Bryan Caplan on Monopoly

Over the last year I've posted several times on monopoly theory. I've discussed the usefulness of what Ronald Coase called "blackboard economics" and alternative ways of evaluating firms' real-world competitive behavior.

In a post on industrial organization and the Structure-Conduct-Performance (S-C-P) model, Bryan Caplan offered a very interesting insight on standard monopoly theory (italics in original):

Still, it's easy to see the intuitive appeal of S-C-P.  Namely: If you are a monopoly, you'll charge high prices, and hence produce low quantity. 

The problem with S-C-P is that it ignores an even more intuitive truism.  Namely: If you want to become and remain a monopoly, you will produce high quantity, and hence charge low prices.

So the question is, how does a firm obtain monopoly status without going through the process of becoming a monopoly? Caplan concludes:

In short, the desire to become and remain a monopoly leads firms to do the exact opposite of what they'd do if their monopoly status were a law of nature - or the law of the land.

This is one of those cases where an important and interesting insight is obvious once it's pointed out. It's also an example of the power of the economic way of thinking and the importance of economic intuition.

Arnold Kling on Falsifiability in Economics

Arnold Kling posted some commentary on falsifiability in economics that I found very interesting. I may not agree with everything he says, but the post is certainly food for thought. Here's an excerpt:

In general, I shy away from using the term “social science,” because I do not think that economists can aspire to the same level of falsifiability as physicists. I believe that the difference between social science and natural science boils down to this:

In natural science, there are relatively many falsifiable propositions and relatively few attractive interpretive frameworks. In the social sciences, there are relatively many attractive interpretive frameworks and relatively few falsifiable propositions.

The reason that there are relatively few falsifiable propositions in the context of social phenomena is that there are many causal factors, and decisive experiments are rarely possible. Social phenomena are characterized by high causal density, to borrow a term from James Manzi.

As a result, economics is closer to history than to physics. If a historian wants to examine the causes of the decline of Rome, or the decline of empires in general, he or she will provide an interpretive framework. That framework cannot be falsified, but readers can compare it to other frameworks and make judgments about its plausibility.

. . .Economists who employ models think of themselves as “doing science,” meaning that they are generating falsifiable propositions. However, in practice, they rarely reject their preferred models. Instead, they explain away anomalous observations. In that sense, they are really using their preferred models as interpretive frameworks.

I recommend reading the whole post as he throws in a couple of examples.

What Should We Make of the Gig Economy?

Noah Smith's recent column on job outsourcing does two things: it repeats mistaken claims about the plight of the average worker in the U.S. and it accurately identifies market-generated opportunities that could deliver economic improvements for everyone. In this post I'll respond to the former and give my thoughts on the latter.

Here are the problems Smith identifies. In some cases he's factually incorrect. In others I think it's important to shed light on the causes of the problems.

The average American worker is confronting a number of problems right now -- stagnant income,  an overhang of debt from the housing bubble, the high cost of college and the replacement of pension plans with high-fee, low-return 401(k) plans. But few would deny that one huge challenge is economic insecurity. Political scientist Jacob Hacker’s 2006 book, "The Great Risk Shift," discusses how many risks that were once borne by companies are now shouldered by individuals. ... Basically, the era of "good jobs” is a memory for most workers. Private-sector unionization is disappearing, average job tenure has plunged and benefits have been cut. 

First on the list is income. Data on total compensation shows that people are better off in real terms than they were 5, 10, and 15 years ago. Wage growth isn't stagnant. Neither is non-wage compensation, implying that benefits are not being cut. If medical benefits have been cut recently, it's likely a result of the "Affordable Care Act."

Food Labels and the Informed Consumer

Product labels are an important part of communicating product information to consumers. For a long time, regulators and politicians have been in the business of mandating the content of labels for a whole range of products, especially food. While other reputation mechanisms are important to being fully-informed, we all rely on labels to some degree.

But mandated labeling has its share of pitfalls. Regulators might require too much information on a label, increasing costs to consumers with little upside. They might reduce the amount of information on a product label by increasing the costs of using certain language. More bizarrely, they might require completely misleading information to be put on a label. Arguments in favor of different labeling requirements can come from consumer pressure groups, but often they come from within industries.

