McCloskey on the Coase Theorem

The Coase Theorem is an important part of economics research, agricultural or otherwise. The standard definition of the theorem is that in a world with zero or very low transactions costs, bargaining over a disputed right between two parties will lead to an efficient allocation of resources regardless of which party is legally awarded the property right. (If you are familiar with the Coase Theorem, you can skip the next paragraph.)

A classic example (which is found in Coase's paper "The Problem of Social Cost" is that of the railroad and the farmer. As trains traveled down the track in the 1900s, they emitted sparks that potentially could set fire to farmers' crops. If this were to happen, who should pay for the lost crop? In a world where transactions costs (that is, costs associated with acquiring information, monitoring the other party, or executing the trade) are zero, it doesn't matter who a court decides is responsible. If it's less costly for the railroad to put on a spark-catching device, the farmer will pay the railroad company to do so. If it's less costly for the farmer to plant his crops farther from the railroad, the railroad company will pay the farmer to do so.

Of course, we don't live in a world of zero transactions costs, so it does matter to whom the court grants the property right. Transactions costs also make it difficult for governments to figure out how to solve the problem. If the government decided it wanted to make farmers reduce their planting to solve the problem, there would be significant costs associated with determining just how far to restrict planting away from the tracks. In the opposite case, the government (that is, the taxpayer) would have to incur a cost to determine precisely which device the railroad should use to contain the sparks. These costs don't disappear in the cases of tradeable permits in fisheries or pollution. The government still has to determine the extent and details of these artificial markets.

It seems strange, but Coase himself maintains that the theorem (as described in the first two paragraphs of this post) is not about his work. He says that it's really George Stigler's theorem, but that Stigler was kind enough to name it after him. This is where McCloskey comes in. Her Summer 1998 column in the Eastern Economic Journal makes some bold claims about the Coase Theorem and, I think, provides some interesting insights, which I reproduce below.

Her interpretation is at odds with the way most interpret the Theorem. Her interpretation, which she says is Coase's (and I have reason to believe it is... Coase spent a lot of time arguing against what he called "blackboard economics"), is a caution to people who take the typical form of the theorem as an argument for "markets are always best" or "government solutions are always best."

PERC Weighs in on EPA's WOTUS Rule

Over the past year, I've explored several aspects of EPA regulation (here, here, here, and here). In a blog post last month at the Property and Environment Research Center (PERC), law professor Jonathan Adler discussed the conservation aspect of the EPA's contentious new definition of "waters of the United States" (WOTUS). In the post, he makes some good points about the ways in which an expansion of federal government conservation efforts could affect private or state government conservation.

Adler says that previous court restrictions on EPA's authority were the impetus behind the new definition of "waters of the United States":

The new definition was prompted by the failure of prior agency definitions to withstand judicial review. In 2001, and again in 2006, the U.S. Supreme Court rejected the agencies’ overly expansive notion of their own jurisdiction. Authority to regulate activities touching upon “waters of the United States” is broad, but not infinite, the Court ruled, and must ultimately connect to the nation’s navigable waters. Already multiple suits are pending in federal court challenging the new WOTUS definition for failing to heed this guidance.

He writes that the underlying theory behind the new definition is that conservation can be maximized if and only if federal regulatory authority is maximized. However, Adler claims that there are potential crowding-out effects associated with the new definition. He gives a couple of examples:

Consider the case of wetlands, which are subject to the Clean Water Act under the new WOTUS rule insofar as they are adjacent or otherwise connected to navigable waters and their tributaries. If federal regulation does not cover all wetlands—and it does not—other steps are necessary to maximize wetland conservation. Yet conservation groups and state and local governments cannot know where their efforts are most needed if they do not know where federal regulatory authority ends and the need for additional efforts begins. 

The expansion of federal regulatory jurisdiction also threatens to penalize and discourage conservation efforts more directly. Among other things, the Clean Water Act prohibits the discharge of pollutants, defined to include clean “fill material” such as dirt, in the nation’s waters without a permit, and the WOTUS rule defines waters to include many wetlands. This means that even the most well-intentioned conservationists may need a federal permit to undertake ecological restoration on private land. Why does this matter? Because obtaining such permits can be costly and time-consuming—and failure to comply can bring criminal penalties. And as has been shown in the context of endangered species, excessively punitive regulations can discourage voluntary conservation on private land.

Adler concludes:

There are more than 100 million acres of wetlands in the United States, and approximately three-fourths of these are on private land. This means that insofar as federal regulatory efforts discourage private conservation, they can have significant, unintended consequences. The unrestrained expansion of regulatory jurisdiction may be good for federal agencies, but it’s not always good for conservation.

What's clear is that this new definition, whatever form it takes, will have substantial effects on agriculture and conservation. We don't yet know whether those effects will be positive or negative on net.

Potpourri

Ag Econ Research & Extension
Jayson Lusk discusses an article on returns to publicly-funded agricultural research and extension. He also tackles the question: "Is ag econ academic research cited?" and answers in the affirmative.

Is Econ 101 Worthless?

David Henderson and Don Boudreaux respond to Noah Smith's contention that most of what we teach in Econ 101 is wrong.

Healthcare Reform
Two perspectives on recent developments related to Obamacare: one from Shikha Dalmia and another from Paul Krugman.

I, Pencil Revisited?
George Leef responds to a criticism of the famous essay "I, Pencil."

Regulatory Announcements
The Obama administration picks some interesting dates to announce new regulations.

A student gives a creative example of an externality.
David Henderson's student has a good understanding of Public Choice.

A new edition of Alchian and Allen's textbook.
Don Boudreaux lists some myths busted in a forthcoming edition of Alchian and Allen.

The Hockey Stick of Banking Regulation

Since the early days of the financial crisis, we've heard from many sources that it was caused by deregulation in the financial sector. Some economists and commentators blamed the crisis on general deregulation, while others pointed to the repeal of specific regulations over the last couple of decades as potential causes.

Recently, the Mercatus Center published RegData, which is a comprehensive measurement of regulatory restrictions by industry and by regulator. This index gives us a better picture of the regulatory environment at the industry level. I've referred to RegData in previous posts about EPA and USDA regulation of agriculture (here, here, here, here, and here).

In this post I provide some graphs and a brief discussion of banking regulation since 1970. This is an especially important issue in agriculture since ag lenders are likely to face liquidity issues due to low farm profits in coming years. 

