
What Sam Walton do to make his family rich?
10 Jul 2014 2 Comments
in applied price theory, applied welfare economics, entrepreneurship, industrial organisation, market efficiency, survivor principle, technological progress Tags: entrepreneurship, innovation, Walmart

HT: antidismal.blogspot via cafehayek
Fixing market failure is a business opportunity
09 Jul 2014 Leave a comment
in applied welfare economics, entrepreneurship, managerial economics, market efficiency Tags: Luke Froeb, market failure, market success

Luke Froeb found that his MBA students fell asleep when he lectured on market failure and the standard possible public policy responses. His teaching evaluations were so poor that keen threatened firing him if he didn’t improve.
Froeb repackaged market failures as a business opportunity. His students sat up in class and paid close attention. The end result of his efforts is the best single MBA textbook around.

Inefficiency from market failure implies the existence of unconsummated, wealth-creating transactions.
Froeb told his students that the first to fill these gaps in the market or be the market maker for the missing market stands to profit.
Alert entrepreneurs make money by identifying unconsummated wealth-creating transactions and devise ways to profitably consummate them.
Froeb argued that mistakes are made – business opportunities are missed – for one of two reasons:
- lack of information or
- bad incentives.
To diagnose a problem, ask 3 questions:
- Who is making bad decision?
- Do they have enough info to make a good decision?
- Do they have the incentive to do so?
The solution is in the answers to these questions:
- Let someone else make the decision, someone with better information or incentives.
- Change the information flow.
- Change incentives
Froeb argues that the art of business consists of identifying assets in low-valued uses and devising ways to profitably move them to higher-valued ones.
At least 20% of New Zealand workers are subject to occupational regulation
08 Jul 2014 Leave a comment
in applied price theory, applied welfare economics, comparative institutional analysis, David Friedman, economics of information, economics of regulation, entrepreneurship, industrial organisation, labour economics, law and economics, managerial economics, market efficiency, Milton Friedman, personnel economics, politics - New Zealand, Ronald Coase Tags: adverse selection, asymmetric information, blackboard economics, moral hazard, occupational regulation, screening, signalling
There are at least 98 regulated occupations in New Zealand covering about 20% of the workforce. In 2011, this amounts to 440,371 workers. The skills that are regulated range across all skill sets and many occupations:
- 49% of regulation is in the form of a licence;
- 18% of regulated work is in the form of licensing of tasks;
- 31% of regulated workers require a certificate; and
- 4% of regulated workers require registration.
There are 32 different governing Acts that regulated occupations in New Zealand with 55% of the workers subject to occupational regulation are employed in just five occupations:
- 98,000 teachers;
- 48,500 nurses;
- 42,730 bar managers;
- 32,733 chartered accountants; and
- 22,749 electricians.
The Health Practitioners Competency Assurance Act 2003 regulates 22 occupations and a total of 89,807 workers. The next best is the 10 occupations regulated by the Health and Safety in Employment Act 2002 which regulates an unknown number of occupations. The Civil Aviation Act 1990 regulates eight occupations and 19,095 workers, the Building Act 2004 regulates seven occupations and 21,101 workers and the Maritime Transport Act 1994 regulates six occupations and 20,500 workers. 12 of the regulated occupations are regulated under laws passed since 2007.
The purpose of occupational regulation is to protect buyers from quacks and lemons – to overcome asymmetric information about the quality of the provider of the service.
Adverse selection occurs when the seller knows more than the buyer about the true quality of the product or service on offer. This can make it difficult for the two people to do business together. Buyers cannot tell the good from the bad products on offer so many they do not buy to all and withdraw from the market.

Goods and services divide into inspection, experience and credence goods.
- Inspection goods are goods or services was quality can be determined before purchase price inspecting them;
- Experience goods are goods whose quality is determined after purchase in the course of consuming them; and
- Credence goods are goods whose quality may never be known for sure as to whether the good or service actually worked – was that car repair or medical procedure really necessary?
The problem of adverse selection over experience and credence goods present many potentially profitable but as yet unconsummated wealth-creating transactions because of the uncertainty about quality and reliability.
Buyers are reluctant to buy if they are unsure of quality, but if such assurances can be given in a credible manner, a significant increase in demand is possible.
Any entrepreneur who finds ways of providing credible assurances of the quality of this service or work stands to profit handsomely. Brand names and warranties are examples of market generated institutions that overcome these information gaps through screening and signalling.

