Various commentators (notably including Tom Nankivell) have raised the issue of the costs and benefits of current speed limits and of more or less rigorous enforcement of those limits, and have asked that I consider costs as well as benefits of enforcing speed limits. I’m going to give some back-of-the-envelope numbers in an effort to inform the debate. The total economic cost of road crashes in Australia is at least $20 billion per year (This BTRE study gives direct costs of $15 billion for 1996, but an analysis based on economic welfare theory would include substantial costs (for example, in the BTRE analysis, there is zero cost in the case when a retired person is killed instantly in a crash).

The main cost of speeding restrictions is that of additional travel time. Assuming that complete abolition of speed limits would reduce average travel time by 20 per cent (very generous, since a lot of travel is on congested roads where the speed limit isn’t a constraint), and taking the BTRE estimate that value of reduced travel time is $10/hour, the total travel time cost of speed limits is around $5 billion per year.

It’s pretty obvious that abolishing speed limits altogether would raise road death rates by more than 25 per cent (the NT is the only jurisdiction in Australia without speed limits and its death rates are several times higher than in the rest of the country, though there are other factors as well as speed in play). The same argument applies, essentially pro-rata to more limited relaxation of limits. It gets harder to justify further reductions as the limit gets lower, but I’d say there’s a pretty good case for more general application of 50k limits in suburban areas to cover everything except main roads.

Turning to other costs and benefits, the survey evidence I’ve seen suggests that the disutility imposed by speeders on other drivers (particularly through tailgating, forcing their way back into traffic etc) is at least as large as any psychic benefits gained by the speeders.

Finally, on the enforcement issue, one point that has secured a lot of agreement is that variance in speed is as much of a problem as speed itself. On the assumption that there are a large number of law-abiding drivers travelling at or near the legal limit, and vehicles such as trucks that cannot safely exceed the limit, this provides a strong argument for both rigorous enforcement and tight tolerances. It also implies that excessively slow driving should be penalised.

British journal Economica is currently listing one of my papers (with Simon Grant) as its feature article on its website. I’m very happy about this, since the paper makes what I think is one of my most important policy arguments, that the discount rate for public investment should be less than the rate of return demanded by private equity investors in comparable projects.

I’d be interested to debate this point with readers, but please have a look at the article first – you don’t need to go through all the algebra to get the main point.

Brad de Long reports on a dinner discussion with Paul Krugman and Janet Yellen, hinking About Puzzling Anomalies in the Flow of Macroeconomic Data . He says

We currently have two large, puzzling anomalies in the macroeconomic dataflow. First, productivity growth is ludicrously, ridiculously, unbelievably rapid. Second, the high current level of the U.S. trade deficit fits very uneasily with the relatively high value of the dollar and the lack of large interest rate differentials in favor of the U.S. relative to other countries

and says

Things that readers think are smart should be attributed to Paul Krugman or to Janet Yellen. Things that people think are dumb should be attributed to me.

. At the risk of showing myself up as dumb (at least relative to these very smart guys), I don’t see a problem in either case.

Beginning with productivity, it’s only labour productivity that’s grown rapidly and seemingly anomalously. Capital productivity has declined markedly, as has multifactor productivity (a weighted average of capital and labour productivity) In part this reflects the economics of embodied technical change – as computing power has become cheaper it has been applied more intensively. But there’s also a big hangover effect from the bubble and bust, when crazy signals from capital markets led lots of firms to undertake unprofitable investments. Once some semblance of reality returns, the natural response is to cut back and it’s much easier to sack the least productive workers than to reduce capital stock. So labour productivity rises fast, but output growth is weak. I’ve done the numbers here (see also here and here), and they fit the data neatly.

On the absence of a large interest rate differential and the relatively high value of the dollar despite the large deficit, this is only a problem if you assume capital markets operate rationally. All the recent evidence is against this assumption, but in any case the markets aren’t as crazy as all that. Most non-US participants are now selling US-denominated assets ,which are only being kept afloat by the efforts of Asian central banks. Strong versions of the efficient markets hypothesis would suggest that such activities must be futile, and that speculators, anticipating the inevitable decline of the dollar would drive the central banks to the wall, but I don’t have any problem ignoring strong versions of the efficient markets hypothesis.

A quick report on the Economists’ conference.

The first plenary was by Paul Ormerod on “What can economic agents learn?”. The central idea is that we need more realistic models in which people’s capacity to learn and make inferences is bounded. I’m fully in agreement with this and am actively working on a way of modelling such ideas. Ormerod didn’t give much detail about his own approach to the problem.