Questioning the Credibility Revolution

If you follow the econonomics blogosphere, you've likely heard a lot about the "credibility revolution." The "credbility" part has to do with the supposed superiority of randomized control trials and quasi-experimental design over traditional models. The "revolution" part has to do with the suggestion that these models should replace, to some degree, theory in determining causality. One popular book, Angrist & Pischke's "Mostly Harmless Econometrics," discusses these methods quite clearly. I've used it a few times as a reference and found it quite helpful.

Of course, this revolution is very important for agricultural economists. We spend a lot of time using empirical methods to examine microeconomic problems. An open mind and critical eye are, I think, important for evaluating the usefulness of these newly-popular methods.

As the title suggests, I'm skeptical of the "revolution" part and somewhat skeptical of the "credibility" part. Experimental methods are nice as far as they go, but the use of experiments (broadly speaking) is more problematic in the social sciences than in the natural sciences. This is especially important if we are going to rely on the data to determine causality for us, rather than relying on sound theory. Further, some people seem to think these methods are the only way to do empirical microeconomics. In this post I'll draw from a few sources to make the arguments that 1) there are some important limitations to these quasi-experimental methods, 2) we shouldn't replace sound theory with data analysis, and 3) the "old" empirical models are just as useful as they always have been.

Roman Frydman on the New Rational Expectations Hypothesis

While reading a post at the Coordination Problem blog, I came across this interview of Roman Frydman (NYU economist) by Lynn Parramore at the Institute for New Economic Thinking. The interview was very interesting and I thought I'd share some of my favorite bits. The whole thing is worth reading.

LP: It seems obvious that both fundamentals and psychology matter. Why haven’t economists developed an approach to modeling stock-price movements that incorporates both?

RF: It took a while to realize that the reason is relatively straightforward. Economists have relied on models that assume away unforeseeable change. As different as they are, rational expectations and behavioral-finance models represent the market with what mathematicians call a probability distribution – a rule that specifies in advance the chances of absolutely everything that will ever happen.

In a world in which nothing unforeseen ever happened, rational individuals could compute precisely whatever they had to know about the future to make profit-maximizing decisions. Presuming that they do not fully rely on such computations and resort to psychology would mean that they forego profit opportunities.

Whither the Young Farmer?

Much is made about the average age of the American farmer. USDA Secretary Vilsack was once quoted as saying, "We have an aging farming population. If left unchecked, this could threaten our ability to produce the food we need – and also result in the loss of tens of thousands of acres of working lands that we rely on to clean our air and water." That's serious stuff, but a more careful analysis reveals that the situation isn't so dire after all.

Analysis by Carl Zulauf indicates that farmers are aging no faster than the general public. Additionally, we would expect, he says, that farmers would be older than the average business owner because modern agriculture is so capital intensive. Todd Kuethe breaks down farmer age by number of farms, acreage, and income, and notes that

The largest share of the income of the sector is captured managers between the age of 45 and 64. Just over half of Illinois' primary farm operators are between ages 45 and 64 (51.5%). This group, however, represents 60% of Illinois' agricultural land and 62.9% of the state's farm income.

Zulauf's observation that capital intensive industries are likely to have older sole proprietors on average is especially interesting given the current land price environment. As Brent Gloy and David Widmar note, land values are currently quite high, but a combination of low returns and rising interest rates could pave the way for a downward correction in land values. I made a similar argument about land values in Texas last October. The potential for a decline in land values may open up opportunities for younger farmers to buy in.

Another potential driver of the increasing age of the average farmer is increased regulation. As I've documented in the past, regulation by the EPA has increased almost continuously over the last 4 decades. Now more than ever farmers are burdened by the cost of regulation by the EPA. This increased regulatory cost creates economies of scale which might serve to hinder entry into the industry.


There are likely many causes of the increase in the average age of the American farmer, but it seems the worst thing that will happen is consolidation. If land values correct and young farmers are able to maintain access to credit, the trend of the aging farmer may at the very least slow down.

Phishing for Reviews

I've read several reviews of Akerlof and Shiller's new book "Phishing for Phools." The book is largely about the ways in which businesses trick people into buying things they "shouldn't." Below I provide some key quotes from 2 positive and 1 negative reviews of the book, followed by two short, negative reviews of the summary article Shiller wrote for the New York Times. Since even the positive reviews say the book lacks depth, I think the New York Times summary is probably a reasonable proxy for the book itself, at least in terms of its primary arguments.

I've not read the book, but based on the breadth of topics covered, it may be good to have as a reference for behavioral economics articles.

Positive Reviews
The Economist:
You Have Been Warned: Two heavyweights show how markets can turn against the unsuspecting

Economic models tend to assume that people are informed about the decisions they make; in the jargon consumers have “perfect information”. This supposedly enables consumers to make markets work to their advantage. But Robert Shiller of Yale University and George Akerlof of Georgetown University argue instead that this assumption is false. There are plenty of market equilibria, the authors find, where one party is being deceived, or “phished”. You may think you are doing well out of markets; you may behave quite rationally; but in fact you are being taken for a “phool”.

The London School of Economics and Political Science - Review of Books:
Book Review: Phishing for Phools

... Nobel Prize winners George A. Akerlof and Robert J. Shiller deliver a timely and much-needed plea against the free market dogma that surprisingly seems to have outlived the financial crisis. According to the two authors, big corporations take advantage of the ‘stories we tell ourselves’ and of our ‘monkey-on-our-shoulder tastes’. Our propensity to make choices according to multiple cognitive and psychological biases makes us easy targets for the phishermen. If one sentence could epitomise their thesis, it would be Jean-Paul Sartre’s’ famous saying: ‘We are what we make of what people want to turn us into.’

Negative Reviews
Arnold Kling (author, blogger, former Fannie Mae economist):
Phools and Their Money

Overall, I do not think that the authors chose well in starting with the Cinnabon example. They do not make the case that people who buy cinnamon rolls are doing something that those consumers would rather not be doing. Instead, it just seems that such consumers are doing something that Akerlof and Shiller find reprehensible. They need to come up with an objective way of making the distinction between satisfying consumer wants and manipulating consumers. It is demagogic to rely on one person's disgust at another person's consumption of fatty foods.

Michael Makovi (recent graduate in economics, Loyola University - New Orleans):
Do Capitalists Manipulate, Deceive, and Cheat?

But government regulation is not an infallible deus ex machina. The question is not whether the market fails, but whether the government is more likely than the market itself to correct those failures. Economist Harold Demsetz coined the term “nirvana fallacy” to make this point: it is not enough to find flaws in the real world; one must prove that some feasible alternative is likely to be less flawed. James Buchanan, one of the fathers of public choice economics, compared advocates of government regulation to the judges of a singing contest who, after hearing an imperfect performance from the first contestant, immediately award the second contestant, reasoning that he must be better.

