Saturday, December 31, 2016

Testing Market Failure Theories

by Levi Russell

I recently picked up a copy of Tyler Cowen and Eric Crampton's 2002 edited volume Market Failure or Success: The New Debate (now only in print with the Independent Institute, though it was originally published by Edward Elgar) and have really enjoyed what I've read so far. The book is a collection of essays by prominent IO scholars organized into four sections: a fantastic introduction by the editors, four essays that form the foundation of the "new" market failure theories based on information problems, four theoretical critiques of said theories, and 8 essays providing empirical and experimental evidence of the editors' thesis: that information-based market failure theory is often merely a theoretical possibility not borne out in real life and that economic analysis of knowledge often provides us with the reasons why.

Two pieces by Stiglitz are featured in the first theoretical section: one on information asymmetries and wage and price rigidities and the other on the incompleteness of markets. Akerlof's famous "lemons" paper and Paul David's paper on path dependence are also included. I was happy to see that Demsetz's "Information and Efficiency; Another Viewpoint" was the first essay in the theoretical critique section as it sets the stage for the other chapters in that section. The empirical and experimental section features Liebowitz and Margolis' response to Paul David on path dependence in technology, Eric Bond's direct test of Akerlof's "lemons" model, and an essay I've never ready by Gordon Tullock entitled "Non-Prisoner's Dilemma."

The introduction provides a short summary of the arguments presented in the following 3 sections and includes a great discussion of the editors' views of the core problems with information-based market failures. Here's the conclusion of the intro chapter:
Our world is a highly imperfect one, and these imperfections include the workings of markets. Nonetheless, while being vigilant about what we will learn in the future, we conclude that the 'new theories' of market failure overstate their case and exaggerate the relative imperfections of the market economy. In some cases, the theoretical foundations of the market failure arguments are weak. In other cases, the evidence doe snot support what the abstract models suggest. Rarely is analysis done in a comparative institutional framework. 
The term 'market failure' is prejudicial - we cannot know whether markets fail before we actually examine them, yet most of market failure theory is just theory. Alexander Tabarrok (2002) suggests that 'market challenge theory' might be a better term. Market challenge theory alerts us to areas where market might fail and encourages us to seek out evidence. In testing these theories, we may find market failure or we may find that markets are more robust than we had previously believed. Indeed, the lasting contribution of the new market failure theorists may be in encouraging empirical research that broadens and deepens our understanding of markets.
We believe that the market failure or success debate will become more fruitful as it turns more to Hayekian themes and empirical and experimental methods. Above, we noted that extant models were long on 'information' - which can be encapsulated into unambiguous, articulable bits - and short on the broader category of 'knowledge,' as we find in Hayek [Hayek's 1945 article The Use of Knowledge in Society can be read here for free. A short explanation of the main theme of the article can be found here. - LR]. Yet most of the critical economic problems involve at least as much knowledge as information. Employers, for instance, have knowledge of how to overcome shirking problems, even when they do not have explicit information about how hard their employees are working. Many market failures are avoided to the extent we mobilize dispersed knowledge successfully. 
It is no accident that the new market failure theorists have focused on information to the exclusion of knowledge. Information is easier to model, whereas knowledge is not, and the economics profession has been oriented towards models. Explicitly modeling knowledge may remain impossible for the immediate future, which suggests a greater role for history, case studies, cognitive science, and the methods of experimental economics. 
We think in particular of the experimental revolution in economics as a way of understanding and addressing Hayek's insights on the markets and knowledge; Vernon Smith, arguably the father of modern experimental economics, frequently makes this connection explicit. Experimental economics forces the practitioner to deal with the kinds of knowledge an behavior patterns that individuals possess in the real world, rather than what the theorist writes into an abstract model. The experiment then tells us how the original 'endowments' might translate into real world outcomes. Since we are using real world agents, these endowments can include Hayekian knowledge and not just narrower categories of information. 
Experimental results also tend to suggest Hayekian conclusions. When institutions and 'rules of the game' are set up correctly, decentralized knowledge has enormous power. Prices and incentives are extremely potent. The collective result of a market process contains a wisdom that the theorist could not have replicated with pencil and paper alone.

Tuesday, December 27, 2016

On Regulatory Cost-Benefit Analysis

by Levi Russell

I recently ran across a fantastic article in Regulation magazine written by George Washington University regulation expert Susan Dudley. The article, entitled "OMB's Reported Benefits of Regulation: Too Good to Be True?" tackles an issue not often raised in policy discussions: What are the assumptions underlying cost-benefit analysis of regulation? Dudley explains in detail the way in which benefits are counted and how the scope of the analysis differs for benefits and costs. A single benefit category, reductions in fine particulate matter (PM 2.5), is responsible for the bulk of benefits calculated by OMB.

Given this focus on fine particulate matter, it would make sense that the science on the harm caused by PM 2.5 would inspire a lot of confidence. On the contrary, Dudley writes:
The OMB identifies six key assumptions that contribute to this uncertainty in PM2.5 benefits estimates. One assumption is that “inhalation of fine particles is causally associated with premature death at concentrations near those experienced by most Americans on a daily basis.” The EPA bases this assumption on epidemiological evidence of an association between particulate matter concentrations and mortality; however, as all students are taught, correlation does not imply causation (cum hoc non propter hoc), and the agency cannot identify a biological mechanism that explains  the  observed  correlation.  Risk  expert  Louis  Anthony  Cox raises questions as to whether the correlation the EPA claims is real. His statistical analysis (published in the journal Risk Analysis) concludes with a greater than 95 percent probability that no association exists and that, instead, the EPA’s results are a product of its choice of models and selected data rather than a real, measured correlation.

Another  key  assumption  on  which  the  EPA’s (and therefore the OMB’s) benefit estimates hinge is  that  “the  impact  function  for  fine  particles  is approximately  linear  within  the  range  of  ambient  concentrations  under  consideration,  which includes concentrations below the National Ambient Air Quality Standard” (NAAQS). Both theory and data suggest that thresholds exist below which further  reductions  in  exposure  to PM 2.5 do  not yield changes in mortality response and that one should expect diminishing returns as exposures are reduced to lower and lower levels. However, the EPA assumes  a  linear  concentration response  impact function that extends to concentration below background levels. The OMB observes, “indeed, a significant portion of the benefits associated with more  recent  rules  are  from  potential  health  benefits in regions that are in attainment with the fine particle standard.”

Based  on  its  assumptions  of  a  causal,  linear, no-threshold relationship between PM 2.5 exposure and premature mortality, the EPA quantifies a number  of  “statistical  lives”  that  will  be  “saved” when concentrations of PM 2.5 decline as a result of regulation. If any of those assumptions are false (in other words, if no association exists, if the relation-ship is not causal, or if the concentration-response relationship is not linear at low doses), the benefits of reducing PM 2.5 would be less than estimated and perhaps even zero.