Deirdre McCloskey presented her ideas on statistical significance, which have already been discussed on this blog. In question time, Adrian Pagan gave a characteristically vigorous defence of the standard approach, making some good points I thought (disclosure: McCloskey’s paper includes a ranking of all the papers published in the American Economic Review according to the adequacy of their treatment of significance in published regressions. My paper with Steve Dowrick ranks a bit below average on this scale. I don’t really think it should have been included, since the main focus of the paper is on nonparametric measures of relative international income. We only threw in a regression to show the difference between our measure and the standard PPP measure).

Richard Freeman gave a talk on “Not your Father’s Union”, talking up the prospect of a resurgence of unionism based on Internet organisation. Coincidentally or otherwise, the same day I got an email from the AFL-CIO (US equivalent of the ACTU), which I’ve appended as an instance of this phenomenon. It was part of a campaign to resist Administration attacks on overtime pay, which was successful in its immediate objective of getting a favorable vote in the House of Representatives.

The higher education session was, as Derrida Derider mentioned, disgustingly civilised, with no fisticuffs between me and fellow-blogger Andrew Norton. I plan to post a full paper before long. There was at least a good crowd, filling the small room. By contrast, my paper on water reform was presented to an audience of about twenty in a theatre with a capacity of 500. Again, I’ll try to post a paper. My idea is to spend money now buying irrigators’ rights to license renewal in ten years’ time.

(AFL-CIO email follows)

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I’ll be presenting twice at the Economists’ conference today. First, in the morning on “Higher Education: The Last Nationalised Industry?” and then in the afternoon on “Discounting and sustainable management of the Murray-Darling system”. After that I’ll be heading back to Brisbane, stopping along the way at Dubbo zoo and the Parkes radiotelescope. Normal blogging should resume next week.

I plan to post copies of my presentations on my website next week, and to have full papers a bit later.

My column in today’s Fin (Subscription required) is about the (putative) bubble in housing prices. After noting that virtually all economists think there is a bubble I observe

There is a paradox here. In a country with a longstanding suspicion of market forces, economists have normally been among the few defenders of the market. Even relative sceptics put more weight than the average Australian on seeking rational economic explanations of market outcomes. Yet in the case of the housing boom, ordinary Australians have shown a faith in the market that would put the most devout Chicago economist to shame….

A bad end to the current boom would mark the failure of the separation between monetary policy and prudential regulation introduced following the report of the Wallis Committee. The whole program of financial deregulation would be called into question.

The implications would be even more striking if the current putative bubble turned out to reflect a sustainable increase in underlying values. If the doubling of house prices over a few years is not a bubble, then it is clearly impossible for economists to recognise one when it is in progress. It would be hard to imagine a more triumphant vindication of the efficient markets hypothesis than this.

If anyone has a plausible story as to how the rise in asset prices is sustainable, I’m eager to hear it. Sustainable in this context means that the value of the flow of services from housing should equal the rental cost implied by current prices and reasonable real interest rates.

This piece in the NYT reports that Warren Buffett is making a countercyclical move into manufactured housing. Until recently, at least, this form of housing (pejoratively referred to as ‘trailers’) has been very significant in the US – around 20 per cent of all new houses, and up to 50 per cent in rural areas.

This raises a number of questions. First, why there is no comparable development in Australia, where manufactured units are typically used only as holiday accommodation? Is it a matter of building regulations, and if so should we be changing these regulations to bring down housing costs? Or, as the NYT story implies, does this kind of housing degenerate rapidly towards slum status. The rapid decline in the manufactured housing market during the boom of the late 90s seems to support the view that this is a last-resort option.

There’s also a bigger question which I’ve been puzzling over for some time. Real incomes for the bottom 40 per cent or so of US households haven’t risen since the 1970s. At the same time, ownership of items like TVs and washing machines has expanded significantly. That’s not surprising, since the relative price of these items has dropped. But that implies that other relative prices have risen, and housing is an obvious candidate. Has housing quality declined for low-income Americans? If consumption of all items has increased, while income has been constant, the implication is obviously that savings have declined, presumably because of the availability of new forms of credit, and the story also hints at this.

I’d be very interested in any comments and grateful if anyone has useful references on the points I’ve raised.

If you haven’t already, you should read Calpundit’s interview with Paul Krugman. For regular readers of this blog, there’s nothing new – unsustainable Bush fiscal policies imply financial crisis partly by resolved by inflation, with a consequent increase in interest rates, frequent mention of Argentina etc. But Krugman says it better than I do, and Calpundit shows new possibilities for blogging with a rare instance of primary newsgathering.

This is the first second draft of my long-promised post on McDonalds and American soft power. I’ve had quite a few useful comments and have incorporate some, still digesting others. More comments much appreciated.

It’s hard to go anywhere in the world without running across American fast food chains like McDonalds and Starbucks, American movies and American sitcoms. This fact has led to lots of dubious inferences.