Peter Klein (Baylor University professor of entrepreneurship):
George Akerlof, Meet Oliver Williamson

Shiller's worldview features a caricature understanding of free markets along with a naive and uncomprehending model of government regulation. I suppose we can blame the Times's editorial team, not Shiller, for the headline "Faith in an Unregulated Free Market? Don’t Fall for It." But it nicely illustrates the Shiller crowd's view that support for free markets is based on faith, rather than two centuries of reason and evidence. You might think that Shiller's coauthor George Akerlof could walk down the hall and speak to his UC Berkeley colleague and fellow Nobel Laureate Oliver Williamson for a better understanding of how markets work. Williamson, of course, is famous for explaining how market actors protect themselves against opportunistic behavior from other market actors through contracts, joint ownership of assets, reputation, exchange of "hostages," and similar practices. It is markets, not government, that enable cooperation and joint production in the face of information and incentive problems.

Relevant Farmer Hayek Posts
The Nirvana Approach in Ag Economics - Contributions of E.C. Pasour

Blackboard Theory Versus the Reality of Markets

Economics in TWO Lessons?!

Demsetz on Comparative Institutions

Crop Insurance Spending Myopia

In the last couple of weeks there's been a lot of focus inside the beltway on crop insurance. First, a 2-year budget deal between Republicans and Democrats planned to cut $3 billion from the crop insurance program. The deal would boost total spending by $80 billion (not including off-budget items) over 2 years. The $3 billion has since been restored to crop insurance in this bill.

More recently another bill called the "Assisting Family Farmers through Insurance Reform (AFFIRM) Act," has been proposed in both the Senate and House. The bill would cut $24.4 billion over 10 years from the crop insurance program by 1) capping RMA's premium share at $40,000, 2) eliminating RMA's share of the premium for all farmers with adjusted gross income over $250,000, 3) retaining the $3 billion cut to insurance providers, 4) reducing the commission paid to insurance salespeople, and 5) eliminating the Harvest Price Option.

The AFFIRM Act is, of course, being sold as a fiscally-conservative measure, but numbers can be deceiving. "Billion" is a big word, but context is important. 

I want to be clear here that I'm not advocating any cuts to or expansions of federal spending, I just want to bring some data to bear on the conversation.

Ideology, Evidence, or Approach: What Drives Economists Beliefs?

Mark Thoma's recent Fiscal Times column presents two possible explanations for the beliefs of economists: ideology and evidence. While these may be important for an individual economist, I think an important third factor is the approach we take or what Arnold Kling calls "interpretive framework." The approach you take to a question might be related to your ideology (causing some to confuse the two) and it certainly affects the way you interpret evidence. All of the facts we observe are interpreted. The approach we take in economics determines, at least to some degree, how we interpret facts.

Conveniently, Thoma's article provides some opportunities to juxtapose the influences of approach, ideology, and evidence on our beliefs. In the first paragraph of Thoma's piece he says:

Potpourri

Ag Regulation

Pointing to recent studies, Jayson Lusk discusses the cost of animal welfare regulation.

In a classic Independence Institute article, ag economist E.C. Pasour Jr. looks at the history of meat inspection regulation.

Meat & Cancer Risk Studies

Matt Bogard and Jayson Lusk both discuss a recent study of the relationship between red meat consumption and cancer risk. There's a great lesson on statistical inference in this episode!

The Importance of (Good) Economics

Don Boudreaux discusses the value of Econ 101.

Alex Teytelboym reports on an unlikely collaboration between Chicago economists and the country's largest food bank.

Arnold Kling brings some realism to the theory of financial markets.

Parisomony in Academic Writing

Victoria Clayton discusses "The Needless Complexity of Academic Writing."

How Progressive is the Tax Code?

The federal tax code has been a big topic of discussion this election cycle. A lot of this discussion has been driven by the increased focus on income inequality. Whatever your views on this subject, I think it's useful to look at the way the tax burden is distributed across income groups. In this post, I'll present data from the Congressional Budget Office (CBO), which you can download here.

The charts below were created using three data series: market income, transfers, and federal taxes. Each series runs from 1979 to 2011 (unfortunately, 2011 is the most recent year for which this data is available) and is broken down into quintiles by market income. The top 1% is also split out into its own category. Every data point is a household average for the group. The data set linked above breaks the top quintile into a few more groups if you're interested in that.

Major Environmental Legislation and EPA Regulations

In my last post on EPA regulation of agriculture, I looked at the majority party in the House, Senate, and the party of the President from 1974 to 2014. Some of it lined up with what I think most people, including me, would assume (i.e. Democrat control means more regulation), but much of it didn't. I suspect part of this is a function of our short memories but a good portion of it could be the relative independence with which regulators operate. They don't necessarily need legislative mandates to change the regulatory environment. One other thing to keep in mind: the regulations in this index can apply to any aspect of agriculture. Regulatory restrictions on forestry, crop farming, ranching, concentrated animal feeding operations, and aquaculture are all included in this index.

In this post I want to show some major legislation and regulatory actions laid over the same 1974-2014 regulatory restrictions data. I don't know if the events I identify on the chart are the causes of subsequent increases in regulation. I picked most of these events off the EPA History website, so the agency itself believes they're significant. If and when I dig into the RegData data for a research project, I'll be able to tell a more interesting story.

The graph shows EPA regulatory restrictions on agriculture. Data were taken from the RegData Database at the Mercatus Center at George Mason University. The data are counts of restrictive words in the Code of Federal Regulations such as "cannot," "must," "shall," etc weighted by the probability that the particular Title and Part apply to agriculture. This time I converted the restrictions count into an index (something the Center recommends) in part to make it easier to see just how much regulatory growth the ag industry has experienced. In 2014, there was 492% more regulation on agriculture than there was in 1974.

Potpourri

Brent Gloy and David Widmar at Agricultural Economic Insights revisit the issue of declining farmland values and come to roughly the same conclusion they did earlier this year.

Farmland values and cash rents in the Corn belt continue to come under downward pressure. When current cash rents are compared to current farmland values, the outcome is a capitalization rate of around 3%. This value is reasonable given current longer term interest rates. However, the bigger question is whether cash rents can be sustained at current levels in this economic environment. 

When one considers the returns that would be generated by a farmland owner-operator relative to current farmland values the rate of return is very low. This means that farmland values and cash rents are likely too high to be justified given the current economics of crop production. This low rate of return can be addressed through farmland values and cash rental rates falling and/or the row crop income situation improving.

