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Jobs, robots and self-driving vehicles

January 15th, 2017 24 comments

Lately I’ve been reading Tim Dunlop’s excellent book Why the future is workless , and thinking about the issues it raises, particularly in the light of the prospect of autonomous vehicles and other transport technologies. Tim raises the obvious question: what will happen to people who currently drive for a living, and the broader issue of whether any kind of work will survive the process of automation.

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Health policy: Excerpt from Economics in Two Lessons

January 8th, 2017 14 comments

Another excerpt from my book-in-progress, Economics in Two Lessons (partial draft here). As usual, praise is welcome, useful criticism even more so.

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Market Failure and Income Distribution: Notes for Economics in Two Lessons

January 5th, 2017 10 comments

For quite a while now, I’ve been working through my book-in-progress, Economics in Two Lessons (partial draft here), focusing on applications of Lesson 2

Lesson 2: Market prices don’t reflect all the opportunity costs we face as a society.

Thinking about the standard market failures (monopoly, externality and so on), I’ve come to the conclusion that I need to say more about the interaction between market failure and income distribution. I’ve already looked at the opportunity costs involved in income redistribution and predistribution, but different kinds of questions are coming up in relation to issues like monopoly, privatisation and for-profit provision of public services.

The discussion here and at Crooked Timber has been very helpful in stimulating my thoughts, but I need to do a lot more clarification. Some preliminary thoughts are over the fold: comments and criticism much appreciated.

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Education: Excerpt from Economics in Two Lessons

December 29th, 2016 21 comments

Here’s another excerpt from my book-in-progress, Economics in Two Lessons. As usual, praise is welcome, useful criticism even more so. You can find a draft of the opening sections here.

In the section over the fold, I’m looking at education.

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Public Services: Excerpt from Economics in Two Lessons

December 28th, 2016 10 comments

As we saw in Section …, Lesson 1 does not apply to public goods, which can be used all, without any diminution of their usefulness, and for which no price can be charged. Many of the core activities of government may be regarded as providing public goods. These include public health measures, the control of air pollution, urban planning, police services and national defense.

More abstract services such as the legal system, the definition and enforcement of property rights, systems of weights and measures and so on are also public goods. Less obviously, macroeconomic management is a kind of public good (or sometimes a public bad). The level of economic activity, the rate of inflation, exchange rates and interest rates affect everyone, though in different ways.

Most advocates of Lesson 1 recognise at least some of these forms of public good provision as essential. The big disputes arise over services such as health, education and welfare services, which have long been provided, or at least funded, by governments. These services are commonly referred to as ‘human services’, and typically involve a personal relationship (doctor-patient, teacher-student, caseworker client and so on) between the service provider and the recipient.

Although these services are sometimes referred to as public goods, they don’t, in general, meet the criteria economists use to define public goods. A hospital bed or school place provided to one person isn’t available to others, and prices can be charged for access to these services.

On the other hand, neither do these services the standard conditions of Lesson 1. There are two central problems that arise. First, these services are expensive and recipients are rarely in a position to pay for them directly. As a result, all of the problems of risk and insurance, discussed in Chapter 10 …, apply to the financing of these services.

The second problem is that the relationship between providers and recipients typically involves an imbalance of information, power or both. A student is not in a good position to judge whether the education she is receiving is good or bad. Similarly, a patient must rely on their doctor’s expertise and professional ethics to get the appropriate treatment. In other cases, such as that of police services, there is also an imbalance of power, which may be misused.

Advocates of Lesson 1, such as Milton Friedman in Free to Choose have generally accepted the need for public funding to overcome the problems of financing education and, at least in some instances, health care. However, Friedman and others have assumed that any other problems can be overcome by market competition and consumer choice. Indeed, they have argued that market competition will help to prevent corruption and abuses of power that arise when governments provide services directly.

As a result, market advocates have favoured policies based on concepts such as ‘contestability’ and ‘contracting out’, in which for-profit firms compete to provide publicly funded services. The archetypal example is the perennial proposal for school ‘vouchers’, that is, funds allocated to students or their parents which can be paid to whichever school they choose to attend.

