Saturday, July 22, 2017

Public Choice Under Fire

The recent publication of Duke historian Nancy MacLean's book entitled "Democracy in Chains" has caused quite a stir among economists interested in public choice and political economy. Having read several positive and negative (links to the many positive and negative reviews and commentary can be found in the updates to this post) reviews and comments on the book, it's clear to me that MacLean's thesis is something like the following: James Buchanan (Nobel Laureate in economics, 1986) along with this colleagues developed a school of economic thought (public choice) with the express intention to undermine democratic institutions in the U.S. to benefit the wealth interests that funded them. Also, as a man from the south, Buchanan was motivated by racism and based his ideas on the thought of other racist scholars.

Aside from the accusations of racism, the substantive critique made clear in the title strikes me as odd. What does it mean to put democracy "in chains?" Does making clear, in a scientific way, the limits of collective decision making put democracy "in chains" or does it allow us to determine what set of underlying institutions provides for the best set of laws?

The normative aspects of public choice are, in my mind, about the latter. The descriptive analysis of the inefficiencies in our actions as politicians, bureaucrats, lobbyists, political interest groups, voters, etc. helps us understand the characteristics of institutions that might limit such inefficiencies. We have, for instance, minority protections in the constitution precisely because a democratic majority might harm them.

MacLean insistst, for example, that libertarians long ago opposed Brown v. Board of Education. In fact, the source she cites comes to precisely the opposite conclusion. Further, Brown is a good example of a minority protection that restricts the will of the majority. If it is "unchained" majority rule that MacLean praises, she should oppose the Brown decision because it explicitly ensured that a problematic majority-rule decision was corrected.

There are, it seems, many other problems with MacLean's book, but her insistence that public choice economics is a tool for the powerful is obviously off base.

Wednesday, July 12, 2017

How Do YOU Read Papers?

by Levi Russell

The other day I put out a Twitter poll with the intent of determining which section of an academic article economists read first. I only included the Introduction, Model, Results, and Conclusions, since Twitter only allows 4 options and I assume most of us read the abstract since it's normally the first thing we see before we download the paper. I typically read articles in the following order: abstract, model, conclusions, results, then intro if I need it. I've recently seen successful economists encouraging young economists to focus on the introduction, so I thought it was worthwhile to see how wrong I am about the "correct" reading order. After all, if it is crucial to focus on writing the intro, it must be the first thing a lot of us read!

Here are the poll results:

My sample was about 60 votes and this included, I imagine, mostly economists who follow me and maybe some of the economists or other academics who follow them. Introduction and Conclusions were nearly tied with just over a third of respondents saying those sections were the first they read. The remainder were split almost evenly between model and results.
The comments were interesting as well.

Good writing in general is necessary to publish. If your goal is to get citations, perhaps focusing on the writing in the intro and conclusions is a good strategy. However, to get cited you first must get published. I don't know about you, but when I review articles I always read them straight through from page 1 to n. First impressions are important, so maybe that's the best argument for focusing on the introduction. Then again, if only about 1/3 of us read the intro first, then perhaps reviewers (assuming they read like I do when reviewing) are reading the wrong way. I don't know if this fits into the broader discussion on academic publishing, peer review reform, and other such issues, but it is interesting to see how people read articles.

What do you think? What section do you read first? How important (relatively speaking) is a well-written introduction?

Monday, July 3, 2017

Economics Resource for High School Students

by Levi Russell

I recently ran across a great web-based resource for teaching economics to high school students. uses a series of short animated videos, each with an even shorter lecture, to explain basic economic concepts like capital and risk, opportunity cost, comparative advantage, moral hazard, and several others.

The program is free, but you do have to give them your email to get access to the videos. If you want the standards-based evaluation materials, they want a little more info. Overall this seems like a great supplement for high-school students and a great resource for home schoolers!

Friday, June 16, 2017

Does Public Choice Describe Political Reality?

by Levi Russell

Ben Southwood, Head of Research at the Adam Smith Institute, recently wrote a piece for Jacobite Magazine in which he argues against the applicability of public choice theory to politics in Western democracies. Below I quote Southwood at length and explain in detail where I think his analysis goes wrong. The overarching theme is this: Southwood seems to think (erroneously) that public choice is about ill intent or corruption on the part of politcians. In fact, it is merely about the application of rational, individual choice frameworks of economics to the study of politics. Politicians may have the best of intentions, but the limitations of collective action and opportunities to maximize their own benefit (as we all try to do, even if that sometimes entails benefiting others we care about or with whose interests ours align) in the political sphere lead them to act in ways that are inconsistent with an idealized view of politics.