Jayson Lusk points to an interesting article that he says should be filed under "Unintended Consequences."

Researchers find that a ban on bottled water on the University of Vermont campus (presumably to cut down on waste) led to more plastic bottles being shipped to campus and to more soda consumption. 

Marian Tupy and Chelsea German at HumanProgress.org tackle Akerloff and Shiller's recent op-ed in the Washington post on the effects of markets on our well-being.

Arnold Kling provides some wisdom on proper critiques of economics. My favorite bit:

A bias toward “engineers” rather than “ecologists.” That distinction comes from Greg Ip’s new book, Foolproof. The engineer is like Adam Smith’s man of system, who ignores evolution, both as a factor that may permit markets to over come their own failures and as a factor that may cause government “solutions” to become obsolete.

Continuing this theme, Steve Forbes provides a critique of economic theory. I enjoyed reading the first page, but lost interest on the second.

Don Boudreaux points to Gene Epstein's response to some of Bill Gates' comments in an interview.

The Foreign Subsidies Database

If you've ever wanted information about agricultural subsidies in other countries, the Foreign Subsidies Database at Texas Tech is a great resource.

The page has several interactive features. One feature is the Subsidy Tables which are laid out in table form and includes information from Argentina, Australia, Brazil, Canada, China, Egypt, the 27 countries of the EU, India, Indonesia, Japan, Mexico, Nigeria, Pakistan, Russia, South Africa, South Korea, Thailand, Turkey, Uzbekistan, Vietnam, and the West African countries.

The tables include information on direct support (price supports, direct payments, import quotas and tariffs, subsidies and export taxes), indirect support (state trading and ownership, investment assistance, and credit and transport subsidies), and statistics on the production, consumption, export, and import market share by country. Commodities listed in the database include corn, cotton, rice, sorghum, soybeans, sugar, and wheat.

The site also includes more detailed information in narrative form on the commodity support in the countries/areas listed above in the Searchable Database. Some of the data goes back several decades. For instance, here's a graph of Australian cotton production, consumption, imports, and exports:

If you're interested in the way other countries subsidize their ag industries, I suggest you check out this site.

The Nirvana Approach in Ag Economics - Contributions of E.C. Pasour

Back in April I wrote about an article by Harold Demsetz that juxtaposes two types of economic analysis: the nirvana approach and the comparative institution approach. In his 1969 article entitled "Information and Efficiency: Another Viewpoint" in the Journal of Law and Economics, Demsetz defines these approaches:

The view that now pervades much public policy economics implicitly presents the relevant choice as between an ideal norm and an existing "imperfect" institutional arrangement. This nirvana approach differs considerably from a comparative institution approach in which the relevant choice is between alternative real institutional arrangements. In practice, those who adopt the nirvana viewpoint seek to discover discrepancies between the ideal and the real and if discrepancies are found, they deduce that the real is inefficient. Users of the comparative institutional approach attempt to assess which alternative real institutional arrangement seems best able to cope with the economic problem; practitioners of this approach may use an ideal norm to provide standards from which divergences are assessed for all practical alternatives of interest and select as efficient that alternative which seems most likely to minimize the divergence.

In spite of Demsetz's critique, the nirvana approach is often used in economics to diagnose market failures; that is, failures of markets to live up to an ideal, theoretical norm. This is no less true in agricultural economics than it is in economics, but in both professions there are New Institutional and Public Choice economists who take Demsetz seriously.

Potpourri

Food
Jayson Lusk disputes the claim that local foods are good for the environment.

Helen Viet writes "An Economic History of Leftovers"

Angus Deaton's Nobel Prize
Pete Boettke's commentary

Peter Klein points to Deaton's critique of randomized control trials.

Regulation
Jared Meyer discusses the effects of regulation on economic growth.

Bonnie Christian on regulating the gig economy

David Henderson comments on Sunstein's review of Akerloff and Shiller's book "Phishing for Phools."

Nobel Criticism and Agricultural Economics

This year's winner of the Prize in Economic Sciences in Memory of Alfred Nobel went to Princeton economist Angus Deaton. The internet was abuzz with commentary all day, so this post is a bit late.

I would wager that most ag economists who took PhD consumer demand after 1980 used "Economics and Consumer Behavior" by Angus Deaton and John Muellbauer in that course. For those of us who don't work in development, Deaton's work on the Almost Ideal Demand System was probably our introduction to him. The blog posts I read today (here, here, here, and here) brought me up to speed on his tremendous contributions and I certainly recommend reading them.

As the title suggests, I read another commentary on the Econ Nobel that was notable for its negativity toward the prize and (at least the author seems to think) to economics in general. The article, written by anthropologist Joris Luyendijk, excoriates the Sveriges Riksbank (the Swedish central bank behind the Econ Nobel and its $1 million cash prize) for failing to present the award to social scientists in different fields, and the economics profession in general for its inability to live up to its claimed status as a science.

Certainly there's a lot packed into the article, but I just want to respond to a few things. First, no one is stopping any organization interested in sociology, anthropology, or political science from establishing an annual prize for contributions to those fields.

Video Series Highlights the Importance of Agriculture

An interesting YouTube series entitled "How to Make Everything" has recently made the rounds in the media. The big story was about Andy George's experience making a chicken sandwich literally almost from scratch. He spent 6 months and $1,500 to make the sandwich.

What struck me about his experiences was that they show the importance of agriculture in our everyday lives. In the sandwich and suit videos, George brings the viewer face to face with the production of wheat, vegetables, poultry, wool, and cotton necessary to feed and clothe us. We can hope that these videos pique the curiosity of viewers who don't know where their food and fiber come from.

These videos also highlight the immense complexity of our modern economy. They are real-world examples of the "I, Pencil" story. They can be economically instructive as well, as Arnold Kling notes in his post:

I just don’t think you capture the phenomenon of specialization and trade with textbook economic models. It is not two-by-two trade.

We owe our immense modern standard of living to the mechanization of agriculture and the specialization it has allowed. George's videos are well worth your time and could certainly be used in an introductory economics course.

Tradeoffs Between Social Policy and Growth

Mark Thoma's recent Fiscal Times column seems to me to be heavy on politics and light on economic analysis. He sets out to convince the reader that there is no tradeoff between social insurance provided by the federal government and economic growth, but I think there are good reasons to doubt this notion.