Further, as the OMB notes, “the value of mortality risk reduction is taken largely from studies of the willingness to accept risk in the labor market[where the relevant population is healthy and has a  long  remaining  life  expectancy]  and  might  not necessarily apply to people in different stages of life or health status.” This caveat is particularly important in the case of PM2.5 because, as the EPA’s 2011 analysis reports, the median age of the beneficiaries of these regulations is around 80 years old, and the average extension in life expectancy attributable to lower PM 2.5 levels is less than six months.
 It's clear that there are some serious, objective problems with the way some benefits of regulation are calculated. Dudley concludes:
The OMB’s role is to serve as a check against agencies’ natural motivation to paint a rosy picture of their proposed actions. While it cannot ensure that agencies consider all the possible consequences of an action in their analyses, it should try to ensure that the boundaries of those analyses are set with some regard to objective science. When a few categories of benefits that have questionable legitimacy puff up benefits by a five-fold margin or more, that does not appear to be the case.
Beyond the objective, scientific questions concerning the benefits of regulation, analysis of the costs are important as well. In my recent piece in Perspective, a magazine published by the Oklahoma Council of Public Affairs, on the costs of environmental regulation of agriculture, I point to the fundamental uncertainty facing regulators. This uncertainty is not accounted for in the cost calculations of the regulations they enforce:
The uncertainty and compliance costs associated with these regulations represent serious concerns for producers. Recent surveys of row crop producers, cattle producers, and feedlot operators indicate that future environmental regulation is a top concern for their businesses over the long term.
This is not to say that regulators are ill-intentioned. They face a highly complex and difficult problem: implementing the will of Congress for the betterment of the American people. The knowledge and information required to regulate even one industry is immense. Not only is it costly to obtain the information necessary to pass effective regulations, regulators can’t be sure that unforeseen unintended consequences won’t diminish the effectiveness of their rules or cause more harm than good. Proposed measures to ensure effective regulation that is not overly burdensome, such as sunset provisions that would require regulations to lapse on a periodic basis, have been put forth but have not been implemented widely. Other propositions include less federal and more local and state control over environmental policy and greater use of common law courts to deal with environmental problems. Both of these proposals acknowledge the information problems inherent in the regulation of agriculture.
There are significant political hurdles to overcome if we are to inject more scientific and objective analysis into regulatory cost-benefit calculation. Knowing how that calculation is done is a crucial first step; Susan Dudley's article is a great way to inform the public so we can get the reform ball rolling!

Monday, December 19, 2016

More on Contestability and the Baysanto Merger

by Levi Russell
In a previous post, I discussed monopoly concerns with Bayer's acquisition of Monsanto. The deal was recently approved by Monsanto shareholders but will likely face significant scrutiny from anti-trust regulators.

In the previous post, I went through a paper by several Texas A&M economists that examined the likely consequences of the acquisition for several row crop seed prices. In this post, I'll make some other comments on contestability.

The A&M paper sticks to standard IO theory:
Concentrated markets do not necessarily imply the presence of market power. Key requirements for market contestability are: (a) Potential entrants must not be at a cost disadvantage to existing firms, and (b) entry and exit must be costless.
In contrast to standard IO theory, VRIO analysis suggests costs are always lower for incumbent firms. Managers of incumbent firms have experience with the specific marketing, managerial, and financial aspects of the industry that new entrants simply don't or must obtain at an additional cost.

Does this imply that no industry is "contestable" in an abstract sense? No. As I pointed out previously, prices are falling in many industries, even in those in which entry would entail 1) significant advantages for incumbents and 2) significant sunk costs. It does imply that the conditions for "contestability" are broader than the standard definition. The resource-based view of the firm provides an alternative view of contestability: The advantages for incumbents and potential sunk costs must simply be small enough that they are outweighed by an entrepreneur's expectation of economic profit associated with entering the industry.

So, when we see apparent divergences between price and marginal cost, as I see it there are three possibilities:

1) there are costs we as third-party observers don't see
2) the economic profit is associated with short-term returns to innovation (e.g. monopolistic competition)
3) there is a legal barrier to entry that is extraneous to the market itself.

This dynamic perspective (which I argue is easily teachable to undergrads) is much more powerful in advancing our understanding of real-world market behavior. Yes, the more unrealistic assumptions made in standard theory allow for more elegant mathematical modeling, but if our goal is to understand causal factors associated with firm behavior, the resource-based view of the fiirm, VRIO analysis, and other dynamic theories are more useful.

Wednesday, November 30, 2016

The Poultry Price Paradox - Why Are Turkeys Cheaper During Thanksgiving?

Guest Post
by David Williamson

Over the holiday, Catherine Rampell wrote a piece for the New York Times that raised an interesting question. Why are turkeys cheaper during Thanksgiving when demand is higher? Rampell offers two possible explanations, but I am not totally convinced by either of them. So, I will spell out my concerns with each of Rampell's explanations below and offer a third explanation of my own. Rampell's comments are in block quotes and mine are not.

Explanation #1 (Rampell) - Turkeys are "Loss Leaders"

The most intuitive and popular explanation for a high-demand price dip is that retailers are selling 'loss leaders.' Stores advertise very low prices — sometimes even lower than they paid their wholesalers — for big-ticket, attention-grabbing products in order to get people in the door, in the hope that they buy lots of other stuff. You might get your turkey for a song, but then you also buy potatoes, cranberries and pies at the same supermarket — all at regular (or higher) markups.
This is certainly the most popular explanation, but I worry that it ignores the consequences of competition. The way your store makes money selling turkeys at a loss is by attracting new customers that would normally buy potatoes, cranberries, and pies from your competitors' stores. But why would your competitors allow you to steal their customers? Wouldn't they lower the price of their turkeys in response? If so, wouldn't this cancel your effort to attract new customers and just leave you losing money on turkeys? Also, as an empirical matter, do stores really charge the same or higher prices for potatoes, cranberries, and pies during Thanksgiving? I can't find any systematic data to answer this question, but Kroger (America's largest traditional grocery store) had sales on all these items before Thanksgiving and not just turkeys.

Explanation #2 (Rampell) - Grocery Stores Are Price Discriminating
[P]lenty of economists...argue that it’s actually demand-side forces — changing consumer preferences — that drive these price drops. Consumers might get more price-sensitive during periods of peak demand and do more comparison-shopping, so stores have to drop their prices if they want to capture sales.
This explanation seems more theoretically consistent to me, but I think it rests on three shaky empirical assumptions. First, a grocery store needs market power to price discriminate. However, even after years of growing concentration, this industry is still pretty competitive (the top four firms account for less than 40% of sales). Second, to preserve its pricing strategy, a price discriminating grocery store needs to prevent others from buying in the cheap market (the Thanksgiving season) and selling in the expensive market (the rest of the year). But how do you stop anyone with a freezer from doing just that? Third, for charging consumers less in November to make sense, it must be that they are more price sensitive during the holidays. But is that true? Rampell gives some good reasons for why it might be true, but I can also see why they might not. Specifically, people tend to be more price sensitive when there are more close substitutes available. I am personally very sensitive to the price of Coke because there are always close substitutes (e.g. Pepsi). But it seems like there are very few substitutes for turkey during Thanksgiving. Would Thanksgiving be the same at your home if you served chicken instead?