This idea was elaborated into a complete ‘reinvention of government’ by writers like Osborne and Gaebler in the late 20th century and implemented, to a large extent, in the wave of market liberal reform led by the Thatcher government in the UK. As a result, we have accumulated plenty of experience of market contestability and for-profit provision.

Theoretical analysis doesn’t give any clear answer as to which model of provision is likely to be best for services like health and education. However, after several decades of experience with market-oriented contestability, the empirical evidence is stark. For-profit provision of such services is at best problematic, and at worst disastrous.

The only other model with success comparable to that of public service provision is not-for-profit provision by organisations with a charitable or activist mission. Church-run schools and hospitals, and activist-run services like women’s shelters and services for the unemployed and homeless, have complemented the public sector, meeting needs that have been unrecognised or underserved.

The issue is not, in the end, one of public versus private. Rather it is the fact that market competition and the profit motive inevitably associated with it is antithetical to the professional and service orientation that is central to human services of all kinds.

Categories: Economics in Two Lessons Tags:

Monopoly and Regulation: Excerpt from Two Lessons book

December 24th, 2016 24 comments

Here’s another excerpt from my book-in-progress, Economics in Two Lessons. As usual, praise is welcome, useful criticism even more so. You can find a draft of the opening sections here.

In the section over the fold, I’m looking at public ownership.

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Monopoly and Regulation: Excerpt from Two Lessons book

December 17th, 2016 12 comments

Here’s another excerpt from my book-in-progress, Economics in Two Lessons. Rather than work sequentially, I’m jumping between:

Lesson 1: Market prices reflect and determine opportunity costs faced by consumers and producers.
and
Lesson 2: Market prices don’t reflect all the opportunity costs we face as a society.

In the section over the fold, I’m looking at monopoly and regulation. Next up, public ownership.

As usual, praise is welcome, useful criticism even more so. You can find a draft of the opening sections here.

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Austrian economists and environmental policy

December 8th, 2016 40 comments

While working on my long-forthcoming book, Economics in Two Lessons, I came across an interesting article by Edwin Dolan published (with commendably openness to criticism) in the Quarterly Journal of Austrian Economics. The conclusion

On a theoretical level, Austrian writers delight in claiming the moral high ground, condemning polluters as aggressors against property rights. On a practical level, however, they leave pollution victims in the lurch. They invite them to sue, but propose a set of legal standards that would guarantee that polluters would always win. They oppose all government measures to reduce pollution, whether through regulation or through measures to make polluters pay. As a result, at least in cases of environmental mass torts, the Austrian paradigm is a polluter’s dream and a victim’s nightmare. It offers far too little of any practical value toward securing property rights, too little toward facilitating environmental coordination, and too little toward promoting libertarian justice. Much work remains to be done.

Unnecessary Wars

October 21st, 2016 39 comments

A long-running theme of this blog has been the disaster of the Great War, and the moral culpability of all those who brought it about and continued it. It’s fair to say, I think, that the majority of commenters have disagreed with me and that many of those commenters have invoked some form of historical relativism, based on the idea that we shouldn’t judge the rulers (or for that matter the public) of 1914 on the same criteria we would apply to Bush, Blair and their supporters.

It’s fascinating therefore to read Henry Reynolds’ latest book, Unnecessary Wars about Australia’s participation in the Boer War, and realise that the arguments for and against going to war then were virtually the same as they are now. The same point is made by Newton in Hell-Bent: Australia’s leap into the Great War (recommended in comments a while ago by James Sinnamon. He shows how, far from loyally following Britain into a regrettably necessary war, leading members of the Australian political and military class pushed hard for war. In Newtown’s telling, the eagerness of pro-war Dominion governments helped to tip the scales in the British public debate and in the divided Liberal candidate. I don’t have the expertise to assess this, but there’s no escaping the echoes of the push towards the Iraq war in 2002 and early 2003, when this blog was just starting out.

The case against war was fully developed and strongly argued in the years before 1914, just as the case against slavery was developed and argued in the US before 1861. Those who were on the wrong side can’t be excused on the grounds that they were people of their time.