Potpourri

Bob Murphy of the Texas Tech Free Market Institute goes through the recent literature on the minimum wage.
Bob concludes:

In the 1980s, there was a genuine consensus that a 10-percent hike in the minimum wage would reduce teenage employment by 1 to 3 percent. However, in the 1990s, various "case studies" began challenging this orthodox view, and more recent studies have generalized techniques to apparently find negligible employment effects. Many economists have used this new research to assure policymakers and the public to pay no heed to warnings about harmful job losses from even aggressive minimum wage hikes.

However, in reality, the employment effect of the minimum wage is still an open question even for modest hikes. Since the 1990s, scores of articles have found negative effects of minimum wage increases. These include "case studies," with one serving as the mirror image of the famous Card and Krueger study. Furthermore, critics have challenged the entire premise of the new techniques, which claim to construct better control groups than the traditional approaches.

Finally, even if we take the very best examples of the "new" results at face value, they provide little comfort that large hikes in the minimum wage—such as a doubling to $15 per hour—will have modest impacts. Policymakers and the public should be wary of the glib assurances of some prominent economists when they claim that such large hikes will not cause teenagers to lose their jobs. The odds are very high that they will.

Arnold Kling has some more thoughts on economic methods.

Two blogs I follow both posted on Instrumental Variables regressions on the same day (here and here). I pointed this out on Twitter and they both wrote responses (here and here). Interesting stuff, but certainly wonkish.

Some interesting commentary on globalization and poor cities in the US from Kevin Williamson.

Peter Klein (and Larry Summers) on behavioral economics as a re-statement of clever (but old and well-known) business practices.
From the article Peter points to:

Have behavioral economists really discovered anything new, or have they simply replaced some wrong-headed notions of post-World War II economics with insights that people in business have understood for decades and maybe even centuries?

Basic Textual Analysis of EPA Regulations

In the last post I showed the relationship between the majority party in the House, Senate, and Presidential office and EPA regulatory restrictions on agriculture from 1974 to 2014. As I noted there, the relationships aren't always clear and they definitely aren't what a "naive" understanding of the current political divide would predict. In this post I thought I'd take a step back and provide a more general summary of EPA regulations, without the focus on politics and agriculture.

The RegData 2.2 database provides highly detailed data on regulation at the federal level. Cutting it down to just EPA regulation yields 11,353 observations. Each observation gives a number of restrictions and word count for a given Part in a given Title in a given year in the Code of Federal Regulations. Titles are divided into Chapters, Subchapters, and Parts, but RegData doesn't split the data up by Chapter or Subchapter.

The Title designation basically tells you which agency you're looking at, though agencies like the EPA can be found in several Titles. The primary Title for the EPA is 40. Parts divide the Titles into subject areas. For instance, Title 40, Part 171 includes information about the certification of pesticide applicators. Part 406 details effluent guidelines for grain mills.

The chart below shows the number of Parts in Title 40 from 1974 to 2014. There are more than 3 times as many Parts now as there were in 1974. Most of the growth in Parts since 1974 occurred before the mid-1990s. If you look at my previous post, the number of parts generally tracks with the number of restrictions on agriculture. I don't know whether this is a coincidence or not.

40 Years of EPA Regulation - Political Factors

I've been a bit lazy about posting lately, but I think the next series of posts will be interesting if you liked our previous posts on the EPA. Within the last few weeks, the Mercatus Center has put out a much longer time series going back to 1974. I have some ideas for journal articles I'll be exploring over time, but as I sift through the data I thought I might share some of the insights they provide as I go.

Most of us who haven't studied the EPA's history in detail probably have a few assumptions about the political drivers of EPA regulation, especially regulation of agriculture. We'd probably think about things like pesticide bans, clean air and water regulations, and fuel standards. We'd probably associate these regulations with Democrats, with an exception for Nixon, who created the EPA.

The charts below show the annual index of regulatory restrictions on agriculture by the EPA (red line). The blue shaded areas indicate years in which Democrats held the majority in the House of Representatives, the Senate, or held the Presidency.

Are Rentiers Valuable?

A few weeks ago I had a short conversation with someone who believed that "unearned income" from asset ownership should be taxed nearly completely away. Why, my interlocutor asked, are speculators and those who live on interest entitled to that money? He said that they hadn't produced anything to earn their money and so should have to give nearly all of it to the poor.

What is "unearned income?" Wikipedia defines it as "income received by virtue of owning property (known as property income), inheritance, pensions and payments received from public welfare. The three major forms of unearned income based on property ownership are rent, received from the ownership of natural resources; interest, received by virtue of owning financial assets; and profit, received from the ownership of capital equipment."

This definition lends itself to a moral distinction between earned income (which is justly acquired since some kind of physical discomfort was required to get it) and unearned income (which doesn't require any work in the present). This distinction is lost on me personally because someone at some point had to work to acquire an asset. It's true that heirs have assets transferred to them without work, but the fact that the maxim "shirtsleeves to shirtsleeves in three generations" is about 2000 years old suggests that their unearned wealth will go to others in pretty short order.

Julien Noizet on Monetary Policy

This is part 3 in an interview series with Julien Noizet. For more about Julien, see the first post.

The interview questions are:
Why do you think inflation has been low in US after the 2008 recession?
What is the most important thing economists get wrong about the way banks work? 
What are your thoughts on NGDP targeting?
What are your thoughts on free banking?


FH: What are your thoughts on NGDP targeting?

JN: I am definitely open to the idea. I believe NGDP targeting would be a strong improvement on the current inflation targeting dogma. It would lead to a more stable economic framework, would at last (in theory) release central bankers from error-prone discretionary policies, respecting the concept of the rule of law. While not my ideal, I still see NGDP targeting as a step in the right direction.

Julien Noizet on What Economists Get Wrong About Banking

This is part 2 in an interview series with Julien Noizet. The first post can be found here.

The interview questions are:
Why do you think inflation has been low in US after the 2008 recession?
What is the most important thing economists get wrong about the way banks work? (this post)
What are your thoughts on NGDP targeting?
What are your thoughts on free banking?

FH: What is the most important thing economists get wrong about the way banks work?

JN: There are a lot of misconceptions about banking among economists. Those misconceptions vary by school of thought. The main problem with mainstream (neo, new classical and new Keynesian) economics is that they often forget banks altogether. Banks seem to merely represent a means of implementing monetary policy. Monetary policy seems to be considered in a vacuum. The issue here is that banking isn’t free. It is actually the most regulated industry on this planet. Bankers are market actors that react to incentives. This can lead to severely distorted economic effects.