Explanation #3 (Me) - The Costs of Stocking Turkey are Lower

My preferred explanation is that because grocery stores are competitive, they must charge prices that reflect the marginal costs of the products they sell. Therefore, if the price of turkeys is higher in July than November, it must be because each turkey is more costly to sell. The tough part is figuring out why. One reason turkeys might be more expensive for grocers to sell in July is that they don't sell very quickly that time of year (i.e. they have low "turnover"). Low turnover means higher costs for grocery stores because every day a product sits unsold on your shelf, you are giving up money you could have earned by stocking something that would sell more quickly. When turkeys start flying off the shelves in November, the cost of stocking each turkeys drops and that is reflected in the price. An advantage of this explanation is that it also implies that we would expect the price of cranberry sauce and pumpkin pie to be lower during Thanksgiving, which I think is the case.

What do you all think? Am I missing something important about Rampell's argument? Am I wrong that higher turnover means lower marginal costs? Are there other reasons why turkeys might cost less to sell and product in November? Your comments are much appreciated. Happy Holidays!

Friday, November 18, 2016

Nudging the Nudgers with Better Regulatory Policy

by Levi Russell

A recent law blog post by Brian Mannix (hat tip to David Henderson for the link) discusses the significance of the Congressional Review Act (CRA) during a presidential transition period. In a nutshell, the CRA allows congress to overturn a regulation written by an agency in the executive branch with a bare majority in each house until the 60th day after it is issued. Of course, like a bill, the president can veto, in which case congress must come up with a 2/3 majority to override the veto. Given that most presidents wouldn't want to stop their own branch of government from implementing regulations, the CRA doesn't often come into play. However, since Republicans control both houses and the incoming president is a Republican, there are some interesting things that could happen given the Republicans' ostensible preference for less regulation. Mannix has some interesting examples in his post so I suggest reading it.

What interested me was a specific line in the post:
Note that the CRA mechanism is distinct from the proposed REINS Act mechanism.  Under REINS, Congress would need to approve of major regulations before they become effective; under the CRA rules become effective if Congress refrains from disapproving.
This got me thinking about behavioral economics and the idea of "nudges." An example of a nudge is a change to the rules that makes the "best" option the default. Often nudges are suggested as part of government policy, but that's not always the case. An oft-repeated example is to make 401k enrollment with your employer the default option while still providing an "opt out" opportunity for those who don't want to contribute to a 401k.

Looking again at the last sentence in the quoted text above, the REINS Act strikes me as a great example of "nudging the nudgers." That is, imposing a rule on those in the executive branch who are in charge of making and enforcing rules based on legislation. Specifically, the REINS Act would make the default position "no new regulations" and only those that passed additional scrutiny by elected representatives would actually be issued. I argue that, at least potentially, the REINS Act would lead to better regulation for a couple of reasons:

1) There would be more oversight by elected representatives of the regulatory process than there is currently.

2) Massive regulations like those written based on Dodd-Frank or the Affordable Care Act would probably be issued more slowly since the regulations would have to be approved by Congress. This would give us a chance to see how the initial regulations actually play out rather than relying on speculative cost/benefit analysis (side note - most regulations aren't subjected to cost/benefit analysis anyway).

Additionally, the REINS Act could reduce the problem of passing on more authority to the executive branch than it was designed to have. This problem arises when Congress passes a very general bill (which is more likely to garner enough votes to pass than a very narrowly-written bill) empowering the executive branch's bureaucracy to write regulations that are less likely to be in line with the will of the people.

The REINS Act was passed in the House last year and is currently sitting in the Senate. It would be great to see more discussion of this bill, but perhaps I just missed it. I'd love to read your thoughts in the comments below!

Bonus: Here's a great article on "nudging the nudgers."

Note that the CRA mechanism is distinct from the proposed REINS Act mechanism.  Under REINS, Congress would need to approve of major regulations before they become effective; under the CRA rules become effective if Congress refrains from disapproving. - See more at:

Tuesday, November 15, 2016

Ignoring Positive Externalities

by Levi Russell

Recently ag economist Jayson Lusk visited UGA to speak on the future of food and the "food movement." One great point he made is that food is quite abundant now relative to any time in the past, and yet there is a very lucrative book and movie industry built around concerns with our food supply. Certainly our food system is far from perfect, but absolute poverty on a global scale has been curtailed dramatically.

A question from the audience particularly interested me: what about externalities related to our current food production methods such as pollution? Lusk's answer was very good. He acknowledged the existence of both negative and positive externalities in food production. He went on to state that both should be considered when designing policy. It certainly seems to me that a lot of attention is paid to the negative externalities associated with food production in the policy world and in the economics profession; relatively little attention is paid to measuring the positive externalities such as the fact that on average Americans spend only about 10% of their disposable income on food and are free to pursue all sorts of other interests.

This discussion reminded me of a paper I read awhile back. It's ungated, and I encourage you to read it if you're interested in this stuff. Here's the abstract:
This paper criticizes the treatment of externalities presented in modern undergraduate economic textbooks. Despite a tremendous scholarly push-back since 1920 to Pigou’s path-breaking writings, modern textbook authors fail to synthesize important critiques and extensions of externality theory and policy, especially those spawned by Coase. The typical textbook treatment: 1) makes no distinction between pecuniary and technological externalities; 2) is silent about the invisible hand’s unintended and emergent consequences as a positive externality; 3) overemphasizes negative externalities over positive ones; 4) ignores Coase’s critique of Pigouvian tax “solutions;” and 5) ignores the potential relevance of inframarginal external benefits in discussions of policy “solutions” to negative externalities. Aside from presentations of “The Coase Theorem” excerpted from only 4 pages of Coase’s voluminous writings, it is as though the typical textbook author slept through nearly a century of scholarly critique of Pigou.

Friday, November 11, 2016

Have GMOs Benefited Us?

by Levi Russell

A recent NY Times article claimed that GMO crops are not delivering the originally-promised benefits of higher yields and lower pesticide application rates. The article is short, so I recommend reading all of it, but here's how it starts:
About 20 years ago, the United States and Canada began introducing genetic modifications in agriculture. Europe did not embrace the technology, yet it achieved increases in yield and decreases in pesticide use on a par with, or even better than, the United States, where genetically modified crops are widely grown.
I later read a couple of articles that provided very detailed responses to the original. One is written by Andrew Kniss, a weed scientist, and the other by Jayson Lusk, an economist. Kniss uses more detailed versions of the data used in the NYT article and discusses the role of toxicity in pesticides. Lusk makes some great points about revealed preference. Both certainly worth a read.

Tuesday, November 8, 2016

Public Choice, Candidates, and the Stock Market

by Levi Russell

This article by Caroline Baum, which makes the case that downward stock market moves are not due to "uncertainty" but to pessimism, makes a strong case and the article is certainly worth a read. Uncertainty (i.e. the things we don't know that we don't know) is always with us, but pessimism ebbs and flows. Baum notes that the VIX or index of stock market price volatility has risen or fallen along with Trump's chances of winning the election. On the other hand, I think other theories about the effects of uncertainty on businesses and the economy make a lot of sense and are backed by strong empirical evidence.