A particularly egregious example was Thomas Friedman’s Golden Arches Theory of Conflict Prevention, which held that no two countries with a McDonalds would ever fight a war. This theory was presented to the world in Friedman’s 2000 February 1999 bestseller The Lexus and the Olive Tree. A few months later, the USAF was bombing Belgrade, a city with seven McDonalds outlets.

More common than this kind of grand theorising are two inferences, one anti-American and one pro-American. More precisely, I should say “critical of/supportive of American economic and social institutions” since many of those who are most “anti-American” in this sense are domestic American social critics.

The anti-American inference is that America is a trashy and decadent society intent on forcing its low-grade way of life on to the rest of the world. One version of this inference is presented in Naomi Klein’s No Logo, though I’ve oversimplifed her message fairly drastically.

The pro-American inference is that the ubiquity of these American icons is evidence of American ‘soft power’ (a term coined by Joseph Nye in Foreign Policy in 1990) and proves that the rest of the world either loves and aspires to the American way of life or is jealous and hypocritically denounces Americanisation while secretly craving it. One version of this inference is presented by Fouad Adjami (link via Geoff Honnor). Again I’ve (over)simplified a complex argument to extract a central theme. Another reader (Ritu) mentions Fareed Zakaria in this context, raising the point that, in the current environment a Muslim-sounding name is probably an asset for someone writing in praise of American soft power.

Economists are generally suspicious of purely cultural accounts of economic outcomes, preferring to focus on technological issues such as factor endowments and on the effects of income and relative prices on demand patterns. This preference isn’t always right – cultural factors, industrial policies and pure chance have an important role to play – but it’s always worth considering the economic basics.

But there’s a standard economic analysis, dating back to the 1950s, that explains a lot about the prevalence of McDonalds without any need for a notion of ‘soft power’. Nicholas Gruen kindly sent me the following extract from one of his pieces, which I assume arose from debates over Australian car industry policy

In 1961, the economist Linder suggested that product specific scale economies and product differentiation combined with local tastes and transport costs to influence the pattern of trade in manufactures (1961: 87ff See also Kravis, I. B., (1956), “Availability and Other Influences on the Commodity Compositioin of Trade, Journal of Political Economy, Volume LXIV). In particular, he suggested that countries domestically manufacture differentiated products which can be manufactured at economic scale because they appeal to majority home market tastes. At the same time they import products to meet minority tastes. Minority tastes cannot be efficiently served from local manufacture because low levels of demand prevent local manufacturers achieving scale economies. Where these products meet majority tastes in other countries, they can be manufactured there at lower cost and then exported back to countries where they meet minority tastes. The resulting pattern of mass marketing at home and niche marketing abroad is well represented in many markets for manufacturers, not least the market for automobiles

Although I obviously picked up the ideas that were being tossed around during the car policy debate, I didn’t read the Kravis and Linder papers or maybe read them and forgot them [insert PJ O’Rourke drug allusion here] The Kravis-Linder model extends neatly to things like movies and McDonald’s franchises.

The most obvious common characteristic of chain restaurant franchises and movies is that of large fixed costs combined with effectively unlimited scale economies. A Hollywood movie can easily cost $100 million to make (the movie Titanic cost far more in real terms than the ship did), but once it’s made the cost of showing it is trivial. Similarly, a huge amount of expenditure goes into the creation of an instantly recognisable franchise like McDonalds or Starbucks, but the marginal cost of adding an extra outlet is relatively small. For brevity we’ll call both movies and franchise outlets “chain services”.

By contrast, the cost structure of an independent supplier, such as a coffee shop, restaurant or live entertainment venue is much flatter, and costs tend to increase beyond a certain size, rather than decreasing. On the other hand, the independent can tailor the product to a local market. The balance between independent local suppliers and chain services will depend on the amount of local variety or, conversely, on the homogeneity of the market as a whole.

It’s easy to see that the best market for which to produce a product of this kind is the biggest and most homogenous one, which, among the developed countries means America. Although America is not a homogenous society it’s at least as homogenous as any European country and about three times as large. So it’s not surprising that chain services have been most successful in America, to the extent that independent suppliers have been largely eliminated in many markets. Obviously, the optimal type and quality of services is that which matches the tastes of the average American consumer in the given market (which may be segmented but must be large).

Now think about similar markets in other countries. Chain services will be slower to develop, and less successful in competition with local independents because the potential market is smaller. This creates a opportunity for entry by American suppliers of chain services, whose fixed costs have already been paid in the American market, and who can therefore sell at lower prices.

An important consequence is that the market position of American chains is not the same in export markets as in America. Being designed for the American market, the product will not meet local tastes in export markets as closely, so it will be perceived as a low-quality, low-price product. This is most obvious with Starbucks, which is routinely used in America as a trope for luxury consumption (“Starbucks + upscale” gets 17600 hits on Google), while being regarded as distinctly second-rate in Australia. But even McDonalds has a noticeably higher status in America than in its overseas markets.