In his description of public choice, Southwood starts off well, but understates the predictive power of public choice theory.
Public choice is true on the margin—that is: people’s actions in politics and government tend to be affected by self-interest—but if you predicted what people did using only or mainly public choice you’d get it wrong nearly every time, at least in the modern West.
In fact, public choice theory can predict the actions taken by politicians, bureaucrats, and voters well, if not perfectly. Politicians may have altruistic motives, but they cannot effectuate their agendas without acting in ways described by public choice theory. Southwood's first example is voting:
Start with voting. Voting is an extremely widespread behavior in Western societies. A third or two fifths of adults will turn out even for the most trivial local elections. Eighty per cent might turn out for a major contest. But public choice cannot explain this.

Your vote has a tiny influence on the outcome of most elections. The chance of an individual voter deciding an American presidential election is about one in sixty million (ranging from one in ten million in some swing states to about one in a billion in Texas or California). If you only care about the election’s impact on your own personal prospects, then the election would need to be worth about a billion dollars to you personally. Elections often make trillions of dollars worth of difference overall, but rarely more than thousands or hundreds to individuals or their families.
This is a complete misunderstanding of public choice theory on voting. The cost-benefit analysis of voting for an individual is straightforward if we account for the social dimesion. People turn out to vote because they and their peer group believe it is part of their civic duty. The cost of voting is small relative to the benefit of signaling to one's peer group that we care about our civic duty. The fact that an individual vote is highly unlikely to affect an election simply doesn't matter.

Southwood goes on:
In public choice theory politicians stand for elected office not in order to enact a program, based on their views and convictions, but in order to maximize their personal power. To do so, they maximize votes at elections. This claim is also a familiar conventional wisdom to the point of cliche: politicians are unprincipled schemers who will do anything for votes.
There's a lot to unpack here. The first sentence gives the impression that politicians' desire to enact a program "based on their views and convictions" precludes their intent to maximize personal power. On the contrary, the former is dependent on the latter! Immediately after their elections, presidents and prime ministers are often said to have a "strong mandate" if they win more votes than expected. This "mandate" is said to give them political leverage to implement their agendas. All of this is orthogonal to their status as "unprincipled schemers who will do anything for votes." They may be unprincipled schemers, or they may be very well-meaning people. The fact is, if they want to implement the policies they think best, they have to work the system. The idea that politicians are evil might be a popular shorthand for public choice theory, but it doesn't represent the theory itself.

Southwood continues:
Public choice also predicts that officials are easily lobbied: they can be bought by rent-seeking special interests. But the literature is almost unequivocal: the source of campaign funds makes little difference to campaigns or policies. The fact that the decisions politicians make affect how trillions of dollars are spent, and yet firms spend figures in the low billions on elections caused a famous economics paper to ask “Why is there so little money in US politics“?
Again, Southwood starts off fine. Campaign donations, lobbying, and the revolving door more generally are all ways certain interest groups can influence politicians. The literature, specifically the paper he cites, does find that campaign donations only influence legislators' votes in some cases. However, this doesn't include lobbying and other rent seeking behavior. There is a revealed preference component here; even if interest groups are not "buying votes" with campaign funds or lobbying firm fees, they apparently see some value in spending several billion dollars per year (at the federal level) on it. We can't observe a counterfactual world in which there is no "money in politics," so it's difficult to know precisely how much impact campaign funds and lobbying have on legislator's behavior. Finally, there is a point to be made here about marginalism. It's true the US federal budget is in the trillions. However, the votes held in any single legislature will only affect this budget at the margins, not halving or doubling the budget year to year.

Public choice is fundamentally not about corruption or other criminal behavior; it's simply economics applied to political problems. Oftentimes, it's about incentive and information problems specific to the political world that result from the constraints we face in human interaction. Regulation can indirectly benefit special interests incentivizing rent seeking behavior, some laws can give politicians the power to benefit themselves personally, and arbitrary enforcement can create confusion and uncertainty. Even popular and well-meaning politicians understand the poor incentives they sometimes face.