The only defence that can be made is that those who were eager for war in 1914 had not experienced the disaster of the Great War and its consequences. The failure of today;s war advocates to learn from this disaster makes their position that much worse. But the same is true of anyone defending the warmakers of 1914 on any grounds other than that of their ignorance.

Categories: Books and culture, World Events Tags:

Book report

August 7th, 2016 6 comments

I’ve been getting lots of free books lately, and the implied contract is that I should write about at least some of them. So, here are my quick reactions to some books CT readers might find interesting. They are

The Great Leveler: Capitalism and Competition in the Court of Law by Brett Christophers

The Rise and Fall of American Growth:
The U.S. Standard of Living since the Civil War
by Robert J. Gordon

The Sharing Economy:The End of Employment and the Rise of Crowd-Based Capitalism by Arun Sundararajan

Econobabble: How to Decode Political Spin and Economic Nonsense by Richard Denniss

Generation Less: How Australia is Cheating the Young by Jennifer Rayner

I’ll be on a panel discussing the last two of these at the Brisbane Writers Festival, Sep 11-16.

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Intellectual property: Extract from Economics in Two Lessons (expanded and amended)

May 25th, 2016 74 comments

Another draft extract from my book-in-progress, Economics in Two Lessons. It’s the last part of the section on “predistribution”, dealing with Intellectual Property. Next up, “redistribution” through taxation and public expenditure.

As always, encouragement is welcome, constructive criticism even more so.

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Minimum wages and predistribution: Extract from Economics in Two Lessons

May 15th, 2016 44 comments

A bit out of order, this is another draft extract from my book-in-progress, Economics in Two Lessons. It’s part of the chapter on income distribution, meant to follow the section on unions, and precede the Australia-US data point and the discussion of corporate profits [links to CT, but all published here also]. After this, I plan to conclude the “predistribution” part of the chapter with a discussion of intellectual “property”, then move on to “redistribution” through taxation and public expenditure.

As always, encouragement is welcome, constructive criticism even more so.

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Predistribution and profits: extract from Economics in Two Lessons

May 15th, 2016 14 comments

Over the fold, another extract from my book-in-progress, Economics in Two Lessons. Encouraging comments appreciated, constructive criticism even more so.

Predistribution and profits

As we’ve seen in previous sections, the social constructions of property rights and institutions surrounding employment makes a big difference to the determination of wages and working conditions. These social constructions affect ‘predistribution’, the distribution of income and wealth that arises before the effects of taxes and public expenditure are taken into account.

Predistribution is equally relevant to the other big source of personal income: profit derived from private businesses and corporations. Without legal structures designed specifically to protect businesses from the risks of failure, profits would be far less secure, and the difficulty of establishing and running a business much greater. Corporate profits are not a natural outcome of a market society, but the product of specific structures of property rights introduced to promote corporate enterprise.

The risks of running a business in the 18th century, and well into the 19th, were substantial and personal. There was no such thing as bankruptcy: a business failure meant debtors prison, where debtors could be held until they had worked off their debt via labor or secured outside funds to pay the balance.

After a brief and disastrous experiment in the early years of the 18th century (the South Sea Bubble), joint stock companies were also viewed with grave suspicion.

The prevailing view was Quoted in John Poynder, Literary Extracts (1844), vol. 1, p. 268. [1]

Corporations have neither bodies to be punished, nor souls to be condemned; they therefore do as they like.

This is often misquoted as

“Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and no body to be kicked?

Adam Smith was similarly scathing, though with more of a focus on the principal-agent problem

The directors of such [joint-stock] companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own…. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.

Exceptions were made only for specially authorised quasi-governmental ventures like the East India Company, focused on foreign trade. In general, limited liability companies were not permitted in Britain or most other countries. The partners in a business were jointly liable for all its debts.

These same rules applied in Britain’s American colonies and continued to prevail in the United States until the middle of the 19th century. The introduction of personal bankruptcy laws put an end to debtors prison, greatly reducing the risks of running a business. The creation of the limited liability company was an even more radical change.