Screening is the less informed party’s effort, usually the buyer, to learn the information that the more informed party has. Successful screens have the characteristic that it is unprofitable for bad types of sellers to mimic the behaviour of good types.
Signalling is an informed party’s effort, usually the seller, to communicate information to the less informed party.
The main issue with quacks in the labour market is whether there are a large cost of less than average quality service, and is there a sub-market who will buy less than average quality products in the presence of competing sellers competing on the basis of quality assurance. This demand for assurance creates opportunities for entrepreneurs to profit by providing assurance.
David Friedman wrote a paper about contract enforcement in cyberspace where the buyer and seller is in different countries so conventional mechanisms such as the courts are futile in cases where the quality of the good is not as promised or there is a failure to deliver at all:
Public enforcement of contracts between parties in different countries is more costly and uncertain than public enforcement within a single jurisdiction.
Furthermore, in a world where geographical lines are invisible, parties to publicly enforced contracts will frequently not know what law those contracts are likely to fall under. Hence public enforcement, while still possible for future online contracts, will be less workable than for the realspace contracts of the past.
A second and perhaps more serious problem may arise in the future as a result of technological developments that already exist and are now going into common use. These technologies, of which the most fundamental is public key encryption, make possible an online world where many people do business anonymously, with reputations attached to their cyberspace, not their realspace, identities
Online auction and sales sites address adverse selection with authentication and escrow services, insurance, and on-line reputations through the rating of sellers by buyers.
E-commerce is flourishing despite been supposedly plagued by adverse selection and weak contract enforcement against overseas venders.
In the labour market, screening and signalling take the form of probationary periods, promotion ladders, promotion tournaments, incentive pay and the back loading of pay in the form of pension investing and other prizes and bonds for good performance over a long period.
In the case of the labour force, there are good arguments that a major reason for investments in education is as a to signal quality, reliability, diligence as well as investment in a credential that is of no value the case of misconduct or incompetence. Lower quality workers will find it very difficult if not impossible to fake quality and reliability in this way – through investing in higher education.
In the case of teacher registration, for example, does a teacher registration system screen out any more low quality candidates for recruitment than do proper reference checks and a police check for a criminal record.
Mostly disciplinary investigations and deregistrations under the auspices of occupational regulation is for gross misconduct and criminal convictions rather than just shading of quality.
Much of personnel and organisational economics is about the screening and sorting of applicants, recruits and workers by quality and the assurance of performance.
Alert entrepreneurs have every incentive to find more profitable ways to manage the quality of their workforce and sort their recruitment pools.
Baron and Kreps (1999) developed the recruitment taxonomy made up of stars, guardians and foot-soldiers.
Stars hold jobs with limited downside risk but high performance is very good for the firm – the costs of hiring errors for stars such as an R&D worker are small: mostly their salary. Foot-soldiers are employees with narrow ranges of good and bad possible outcomes.
Guardians have jobs where bad performance can be a calamity but good job performance is only slightly better than an average performance.
Airline pilots and safety, compliance, finance and controller jobs are all examples of guardian jobs where risk is all downside. Bad performance of these jobs can bring the company down. Dual control is common in guardian jobs.
The employer’s focus when recruiting and supervising guardians is low job performance and not associating rewards and promotions with risky behaviours. Employers will closely screen applicants for guardian jobs, impose long apprenticeships and may limit recruiting to port-of-entry jobs.
The private sector has ample experience in handling risk in recruitment for guardian jobs. Firms and entrepreneurs are subject to a hard budget constraints that apply immediately if they hire quacks and duds.
Blackboard economics says that governments may be able to improve on market performance but as Coase warned that actually implement regulatory changes in real life is another matter:
The policy under consideration is one which is implemented on the blackboard.
All the information needed is assumed to be available and the teacher plays all the parts. He fixes prices, imposes taxes, and distributes subsidies (on the blackboard) to promote the general welfare.
But there is no counterpart to the teacher within the real economic system
Occupational regulation comes with the real risk of the regulation turning into an anti-competitive barrier to entry as Milton Friedman (1962) warned:
The most obvious social cost is that any one of these measures, whether it be registration, certification, or licensure, almost inevitably becomes a tool in the hands of a special producer group to obtain a monopoly position at the expense of the rest of the public.
There is no way to avoid this result. One can devise one or another set of procedural controls designed to avert this outcome, but none is likely to overcome the problem that arises out of the greater concentration of producer than of consumer interest.
The people who are most concerned with any such arrangement, who will press most for its enforcement and be most concerned with its administration, will be the people in the particular occupation or trade involved.
They will inevitably press for the extension of registration to certification and of certification to licensure. Once licensure is attained, the people who might develop an interest in undermining the regulations are kept from exerting their influence. They don’t get a license, must therefore go into other occupations, and will lose interest.
The result is invariably control over entry by members of the occupation itself and hence the establishment of a monopoly position.
Friedman’s PhD was published in 1945 as Income from Independent Professional Practice. With co-author Simon Kuznets, he argued that licensing procedures limited entry into the medical profession allowing doctors to charge higher fees than if competition were more open.
Data Source: Martin Jenkins 2012, Review of Occupational Regulation, released by the Ministry of Business, Innovation and Employment under the Official Information Act.
David Friedman – Poor People are Worse off Thanks to Government – YouTube
06 Jul 2014 Leave a comment
in applied welfare economics, David Friedman Tags: poverty
Would You Give Up The Internet For Life For 1 Million Dollars?
05 Jul 2014 Leave a comment
in applied price theory, applied welfare economics, entrepreneurship, liberalism, technological progress Tags: The Great Enrichment, The Great Fact
from Would You Give Up The Internet For 1 Million Dollars? – YouTube via Luke Froeb.
Welfare economics of monopoly and rent seeking
04 Jul 2014 Leave a comment
in applied price theory, applied welfare economics Tags: monopoly, rent seeking, Tullock