Reading Baum's article reminded me of a piece by Andrea Hamaui on the Stigler Center's blog breaking down recent moves in the stock market by industry. Hamaui notes that the recent Clinton bump was due largely to gains in the healthcare and finance industries. Instead of making broad statements like "candidate X is good for the economy because the stock market rose when his/her odds of winning increased," looking at the industry breakdown allows us to analyze this from a Public Choice standpoint. The recent surge in finance and healthcare stock prices is likely due to the expectation that Clinton's policies would favor the firms currently operating in those industries. Continuation of current policies that make entry into these industries more and more costly increase the market power of incumbent firms. Stock market indices don't measure the value of firms that don't exist, or more precisely, the firms that weren't formed due to high policy barriers to entry.

Friday, November 4, 2016


by Levi Russell

Here I want to highlight a couple of conversations I think are interesting.

In response to this article on GMOs, Jayson Lusk (economist, Ok State) and Andrew Kniss (weed scientist, U Wyo) provide some deeper analysis on the effects of GMOs on yield and input usage.

A recent Council of Economic Advisors report (summarized here in the WSJ) alleges that monopsony power (market power wielded by buyers) is a driving force in labor markets these days. David Henderson provides an in-depth critique in, so far, 3 posts here, here, and here. I'll update when the rest of the posts come out.

Thursday, October 27, 2016

Can Plows Create Mountain Ranges?

by Levi Russell

According to the EPA, the Clean Water Act does not require a permit for normal agricultural practices including the following:
Normal farming, silviculture, and ranching practices. Those activities include plowing, seeding, cultivating, minor drainage, and harvesting for production of food, fiber, and forest products.

Upland soil and water conservation practices.

Agricultural stormwater discharges.

Return flows from irrigated agriculture.

Construction and maintenance of farm or stock ponds or irrigation ditches on dry land.

Maintenance of drainage ditches.

Construction or maintenance of farm, forest, and temporary mining roads.
That sounds pretty comprehensive to me, but the EPA and US Army Corps of Engineers has apparently decided to circumvent their own rule. A report released by the Majority Staff of the Senate Committee on Environmental and Public Works claims that
Landowners will not be able to rely on current statutory exemptions or the new regulatory exemptions because the agencies have narrowed the exemptions in practice and simply regulate under another name.  For example, if activity takes place on land that is wet: 
- plowing to shallow depths is not exempt when the Corps calls the soil between furrows “mini mountain ranges,” “uplands,” and “dry land;”
- discing is regulated even though it is a type of plowing;
- changing from one agricultural commodity constitutes a new use that eliminates the exemption; and 
- puddles, tire ruts, sheet flow, and standing water all can be renamed “disturbed wetlands” and regulated. 
This expansion of jurisdiction is apparently not what the EPA previously claimed it would be. If farmers are required to get permits to cultivate the soil, I'd bet on a couple of things:
1) the average farm size will grow dramatically as smaller farmers go out of business very quickly;
2) food prices will rise, or will fall more slowly than they otherwise would.

I doubt the average person looking at this situation would call those outcomes "good" but they're highly likely in my opinion. As Public Choice theory indicates, the EPA is not a residual claimant with regard to its policies, so its incentives are not as well-aligned as are the owner of the typical non-monopoly firm. Further, the EPA has plenty of incentive to increase the quantity of work for its employees and lawyers. This question remains: Will the farm lobby be able to keep their exemptions?

Sunday, October 23, 2016

Monopoly Concerns with Baysanto

by Levi Russell

The recent merger of DuPont/Pioneer with Dow and the acquisition of Monsanto by Bayer have sparked a lot of discussion of market concentration, monopoly, and prices. A recent working paper published by the Agriculture and Food Policy Center (AFPC) at Texas A&M University written by Henry Bryant, Aleksandre Maisashvili, Joe Outlaw, and James Richardson estimates that, due to the merger, corn, soybean, and cotton seed prices will rise by 2.3%, 1.9%, and 18.2%, respectively. They also find that "changes in market concentration that would result from the proposed mergers meet criteria such that the Department of Justice and Federal Trade Commission would consider them “likely to enhance market power” in the seed markets for corn and cotton." (pg 1) The paper is certainly an interesting read and I have no quibble the analysis as written. However, some might draw conclusions from the analysis that, in light of other important work in industrial organization, are not well-founded.

The first thing I want to point out is that mergers an acquisitions can, at least potentially, result in innovations that would justify increases in the prices of the merged firm's products. To the extent that VRIO analysis is descriptive of firm's behavior with respect to innovation, we would expect that better entrepreneurs would be able to price above marginal cost. Harold Demsetz made this point in his 1973 paper Industry Structure, Market Rivalry and Public Policy. The authors of the AFPC study point this out as well, but the problem is that, even though we have estimates of potential price increases due to the mergers, it is very difficult to determine whether any change in price in the future is actually attributable to market power or simply due to innovation in the seed technology.

Secondly, the standard models of monopoly assert that pricing above marginal cost is at least potentially a sign of a firm exercising market power. Here, articles by Ronald Coase and Armen Alchian are relevant. I provided a discussion of the relevant portions in a previous post so I'll just briefly summarize here: pricing above marginal cost is an important signal that the current market demand is potentially not being met by the firms in the industry. It's a signal to other potential investors that entering the industry might be worth it. Further, there is an issue of measurement. Outside observers may calculate fixed cost, variable cost, and price and determine that a firm is pricing above marginal cost. However, there may be costs of which said observers are unaware. For example, there may be significant uncertainty (which is not the same as risk) about the future prospects of the industry. This is certainly possible in the biotechnology industry since the government heavily regulates firms in this sector. This is not to say that such regulation is bad or should be removed, simply that it presents costs that are difficult for outsiders to calculate.

Finally, I want to examine one part of the analysis in the AFPC paper. On pages 10 and 11, the authors write (citations deleted):
A market is contestable if there is freedom of entry and exit into the market, and there are little to no sunk costs. Because of the threat of new entrants, existing companies in a contestable market must behave in a reasonably competitive manner, even if they are few in number.
Concentrated markets do not necessarily imply the presence of market power. Key requirements for market contestability are: (a) Potential entrants must not be at a cost disadvantage to existing firms, and (b) entry and exit must be costless. For entry and exit to be costless or near costless, there must be no sunk costs. If there were low sunk costs, then new firms would use a hit and run strategy. In other words, they would enter industry [sic], undercut the price and exit before the existing firms have time to retaliate. However, if there are  high sunk costs, firms would not be able to exit without losing significant [sic] portion of their investment. Therefore, if there are high sunk costs, hit-and-run strategies are less profitable, firms keep prices above average costs, and markets are not contestable. 
I submit that under this definition, scarcely any industry on the planet is contestable, yet we see prices fall in many industries over time, even in those we would expect to have significant sunk costs and in which we would expect incumbents to have significant cost advantages over new entrants.

It's true that we sometimes must make simplifying assumptions that are at odds with reality to forecast future market conditions. However, some might infer from the AFPC paper (though I stress that the authors do not) that something must be done by anti-trust authorities to unwind the mergers and acquisitions under discussion. To infer this would be to commit the Nirvana Fallacy. To expect anything in the real world (whether in markets or in the policymaking arena) to be "costless" is an impossible standard.

