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.