Julien Noizet on Low Inflation

Julien Noizet's blog is, in my mind, indispensable. Julien is a banker who also understands economics very well; a combination that allows him to offer unique insights into macroeconomics and banking. I've featured content from his blog in the past and wanted to get his thoughts on recent macroeconomic trends and banking theory. Julien was kind enough to answer 4 questions I thought Farmer Hayek readers might be interested in.

The questions are:
Why do you think inflation has been low in US after the 2008 recession? (this post)
What is the most important thing economists get wrong about the way banks work?
What are your thoughts on NGDP targeting?
What are your thoughts on free banking?

I'll provide links in each post to the other 3 as they come out.

FH: Why do you think inflation has been low in the US after the 2008 recession?

JN: First, it depends what we mean by inflation. If we simply mean ‘CPI inflation’, then the reasons aren’t fully clear. The ability of the banking system to expand lending has been multiplied by the large amounts of reserves injected into the system through the various QE programmes. Excess reserves have jumped and the money multiplier has collapsed, indicating that banks haven’t increased lending volume much. However, it is a mistake to believe that inflation would sky-rocket within years of this massive liquidity injection by the Fed. The crisis involved a balance sheet-led recession, meaning that many banks and bank customers were insolvent. In such case, people and companies attempt to clean up their balance sheet before borrowing again. The experience of the Great Depression clearly showed that it can take decades for the money multiplier to get back to its previous highs.

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?

The PR Cost of Pro-Ag Policy

Last week, Jayson Lusk commented on a recent strike down of an ag-gag law in Idaho. Such laws are designed to keep anti-ag activists from recording footage on farms and using it to make the industry look bad.

Lusk points out the potential for unintended consequences:

From the farmer's perspective, it isn't hard to see understand the motivation for such laws.  But, what kind of PR does such a law create for the agricultural sector?

... in trying to protect themselves from undercover activists, proponents of the law now created bad publicity for the entire industry (even for producers who weren't video taped and who did no wrong) in one of the largest newspapers in the country.  It is not as if there is no legal recourse for activists who break the law.

In an era where consumers demand greater transparency, the industry probably isn't doing itself any favors by engaging in public actions that make it appear as if there is something to hide.

 So, the industry pushes for ag gag laws, they pass, and those who love to bash the industry have more ammo. As the article Lusk refers to points out, we already have laws against "trespass, fraud, and defamation." Does the ag industry need enhanced versions of those laws? What are the public relations costs?

Over the last few weeks, I've had similar questions about all pro-ag laws. There are plenty of laws and regulations that impose heavy costs on the industry. I'd wager that most anti-ag activists are happy about them and wish they were more plentiful. However, there are a lot of pro-ag laws on the books that very likely impose a PR cost on the industry.

Consider the passage of the farm bill last year and the media frenzy it created. For example: here, here, and here. (I defended it here.) What does it cost the industry to deal with the objections made by anti-ag activists? I don't think that cost, whatever it is, comes to mind often enough in policy discussions. Ag is organized very well at the state and national levels with the many breed associations, crop producers' boards, Farm Bureau, and other organizations out there. I see no reason that these groups should ignore the PR costs of pro-ag policy.

Does the US Have a "Cheap Food" Policy?

It's often said, in defense of payments to ag producers, that these subsidies constitute a "cheap food" policy. Advocates of the policy contend that the subsidies incentivize increased production such that food prices fall. It's a win-win: producers benefit directly from the subsidy and consumers (especially the poor) benefit from reduced prices at the grocery store.

Leaving aside the question of whether or not these types of policies should exist, it's interesting to see whether the subsidies actually result in lower food prices. It's important to note that direct payments to producers have been reduced as of the 2014 Farm Bill and that the USDA spends an increasingly greater percentage of its budget on direct food assistance. That said, the article's findings are still interesting today.

With all that out of the way, I want to summarize the findings of a paper by Corey Miller and Keith Coble of Mississippi State University. The paper is relatively old; it was published in 2007 in Food Policy, but it nevertheless provides some interesting insights. The gated, full version is here and an un-gated but incomplete version can be found here.

Potpourri... Again

Bob Murphy, in his characteristic fashion, uses Paul Krugman's analysis to show that fiscal austerity leads to a robust recovery.

The story of Tesla's crony capitalism takes a sharp turn for the worse. 

Not content with the billions it gets in government help, Tesla Motors now wants tougher fuel economy standards that would cripple its competitors.

It's just regulatory capture. Of course, such regulations are seldom consistent with what consumers actually want:

Tesla expects to sell about 55,000 cars in 2015. Chevy sold more Silverado pickups — which get a paltry 20 mpg — in one month. Overall, consumers bought about 120,000 plug-in electrics last year, while Ford sold more than four times as many of its F-150 trucks.

The only thing Tesla's "tough" fuel economy standards would do is force millions of consumers to buy cars they clearly don't want.

Then again, Tesla is already heavily dependent on government. As the Los Angeles Times reported earlier this year, Tesla Motors has received almost $2.4 billion in government support in the form of special tax breaks, cheap government loans, regulatory "credits" and subsidies to buyers.

The sad part is, even with all the favors it gets, Tesla can't manage to turn a profit:

The Silicon Valley automaker is losing more than $4,000 on every Model S electric sedan it sells, using its reckoning of operating losses, and it burned $359 million in cash last quarter in a bull market for luxury vehicles. The company on Wednesday cut its production targets for this year and next. 

And speaking of regulation, here's yet another example of how licensure regulations keep the poor from improving their lives.

Natural Resource Potpourri

I don't have the expertise in natural resource economics to really do a lot of writing on the topic. However, I want to make sure we cover it at least occasionally, so I'll probably stick to this potpourri format for now. I hope some day we find a contributor who is interested in this area.

Lynne Kiesling has a great post on the benefits of retail electric markets. Living in the state of Texas, I can attest to the advantages of this kind of direct competition between providers. Here's Kiesling:

The report’s policy recommendations are in keeping with the idea that market processes provide opportunities for producers and consumers to benefit through experimentation and trial-and-error learning, and that product differentiation through innovation is the most potent form of dynamic competition for creating meaningful consumer benefits.

Digital Trends has an interesting piece on electric vehicles and their actual impact on the environment:

The best outcome for EVs was a 24-percent improvement in global-warming potential over the average gas powered car, and between 10 percent and 14 percent over diesel. These numbers are nothing to sneeze at, but they change radically depending on the source of electricity that EVs are powered on. 

The above numbers rely on the European power mix, which more heavily favors nuclear, hydroelectric, and renewable sources of energy than other parts of the world. 