Monopolisation has resulted in a higher price being paid (Pm not Pc) and the quantity bought (Qm not Qc) has been reduced. Part of the consumer surplus triangle has been shifted to producers as excess profits but part of it is totally lost to society as shown by the reduction in output from Qc to Qm.
The monopolised industry may result in more efficient production techniques and lowered costs. The net welfare gain or loss to the total economy is the difference between the red and blue areas.
Tullock’s (1967) argument is that if a successful monopolist can extort the excess profits from his customers such as through a government licence giving them a monopoly, such a large prize is worth the investment of up to an equivalent amount of resources equal to the capitalised value of the future monopoly profits.

Rational entrepreneurs should be willing to invest resources in attempts to form a monopoly until the marginal cost equals the properly discounted marginal return. Under certain assumptions (see Posner 1975) the competitive outlays to establish a monopoly will exactly equal the present value of the profit rectangle.

The Tullock rectangle may have to be added to the Harberger triangle when calculating the potential loss of welfare associated with monopoly.
Euroland is presented by progressives as the type of mixed economies they prefer and larger governments they want
03 Jul 2014 Leave a comment
in applied welfare economics, economic growth, macroeconomics Tags: Eurosclerosis, progressive politics
The OECD countries with persistently high unemployment rate are the European welfare states – about double figures for 2 decades or more now. The reality is progressive politics pits workers against worker, and the middle-class against the poor and rich with the progressives cheering for the middle-class.
Euroland has a labour aristocracy – a two-tier system with ultra-secure workers with the permanent jobs and vulnerable temporary workers. The prime-age workers with the permanent jobs are pitted against the young, the unemployed and the older workers – these three groups are either locked-out or pushed-out. It took the equally worse recession in U.S. post-war history for their unemployment rates to reach the levels in Euroland in most any year out of the last 20.

Progressive solutions have been tried and they failed: a new word had to be invented to capture the resulting high unemployment rates and stagnant productivity growth from adopting progressive policies: Eurosclerosis!

The current-account deficit is a false problem
01 Jul 2014 1 Comment
in applied welfare economics, international economics Tags: capital account surpluses, current account deficits, foreign investment, international trade in savings, John Cowperthwaite
The current account balance equals net foreign investment. When net foreign investment is positive, the current account is in deficit. The current account balance is the result of the international trade in savings and the relative rewards and incentives of investing at home or abroad:
- The current account is in surplus when national saving is greater than net domestic investment; and
- The current account is in deficit when national saving is less than net domestic investment.
New Zealand can import more than it exports courtesy of this foreign investment.
- The difference between exports and imports, or net exports, is the trade balance.
- But for net foreign investment, the trade balance would have to always balance.
For most of the last 20-years, exports have been the same as imports, more or less, so the New Zealand current account deficit has little to do with the level of exports or imports.

