Alchian and Allen on the irrelevance of economists and economic principles to progress
24 Jun 2014 Leave a comment
Coase and Demsetz on comparative institutional analysis and the fallacy of comparing actual institutions with unrealistic, idealised alternatives
23 Jun 2014 Leave a comment
in comparative institutional analysis, constitutional political economy, Ronald Coase, Ronald Coase Tags: Harold Demsetz, Roanald Coase
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It is my belief that the failure of economists to reach correct conclusions about the treatment of harmful effects cannot be ascribed simply to a few slips in analysis. It stems from basic defects in the current approach to problems of welfare economics
Ronal Coase (1960)
The view that now pervades much public policy economics implicitly presents the relevant choice as between an ideal norm and an existing ‘imperfect’ institutional arrangement.
This nirvana approach differs considerably from a comparative institution approach in which the relevant choice is between alternative real institutional arrangements…
the design of institutional arrangements that provide incentives to encourage experimentation (including the development of new products, new knowledge, new reputations, and new ways of organizing activities) without overly insulating these experiments from the ultimate test
of survivalHarold Demsetz (1969)
Alchian and Allen’s list of economic fallacies
13 Jun 2014 Leave a comment
in applied price theory, Armen Alchian Tags: Armen Alchian, Bill Allen
- Price controls prevent higher costs to consumers;
- reducing unemployment requires creating more jobs;
- larger incomes for some people require smaller incomes for others;
- free, or low, tuition reduces costs to students;
- unemployment is wasteful;
- stockbrokers and investment advisors predict better than throwing a dart at a list of stocks;
- international trade deficits are bad and surpluses are good;
- inflation is caused by government deficits;
- government budget deficits reduce saving and raise interest rates;
- new taxes are borne by the consumer of the taxed items;
- employers pay for "employer provided" insurance;
- tax-exempt bonds avoid taxes;
- minimum wages help the unskilled and minorities;
- housing developers drive up the price of land;
- foreign imports reduce domestic jobs;
- "equal pay for equal work" aids women, minorities and the young;
- very low unemployment causes inflation; and
- the Federal Reserve Board controls the rate of interest.
Source: Universal Economics
Armen Alchian would have been 100 today
13 Apr 2014 Leave a comment
in applied welfare economics, Armen Alchian, market efficiency Tags: Armen Alchian, price system, property rights
From Alchian’s and William Allen’s 1968 “What Price Zero Tuition?“
Since the fiasco in the Garden of Eden, mankind has suffered from scarcity: there cannot be enough goods and services to satisfy completely all the wants of all the people all the time.
Consequently, man has had to learn the hard way that in order to obtain more of this good he must forego some of that: most goods carry a price, and obtaining them involves the bearing of a cost.
Poets assure us that the best things in life are free. If so, education is a second-best good, for it decidedly is not free. But if education is not free, if a price must be paid, who is to pay it?
By developed instinct, the economist initially presumes it to be appropriate that payment of the price should be made by those who receive the good.
"Those who get should pay" is a strong rule of thumb; the economist will deviate from it only for profoundly compelling reasons.
via Quotation of the Day…. Cafe Hayek
Alchian and Allen wrote the best economics textbook ever.
Exchange and Production: Competition, Coordination and Control in 1977
Armen Alchian on property rights
The Girl Scouts, entrepreneurial alertness and the theory of the firm
11 Apr 2014 Leave a comment
in entrepreneurship, theory of the firm Tags: Girl scouts
Girl Scouts (the firm) allow entrepreneurship from within. This girl was alert enough to camp outside of a marijuana dispensary.
Alchian, Demsetz and the efficiency enhancing roles of unions
31 Mar 2014 Leave a comment
in Armen Alchian, labour economics, theory of the firm Tags: transaction costs, unions
Many look at unions as a cartel that raises wages at the expense of non-members.
What has been under-sold is the efficiency enhancing role of unions in Alchian and Demsetz (1972) – their modern classic on the theory of the firm.
Employee unions, whatever else they do, act as monitors for employees.
- Are correct wages paid on time? Usually, this is easy to check.
- But some forms of employer performance on the employment contract are less easy to meter and is at risk to employer shirking.
Medical, hospital, and accident insurance and retirement pensions are contingent payments paid in kind by employers to employees. Each employee cannot judge the character of such payments as easily as with money wages.
A specialist monitor – a union hired by the employees – monitors those aspects of employer payments that are more difficult for employees to monitor. As an example, many unions sit on the board of directors of pension funds as an employee watch dog.
Because of economies of scale in monitoring and enforcing contracts, unions may arise as an institution to reduce the costs of contracting for employees with investments in specific human capital and back-loaded pay, including employee pension plans.