An example of the first problem is mandatory country-of-origin labeling (or MCOOL) of meat products. Though there are efforts in congress to repeal MCOOL, it is currently the law of the land. A fact sheet distributed by K-State concludes:

The overriding finding of limited awareness of MCOOL, narrow use of origin information in purchasing decisions, and no evidence of a demand impact following MCOOL implementation is consistent with the argument that voluntary labeling by country of origin would have occurred if it were economically beneficial to do so. More broadly, the findings of this project generally support the assertions of MCOOL opponents who have asked “where is the market failure?” 

MCOOL creates international trade issues and increases costs to producers, processors, and retailers with little to no upside.

Does Lower Unemployment Imply a Stronger Economy?

With all the buzz about a $15 minimum wage, or a $10.10 minimum wage, there's been a lot of discussion about the effects of minimum wage on the labor market. While some of the empirical work on the subject says the minimum wage doesn't affect employment, most of it says otherwise.

Another popular topic these days is Federal Reserve policy; specifically how and when the Fed will raise interest rates. A major concern is that raising rates "too soon" will cause unemployment to stop falling or start rising again. The Fed has cited improvements in labor markets as a sign that it could start raising interest rates soon. Looking only at the unemployment rate, the idea that labor markets are improving makes sense.

In this post I'll discuss unemployment and labor force participation rate data since the recession, then give a numerical example that shows that even if the unemployment rate is falling, the labor market and the economy overall may not be improving as much as we'd like to think.

Policy Pessimism (Realism?) in Economic Theory

One of my favorite Hayek quotes regards the necessity of humility in policy design:

"The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."

I've come across a few interesting posts in the last few days on this topic and thought readers would be interested. I've reproduced the first post in its entirety.

Mike Munger lists four economic theories that imply there are serious limitations on the ability of policy to fix the problems identified with standard theory:

1. The theory of the second best. 

Simply put, if the world or model has multiple distortions in it, removing only one of those distortions may not make things better. This applies so strongly to macro and development economics, but it rarely even mentioned. Consider corruption. Suppose a polity has bad laws, weak rule of law, oppressive regulations, little protection of property rights and corruption. In such an environment, an anti-corruption campaign alone may actually make many people worse off. You can no longer bribe your way out of the oppressive regulation or bribe your way into protection of your property. This one is a real doozy. 

2.  Arrow's impossibility theorem. 

Simply put, this tells us that there is no ideal, comprehensive way of aggregating individuals preferences into an aggregate choice. Arrow shows there is no mechanism that is non-dictatorial, satisfies independence of irrelevant alternatives, and pareto efficiency. 

Or as the great philosopher Robyn Hitchcock put it, "When I hear the word "Democracy", I reach for my headphones." 

3. Related is Hurwicz's impossibility theorem of mechanism design, which shows that there is no strategy-proof, Pareto-efficient, and individually rational rule for allocation. In other words, a planner cannot get truthful revelation from people about their preferences and willingness to pay without wasting resources in the process. 

4. The Folk Theorem. 

This is a strange one because some "folks" take is as a feature, rather than the devastating bug that it really is. The folk theorem shows that if people are patient enough, any behavior pattern can be an equilibrium of an infinitely repeated game. I have actually seen papers invoke the folk theorem in a positive sense, citing it to prove their preferred story is an equilibrium story, without realizing the irony that in that setting ANY story is an equilibrium story.  Ouch.

Per Bylund says economics is dead and is being killed again.

Don Boudreaux shared an interesting quote from Dierdre McCloskey's book The Bourgeois Virtues. His own commentary on the post is interesting as well.

And here are a couple of related Farmer Hayek posts:
Demsetz on Comparative Institutions
Blackboard Theory Versus the Reality of Markets

Whole Foods Co-Founder on "Why Intellectuals Hate Capitalism"

This is just a fantastic conversation. Nick Gillespie usually does a good job with interviews; this time he did a great job. John Mackey, co-founder of Whole Foods,

My only quibble is that he misunderstands the idea of firms maximizing shareholder value. Keeping your customers happy and creating the perception in the public's eye that you value other stakeholders is 100% consistent with maximizing long-run shareholder value. What else do shareholders want?