A current account could be called a capital account surplus, but this label lacks that certain demonic ring the media laps up. Deficits are bad, surpluses are good. How can a surplus be bad? Who wants to cut a surplus?
John Cowperthwaite solved Hong Kong’s current account problems by not collecting trade statistics. His concern was:
If I let them compute those statistics, they’ll want to use them for planning.
Cowperthwaite refused to collect economic statistics
for fear that I might be forced to do something about them
If New Zealand did not collect trade statistics, would anyone be the worse off? How would we notice?
People knew that unemployment and inflation were a problem long before statistics agencies descended upon us.
The better solutions to unemployment and inflation are rules-based and were developed again long before statistics were collected.
Rules based policy regimes that attempt to stabilise unemployment and inflation often reject discretionary responses to the latest statistical releases.
Indeed, the main focus of rules based policy regimes is to prevent monetary and fiscal policy from becoming an independent source of instability. The secret of inflation targeting is to do as little as possible and not make things worse by doing much more that keeping monetary supply growth in check.
What is the welfare cost of a current account deficit and how does it compare?
- Welfare cost of inflation of 10% is maybe 1-2% of national income; and
- The annual welfare cost of the post-war business cycle is about 1% of national income.
People apparently fear the current account because it may lead to recessions and inflation. But the current account must be a small component of the factors contributing to the welfare cost of inflation and the annual welfare cost of the post-war business cycle.
There are a large number of other factors that cause recessions and and one factor that causes inflation. These must get their share of the 1-2% of national income that is the welfare cost of post-war business cycles and inflation of 10%. Adding up constraints mean that the welfare cost of the current account deficit, if there is such a welfare cost, must be small.
Scobie, Zhang and Makin (2008) found average income gains of $2,600 per New Zealand worker on a cumulative basis from capital inflows over the period 1996 – 2006. International capital mobility allows New Zealand to fund additional investment from external sources which raises wages in New Zealand because there is more technology and capital per worker in New Zealand. To the extent that foreign investment occurs, it raises the amount of capital in a country, driving wages up and profits down.
The current account reflects the relative returns of investing at home and abroad and any consumption smoothing. People save and borrow to smooth out consumption during any temporary ups and downs in their annual incomes.
The current-account balance typically gets worse—moves into deficit—in good times. Reason for this is in good times, people anticipate higher permanent incomes in the future and start spending now before the higher income actually arrives.
New Zealand and Australia based their prosperity on borrowing in anticipation of future increases in production based on exploiting the ample land and natural resources in New Zealand and Australia. This increase of wealth could be spread out over many periods including before it actually arrived because of the ability to borrow in the international credit markets in anticipation of permanently higher future incomes.
Good old fashioned altruism versus a grubby market for kidneys
30 Jun 2014 Leave a comment

via Carpe Diem
How to refute the case for a minimum wage when genuinely calling for a smarter federal minimum wage
30 Jun 2014 1 Comment
in applied price theory, applied welfare economics, labour economics, minimum wage Tags: federalism, george stigler, minimum wage, monopsony

What if minimum wage rates could somehow be tied to specific locations as suggested by former White House economist Jared Bernstein puts it in an essay in the New York Times:
When we adjust a national minimum wage of $10.10 for regional differences, these are the amounts you’d need to have the same buying power: $11.94 in Washington, D.C., and $11.40 in California, but only $8.90 in Alabama and $9.08 in Kansas.
And of course, prices vary within states as well. In the New York City area, it would take $12.34 to meet the national buying power of $10.10; upstate around Buffalo, you’d need only $9.47. In the Los Angeles area, it would take $11.94; go up north a bit to Bakersfield, where prices are closer to the national average, and it’s $9.83.
To repeat what George Stigler said on the unsuitability of a nation-wide minimum wage in 1946 when there was monopsony, and therefore a small minimum wage increase is less likely to result in a reduction in employment:
If an employer has a significant degree of control over the wage rate he pays for a given quality of labour, a skilfully-set minimum wage may increase his employment and wage rate and, because the wage is brought closer to the value of the marginal product, at the same time increase aggregate output…
This arithmetic is quite valid but it is not very relevant to the question of a national minimum wage. The minimum wage which achieves these desirable ends has several requisites:
1. It must be chosen correctly… the optimum minimum wage can be set only if the demand and supply schedules are known over a considerable range…
2. The optimum wage varies with occupation (and, within an occupation, with the quality of worker).
3. The optimum wage varies among firms (and plants).
4. The optimum wage varies, often rapidly, through time.
A uniform national minimum wage, infrequently changed, is wholly unsuited to these diversities of conditions
A smarter federal minimum wage is a federal minimum wage of zero. Let each state and city set a minimum wage in accordance with its own economic conditions and the blackboard economics of monopsony and competition in the labour market.


As soon as you concede that there is not one single national labour market, other concessions must be made. This slippery slope includes that the monopsony power of employers might vary from state to state, city to city, and local labour market from local labour market.
Even a state or city minimum wage regulator would have to pretend to know an immense amount of information about the labour market with most of this information in a tacit form that cannot be summarised in statistics or other decision aids for regulators. As Hayek reminded in his classic in 1945 on The Use of Knowledge in Society:
the fact that the sort of knowledge with which I have been concerned is knowledge of the kind which by its nature cannot enter into statistics and therefore cannot be conveyed to any central authority in statistical form.
The statistics which such a central authority would have to use would have to be arrived at precisely by abstracting from minor differences between the things, by lumping together, as resources of one kind, items which differ as regards location, quality, and other particulars, in a way which may be very significant for the specific decision.
It follows from this that central planning based on statistical information by its nature cannot take direct account of these circumstances of time and place and that the central planner will have to find some way or other in which the decisions depending on them can be left to the "man on the spot."



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