These changes faced vigorous resistance from advocates of the free market. David Moss, in When All Else Fails, his brilliant history of government as the ultimate risk manager, describes how the advocates of unlimited personal responsibility for debt were overwhelmed by the needs of business in an industrial economy. The introduction of bankruptcy and limited liability laws took much of the risk out of starting and operating a business.

By contrast, in Economics in One Lesson, Hazlitt doesn’t mention limited liability or personal bankruptcy and seems to assume (like most defenders of the market) that these are a natural feature of market societies. More theoretically inclined propertarians have continued to debate the legitimacy of bankruptcy and limited liability laws, without reaching a conclusion.

This debate over whether bankruptcy and corporation laws are consistent with freedom of contract is really beside the point. The distribution of income and wealth is radically changed both by the existence of these institutions and by the details of their design. In particular, the massive accumulations of personal wealth made possible by capital gains from share ownership would simply not exist. Perhaps there would be comparable accumulations of wealth derived in some other way, but the owners of that wealth would be different people.

A crucial policy question, therefore, is whether current laws and policies relating to corporate bankruptcy and limited liability have promoted the growth of inequality and contributed to the weak and crisis-ridden economy that has characterised the 20th 21st century. The combination of these factors has produced absolute stagnation or decline in living standards for much of the US population and relative decline for all but the top few per cent.

There can be little doubt that this is the case. As recently as the 1970s, a corporate bankruptcy was the last resort for insolvent companies, typically leading to the liquidation of the company in question. As well as being a financial disaster, and a source of shame for all those involved. For this reason, nearly all major companies sought to maintain an investment-grade credit rating, indicating a judgement by ratings agencies that bankruptcy was, at most, a fairly remote possibility.

Since that time, bankruptcy has become a routine financial operation, used to avoid inconvenient liabilities like pension obligations to workers and the costs of cleaning up mine sites, among many others. The crucial innovation was “Chapter 11”, introduced in the Bankruptcy Reform Act of 1978.

The intended effect of Chapter 11 was that companies could reorganise themselves while going through bankruptcy, and re-emerge as going concerns. The (presumably) unintended effect was that corporate managers ceased to be scared of bankruptcy. This was reflected in the spectacular growth of the market for ‘junk bonds’, that is, securities with a high rate of interest reflecting a substantial probability of default. Once the preserve of fly-by-night operations, junk bonds (more politely called ‘high-yield’) became a standard source of finance even for companies in the S&P 500.

At the same time, legislative changes and the growth of global capital markets greatly enhanced the benefits of corporate structures, while eliminating many of the associated costs and limitations. At the bottom end of the scale, the ‘close corporation’ with only a handful of shareholders, became the standard method of organising a small business. This process was aided by a long-series of pro-corporate legislative changes and court decisions (notably in Delaware, which has long led the way in this process, and where vast numbers of US companies are incorporated). At the top end, the rise of global financial markets from the 1970s onwards allowed the creation of corporate structures of vast complexity, headquartered in tax havens and organised to resist scrutiny of any kind.

At the behest of these corporations, governments have negotiated agreements supposedly designed to ensure that corporate profits are not taxed twice in different jurisdictions. In reality, using a combination of complex corporate structures and governments (notably including those of Ireland and Luxembourg) eager to facilitate tax avoidance in return for a small slice of the proceeds, the effect has been to ensure that most global corporate profits are not taxed even once in the countries where they are earned.

What can be done to redress the balance that has been tipped so blatantly in favor of corporations. The obvious starting point is transparency. Havens of corporate secrecy, from Caribbean islands to US states like Delaware must be made to reveal he true ownership of corporations, in the same way that tax havens like Switzerland, used mostly by wealthy individuals, have been forced to disclose the ownership of previously secret accounts.

The use of complex corporate structures to avoid tax is a much more difficult problem to tackle. Some measures are being taken to attack what is called “Base Erosion and Profit Shifting’, but past experience suggests that slow-moving processes of this kind will at best keep pace with the development of new forms of avoidance and evasion. It’s necessary to re-examine the whole structure of global taxation agreements. Instead of focusing on the need to avoid taxing corporate profits twice, the central objective should be to ensure that they are taxed at least once, in the place where they are actually generated.