The global warming potential for EVs that rely on natural gas – generally considered to be the cleanest fossil fuel – show an improvement of only 12 percent over gasoline, and break even with diesel. 

Most alarming, EVs that depend on coal for their electricity are actually 17 percent to 27 percent worse than diesel or gas engines. That is especially bad for the United States, because we derive close to 45 percent of our electricity from coal. In states like Texas, Pennsylvania, and Ohio, that number is much closer to 100 percent. That’s right folks; for residents of some of the most populous states, buying an EV is not only toxic, it’s warming the planet more than its gas-powered counterparts.

Acton Institute's Milton Friedman Quotes

July 31st would have been Milton Friedman's 103rd birthday. Several blogs featured tributes to Friedman, but I really enjoyed the Acton Institute's six quotes by Friedman on economics and freedom.

Friedman was a fantastic communicator of sound economics and the benefits of free markets to the public. His interviews, debates, and televised discussions with other thinkers are still relevant informative decades later.

I've reproduced the 6 quotes below:

The conditions for freedom: “History only suggests that capitalism is a necessary condition for political freedom. Clearly it is not a sufficient condition.”

On shortages: “We economists don’t know much, but we do know how to create a shortage. If you want to create a shortage of tomatoes, for example, just pass a law that retailers can’t sell tomatoes for more than two cents per pound. Instantly you’ll have a tomato shortage.”

On private property: “Nobody spends somebody else’s money as carefully as he spends his own. Nobody uses somebody else’s resources as carefully as he uses his own. So if you want efficiency and effectiveness, if you want knowledge to be properly utilized, you have to do it through the means of private property.”

On minimum wage laws: “The high rate of unemployment among teenagers, and especially black teenagers, is both a scandal and a serious source of social unrest. Yet it is largely a result of minimum wage laws. We regard the minimum wage law as one of the most, if not the most, anti-black laws on the statute books.”

On freedom and fairness: “’Fair’ is in the eye of the beholder; free is the verdict of the market. The word ‘free’ is used three times in the Declaration of Independence and once in the First Amendment to the Constitution, along with ‘freedom.’ The word ‘fair’ is not used in either of our founding documents.”

On free markets: “What most people really object to when they object to a free market is that it is so hard for them to shape it to their own will. The market gives people what the people want instead of what other people think they ought to want. At the bottom of many criticisms of the market economy is really lack of belief in freedom itself.”

Krugman the Psychologist

In his July 25th column, Paul Krugman attempts to discredit a view he apparently doesn't understand. This time, he focused on Ron Paul, calling him names, comparing him to Bernie Madoff, and suggesting that he is a white supremacist. He claims that the only reason people would believe Ron's analysis is that they too are crotchety racists. Sadly, this is par for the course for Krugman.

When he's done psychologizing, he does manage a bit of substance in the post. He apparently thinks his criticism is utterly devastating to Ron and to Austrian Business Cycle Theory (ABCT). His claim is that, since the CPI hasn't risen due to loose monetary policy, the ABCT is wrong and so is everyone who espouses it.

ABCT has little to say about consumer prices, but a lot to say about asset prices. Though it certainly doesn't apply in all situations, ABCT can explain the dynamics of asset markets in the face of interventionist monetary policy. The 2008 crisis is a textbook example.

When it comes to consumer price inflation, proponents of ABCT have made different predictions at different times. One example is a bet between David Henderson and Bob Murphy. Mish Shedlock is another example of a proponent of ABCT who thought, at one time or another, that deflation was a bigger risk than inflation.

The Importance of Applying Market Process Theory

I came across an interesting post by Chris Dillow on markets vs gov't direction of resources. He starts off by criticizing an article in the Telegraph about privatization as a solution to the tragedy of the commons.

He rightly points out that many commentators fail to provide a sophisticated analysis of the markets vs gov't trade-off. Dillow deserves kudos for mentioning (if only briefly) the work of Elinor Ostrom in analyzing non-market and non-gov't solutions to the tragedy of the commons.

However, his own analysis of the market vs gov't trade-off lacks the important insights of market process theory. His discussion of the role of transactions costs in the examination of this trade off is problematic as well. He writes:

As Terry Anderson has shown (pdf), the emergence of property rights requires among other things that technology permits a lowish-cost enforcement of those rights.

and later

 This is, of course, a variant on Coase's famous point (pdf) - that there are costs to market transacting. These costs must be weighed against the costs of other forms of economic organisation - be it the firm or state control.

There are a couple of problems here. He claims that property rights require "lowish-cost enforcement of those rights" and that said costs "must be weighed against the costs of other forms of economic organization." First of all, there is the question of who is responsible for "weighing" these costs. If it's the state, there is clearly an incentive for politicians and bureaucrats to claim the costs of property rights are too high and that the state should control the resource on efficiency grounds. The same incentive problem exists for firms that are in a position to lobby the state for exclusive rights to the resource. Markets are clearly at a disadvantage in these cases.

Noah Smith and the Panglossian Fallacy

Over the past few months, I've spent some time pushing back against what I believe are poor arguments made by professional economists who oppose market direction of resources. The "arguments" I want to examine this time aren't really arguments. They're really just bald assertions with nothing to back them up. I suppose this makes my job easy, so I'll try to be brief.

Noah Smith's recent Bloomberg View piece makes the case that Berkeley is, in fact, the #1 economics department in the U.S. Chicago, he claims, has lost its luster and M.I.T. plays second fiddle to Berkeley in its ability to "influence" the profession.

While Smith makes some good points about the intellectual diversity and pioneering work by Berkeley faculty, his derision of Chicago borders on childish. Here's Smith:

... the Chicago school is a term used to refer to free-market fundamentalism and the belief that economic actors are always rational ...

and

The Chicago School was Panglossian in its belief that markets work well; the Berkeley Reformation showed deep, fundamental reasons that they break down.

This is a recurring theme in Noah Smith's writing: he paints his intellectual opponents as idiots or religious zealots who unthinkingly spout discredited theories about markets and government action. While this is true about a lot of non-economists on the internet, it doesn't properly characterize professional economists who favor markets. Further, as usual, Smith offers no evidence to back up his extreme claims.

Potpourri

Jayson Lusk gives his thoughts on a (relatively) recent book that points out some flaws in the "conventional wisdom" regarding saturated fat and other food no-nos. This one is definitely going on my reading list.

I agree with a lot of what Arnold Kling says about open-access versus limited-access orders. The idea that a country can only be one or the other seems patently false.

