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By means of glasses, hotbeds, and hotwalls, very good grapes can be raised in Scotland, and very good wine too can be made of them at about thirty times the expense for which at least equally good can be brought from foreign countries. Would it be a reasonable law to prohibit the importation of all foreign wines, merely to encourage the making of claret and burgundy in Scotland? …As long as the one country has those advantages, and the other wants [lacks] them, it will always be more advantageous for the latter, rather to buy of the former than to make. |
Adam Smith on growing grapes in Scotland
27 May 2014 Leave a comment
in applied price theory, industrial organisation Tags: Adam Smith, free trade, industry policy, protectionism
Ronald Coase and the preoccupation with monopoly
23 May 2014 Leave a comment
in industrial organisation, law and economics, Ronald Coase Tags: market process, monopoly
One important result of this preoccupation with the monopoly problem is that if an economist finds something—a business practice of one sort or other—that he does not understand, he looks for a monopoly explanation. And as in this field we are very ignorant, the number of ununderstandable practices tends to be rather large, and the reliance on a monopoly explanation, frequent.
After this foray written in 1971, Coase went further in an appreciation written for George Stigler’s Nobel Prize in 1982:
…for reasons which are not altogether clear to me, it is a field [of industrial organisation] which has come to concentrate on The Monopoly Problem and, more specifically in the United States, on the problems thrown up by the administration of the antitrust laws.
The result has not been a happy one for economics.
By concentrating on the problem of monopoly in dealing with an economic system which is, broadly speaking, competitive, economists have had their attention misdirected and as a consequence they have left unexplained many of the salient features of our economic system or have been content with very defective explanations.
The share market as a spy, investigator and muckraker: using share price movements to uncover secrets and solve mysteries
23 May 2014 Leave a comment
in applied price theory, financial economics, industrial organisation, survivor principle Tags: Armen Alchian, event studies
Armen Alchian successfully identifying lithium as the fissile fuel in the Bikini Atoll atomic bomb using only publicly available financial data. The early 1954 RAND corporation memo by Alchian was classified a few days later.
The Stock Market Speaks: How Dr. Alchian Learned to Build the Bomb by Joseph Michael Newhard, August 27, 2013 at for a replication study of Alchian’s event study of share market reactions to the Bikini Atoll nuclear detonations in 1954 updated with declassified information and modern finance theory.
An extra challenge for Alchian was not only was the component of the bomb classified, whether the explosion was atomic or hydrogen was classified too.
The share price of the supplier of lithium surged within a few days.
The replication study by Newhard found a significant upward movement in the price of Lithium Corporation relative to the other corporations. Within three weeks of the explosion, its shares were up 48% before settling down to a monthly return of 28% despite secrecy, scientific uncertainty, and public confusion surrounding the test; the company saw a return of 461% for the year.
The share market is a surprising efficient tool for discerning new knowledge.
After the Challenger space shuttle disaster in 1986, the share market identified within the hour which component supplier made the faulty part and marked it down accurately as to damages and loss of business. The blue ribbon commission of inquiry took 6-months to find the culprit.
In the period immediately following the crash, securities trading in the four main shuttle contractors singled out Morton Thiokol as having manufactured the faulty component.
Intraday stock price movements following the challenger disaster
At market close, Thiokol’s shares were down nearly 12 per cent. By contrast, the share prices of the three other firms started to creep back up, and by the end of the day their value had fallen only around 3 per cent.
Morton Thiokol shed some $200 million in market value on the day. Over the next several months, the other contractors recovered and outperformed the market while Morton Thiokol lagged.
As a result of the investigation, Morton Thiokol had to pay legal settlements and perform repair work of $409 million at no profit. It also dropped out of bidding for future business.
The $200 million equity decline for Morton Thiokol in hindsight is a reasonable prediction of lost cash flows that came as a result of the judgment of culpability in the crash.
William Brown found that a group of firms that had significant ties to Lyndon Johnson increased in the market value after President Kennedy’s assassination. The share prices of General Dynamics, whose main aircraft plant was located in Fort Worth, Texas, climbed from $23.75 on November 22 to $25.13 on November 26, and by February 1964 was up over $30, a jump of around 30 per cent in three months.
Over the ten trading days following the announcement of Timothy Geithner’s nomination as U.S. Treasury Secretary, financial firms with a connection to Geithner experienced a cumulative abnormal return of about 12% relative to other financial sector firms. This reversed when his nomination ran into trouble due to unexpected tax return issues.