More generally, though, the idea that corporations are a natural part of the economic order, with all the human rights of individuals, and none of the obligations needs to be challenged. Limited liability corporations are creations of public policy, useful to the extent that they promote the efficient use of capital but dangerous to the extent that they facilitate gross inequalities of income and opportunity.

Categories: Economics in Two Lessons Tags:

Why is global finance so profitable (crosspost from CT)

May 12th, 2016 21 comments

In a recent post, I asserted that

activities like tax avoidance/evasion and regulatory arbitrage aren’t peripheral flaws in a financial system primarily concerned with the efficient global allocation of capital. They are the core business, without which the profits of the global financial sector would be a tiny fraction of the $1 trillion or so now reaped annually

As I’m working on income distribution issues my long-running book project, this seems like a good time to see if this claim can be backed up by hard numbers.

First up, here’s my source for the $1 trillion number (actually $920 billion). As a plausibility check, I’ve tried to estimate the total size of the global financial sector. Various sources, including Wikipedia estimate that the banking and insurance sector accounts for 7-8 per cent of US gross product. Extrapolating to world gross product of about $80 trillion that would give around $6 trillion for the total size of the sector. The US is almost certainly more financialised than the world as a whole. Still, the profit number looks about right. A trickier question is whether the rents accruing to managers and top professional in the sector should be counted as part of profits. I’d guess that these rents account for at least another $1 trillion, but I have no real idea how to test this – suggestions welcome.

Is tax avoidance/evasion and regulatory arbitrage a big enough activity to account for a substantial share of a trillion dollars a year? Gabriel Zucman estimates that there’s $7.5 trillion stashed in tax havens, of which around $6 trillion is untaxed. He estimates the tax avoided at $200 billion . I’ll estimate that half of that ($100 billion) is creamed off in financial sector, mostly as profits or rents. That implies a profit margin of a bit under 2 per cent, which seems reasonable.

Tax evasion by wealthy individuals is only a small part of the story. Legal tax avoidance is almost certainly more important. Most of that involves companies, but it’s important to distinguish between “close” corporations, which hide the activities of an individual or family and large global corporations. I don’t have any idea how to measure the cost of avoidance through close corporations. As regards global corporations, Zucman estimates that “a third of U.S. corporate profits, or $650 billion, are purportedly earned outside the country, with a cost to the US of $130 billion a year . Extrapolating to the world as a whole, that would be at least $500 billion. Again, assuming the financial sector creams off half of the sum, we get $250 billion (the fact that the finance sector itself accounts for around 40 per cent of all corporate profits means there’s a problem of recursion that I haven’t worked through)

Then there’s manipulation of exchange rate and bond markets. I have no idea how to measure this, but given that the notional volume of trade in some of the markets concerned is measured in the hundreds of trillions, it seems plausible that the profits and rents from market-rigging must be at least in the tens of billions.

These are probably the biggest scams, but there’s also regulatory arbitrage, privatization (a huge source of rent over recent decades), domestic tax avoidance and more.

Adding them up, I’d suggest that $500 billion a year is a low-end estimate for the profits and rents associated with various forms of anti-social financial sector activity.

There’s lots of potential error around these numbers, but the order of magnitude seems reasonable to me. As against the claim that the explosion in financial sector activity and profits over the past 40 years has been driven by the benefits of a more efficient allocation of capital by rational markets, the claim that it’s all about tax-dodging and socially unproductive arbitrage seems pretty plausible.

Obviously, the social cost of a financial system devoted to undermining tax and regulatory systems far exceeds the profits earned from the activity. That’s true of any kind of socially destructive, but privately profitable, activity. But the problem is greater in the case of financial sector activity because of the disastrous effects of financial crises.