It will be interesting to see what becomes of these mergers and whether seed prices move sharply upward in coming years. What is certain is that there is tremendous causal density in any complex system, such as the market for bio-engineered seed. Thus, policymakers should be humble and cautious about applying the results of theoretical and statistical analysis in their attempts to better our world.

Thursday, October 20, 2016

Klingian Philosophy of Economic Science

by Levi Russell

One of my favorite things to do in this blog is to talk about unconventional perspectives on economic theory. A great source for such unconventional views is Arnold Kling's blog. The recent Nobel Prize awarded to Oliver Hart and Bengt Holmstrom prompted Kling to write a series of posts detailing his views on economic theory, specifically about the epistemology of economics. Kling's own brand of unconventionality is especially interesting given that he received his PhD from MIT. Below I reproduce a post from last week:

A commenter writes,
So in your opinion intuition is sufficient. As long as we can tell an intuitive story about something, that is as good as proving it?
I think that “proof” is too high a standard to use in economics. If our knowledge is limited to what we can prove, then we do not know anything. I think that we have frameworks of interpretation which give us insights. This is knowledge, even if it is not as definitive or reliable as knowledge in physics or chemistry.

As an example, take factor-price equalization. The insight is that the easier it is to trade across countries, the more that factor prices will tend to converge. I think that this is an important insight. It is one of what I call the Four Forces driving social and economic trends in recent decades. (The other three are assortative mating, the shift away from manufacturing toward health care and education, and the Internet.)

Paul Samuelson proved a “factor-price equalization theorem” for a special case of two factors, two goods and two countries. However, it is very difficult, if not impossible, to extend that theorem to make it realistic, including the fact that not all industries are subject to diminishing returns. In my view, Samuelson’s theorem per se offers no insight, because it is so narrow in scope. The unprovable broader insight is what is useful.

Incidentally, I also think that factor-price equalization is hard to prove statistically. Too many other things are happening at once to be able to say definitively that factor-price equalization is having an effect, say, on unskilled workers’ wages in the U.S. and China. I believe that it is having an effect, and there are studies that support my view, but it is not provable.

In order to prove something mathematically, you have to make narrow assumptions. In physics or engineering, this often works out well. When you roll a ball down an inclined plane, ignoring friction causes only a small error in the calculation.

In economics, the factors that you leave out in order to build a mathematical model tend to be more important. As a result, the requirement to express ideas in the form of mathematical models is harmful in two ways. We waste time proving false theorems and we miss out on useful insights.
The narrow assumptions lead you to prove something which is false in the real world.. For example, the central insight of the “market for lemons” proof is that a used car market cannot work. However, once we expand the assumptions to allow for warranties, dealer reputations, mechanics’ inspections, and so on, the original theorem does not hold.

Meanwhile, there are insights that are missed because they cannot be represented in an elegant mathematical way. A lot of the insights that I offer in Specialization and Trade fall in that category.
Our goal should be to acquire knowledge. The demand for proof hurts rather than helps with that process.
Bonus: I really enjoyed this piece from the Sloan Management Review published back in 2011.

Teaser: I'll be giving my thoughts on the Baysanto merger later this week or weekend.

Thursday, October 13, 2016

Some Alternative Views on the Recent Nobel

by Levi Russell

I enjoy talking about and linking to alternative, minority points of view in economics on this blog. Sometimes the views I talk about are genuinely only held by a minority, others are held by many but are under-emphasized or, in my mind slightly misunderstood.

In this case, I just want to link to some short (and one very long) posts I read about Hart and Holmstrom's Nobel. Certainly I'm happy to see the prize go to work on theory of the firm and contracts and I believe they are deserving of it. That said, here are some alternative perspectives you might not read in other outlets.

Pete Boettke has a rather long, but certainly interesting, post here.

Arnold Kling gives his thoughts in two posts here and here.

Finally, here's Peter Klein on the prize.

Friday, October 7, 2016

Farmers as Environmentalists

by Levi Russell

This morning in my daily ag reading I came across an article entitled "Greens Make Green." The author lays out the case for the farmer-as-environmentalist better than I've ever seen, so I thought I'd share it here. The underlying economic argument here is that there is great incentive compatibility between farmers (who are interested in long-term profits) and environmental sustainability. Do you find it compelling? Let me know in the comments.

In truth, farmers and environmentalists should be allies. The environmental and agricultural communities have more in common than conventional wisdom might suggest. Both desire to preserve our planet and its resources for future generations. I am not shy about saying farmers are the original environmentalists.

To a person, every farmer I have ever met is driven by an ethical obligation to protect the environment. They view themselves as stewards of the land. And for good reason: Nearly all want their children and grandchildren to carry on the tradition. Cousins Scott and Tom Deardorff II reflect the common theme of sustainability that connects the past to the present and future. Founded in 1937 by patriarch and great-grandfather W. H. Deardorff, Southern California-based Deardorff Family Farms has dedicated four generations to refining its environmental craft. For nearly eight decades, the Deardorff family has been driven by the relentless pursuit of improvement, pioneering many farming practices aimed at increasing productivity while reducing their reliance on natural resources.

Today, Scott and Tom have not only embraced but expanded the family legacy of stewardship. For example, they have invested heavily in the latest water-saving technologies, including drip irrigation and state-of-the-art weather stations and soil moisture monitors. The cousins have also curtailed the use of fertilizer and pesticides on their organic vegetable farms through innovative soil fertility programs and integrated pest management systems. And they recently completed construction on a cooling and packing facility that meets the highest green building standards in the country.

Multigenerational farms like theirs are the heart and soul of agriculture in the West and across the country. They are the very embodiment of sustainability. We should be so lucky as to entrust all our natural resources to the collective care of such thoughtful stewards.

If you can't bring yourself to buy the moral argument, at least consider renting the financial one. Farmers are business owners. They are motivated by sustainable profit. Their businesses are dependent on healthy soil and clean water, both of which lead to stronger yields and higher quality products. The math is quite simple: An environmentally healthy farm can deliver sustainable profits, while land that has been abused will one day cease to produce anything. Furthermore, inputs like fertilizer and pesticides are expensive; a business that doesn't minimize operating costs won't stay in business very long. Clean air, soil, and water are all outcomes supported by environmentalists. So why do so many continue to paint farmers as the enemy?

In his farewell address, President Eisenhower famously warned the nation against "unwarranted influence .  .  . by the military-industrial complex." Today we see the maturation of an environmental-industrial complex, defined by multimillion-dollar global enterprises closely integrated with academia and government regulators implementing environmental programs.

Like a storyline out of Mad Men, environmental activists have channeled their inner Don Drapers, fomenting fear of business and industry, and of human activity generally, in order to build a database of committed donors. It is an ingenious business model, used by corporate America since the early 1920s, when Gerard Lambert stigmatized halitosis to sell Listerine. Marketers have long understood that fear is a powerful motivating tool.