Pat Akey (2013) looked at the abnormal returns in share prices around close U.S. congressional elections. Firms gain on the election of a politician with whom they are connected – and they lost when he or she is defeated. The cumulative abnormal return to be between 1.7% and 6%.
Corporate welfare and middle-class welfare defined
20 May 2014 Leave a comment
in applied welfare economics, industrial organisation, Public Choice, rentseeking, survivor principle Tags: corporate welfare, farm welfare, middle-class welfare
The term corporate welfare was coined by Ralph Nader in 1956. Corporate welfare is subsidies, tax breaks, or other favourable treatment for business and implies that business are much less needy of such treatment than the poor.
The Right talks of the deserving and undeserving poor. The Left countered with payments to business.
Supporters of corporate welfare often justify them as remedying some sort of purported market failure.
Businesses, big and small, see market failure everywhere under balance sheets that are in the red.
The notion behind corporate welfare is profits should be private while losses should be a reason for a taxpayer bailout.
Both direct and indirect subsidies to businesses are classified as corporate welfare. The reason is businesses as supposed to make a profit or go out of business.
If a business is losing money, they should try better or do something different or just go out of business.
Losses are not a reason for a taxpayer bailout. No business project should be premised on government subsidies.
The purpose of the capital market is to direct investment to projects that have a future and take support away from failing projects.
The capital market is picking winners and losers every day because that’s its job. That’s what it’s good at.
The participants in the capital market who are not good at picking winners and avoiding losers will themselves will go soon out of business.
Corporate welfare is increasingly used interchangeably with crony capitalism.
A kissing cousin of corporate welfare is farm welfare. These are the countless subsidies that farmers get in Europe and America, and in the past, in New Zealand.
Middle-class welfare is cash payments by the government to the non-poor. These payments to the middle-class can be for having children such as in Working for Families, for early-childhood education or for childcare. Middle-class welfare also can be tax breaks and subsidies for retirement savings of the nonpoor.
It is pointless to tax the middle-class and then give them their money pretty much straight back as a cash payment for a particular purpose be it child care or for their retirement. Middle-class welfare covers at least in part expenses the middle-class could have covered themselves but for the taxes.
What is evidence of price collusion?
16 May 2014 Leave a comment
in industrial organisation, law and economics, Richard Posner Tags: cartels
Posner and Easterbrook suggest that these industry behaviours together are suspicious.
- Fixed relative market shares among top firms over time.
- Declining absolute market shares of the industry leaders.
- Persistent price discrimination.
- Certain types of exchanges of price information.
- Regional price variations.
- Identical sealed bids for tenders.
- Price, output, and capacity changes at the time of the suspected initiation of collusion.
- Industry-wide resale price maintenance or non-price vertical restraints.
- Relatively infrequent price changes; smaller price reactions as a result of known cost changes.
- Demand is highly responsive to price changes at market price.
- Level and pattern of profits relatively favourable to smaller firms.
- Particular pricing and marketing strategies.
Aaron Director’s most creative suggestion of evidence of price collusion is disputes between the marketing and finance departments of a large company. The market department wants to cut prices because there would be a large increase in sales. The finance department says no because this would take the price below the monopoly or agreed cartel price.
The next time you make an allegation of price fixing
15 May 2014 Leave a comment
in entrepreneurship, industrial organisation, law and economics, Richard Posner Tags: cartels
Remember this, firms are only likely to collude in certain market environments.
Brozen and Posner suggest the following pre-conditions to collusion
- market concentration on the supply side;
- no fringe of small sellers;
- high transport costs from neighbouring markets;
- small variations in production costs between firms;
- readily available information on prices;
- inelastic demand at the competitive price;
- low pre-collusion industry profits;
- long lags on new entry;
- many buyers (otherwise selective discounting to big buyers will be too tempting while monitoring adherence to the agreement will be difficult);
- no significant product differentiation;
- large suppliers selling at the same level in the distribution chain;
- a simple price, credit and distribution structure;
- price competition is more important than other forms of competition;
- demand is static or declining over time; and
- stagnant technological innovation and product redesign.
Stable collusive arrangements are thus likely to be rare; the absence of any of the conditions will tend to undermine the potential for successful collusion.