A data point on minimum wages

April 29th, 2016 23 comments

I’m currently working on a section of my Economics in Two Lessons book dealing with minimum wages in the context of predistribution policies, so I thought I would compare Australia with the US, where the idea of a $15/hour minimum wage is currently a hot topic. In Australia there are two kinds of minimum wage. The PPP exchange rate is estimated at $A$1.30 = $US, which is fairly close to the market exchange rate at present, so I’ll give both $A and estimated $US equivalents

The standard minimum wage for workers aged 21 and over is $A17.29 hour ($US13.30) applying to employees under standard award conditions. These include four weeks annual leave, sick leave, employer contributions to pension plans and so on.

More comparable to the situation of US minimum wage workers are “casual” workers, employed on an hourly basis. Casual workers get a loading of at least 25 per cent, bringing the wage up to at least $A21.60 an hour ($US16.60), to compensate for the absence of leave entitlements. In addition, they have entitlements including:

* “Penalty” rates for weekend and night work (usually a 50 per cent loading, 100 per cent on Sundays)
* For workers employed on a regular basis, protection against unfair dismissal.

The policy question is: what impact have these high minimum wages had on employment and unemployment. That’s too big a question to answer comprehensively, but we can look at the obvious data points: the official unemployment rates (5.7 for Oz, 5.5 per cent US) and the 15-64 employment population ratios (72 per cent for Oz, 67 per cent US). So, it certainly doesn’t look as if the Australian labor market has been crippled by minimum wages.

Note: I’ll respond in advance to the widespread misconception that Australia is a special case due to mineral resources. Mining accounts for about 2 per cent of employment in Australia, and (because most mines are owned by multinationals) its contribution to Australian national income is also so, probably around 5 per cent.

* Workers aged 18 get about 70 per cent of the adult minimum, equivalent to around $US11.50 for casuals. But the great majority of US minimum wage workers (about 80 per cent) are 20+.

What do Australian economists think about policy?

April 28th, 2016 10 comments

Jan Libich of La Trobe University has a new book out called Real-World Economic Policy: Insights from Leading Australian Economists. Each chapter has a fairly accessible introduction to an economic policy issue, along with an interview with an Australian economist: examples include Bob Gregory, Andrew Leigh and Warwick McKibbin. It’s useful both as an intro text and to get a bit of insight into how some of our leading economists think about the issues facing Australia.

Categories: Books and culture, Economic policy Tags:

The Great War of 1911 (crosspost from Crooked Timber)

January 11th, 2016 16 comments

I recently read Time and Time Again by Ben Elton. It’s about a time traveller who returns to 1914 Europe, aiming to prevent the assassination of Archduke Franz Ferdinand, and, therefore, the Great War. Of course, the war isn’t prevented, and it turns out that there are vast numbers of timelines flowing from the summer of 1914, all more or less disastrous. This has inspired me to draft an alternate history I’ve long had in mind, where the War starts in 1911, as a result of the Agadir crisis.

I’ve changed the dates of some actual events, and the outcomes of some internal political debates, to bring more aggressive leaders and policies to the fore. I’ve also borrowed one improbable event from an earlier war. Still, the result seems to me no more improbable than the actual genesis of the War, beginning with the fatal wrong turn by Franz Ferdinand’s driver. Feel free to disagree, or to fill in some details of your own.

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The Australian exception (crosspost from Crooked Timber Piketty seminar)

January 2nd, 2016 20 comments

Note I wrote two pieces in response to Piketty’s Capital . This one, on Australia, was based on one already published here, but I was asked to crosspost it and I’ve now done so.

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Categories: Books and culture, Economic policy Tags:

Are recessions abnormal (crosspost from Crooked Timber)

November 9th, 2015 14 comments

I’m on to the macroeconomics section of my book in progress, Economics in Two Lessons. The key point of this section is that, whereas the academic economics profession has wasted most of the last thirty years on the project of founding macroeconomics on (some near approximation of) standard neoclassical microeconomics, the validity of the core results of neoclassical microeconomics depend on the assumption that the economy is operating at full employment[^1]. This observation isn’t original – it was why Keynes saw his theory as saving capitalism from itself. Even the title I used in this post on the macro foundations of microeconomics turns out to be a reinvention of the wheel.