Every cause needs a bad guy, a threat that must be put down. For Listerine, it was bad breath. For too many environmental organizations, farmers—cast as the pillagers of Mother Earth—have served as compelling bogeymen (typically referred to as "corporate agriculture," "industrial agriculture," or the like) to alarm the 98 percent of Americans who aren't farmers.

We are all motivated to some degree by self-interest. Farmers are motivated by the love of farming and social good that comes from providing healthy food, and they are also motivated by the desire to succeed financially. Environmental activists working in big organizations aren't all that different. There is no doubt that most choose a career based on a commitment to environmental values and a desire to do good. And there is also no doubt that another motivation, and one that is entirely defensible, is the financial reward and career security that these organizations can provide.

Unfortunately, in the public debate, it is perfectly acceptable to point to farmers' financial motivations and equally unacceptable to acknowledge the financial motivations of environmental advocates. Those in private enterprise who are targeted by the policy and political initiatives of the environmental lobby ought to be more vocal about that.

If one can acknowledge the reality that the environmental lobby is motivated not only by the values of environmentalism, but also by the financial rewards of growing a motivated donor base, one might ask whether it would benefit these organizations to ever declare a problem solved. After all, while committed donors might feel good upon hearing such an announcement, they would also have one less reason to contribute.

Nowhere was this more in evidence than during the opposition waged against Senator Dianne Feinstein's compromise California drought legislation in 2014, which culminated in a joint-letter from multiple organizations slamming her bill.

Not one to seek the ire of environmentalists, the senator candidly responded—as quoted in the San Francisco Chronicle—that they "have never been helpful to me in producing good water policy." She went on to lament, "I have not had a single constructive view from environmentalists of how to provide water when there is no snowpack."

The practice of environmental protection and the business of environmentalism are two sides of a scale. Our nation's natural resources have benefited from much that has come from the former, but today the scale is weighted too much to the latter. It is the business side of environmentalism that produces the political targeting of agriculture.

It should stop. We share a common aim: to safeguard the planet for its people, animals, and plants. Imagine how much good could be accomplished if all farmers, regardless of size, whether conventional or organic, were accepted and embraced as partners for environmental protection. Now that is a narrative I know Don Draper could sell.

Tom Nassif is president and CEO of the Western Growers Association.

Monday, October 3, 2016

A Simple Observation

by Levi Russell

I don't claim to be the first to make this observation and it might very well be something that is discussed often in undergrad micro (though I can't find it mentioned in the 20 or so lecture notes I found online on the subject. Nevertheless, I thought I'd discuss the following briefly:
From the perspective of the consumer, price discrimination and cross subsidization are the same thing.
Here are the simple definitions Google gives when you search "price discrimination" and "cross subsidization"
price dis·crim·i·na·tion
the action of selling the same product at different prices to different buyers, in order to maximize sales and profits
Cross subsidization is the practice of charging higher prices to one group of consumers to subsidize lower prices for another group.
In cases like afternoon matinees at a movie theater or senior citizen discounts at the grocery store, we can certainly see the positive side of firms charging different prices for different people. While it's true that this increases producer surplus, presumably, some of the people who receive the good at the lower price wouldn't be able to get it if the other group weren't paying a higher price.

The problem is that we use two terms to describe the same concept. The first one has a clearly negative connotation (discrimination) but the second sounds more sterile and scientific. There are certainly cases in which we might view price discrimination/cross subsidization as a bad thing. For instance, when an online retailer charges a higher price for someone who shops online a lot. Still, I can't help but think "cross subsidization" is a better term for the phenomenon since it isn't loaded with a negative connotation that might diminish students' focus on its effects, both positive and negative.

Thursday, September 22, 2016

Political Economy of Crop Insurance

by Levi Russell

Last week my (co-authored) article on the political economy of crop insurance in the next farm bill (coauthored with Art Barnaby of Kansas State University) was published in Choices Magazine. I thought I'd reproduce the theme overview here and link to all 4 articles for those who are interested.

The Farm Bill, passed every four or five years, is a large piece of legislation which includes agricultural, food, conservation, and rural development programs. The most recent bill, passed in 2014, made significant cuts to commodity programs and increased budgeted spending on crop insurance. This change shifts the focus of farm risk management toward crop insurance, making it an even more important part of a producer’s toolkit. Looking ahead to the next farm bill in 2018/2019, this focus on crop insurance will likely continue.

The articles in this issue anticipate three discussions surrounding crop insurance’s role in the next farm bill: the political economy of crop insurance by Barnaby and Russell, economic evaluation of crop insurance’s role in the safety net by Zacharias and Paggi, and crop insurance’s role in specialty crop agriculture by Paggi.

Barnaby and Russell examine three crop insurance alternatives which are likely to be proposed in the debate over the next farm bill:

 1. Replacing crop insurance with a free, area-based disaster program,
 2. Making modifications to existing policy which would significantly reduce support to  farmers and jeopardize the private delivery system, and
 3. Complete elimination of the safety net.

The article summarizes the political factors and their interaction with the economic effects of these proposals.

Zacharias and Paggi identify the key considerations for improving crop insurance’s role in the farm safety net. Among these are regional and commodity-specific considerations, government budget constraints, and interactions between crop insurance and other titles in the farm bill. They emphasize the importance of developing appropriate metrics for evaluating the simultaneous performance of crop insurance and commodity programs and conclude with a research agenda for examining these issues.

Paggi discusses the broader role of crop insurance as a risk management tool for specialty crop producers. Specialty crops are of interest due to the increase in specialty crops’ share of the total crop insurance liability over the last 15 years. Paggi details the connection between crop insurance and specialty crops and provides a discussion of factors affecting the future of this connection.

Finally, Woodard addresses the elasticity of demand for crop insurance issues.  This key value will determine the maximum achievable size of any cuts in USDA’s share of the crop insurance premium and still maintain a politically acceptable level of farmer participation in crop insurance needed to prevent any future ad hoc disaster program.  It is critical for policy makers to understand the impact of elasticity of demand to prevent unintended consequences by making Federal budget cuts to crop insurance.  All budget cuts are not equal so how those cuts, if any, are made is extremely important.

Given the important role of crop insurance in the future of the farm safety net, political and economic factors affecting policy decisions are particularly of interest. This issue provides a first look at the conversations policy makers, industry representatives, and academic economists will have leading up to the next farm bill.

Monday, September 19, 2016

Anti-Trust vs Regulation: The Case of Baysanto

by Levi Russell

Bayer's impending purchase of Monsanto is all over the news lately. As is typical in these situations, the conversation centers around concerns of increasing market power and monopoly profits. Regular readers might expect me to focus on the notion that industry concentration doesn't necessarily imply welfare losses, but I'm not.

It seems to me that the relationship between anti-trust legislation and regulation is an under-discussed issue in these cases. Agribusiness firms are heavily regulated by three of the most powerful regulators in the US: the FDA, the USDA, and the EPA. Many regulations function as fixed costs, implying that there are economies of scale in regulatory compliance. Thus, the greater the regulatory burden placed on firms in an industry, the greater the inducement to merge.

These regulatory economies of scale militate directly against the goals of anti-trust policy. The latter, perhaps as an unintended consequence, gives us fewer and larger firms while the latter attempts to reign in these cost-saving mergers in the name of competition. If we're going to seriously discuss regulation and anti-trust, we need to be cognizant of the interplay between them.