Wednesday, May 31, 2017

Environmental Law Tradeoffs for Ag

by Levi Russell

Tiffany Dowell at Texas A&M has a great, concise blog post about a recent circuit court decision that will undoubtedly increase costs associated with environmental regulation of farms. As usual, I encourage you to read the entire post, but here's an excerpt:
Environmental groups, led by Waterkeeper Alliance, argued that CERCLA and EPCRA do not allow the EPA to exempt anyone from reporting requirements if there are releases over the statutory reportable quantity.  Further, the environmental groups claim that the rule is arbitrary in treating waste on farms differently than similar waste in other places, such as at a zoo or a slaughterhouse, which would not be exempted from reporting.  On the other side, the National Pork Producers Council also filed suit, albeit for a very different reason.  The Council claimed that the CAFO exception is not allowed because it was based upon the public’s desire for information, rather than based upon the purpose for which the statute was enacted–facilitating emergency response.
Now that the rule containing the farm exemption is no longer in place, under federal law, farms that may emit hazardous substances from animal waste above the threshold amount are legally required to report such emissions.   One major problem, which was noted by the court, is that there has been no determination of how these emissions should be measured.  It is unclear how farmers are expected to know whether their emissions are above reportable quantity, or how they are to measure them for reporting.  It may be that some operations can simply file an annual notice of continuous release if the releases are “continuous and stable in amount and rate.”  Hopefully, the EPA will offer some additional guidance documents in light of this ruling.  Operations for which this may be an issue should consult with their attorney to determine what steps to take.
A few things to note here:

1. The exemption was not for large animal feeding operations, it was for regular farms. With that exemption gone, farmers will be subject to significant regulatory uncertainty and cost.

2. That uncertainty and cost will fall disproportionately on small farmers. While this type of regulation will apply to larger farms, it will be difficult, at least in the short run, to know exactly where the threshold is. How many cows/hogs/chickens/etc does it take to create 100 pounds per day of ammonia or hydrogen sulfide? It will also complicate investment decisions for small farmers.

3. There's clearly an industry concentration vs environmental quality tradeoff here. A public concerned with the continued existence of the "family farm" would be smart to consider this tradeoff.

4. Tiffany notes that public comment played a role in the circuit court's decision, implying that interested parties can have some say in the regulatory process, at least when regulations are challenged in the courts. I suspect this will be a losing battle for ag in the future if the public continues to grow more concerned about these issues.

Friday, May 26, 2017

Boetkke on Buchanan

by Levi Russell

I've enjoyed reading every bit of George Mason University economist Peter Boettke's work that I've had the time to read in the past several years. His work is very interesting in part because he addresses issues most of us don't spend a lot of time on. In this post, I reproduce some of my favorite quotes from a recent speech Boettke gave. The speech focuses on Jim Buchanan's perspective on economics generally and political economy specifically. As usual, I suggest you read the whole speech, as it is very good and very short.

The problem as Buchanan sees it is that economics as a discipline has a public purpose, but modern economists have shirked on that purpose and yet are still being rewarded as if they were earnestly working to meet their educational obligation. As he put it:“I have often argued that there is only one ‘principle’ in economics that is worth stressing, and that the economist’s didactic function is one of conveying some understanding of this principle to the public at large. Apart from this principle, there would be no general basis for general public support for economics as a legitimate academic discipline, no place for ‘economics’ as an appropriate part of a ‘liberal’ educational curriculum. I refer, of course, to the principle of the spontaneous order of the market, which was the great intellectual discovery of the eighteenth century” (1977 [2000]: 96).

Prices serve this guiding role, profits lure them, losses discipline them, and all of that is made possible due to an institutional environment of property, contract and consent. These are the basic principles from which we work in economics. Important to note, economic analysis relies neither on any notion of hyper rational actors myopically concerned with maximizing monetary rewards, nor on postulating perfectly competitive markets. It relies simply on the notion that fallible yet capable human beings are striving to better their situation, and in so doing enter into exchange relations with others. Atomistic individualism and mechanistic notions of the market is, as Buchanan has stressed, nonsensical social science.

From a Buchanan perspective, basic economics can be conveyed in 8 points.
1.Economics is a "science" but not like the physical sciences. Economics is a "philosophical" science and the strictures against scientism offered by Frank Knight and F. A. Hayek should be heeded.
2. Economics is about choice and processes of adjustment, not states of rest.Equilibrium models are only useful when we recognize their limits.
3. Economics is about exchange, not about maximizing. Exchange activity and arbitrage should be the central focus of economic analysis.
4. Economics is about individual actors, not collective entities. Only individuals choose.
5. Economics is about a game played within rules.
6. Economics cannot be studied properly outside of politics. The choices among different rules of the game cannot be ignored.
7. The most important function of economics as a discipline is its didactic role in explaining the principle of spontaneous order.
8. Economic [sic] is elementary.