Having noted the importance of the full employment assumption in the abstract, how relevant is it? If the economy is, with notably rare exceptions, at, or close enough to, full employment, then it seems safe enough for economists to continue, as the profession has for 40 years or so, to treat macroeconomics as a special subfield with little relevance to the rest of the discipline.

To put the question simply, are recessions abnormal?

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TANSTAAFL: What about “free” TV, radio and Internet content?

October 11th, 2015 35 comments

Another excerpt from my book in progress, Economics in Two Lessons. There’s a partial draft here if you want to read it in context. I could spend a lot more time on the topic of advertising, but much of the ground has been covered in Akerlof & Shiller’s latest Phishing for Phools. As always, both praise and useful criticism are very welcome.

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Bookplug: Phishing for Phools, Classical Greece, Luck in Politics

September 30th, 2015 19 comments

Among the winners of the Economics Nobel [1] two of the most interesting are George Akerlof and Robert Shiller. Their book Animal Spirits provided me with much of the intellectual stimulus to write my own Zombie Economics. Their latest has the intriguing title Phishing for Phools: The Economics of Manipulation and Deception.

The central theme is simple. We are all prone to errors in reasoning. Given the complexity of the world, and the finiteness of our reasoning capacity, it could scarcely be otherwise. This obviously leads to decisions that differ from the perfect optimality assumed in simplistic versions of economics.

More importantly, markets create opportunities for others to exploit and amplify our errors in reasoning. Advertising uses all sorts of device to encourage us to make decisions that we would not make if we gave careful and rational consideration to our choices. The entire credit card industry relies for its profitability on the fact that cardholders don’t (as is almost always sensible) pay off their balances every month. And so on.

As Akerlof and Shiller observe, the fact that markets systematically amplify reasoning failures undermines the standard claims about the optimality of market processes.

The proposed policy responses are a bit limited, focusing mainly on regulation and consumer protection. Still, the book is well worth reading.

An interesting side point is an argument that the harms of alcohol, a notorious source of suboptimal decisions, have been greatly underestimated.

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Income distribution: where should we start ?

September 26th, 2015 18 comments

Here’s another draft extract from my book-in-progress, Economics in Two Lessons, looking at income distribution. The entire draft section on this topic is available here. And the introduction, describing the general approach of the book is here.

Praise is welcome, and useful criticism even more so. As a reminder, this is an extract. If you think a crucial point has been missed, point it out, but bear in mind that it may be addressed elsewhere in the book.

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Economics in Two Lessons: Income Distribution

September 7th, 2015 44 comments

Here’s another excerpt from my book-in-progress, Economics in Two Lessons. Rather than work sequentially, I’m jumping between:

Lesson 1: Market prices reflect and determine opportunity costs faced by consumers and producers.

and

Lesson 2: Market prices don’t reflect all the opportunity costs we face as a society.

In the section over the fold, I’m looking at how opportunity cost reasoning applies to policies that change the distribution of income, wealth and other entitlements.

As usual, praise is welcome, useful criticism even more so. You can find a draft of the opening sections here.

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War and technological progress

August 22nd, 2015 46 comments

One of the big benefits of blogging for me is the chance to try out my ideas on an audience I couldn’t easily reach (or at least hear back from) in any other way. That’s particularly true when I’m writing a book, which is always a difficult process for me. My last post, on the opportunity cost of war produced a great comments thread. Particularly useful was a discussion, started by Chris Bertram at Crooked Timber, of the oft-heard claim that war stimulates scientific and technological progress. I’ve used my response, along with points appropriated from commenters to draft a new section for the book, pointing out how this claim ignores the problem of opportunity cost.

As always, comments of (nearly) all kinds are appreciated, and useful ones may be recycled.

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The opportunity cost of war

August 19th, 2015 37 comments

What is true of natural disasters is even more true of the disasters we inflict on ourselves and others. Of these human-made calamities, the greatest is war. The wars engaged in by the US, Australian and other governments come at the opportunity cost of domestic programs that could save thousands of lives every year. The cost of war, in terms of American (and Australian) lives, is many times greater than battlefield casualty counts would suggest.