Bob Murphy discusses the predictive failure of the Keynesian model regarding the 2013 sequester.

Steve Horwitz identifies three regulatory barriers to upward income mobility.

Krugman and Friends Don't Get Uber

Krugman's recent blog post on Uber and progressive politics is revealing. Progressives like Krugman want Uber and other players in the sharing economy under the control of bureaucratic regulation that ostensibly solves the problems of unfair employee treatment. The problem is that Krugman and other progressives seem unable or unwilling to explain what problems exist and how centralized, bureaucratic regulation will help. Krugman is in block quotes, I'm not.

You might not have thought that a taxi service would move onto center stage in our great political debates. But Uber actually is looking like a surprisingly important political issue. Why?

Well, Uber actually brings two things to the taxi market. One is the smartphone revolution, letting you tap a screen instead of standing out in the rain waving your arm, and cursing the guy who darts out half a block from you and snags the cab you were trying to hail.

The other is the company whose workers supposedly are free contractors, not employees, exempting the company from most of the regulations designed to protect employee interests. And it’s the second aspect that brings us into divisive politics.

Krugman clearly sees the advantages Uber provides its customers but goes straight for the regulatory playbook when it comes to the benefits employees reap from the sharing economy.

On one side, Republicans are eager to dismantle as many worker protections as they can. So from their point of view Uber’s not-our-problem approach to workers would be desirable independent of the technology.

On the other side, we’re recently seen the emergence of the “new liberal consensus“, which argues (based on a lot of evidence) that wages are much less rigidly determined by supply and demand than previously thought, and that public policy can and should nudge employers into paying more. If that’s your policy plan, you really don’t want to see employers undermine it by declaring that they aren’t really employers.

The link Krugrman provides says very little about evidence, relying instead on the supposed "superior" rhetoric of progressives. If people don't want to join unions, should they be forced to? If price floors create excess supply in other markets, why not in labor markets? Keep in mind, if labor markets are characterized by monopoly, an exploitable profit opportunity exists. What is keeping entrepreneurs from making money hiring underpaid workers?

It’s surely possible to separate these two issues, to promote the use of new technology without prejudicing the interests of workers. But progressives need to work on doing that, and not let themselves get painted as enemies of innovation.

 Krugman doesn't let us in on how this separation of the two issues can be accomplished. If firms like Uber are treated as traditional employers, rather than facilitators of mutually beneficial trade, the inefficiencies plaguing traditional providers of transportation and lodging services will rear their ugly heads. Air BnB will just be a cell-phone-enabled hotel service. Uber will be taxi service with an app.

The reality is that the firms that make up the sharing economy are successful precisely because they avoid the inefficiencies of progressives' pet regulations and provide a platform for mutually beneficial exchange between parties. These incredibly efficient electronic middle men allow providers of services to decide when, where, and how they work on a minute-by-minute basis. Krugman and other progressives need to spell out precisely how the regulations of yesteryear can improve this situation.

Confusion on GMOs from Financial Heavyweights

Mark Spitznagel and Nassim Taleb have an interesting article in the NYT attempting to draw an analogy between systemic financial vulnerability and alleged problems with GMOs. They start off by describing some ways in which the financial system was vulnerable leading up to the crash.

I find a lot I can agree with in that section, but my agreement stops in the second half where they attempt to convince the reader that alleged problems with GMOs fit the same patterns. I'll give my thoughts on each of these 5 issues.

First, there has been a tendency to label anyone who dislikes G.M.O.s as anti-science — and put them in the anti-antibiotics, antivaccine, even Luddite category. There is, of course, nothing scientific about the comparison. Nor is the scholastic invocation of a “consensus” a valid scientific argument. 

Interestingly, there are similarities between arguments that are pro-G.M.O. and snake oil, the latter having relied on a cosmetic definition of science. The charge of “therapeutic nihilism” was leveled at people who contested snake oil medicine at the turn of the 20th century. (At that time, anything with the appearance of sophistication was considered “progress.”)

None of this should be convincing to anyone, as it doesn't have a shred of logic to it. The first paragraph has nothing to do with the usefulness or safety of GMOs, but it does reveal the authors' experience with other people who disagree with them. In the same way, the second paragraph fails to make their point. Just because some of the name calling that exists now is similar to the name calling surrounding snake oil salesmen doesn't mean GMOs are like snake oil in any other way. I would have expected more from both of these men, as they're clearly very intelligent.

Blackboard Theory Versus the Reality of Markets

Mark Thoma's recent article in the Fiscal Times does a great job of laying out the typical case most undergraduate economics majors hear for government intervention in markets. Undergrads are taught the requirements for perfect competition in markets: an infinite number of buyers and sellers, perfect information, price-taking behavior by firms, etc. Thoma is quick to point out that these conditions are not often found in real-world markets, thus government intervention is necessary to correct the failures of real-world markets to live up to these ideals.

As Farmer Hayek readers might expect, I didn't find his arguments terribly convincing. First, this is a classic case of the Nirvana fallacy. The real world will never live up to any perfect ideal. The policy-relevant comparisons are thus not between this impossible ideal and real-world markets, but between alternative policy regimes that actually exist or could exist.

Big Data and Hayek

A recent post by Matt Bogard drew my attention to a Forbes article entitled "Big Data Versus Hayek." Both Matt's post and the article are interesting, and I recommend reading both (they're short), but I want to pick a few nits with the Forbes article.

The authors mention a few examples of firms using big data methods to "set prices" and note that

What’s interesting about such centralized, algorithmic approach to price setting is how un-Hayekian it is.

This is an interesting point as far as it goes, but a couple of things should be noted. Hayek's point about centralized decision making was about markets, not firms. If complete decentralization were optimal, then no firm need exist. Of course, such an absurd conclusion can't be drawn from Hayek's work.

Firms are obviously necessary (and Matt makes some good points about this in relation to Coase), but Hayek's point is about the markets in which firms operate. Decentralized markets generate prices that reflect the availability of resources needed for production and the tastes and preferences of consumers; these prices allow firms to provide what consumers want. The USSR was (largely) without the coordinating effect of prices, a key cause of its demise.

The second problem is the idea that these firms are "setting prices." Surely a price tag or the rate offered on the Uber app will in some sense be "set" by the firm. However, the firm has very little control over the price they receive because ultimately the consumer determines the equilibrium price to which actual prices continually move. The influence of regulations, competitors, and (perhaps most powerfully) the preferences of consumers will decide what price the firm receives. The firm can "set" any price it likes, but decentralized free markets ensure that these prices come to closely approximate the value consumers place on the product.