Media conspiracies versus cartel theory
14 May 2014 Leave a comment
in entrepreneurship, industrial organisation Tags: cartels, conspiracy theories, media bias
Media conspiracy theories suggest someone is in control; that dark, all-powerful cabals of men in cultish robes control the world. The truth is no one is in control. What about 57 channels, nothing on!
Newspapers, TV and cable, are not a monopoly. A monopoly is a single seller of as product with a legal right to bar new entry. It is an exclusive right to sell something.
At best, newspapers, TV and cable, are a large and unwieldy cartel under pressure from costs and new entry. The Internet makes electronic news competition global.
There are many different Australian news outlets and media types, three national networks, plus many cable news networks and 9 media owners. That is more than enough to destabilise any cartel.
Why is the mass media special? A supply-side model of media ownership suggesting that media outlets weigh the rewards of bias—political influence or personal pleasure—against the cost of bias—lost circulation from providing faulty news.
The mass media is a big business, and they increase readership and revenue by presenting factual and informative news.
The most likely to turn-off are women, and women vote to the Left more often than do men. The media is perhaps pandering to this centre-left marginal buyer.
A news cartel is like any other cartel. All cartels break-down and only some get back together.
Cartels contain seeds of their own destruction. Cartel members are reducing their output below their existing potential production capacity, and once the market price increases, each member of the cartel has the capacity to raise output relatively easily.
All cartels must decide how to allocate the reduction of output that follows the price increases across members with different costs structures and spare capacity.:
- The tendency is for cartel members to cheat on their production quotas, increasing supply to meet market demand and lowering their price.
- Most cartel agreements are unstable and at the slightest incentive they will quickly disband, and returning the market to competitive conditions.
One sign of a cartel that was developed by Aaron Director is periods of stable prices, despite cost fluctuations, followed by sudden price changes when the cartel collapses or decide to increase prices.
For a news cartel, this means toeing the line and then periods of truth, and then a sudden return to the party line when the cartel starts-up again.
The exercise of collective market power will not be stable unless sellers agree on prices and production shares; on how to divide the profits; on how to enforce the agreement; on how to deal with cheating; and on how to prevent new entry.
A cartel is in the unenviable position of having to satisfy everyone, for one dissatisfied producer can bring about the feared price competition and the disintegration of the cartel.
Thus a successful cartel must follow a policy of continual compromise. Little wonder that John. S McGee wrote that:
The history of cartels is the history of double crossing
Competition as a force for media accuracy or infotainment
09 May 2014 Leave a comment
in entrepreneurship, industrial organisation, market efficiency, survivor principle Tags: infotainment, media bias, Tyler Cowen
Limiting the number of TV stations has unusual effects on media slant and muckraking.
Tyler Cowen argues that competition by itself is not a powerful force for media accuracy.
In the traditional conception of the demand for news, audiences read, watch, and listen to the news in order to get information. The quality of news is its accuracy.
But when there are many media outlets, competition results in a common slanting of news towards reader biases in the audience niche each network are serving. The market is very good are serving up what the customer wants.
Competition forces news outlets to cater to their customer’s niche preferences.
- Realised profit is the criterion by which the market process selects survivors: those who realise positive profits survive; those who suffer losses disappear.
- Positive profits accrue to those news outlets who are better than their competitors. These lesser rivals will exhaust their retained earnings and fail to attract further new investor support.
On topics where reader beliefs diverge on politically divisive issues, media outlets profit from segmenting the market and slanting reports to the biases of their niche audiences.
There is less bland truth-telling and more of the polemics that each market niche wants.
This means that left-wing and right-wing media outlets will hound the political enemies of their readers to cater to the preferences of their audience niche.
The clearest illustration of infotainment is the Lewinsky affair:
- The left wing press presented information designed to excuse Clinton’s sins; and
- The right wing press dug out details pointing to his culpability.
When there are only a few media outlets, the networks instead go for the median viewer/reader and offer more sedate and less scandal driven coverage.
More media competition increases the chances of the muckraking that brings down ministers and governments.
Richard Epstein “The Coming Meltdown in Labor Relations”
07 May 2014 Leave a comment
in industrial organisation, labour economics, law and economics, liberalism, personnel economics, Public Choice, Richard Epstein
Those subservient press barons
07 May 2014 Leave a comment
in economics of regulation, entrepreneurship, industrial organisation, politics, Public Choice, survivor principle Tags: media bias, rent extraction
Both political parties used television licensing and the threat of cable TV to manipulate Murdoch, Packer and the other press barons. They were victims of Fred McChesney’s concept of rent extraction:
- Rent extraction is the politician’s pastime of threatening harmful legislation to extract political support and contributions from well-heeled private institutions.