That’s the theme of this extract from my book-in-progress, Economics in Two Lessons. You can find a draft of the opening sections here.

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Are natural disasters economic disasters ?

August 14th, 2015 14 comments

Yes. This has been the latest in our series “Short Answers to Misconceived Questions”.

Actually, there’s a longer answer over the fold, another extract from my book-in-progress Economics in Two Lessons. You can find a draft of the opening sections here.

This extract is a subsection of Part 2, in which I explore the implications of Lesson 1:
Market prices reflect and determine opportunity costs faced by consumers and producers.
The conclusion is

if the damage bill measures the cost of restoring assets to their pre-disaster condition, it is also equal to the opportunity cost of the disaster, namely the goods and services that would otherwise have been produced.

I’ll be interested to see whether readers’ reaction is “That’s obvious” or “That’s obviously wrong”, assuming of course that you have any reaction at all. As always, civil comments of all kinds are welcome, particularly constructive criticism.

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Competitive equilibrium (excerpt from Economics in Two Lessons)

July 18th, 2015 45 comments

I’m now coming up to (what I hope will be) the most challenging part of my book-in-progress, Economics in Two Lessons. The core theoretical point the first part of the book (Lesson 1) is that, under a set of ideal assumptions, competitive equilibrium prices both reflect and determine the opportunity costs faced by consumers and produces. This means that there is no way to rearrange consumption to make someone better off unless someone else is made worse off. (I’ve already mentioned my reasons for avoiding the term “Pareto-optimal” in this context.

What I’m trying to do here is to spell out the logic underlying these results in a way that foreshadows the discussion of market failure and income distribution, in Lesson 2, but still shows the power of market mechanisms. I’ll probably need a few goes at this, and this is my first try. Critical comments on everything from the underlying theory to editorial nitpicks are welcome. Sincere praise is also welcome of course, but constructive criticism is best of all.
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TISATAAFL

July 11th, 2015 32 comments

Another excerpt from my book-in-progress, Economics in Two Lessons. To recap, the Two Lessons are

Lesson 1: Market prices reflect and determine opportunity costs faced by consumers and producers.
Lesson 2: Market prices don’t reflect all the opportunity costs we face as a society.

In this section, I’m working on Lesson 1, leading up to the point (my restatement of what’s usually called the First Fundamental Theorem of Welfare Economics) that an ideal competitive equilibrium is one in which there are no unexploited potential gains from technical improvements or mutually beneficial exchange. For reasons I’ve spelt out already I don’t want to use the term “Pareto-optimal” to talk about this. I also want to confine “efficient” to its normal meaning of “technically efficient” and avoid the common economist practice of extending this to cover various definitions of “market efficiency”. So, I’m talking about “free lunches” or, more formally, benefits with no opportunity cost.

In Lesson 2, I’ll be looking, among other things, at the Second Welfare Theorem, which says any outcome with no free lunches corresponds to a particular initial allocation of property rights, broadly defined to include taxation obligations and entitlements of all kinds.

Now please comment, criticise and hopefully enjoy

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Happiness and unhappiness

June 30th, 2015 53 comments

I have a chapter in a newly released book on happiness, extracts of which have been published in The Conversation. My argument, summed up as Measures of happiness tell us less than economics of unhappiness, is a reworking of points I’ve made in the past. In particular, I argue that it’s more useful to think about removing avoidable sources of unhappiness, and that has been the great success of social democracy and the welfare state.

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To help poor people, give them money (Draft excerpt from Economics in Two Lessons)

June 16th, 2015 97 comments

Here’s another draft excerpt from my book in progress, Economics in Two Lessons. To recap, the idea of the book is to begin with the idea that market prices represent opportunity costs for the households and business who face them (Lesson 1), and then go on to explain why market prices won’t in general equal opportunity costs for society as whole (Lesson 2). A lot of the book will be applications of the two lessons, and this section is an application of Lesson 1.

As before, all kinds of comment and criticism, from editorial points to critiques of the entire strategy are welcome.

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