The big American chain service suppliers have tried to address this problem by tailoring their products more to foreign markets. But the more this is done, the less the cost advantages of multinational operation. Most attempts of this kind have been notably unsuccessful.

The same point applies to movies and particularly to TV, where the minimum efficient scale is lower. As soon as a country gets a big enough and rich enough market, and can establish its own TV industry, home-made shows (including local remakes of successful foreign shows) tend to take the top spots, while cheaper imports are used as filler. The US market is so big that the main networks almost invariably prefer a remake to the use of imported material.

What are the costs and benefits of all this. Obviously, Americans , considered as workers and investors, benefit from the fact that their scale economies give them cost advantages in markets for films, franchise production and so on.

This partly comes at the expense of other exporters. In talking about American ‘soft power’, it’s not often noted that, with some important exceptions such as computers, it’s rare nowadays to encounter American manufactured products outside the US. Looking around my house there’s a French car, some German whitegoods, and heaps of things made in Japan, East and Southeast Asia and even Australia. The only items that are obviously American are the Powerbook and its predecessors, and even they were mostly made in Singapore.

The effects on American consumers are ambiguous, but arguably negative on balance. Although they benefit from having films and chain restaurants tailored precisely to their tastes, they have far fewer alternatives than before the rise of the chains, particularly if their tastes differ a bit from the mean.

By contrast, precisely because the chain product is rather less attractive, consumers in markets outside the US tend to keep alternatives in existence. One of the traps for writers on ‘soft power’ is that, observing the proliferation of McDonalds, Starbucks and so on, they imagine that everyone in the countries they visit is a customer of these enterprises. This is, roughly speaking, true in the US, but the market share for these chains is smaller everywhere else.

A closely parallel analysis applies to language (thanks to Jack Strocchi for raising this point). There are big economies of scale and, as the language with the most (income-weighted) native speakers, English has a natural comparative advantage. So the natural outcome is one where English monoglots can make themselves understood almost anywhere, while non-native speakers of English who wish to function in the global economy must be, at a minimum, bilingual. If, as seems likely, bilinguality has cognitive benefits, as well as the obvious cost of learning a second language, the welfare effects have the same sort of ambiguity as McDonalds – the monoglots have lower cost and more convenience but less variety. [An interesting countertrend to all this is the rise of Spanish in the United States itself – to the point where native English speakers like George and Jeb Bush find it useful to be at least partly bilingual]

Even though a purely cost-based analysis works pretty well, it would be silly to dismiss ‘soft power’ altogether. Clearly, American movies and products do better at times and in places where the American way of life is viewed as cool and desirable. But relative prices are probably more important. Korean cars sell like hotcakes in Australia, but that doesn’t mean that the average Australian wants to move there.

Similarly, American movies sell well because economies of size mean they can have big budgets, and therefore, top-quality special effects and cinematography. That doesn’t mean that the average moviegoer or TV-watcher has any particular opinion about American foreign policy or social structure.

Less sophisticated audiences may be led to assume that the average American has the upper-middle class living standard typically presented in these productions. On the other hand, for middle-class consumers in developed countries, exposure to McDonalds and Starbucks leads to the equally misleading inference that American living standards are far below those prevailing in their own countries.

Like most people, I suspect, I find the details of international trade negotiations eyeglazingly boring. So, I was as surprised as anybody when the WTO meetings in Cancun suddenly collapsed, with less developed countries walking out en masse.

The immediate cause seems to have been the fact that the meetings focused on liberalised investment rules (pushed by the Europeans) while the poor countries wanted to talk about agricultural barriers and to have their proposal treated equally with a joint EU/US offer.

The underlying cause, in my view, is that the WTO now lacks a real backer, that is, a rich and powerful country or group of countries who want it to play a central role. The UN is backed by the Europeans, the IMF (with occasional qualms) by the US and the World Bank by both. Until recently, the WTO had the backing of the US which was historically the world’s biggest exporter and stood to gain a lot from expanded trade.

But now the US has switched to a strategy of bilateral negotiations like the proposed FTA with Australia where it can extract better terms. Moreover, like most net importers, the US is becoming more protectionist as its trade deficits build up.

Finally, the aggressive overreach by the WTO itself (things like the tuna-dolphin decision, that led to the Seattle explosion a few years ago means that the organisation has few real friends among NGOs and the broader public.

Given that, in the dispute over US steel tariffs, the WTO is bound to rule against the US, and the US seems unlikely to back down, it’s conceivable, though still improbable, that the organisation could collapse completely in the next few years.