In addition to these narrow contract-monitoring economies of scale, a union creates a continuing long-term employment relationship that eliminates the last-period (or transient employee) contract-enforcement problem and creates bargaining power (a credible strike threat) to more cheaply punish a firm that violates the employment contract.
- As a union makes it more costly for a firm to cheat an individual worker in his last period of work, workers are more likely to invest in specific human capital and accept back-loaded pay schemes, both of which raises their career wages and productivity.
- A strike is a cheaper way to enforce a contract than is litigation. Many firms stop dealing with a bad customer/unreliable supplier until a bill or problem is fixed. A quick strike is no different.
Unions are more likely to exist when the opportunistic cheating problem is greater, namely, when there is more firm-specific human capital present in the employment relationship.
Unions perform many of the functions carried out by professional agents in the sports and entertainment industries. These specialists know the going rate for specific talents; act as a credible and informed negotiating agent; warn their clients off working for bad employers; and punish bad employers by not referring future clients to them.
The traditional literature on unions argues that unions act as a productivity shock and give employee voice in workplace affairs, which lowers job turnover. Unions as an institution to reduce contract negotiation and enforcement costs is better nested in the modern theory of the firm. Of course, unions can also act as cartels.
The next blog on unions will be on the withering away of the union wage premium. The final blog will be on how strikes can enhance the profits of employers!
Whatever is, is efficient – part 1
27 Mar 2014 Leave a comment
in Armen Alchian, behavioural economics, industrial organisation, labour economics, market efficiency Tags: Armen Alchian, behavioural economics, rational behaviour, rational choice economics, Richard Posner
Armen Alchian would ask “If something is so optimal, why don’t we see it then?”
The best way Alchian related this discipline on thinking was to point to something like the question of optimal taxes. If optimal taxes are so optimal, why don’t we see more of these optimal taxes in practice?
There must be other costs left out of your optimal tax analysis. There might be less obvious costs in the political system in organising support or other changes that are required that are overlooked, making optimal taxes such a ‘low-cost’ option. Most objectives look better than they are if you ignore some of the costs of achieving those objectives.
Alchian asserted that “whatever is, is efficient.”
- If the status quo was not efficient, something else would eventuate;
- Of course, if you try to change anything that is – that too is efficient because otherwise you would not try to do so.
The key point is why are we weighing only some costs and not others? Why are these costs (involved in minimizing particular dead-weight losses that would be involved in setting a particular optimal tax) less important than other types of costs (those involved in informing people of what the options are or of organizing them to go and try to adopt the alternative option)? Optimal taxes are also decidedly less optimal if they allow governments to raise more revenue, and the extra revenue is not spent wisely.
Alchian’s analysis of institutions and processes spent a lot of time showing that many often puzzling institutions and practices arose to lower various costs of decision making and transacting in the market and within organisations and groups. Many of these costs are far from obvious and must be teased out through difficult, time-consuming analysis.
Alchian was a great teacher. He taught in the Socratic Method. He posed countless questions to force his students to think harder and deeper.
Behavioural economics is an example of a whole field that expanded not by thinking harder and deeper using standard economic tools. It explains anomalous behaviour and seemingly irrational choices as the result of cognitive quirks or short-sightedness and a range of people’s other shortcomings. That is easier than spending a few more decades getting to the bottom of the matter.
George Stigler in the 1960s made a marvellous critique of what became behavioural economics back in the early 1960s by saying that in every decade for the last 150 years, economists dabbled in psychology.
Stigler said that they missed the point of economics as a method. He argued that the simple hypothesis of rational behaviour is so powerful because it can account for so much of human behaviour. Stigler adds this in his Tanner Lectures in 1981:
Members of other social sciences often remark, in fact I must say complain, at the peculiar fascination that the logic of rational decision-making exerts upon economists.
It is such an interesting logic: it has answers to so many and varied questions, often answers that are simultaneously reasonable to economists and absurd to others. The paradoxes are not diminished by the delight with which economists present them…
The power of self-interest, and its almost unbelievable delicacy and subtlety in complex decision areas, has led economists to seek a large role for explicit or implicit prices in the solution of many social problems.
Richard Posner went further and argued that behavioural economics may not be a science in Popper’s sense of falsifiability.
Posner referred to Cardinal Bellarmine’s famous description of what he saw in Galileo’s telescope which was pointing to the moons rotating around Saturn. Cardinal Bellarmine explained it as a trick of the devil.
Behavioural economics, in Richard Posner’s view, is close to Cardinal Bellarmine’s trick of the devil methodology because it explains anomalies away either as cognitive quirks or as rational behaviour. Nothing is an anomaly for behavioural economics so nothing can falsify it. Instead of the devil making me do it, a cognitive quirk made me do it.