- Payments to politicians are often made not for political favours, but to avoid political disfavour, that is, as part of a system of political extortion or rent extraction.
Rent extraction is money for nothing – money paid in exchange for politicians’ inaction.
The politician is paid, not for rent creation, but for withholding legislative and regulatory action that would destroy existing private rents.
McChesney establishes the conditions under which of rent creation or extraction will occur. The relative attractiveness of the two strategies depends on the elasticities of demand and supply.
- If demand is relatively inelastic, rent creation will occur; and
- If supply is relatively inelastic, rent extraction will occur.
The existence of an organization or a large established firm lowers transaction costs for the politicians negotiating and collecting donations and support, making rent expropriation threats easier.
It is hard to extort rents from those with little in the way of organisation. A cost of being an established lobbying organisation or a large firm with high fixed costs is a greater potential for rent extraction.
The print and electronic media are ripe for rent extraction because of their immobile assets and heavy regulation.
Investors in heavily regulated capital intensive industries such as the mass media, digital and print, do not bite the hand the feeds them.
Little wonder that the media barons were honoured supplicants to whomever is in power in Canberra. They are soon Labor’s business mates whenever Labor was in power.
Threatening to allow cable TV was the big stick in every Australian government’s hand until the 1990s to extract support or at least subservience from the media.
Rupert Murdoch has unashamedly backed political winners, only to dump them when he was convinced that they were washed up or that his newspapers might be left stranded on the losing side of politics.
Murdoch’s see-sawing political stances are entirely pragmatic. He has always been prepared to back winners just before they win, and to shift allegiances on non-ideological grounds.
The Rawlsian social justice case for super-entrepreneurs and many more billionaires
04 May 2014 Leave a comment
in applied welfare economics, economic growth, entrepreneurship, industrial organisation, market efficiency, Rawls and Nozick, technological progress Tags: envy, John Rawls, super-rich, SuperEntrepreneurs, top 1%, top talent
The report SuperEntrepreneurs shows that:
- SuperEntrepreneurs founded half the largest new firms created since the end of the Second World War
- There is a strong correlation between high rates of SuperEntrepreneurship in a country and low tax rates
- a low regulatory burden and high rates of philanthropy both correlate strongly with high rates of SuperEntrepreneurship
- Active government and supranational programmes to encourage entrepreneurship – such as the EU’s Lisbon Strategy – have largely failed.
- Yet governments can encourage entrepreneurialism by lowering taxes (particularly capital gains taxes which have a particularly high impact on entrepreneurialism while raising relatively insignificant revenues); by reducing regulations; and by vigorously enforcing property rights.
- High rates of self-employment and innovative entrepreneurship are both important for the economy.
- Yet policy makers should recognise that they are not synonymous and should not assume policies which encourage self-employment necessarily promote entrepreneurship.
- Policy makers should use a definition of entrepreneurship which is based on innovation.
SuperEntrepreneurs examined about 1,000 self-made men and women who have earned at least $1 billion dollars and who appeared in Forbes magazine list of the world’s richest people between 1996 and 2010.
Hong Kong has the most, with around three SuperEntrepreneurs per million inhabitants, followed by Israel, the US, Switzerland and Singapore.
The US is roughly four times more super-entrepreneurial than Western Europe and three times more super-entrepreneurial than Japan.
Super-entrepreneurs tend to be well-educated – 84% have a university degree.
Many started their own company but there is no clear relationship between self-employment and successful entrepreneurship
Steven Kaplan and Joshua Rauh’s “It’s the Market: The Broad-Based Rise in the Return to Top Talent” Journal of Economic Perspectives 2013 found that those in the Forbes 400 richest are less likely to have inherited their wealth or grown-up wealthy.
Today’s super-rich are self-made rich because they produce new and better products and services that people wanted and are willing to pay for.
John Rawls was alive to the importance of incentives in a just and prosperous society.
With his emphasis on fair distributions of income, Rawls’ initial appeal was to the Left. Left-wing thinkers then started to dislike his acceptance of capitalism and his tolerance of large discrepancies in income and wealth.
Rawls excluded envy when we are behind his veil of ignorance designed the social contract about how the society will be organised. He believed that principles of justice should not be affected by individual inclinations, which are mere accidents.