Of course, there are plenty of problems with the regulatory revolving door and other public choice issues to deal with as well. On this front, it seems fairly obvious that the incentive to rent-seek is positively correlated with the prize being offered. Perhaps this is an argument for less power vested in the administrative state and more power returned to the courts.

Thursday, September 15, 2016

Coase and Hog Cycles

by David Williamson

If you read this blog, then you're probably familiar with Ronald Coase's work on the importance of transaction costs. But did you know that Coase devoted a substantial portion of his early career to criticizing the Cobweb Model? He actually wrote 4 separate articles on the subject between 1935 and 1940, but not one makes Dylan Matthew's list of Coase's top-five papers. This work is actually really fascinating in the context of economic intellectual history, so here is a quick summary!  

The 1932 UK Reorganization Commission for Pigs and Pig Products Report

It all started when the UK Reorganization Commission for Pigs and Pig Products claimed in a 1932 report that government intervention was needed to stabilize prices in the hog industry. The Commission found that hog prices followed a 4-year cycle: two years rising and two years falling. The Commission explained this cyclical behavior using the Cobweb Model. In this model, products take time to produce. So, to know how much to produce, firms have to guess what the price will be when their product is ready to bring to the market. If producers are systematically mistaken about what prices will be, this could lead to predictable cycles in product spot prices.

The Cobweb Model

How forecasting errors can lead to cycles in product prices is illustrated in the figure below. Suppose we begin time at period 1 and hog producers bring Q1 to the market to sell. Supply is essentially fixed this period because producers can't produce more hogs on the spot, so the price that prevails on the market will be P1. Since this price exceeds the marginal cost of production (represented by S), the individual producers wish they had produced more. Now, when the producers go back home to produce more hogs, they have to guess that the price will be when their hogs are ready to sell. Suppose it will take 2 years to produce more hogs. The UK Reorganization Commission argued that hog producers will assume the price of hogs next period will be the same as it was this period (in other words that producers had "static" expectations about price). That means, in this context, hog producers think the price of hogs in 2 years will still be P1. So each producer will individually increase production accordingly. However, when the producers return to the market in 2 years, they will find that everyone else increased production too and that quantity supplied is now Q2. As a result, the price plummets to P2 and the producers actually lose money. Not learning their lesson, the hog producers will again go home and assume that the price next period will be P2 and collectively cut back their production to Q3. Hopefully you see where this is going, even if the hog producers don't. The price will go up again in 2 years and then down again in 2 more. Thus, we have a 4-year cycle in hog prices. How long will this cycle continue? That depends on the elasticities of supply and demand. If demand is less elastic than supply, as was believed to be the case in the hog market, then the price swings will continue forever and only get bigger as time goes on.

Source: Wikipedia

Coase Takes the Model to the Data

The Cobweb Model is really clever, but does it actually capture the reality of the hog market? Coase and his co-author Ronald Fowler tried to answer that question by evaluating the model's assumptions. First, are hog producer expectations truly static? Expectations cannot be observed directly, but Coase and Fowler (1935) used market prices to try and infer whether producer expectations were static. It didn't seem like they were. Second, does it really take 2 years for hog producers to respond to higher prices? Coase and Fowler (1935) spend a lot time discussing how hogs are actually produced. They found that the average age of a hog at slaughter is eight months and that the period of gestation is four months. So a producer could respond to unexpectedly higher hog prices in 12 months (possibly even sooner since there were short-run changes producers could also make to increase production). So why does it take 24 months for prices to complete their descent? Even if we assumed producers have static expectations, shouldn't we expect the hog cycle to be 2 years instead of 4?  

This evidence is hard to square with the Cobweb Model employed by Reorganization Commission, but Coase's critics were not convinced. After all, if it wasn't forecasting errors that were driving the Hog Cycle, then what was? "They have, in effect, tried to overthrow the existing explanation without putting anything in its place" wrote Cohen and Barker (1935). Coase and Fowler (1937) attempted to provide an explanation, but this question would continue to be debated for decades.

The Next Chapter

Ultimately, John Muth (1961) proposed a model that assumed producers did not have systematically biased expectations about future prices (in other words that they had "rational" expectations). Muth argued this model yielded implications that were more consistent with the empirical results found by Coase and others. For example, rational expectations models generated cycles that lasted longer than models that assumed static or adaptive expectations. So a 4-year hog cycle no longer seemed as much of  a mystery. I'm not sure what happened to rational expectations after that. I hear they use it in Macro a bit.  Anyways, if you are interested in a more detailed summary of Coase's work on the Hog Cycle, then check out Evans and Guesnerie (2016). I found this article on Google while I was preparing this post and it looks very good.


Evans, George W., and Roger Guesnerie. "Revisiting Coase on anticipations and the cobweb model." The Elgar Companion to Ronald H. Coase (2016): 51.

Coase, Ronald H., and Ronald F. Fowler. "Bacon production and the pig-cycle in Great Britain." Economica 2, no. 6 (1935): 142-167.

Coase, Ronald H., and Ronald F. Fowler. "The pig-cycle in Great Britain: an explanation." Economica 4, no. 13 (1937): 55-82.

Cohen, Ruth, and J. D. Barker. "The pig cycle: a reply." Economica 2, no. 8 (1935): 408-422

Muth, John F. "Rational expectations and the theory of price movements."Econometrica: Journal of the Econometric Society (1961): 315-335.

Monday, September 12, 2016

Pigovian Prices

by Levi Russell

An interesting exchange occurred last month between two economists/bloggers. Stephen Gordon, an economics professor at Université Laval in Canada, wrote a column on the concept of a carbon tax price. In it, he argues:
As the Conservatives should really know by now, market-based approaches to reducing GHG emissions are more efficient than regulations. It’s better to let households and firms make their own priorities in response to price signals instead of having them imposed by the government. And the extra upside of market-based approaches like carbon taxes or cap-and-trade is that some of the costs of the policy are transformed into government revenues that can be used to compensate vulnerable groups or even to reduce other taxes.
So it seems that Professor Gordon equates a price with a tax. Hoover Institution economist David Henderson responded, taking Gordon to task for his apparent confusion of a price with a tax.
But carbon already has a price, or, more exactly, multiple prices. Natural gas has a price; oil has a price; coal has a price. And their prices are related to the valuable carbon component of those fuels because it’s carbon that makes those fuels valuable. Just as there’s no such thing as a free lunch, carbon is not free.

So why does Professor Gordon claim that taxing carbon means “putting a price on carbon?”

I can only speculate because I don’t know him, but here’s what I’m willing to bet dollars to doughnuts on: he calls a tax a price in order to lull the reader into thinking that it’s not a tax. Later in the piece he admits that it’s a tax but in his first mention, which sets the stage, he doesn’t.

Gordon later responded:
A market price is what a consumer has to pay in order to purchase a good or service. In contrast, a tax is, er, what a consumer has to pay in order to purchase a good or service.