Posner’s key point was:
Rational-choice economics makes the analyst think hard. Faced with anomalous behaviour, the rational-choice economist, unlike the behavioural economist, doesn’t respond, “Of course, what do you expect?” Troubled, puzzled, challenged; he wracks his brains for some theoretical extension or modification that will accommodate the seeming anomaly to the assumption of rationality.
Rather than attribute odd behaviour to cognitive quirks or short-sightedness, the better explanation is the behaviour is not fully understood.
Why are there so few workers’ co-ops?
19 Mar 2014 6 Comments
in Austrian economics, industrial organisation, labour economics, managerial economics, organisational economics, theory of the firm Tags: adverse selection, cooperative ownership, Jon Elster, kibbutzim, moral hazard, Ran Abramitzky, Robert Nozick, worker ownership
If workers’ cooperatives are so efficient, why are there so few cooperatives? Workers’ cooperatives should be able to slowly undercut other firms on price because they do not have to pay a profit to the capitalists.
Building societies, credit unions and some life insurance companies were mutually owned by their customers for a long time, but recently fell out of favour because of a growing lack of competitiveness and under-capitalisation.
Cooperatives are not economically viable because of intrinsic difficulties of entrepreneurship and management. And most workers prefer to work in firms for a wage rather than wait for the co-op to start up and hopefully break even before they get their first pay cheque. That could be a slow train coming.
The kibbutzim are Israeli agricultural communities initially organized on socialist lines, mostly between the 1910s and 1950s. The kibbutz is an example of voluntary socialism. The founders of kibbutzim were socialist idealists wanting to create a new human being.
Robert Nozick pointed out that few people actually join a kibbutz. Six per cent is the maximum proportion of any population who would voluntarily choose to live in these socialist communities. More recently, 2.6% of the Israeli population live on a kibbutz.
Originally, most kibbutzim followed strict socialist policies forbidding private property; they also required near-total equality of income regardless of differences in productivity, and in some cases, even abandoned the specialisation of labour. Kibbutzim are communities whose aim is equal sharing.
Kibbutzim were expected to fail because of moral hazard and adverse selection. Other organisations subject to adverse selection and moral hazard are professional partnerships, co-operatives, and labour-managed firms because they are all based on revenue sharing.
Kibbutzim have persisted for most of the twentieth century and are one of the largest communal movements in history. About 40% are still run on communist principles. Why is this so?
The kibbutz movement was founded by individuals who can be regarded as ex-ante homogeneous in their ability and potential income, and who came to a new land full of uncertainties. They were young unattached individuals who share a comparatively long period of social, ideological, and vocational training.
An even more durable example of voluntary collectivist living is Catholic monasteries and convents, but notice that these too were founded on a realization that close family ties are inimical to communal order.
Kibbutz founders wanted insurance, but their founders realised that members who would turn out to have high abilities might leave the Kibbutz.
- The founders of the kibbutzim decided to abolish all private property and to own all wealth commonly, which served as a lock-in device.
- Like monasteries and convents, kibbutzim deter members from fleeing through this communal ownership of property. You leave with the shirt on your back!
Kibbutzim also put prospective members through lengthy trial periods to make sure they are made of the right stuff. Those raised on a kibbutz tend to have learned kibbutz-specific skills, such as agronomy, which also makes exit to the outside world even more difficult.
Kibbutzim are similar to law firms, medical and business partnerships that pool income for risk sharing purposes.
Mutual monitoring and peer pressure replace direct monetary incentives in mitigating moral hazard in a kibbutz (and in monasteries and convents) in the same way as in professional partnerships, cooperatives, and labour-managed firms with pooled assets and the option of exit.
The trade-off between insurance and adverse selection determines the level of equality within a kibbutz and its size, as with any other professional partnership:
- Kibbutz vary in size from less than a hundred to over a thousand, but most have between 400 and 600 members, with an average of 441 members.
- Kibbutz size is limited by the savings on income insurance no longer offsetting the costs of moral hazard and other transaction costs as the Coasian firm grows in size.
Ran Abramitzky writes with great insight on the economics of the kibbutzim. He is writing a book The Mystery of the Kibbutz: How Socialism Succeeded. He found that high-ability individuals are more likely to leave a kibbutz. The brain drain would be worse if kibbutzim didn’t make it so costly to exit. Is this a familiar theme of socialism?
Many hybrid organisations exist in the market, ranging from joint ventures and agricultural seller and supermarket buyer co-ops to labour-owned firms such as in most of the professions.
But rarely do we find real life existing cooperatives with all workers and only workers having equal ownership rights. As Jon Elster noted, there are often non-working owners, non-owning workers and unequal distribution of shares in real life workers’ co-ops. All other types of co-ops and professional partnership share this feature.
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