum wages reduce the creation of new jobs. In [the New Zealand Election Survey of voters], 983 respondents either strongly agreed or agreed that minimum wages reduce the creation of new jobs, 698 were neutral, and 1461 disagreed or strongly disagreed. ... Whaples' 1996 survey of economists found that 87% of labour economists agreed that minimum wages increase unemployment among the young and unskilled.

Voters reckoning that minimum wages have no effect greatly outnumber those thinking that minimum wages hurt job creation.

I could have forgiven Key if he'd let it go to first reading, let the evidence for the effects of minimum wages be debated in committee, encouraged some popular discussion, then decided to back down because he wasn't able to bring the public onside. It would have been courageous to go beyond first reading if opinion were against it, and Key is hardly courageous. But to kill it before committee? When they opposed Labour's move back in '08 and didn't promise anything on the subject?

I'd happily trade the government for a futures market. But not for a polling firm.

Sciency

Best line in the new Gelman article on zombies:

We originally wrote this article in Word, but then we converted it to Latex to make it look more like science.

As I aim for science rather than sciency, I stick to Word.

Satel on Addiction

Wow. It's not just us crackpot rational choice economists who take choice seriously.

Now comes an important and provocative book called Addiction: A Disorder of Choice by the psychologist Gene Heyman, a research psychologist at McLean Hospital and a lecturer at Harvard. Heyman mounts a devastating assault on the brain-based model of addiction. Not that he views addiction as independent of the brain—no serious person could even entertain such a claim. What he rejects, however, is the notion that excessive drug or alcohol consumption is an irresistible act wholly beyond the user’s control, as the term “addiction,” commonly understood, implies. If anything, Heyman writes, “[a]ddiction … helps us understand voluntary behavior.” How so? “[B]ecause,” he explains, “it is not possible to understand addiction without understanding how we make choices.”

...

Good intentions aside, is the “brain disease” of addiction really beyond the control of the addict in the same that way that the symptoms of Alzheimer’s disease or multiple sclerosis are beyond the control of the afflicted? Showing how the two differ is an important theme of the book. If, as Heyman says, “drug-induced brain change is not sufficient evidence that addiction is an involuntary disease state,” then how are we to distinguish between voluntary and involuntary behavior?

Heyman’s answer is that "voluntary activities vary systematically as a function of their consequences, where the consequences include benefits, costs, and values.” Take, for example, the case of addicted physicians and pilots. When they are reported to their oversight boards they are monitored closely for several long years; if they don’t fly right, they have a lot to lose (jobs, income, status). It is no coincidence that their recovery rates are high. Via entities called drug courts, the criminal justice system applies swift and certain sanctions to drug offenders who fail drug tests—the threat of jail time if tests are repeatedly failed is the stick—while the carrot is that charges are expunged if the program is completed. Participants in drug courts tend to fare significantly better than their counterparts who have been adjudicated as usual. In so-called contingency management experiments, subjects addicted to cocaine or heroin are rewarded with vouchers redeemable for cash, household goods, or clothes. Those randomized to the voucher arm routinely enjoy better results than those receiving treatment as usual.

Contingencies are the key to voluntariness. No amount of reinforcement or punishment can alter the course of an entirely autonomous biological condition. Imagine bribing an Alzheimer’s patient to keep her dementia from worsening, or threatening to impose a penalty on her if it did. This is where choice comes in: choosing an alternative to drug use. Heyman realizes how odd this might seem. How can otherwise rational people choose self-destruction unless they are diseased? This question was raised in colonial America. Dr. Benjamin Rush, also known as the father of American psychiatry, was among the first to promote the notion that alcoholism was a disease. And he did so not on the basis of medical evidence, Heyman reminds us, “but rather [upon] the assumption that voluntary behavior is not self-destructive.”

Sounds like a mix of Becker-Murphy on rational addiction and Szasz-Caplan on disorder as extreme preference; will have to add the book to the pile....

HT: Arts & Letters Daily.

Markets and information aggregation [updated2]

I have just lost about $114. But, I lost it in a particularly interesting way.

The graph above shows the price of a contract paying $1 if Sir Roger Douglas's Private Member's Bill allowing the youth minimum wage to diverge from the adult minimum wage were to pass first reading. This wouldn't drop the youth minimum wage but would allow future reviews of the minimum wage to set a different rate between adults and youths. I figured this likely would lead to erosion of the real value of the youth rate over time rather than any sudden cuts.

I thought there was at least a 25% chance of the bill passing first reading: it seemed likely to me that Key would let it get through first reading, see what evidence would be presented, then stick his finger up in the wind to see what public opinion said about the evidence presented at committee. And so I bought fairly heavily, but at prices below the $0.33 or so where it stabilized for the last couple weeks.

National's weekly caucus meeting was Tuesday morning. At 11:03 Tuesday morning, somebody went in and put in a sell order for $60, running the order book down to $0.0001. As the market maker had a slight glitch, it didn't re-seed the book with sell orders all the way down; instead, the low ask stayed at $0.2315. At 11:54, somebody bought at that ask price; the price bid up again to $0.256. Tuesday evening saw more determined selling, with a few big sell orders against the order book: the first for 140 units at 18:33, another for 160 units at 19:09, 40 units at 19:45, 100 units at 19:46, 210 units at 19:47. There were a couple of small price rallies, but it came down to the $0.01 mark again this afternoon at 14:35.

A very plausible interpretation is that somebody came out of the National Caucus meeting and started selling like hell. [UPDATE: Caucus closed at 11:40. So somebody started trading DURING THE MEETING.] An alternative interpretation is that a noise trader came in at a time that made it look like a very well informed trader, and everybody subsequently herded. I find the former more likely because of the succession of hard runs down the book.

So a best guess is that National's decided not to support the bill. I wonder at what time they'd have informed their coalition partner, because they seem to have decided to tell the market almost immediately. I wonder whether information travels through Parliament more quickly via iPredict than through normal channels.

If the story above is true, then National are utter cowards. John Key seemingly hasn't even the balls to let this bill through first reading as a trial balloon, getting some of the evidence out there. I'm disgusted with the National Party and annoyed that I've lost $100.[Updated below, maybe that's too harsh.]

But I'm heartened that the market seems to aggregate information so quickly. A victory for iPredict, even if a loss for Crampton.

Aha: last minute check of the forum confirms that National won't be supporting. Cowards. What a waste of a government. At least they're not saddling us with a Commonwealth Games.

Update: Maybe Key's just saving up his political capital for the budget. He's been saving it all up since 2008, so he should have room for a lot of good stuff in there: serious welfare reform, serious tax reform (top rate below 33 percent), serious spending cuts even if they're only scheduled for implementation later on. Getting harder to remain optimistic though.