Rawls also argued that the liberties and political status of equal citizens encourage self-respect even when one is less well off than others; and background institutions (including a competitive economy) make it likely that excessive inequalities will not be the rule. He supposes that
the main psychological root of our liability to envy is a lack of self-confidence in our own worth combined with a sense of impotence
Then there is the old Russian joke that tells the story of a peasant with one cow who hates his neighbour because he has two. A sorcerer offers to grant the envious farmer a single wish any thing he wants: “Shoot my neighbour’s cow!” he demands.
The Death of the Renaissance Man?
03 May 2014 Leave a comment
in human capital, industrial organisation, labour economics, technological progress Tags: Ben Jones, innovation, polymaths, renaissance man
Ben Jones in ‘The Burden of Knowledge and the Death of the Renaissance Man: Is Innovation Getting Harder? found that as knowledge accumulates as technology advances, successive generations of innovators may face an increasing educational burden.
Innovators can compensate through lengthening their time in education and narrowing expertise, but these responses come at the cost of reducing individual innovative capacities.
This has implications for the organization of innovative activity – a greater reliance on teamwork – and has negative implications for economic growth.
Jones found that the age at first invention, specialisation, and teamwork increased over time in a large micro-data set of inventors. Upward trends in academic collaboration and lengthening doctorates can also be explained in his framework.
Using data on Nobel Prize winners, Jones found that the mean age at which the innovations are produced to win the Prize has increased by 6 years over the 20th Century.
- Before 1901, two-thirds of the Nobel laureates did their prize-winning work before the age of 40 and 20 per cent did it before age of 30.
- By 2000, however, great achievements seldom occurred before the age of 40.
It’s now taking longer for scientists to get their basic training and start their careers. There is simply more to learn because knowledge in all fields has grown by quantum leaps in the past century.
Nobels are being handed out for different types of work than a century ago.
- There has been a trend away from awarding prizes for abstract, theoretical ideas.
- Now more honours are being bestowed on people who have made discoveries through painstaking lab work and experimentation – which takes a lot of time to do.
Jones’ theory provides an explanation for why productivity growth rates did not accelerate through the 20th century despite an enormous expansion in collective research effort and levels of education and many more graduates.
The more experienced readers of this blog might remember that the better of their professors seemed to be masters of the entire field of economics and could teach almost any subject.
These days, too many professors rely on textbooks with annual editions that come with the lecture notes, assignments and test-banks written for them by the publishing company.
Are there any polymaths left? Posner? Tullock?
Brave Kitten Stands Up to a Really Big, Loud Dog
23 Apr 2014 Leave a comment
in cats, survivor principle Tags: brave kitten
via Brave Kitten Stands Up to Dog – YouTube.
But this is also an example of natural selection. Most predators fear a fight so standing up to them may tip the balance. The young of other prey animals sit still so as to not trigger the chase, kill instinct.
PEETA (People Enjoy Eating Tasty Animals)-updated
23 Apr 2014 1 Comment
in applied welfare economics, law and economics, liberalism, survivor principle Tags: food, natural selection, PEETA, PETA
The web site formally known as People Enjoy Eating Tasty Animals (PEETA) is one of my favourite web sites.
When called PEETA in 1996 or so, this web site was the subject of a pioneering intellectual property court case by PETA.
The web site is a resource for those who enjoy eating meat, wearing fur and leather, hunting, and the fruits of scientific research. More on animal testing later with the help of Penn and Teller.
via People Eating Tasty Animals.
BTW, why are people not allowed to eat tasty animals, but other animals are allowed to eat each other if they can catch them. Should carnivores be required to become vegans? That would be a death sentence for them.
The case against industry policy in one photo
22 Apr 2014 Leave a comment
in industrial organisation, market efficiency, politics - New Zealand, Public Choice, survivor principle Tags: industry policy, picking losers, picking winners
Industry policy is back in vogue in New Zealand:
- The National Party-led Government is keen on smart specialisation.
- The Labour Party wants a Manufacturing Upgrade targeting R&D and innovation.
The case against picking winners is the answer to the question in the picture of the weirdoes below.
One of the people in the photo won a competition on the radio that offered free company photos. That is how Microsoft could afford the photo. That photo became one of the most iconic photos in American business history.
I first saw this photo 12-14 years ago at a presentation, so who first designed the caption is lost in time.
Utopia, you are standing in it! 
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