This is one of those cases of a distinction without a difference. Unless you’re the sort of person who reads the fine print on the pumps at the gas station, you probably don’t know what the market price of gasoline is, and even if you do, you probably don’t care — at least as far as it affects how much gasoline you buy. What really matters is the total you have to pay. So when the focus is on how carbon taxes work to reduce greenhouse gas emissions — as mine was — then there’s not much point in using up column space to make the price-tax distinction. (Although if you want to play this game, think of a carbon tax as the price governments charge for degrading a communally owned resource.)
It's interesting to note here that neither Henderson nor Gordon are getting at the fundamental difference between prices and taxes. Prices, to one degree or another, transmit information about the relative scarcity of resources. If the price of a good rises, consumers of the good are incentivized to use it more frugally while producers are incentivized to produce more of it. It doesn't really matter whether the initial cause of the price rise was a reduction in supply or an increase in demand; what matters is the incentive the price change has on behavior.

One might be tempted to argue that a tax can be used to correct market prices when they don't reflect all relevant information. Indeed, this is the Pigovian paradigm that has existed in the profession for nearly 100 years. However, there have been significant challenges to this paradigm that are, in my mind, not fully appreciated. Though Henderson doesn't make this point in his final response to Gordon, I think it gets to the heart of the matter. Perhaps a tax on carbon is a sensible policy, but to simply assume that governments can get that price right ignores the reality that information and incentive problems present in markets are not absent from governments.

Friday, September 9, 2016

Beef Trade and the TPP

by Levi Russell

As one of my colleagues recently pointed out at an Extension meeting, both major-party candidates are (at least claiming to be) anti-international-trade. It's true that trade restrictions would be harmful to many segments of the U.S. agriculture sector, including beef. I ran across a great article in Beef Magazine last month that shows the U.S.' top trade partners. The chart below is lifted from the article.

As you can see, Australia is responsible for a substantial proportion of beef (not cattle) imports into the U.S. Our exports go primarily to Asian markets and our geographical neighbors. The article goes into some detail about the recent change in fresh beef imports from Brazil. The new policy is a tariff-rate-quota; details are available in the article and in this video.

Since I strive to tell the other side of the story as fairly as possible, I thought I'd link to what I believe is the most sophisticated argument against the Trans Pacific Partnership I've read. I recommend reading it, even if you are pro-TPP.

Wednesday, September 7, 2016

Remembering Ronald Coase

by Levi Russell

The third year anniversary of Ronald Coase's death was last Friday. My Facebook and Twitter were alive with remembrances of this great economist, so I thought I'd put a few articles/videos/podcasts related to Coase for FH readers.

Though Coase is most famous for his work on transaction costs, what I find most interesting about his is his unique approach to economics in general. In the opening of this video interview, Coase says "Economics has become a theory-driven subject and I believe the approach should be empirical. You study the system as it is, understand why it works the way it does, and consider what changes could be made and what effects they would have." Coase derisively referred to abstract theoretical economics as "blackboard economics." In reading his work, the reader gets the sense that Coase is looking at the behavior of real people and trying to determine the underlying causal mechanisms. This is what makes Coase a great economist.

Here's an article on Coase that gives his background and surveys his most popular work. Here's a video featuring lectures on Coase's contributions by other well-known economists.

The video I linked to above, as well as this blog post of mine featuring Deirdre McCloskey, corrects the record on "the Coase Theorem." Speaking of my blog posts, here's another one that provides a summary of one of Coase's lesser-known, but no less fantastic, papers.

Finally, this post of mine summarizes a point by Bryan Caplan that, given his stated perspective on economic theory, I think Coase would have appreciated. It's a simple empirical observation that fundamentally challenges typical applications of standard monopoly theory.

Thursday, September 1, 2016

Rent-Seeking and Regulation are Inseparable

Over at Marginal Revolution, Alex Tabarrok links to a piece by Tim Carney on a move by the Securities and Exchange Commission to continue requiring mutual fund companies to send mostly-worthless documents to their clients. I've reproduced the Marginal Revolution post below (Carney indented, Tabarrok in italics):

Five years ago, a new quirky-sounding consumer-rights group set up shop in a sleepy corner of Capitol Hill. “Consumers for Paper Options is a group of individuals and organizations who believe paper-based communications are critically important for millions of Americans,” the group explained in a press release, “especially those who are not yet part of the online community.”

This week, Consumers for Paper Options scored a big win, according to the Wall Street Journal. Securities and Exchange Commission chairman Mary Jo White has abandoned her plan to loosen rules about the need to mail paper documents to investors in mutual funds.

Mutual funds were lobbying for more freedom when it came to mailing prospectuses — those exhaustive, bulky, trash-can-bound explanations of the contents of your fund. In short, the funds wanted to be free to make electronic delivery the default, while allowing investors to insist on paper delivery. This is an obvious common-sense reform which would save whole forests of trees.
You won’t be surprised to lean that Consumers for Paper Options is funded by paper mills, timber firms and the Envelope Manufacturers Association.

What bothers me about these stories is not the rent-seeking–that is to be expected. What bothers me is that there is a law that prescribes how mutual funds must inform their customers. Why must every aspect of commercial life be governed by a gun? And this is where I expect pushback–the mutual funds will rip us off if we don’t have these laws, blah, blah, blah. Fine, believe that if you must, but then you have no cause to complain about rent seeking. You created the conditions for its existence.

Wednesday, August 31, 2016

The Academic Literature on State Tax Cuts

by Levi Russell

State fiscal policy continues to be a popular issue. Some are criticizing right-leaning state governments for lowering taxes with the intention of boosting growth. These commentators point out that growth in these states has not skyrocketed. Others are criticizing left-leaning states for funding issues with their public pensions and financial problems associated with Affordable Care Act co-ops. These other commentators point out that these financial issues are not easy to solve and that a more conservative spending approach is probably warranted.

So, being an economist, I thought I'd look at the academic literature on the effects of state-level taxation on economic growth. I pulled the 5 most recent articles I could find on the subject from Google Scholar and looked at the results. Of the 5 articles (of which one examined Canadian provinces) I read, 4 showed a negative effect of state taxation on growth. One showed no effect on own-state growth, and a positive effect from other states' tax increases. I may have missed some other important analysis on this subject, but it seems to me that we can (at least provisionally) conclude that 1) it's not likely that lower taxes are harming growth at the state level and that 2) it's probably a good idea to find ways to fix over-spending rather than increase taxes.

Here are the articles I read. If I missed an important, recent paper, please link to it in the comments below!

Another look at tax policy and state economic growth: The long-run and short-run of it, Economics Letters, 2015, Bebonchu Atems (one of my former graduate school colleagues)

The Determinants of U.S. State Economic Growth: A Less Extreme Bounds Analysis, Economic Inquiry, 2008, W. Robert Reed

The Impact of Tax Cuts on Economic Growth: Evidence from the Canadian Provinces, National Tax Journal, 2012, Ergete Ferede and Bev Dahlby

Redistribution at the State and Local Level: Consequences for Economic Growth, Public Finance Review, 2010, Howard Chernick

The Robust Relationship between Taxes and U.S. State Income Growth, National Tax Journal, 2008, W. Robert Reed