Monday, May 15, 2017


by Levi Russell

Here's a collection of articles I've read over the last week or so.

David Henderson on Thoma on potential changes to banking regulation.

Economist Allan Meltzer recently passed away. Here and here are two commentaries on his work.

A major contribution of another recently-deceased and well-known economist William Baumol is discussed here.

Don Boudreaux has a fantastic post on the importance of Econ 101. Here's a short excerpt:
To put the point a bit differently, ECON 101 instills the good habit of looking past stage 1, which is the stage at which most non-economists stop their investigations of economic consequences.  ECON 101 prompts those who grasp it to look also to stages 2, 3, and 4.  More-advanced economics courses – all the way to ECON 999 – teach that in theory there is also the possibility of stages 5, 6, 7, …. n.  Awareness of these theoretical possibilities is, of course, useful.  But awareness of stages 5, 6, 7, … n is either meaningless or, worse, practically dangerous without also an awareness of stages 2, 3, and 4.  And nearly all economic ignorance in the real world is simple unawareness of stages 2, 3, and 4.  (It’s also mistaken to conclude – as Kwak concludes – that awareness of stages 5, 6, 7, …. n regularly nullifies policy conclusions drawn from awareness of stages 1 through 4.)
Here's a great piece at Cato on the Net Neutrality issue.

Economics blogger Jim Rose corrects Noah Smith's oft-repeated claim that the economics profession was, until recently, dominated by right-wingers and libertarians.

Saturday, May 6, 2017

A Modest Proposal for Improving Health Insurance and Care

by Levi Russell

I want to start off by saying I'm not an expert in health insurance or healthcare economics. That said, I've read my fair share of analysis on the subject and understand how the math of insurance works. In the current debates over the ACA vs the AHCA, "high-risk pools," redistribution, and (largely academic) discussions over the inability of insurers to accurately price risk due to regulations, I thought I'd sketch out what I think is a basic free-market healthcare "system." Please note that I often about the mistake of committing the Nirvana Fallacy, so none of what you read below should be interpreted as a claim that "markets are perfect" or any other silly Utopian view. I think there's a lot that can be done to simply improve on current policy. Here I discuss how I would like to see that happen.

Health Insurance

The way I see it, the primary problem with the current health insurance system is that it isn't actually insurance. It's a third-party payer system in which people pre-pay primarily for routine care. These plans have low deductibles, co-pays, and high "premiums." Again, a large percentage of one's "premiums" aren't really premiums.

These generous "insurance" plans are a product of decades-old payroll tax policy. Employees are taxed on their earnings, but are not taxed on so-called "fringe benefits." Employers, competing for the best talent, provided more and more generous fringe benefits rather than increase taxable wages. This led to the current comprehensive health insurance plans prevalent today and created the perverse third-party-payer incentives that have driven up the cost of insurance and care.

Due to concentration in the (massively regulated) medical care industry, hospitals are able to dramatically inflate the cost of care, which pushes up premiums. Insurance companies, also a highly concentrated industry partly thanks to the ACA, have very little incentive to negotiate for lower prices resulting in a bizarre circumstance in which paying out of pocket for routine care is cheaper than using comprehensive care "insurance."

Given these problems, what can we conclude about policy changes that could improve insurance?

1. Stop favoring "fringe benefits" with payroll tax policy. This will allow for a divorce of employment from health insurance, partly solving the pre-existing condition issue.

2. Stop forcing insurers to ignore basic health factors in pricing insurance and to cover pre-existing conditions. This has led to more concentration and certainly hasn't helped drive premiums down overall. However we handle redistributive aspects of health care, we certainly need a functioning price system.

3. Remove caps on contributions to health savings accounts. Provide subsidies to low-income people in the form of tax credits so they can afford catastrophic plans and can contribute to their health savings accounts (HSAs). This will allow parents to ensure that their children have insurance for horribly tragic terminal conditions long before they are born. This would also go a long way to solving the pre-existing conditions problem.

4. Provide something like Medicaid/Medicare for the (I suspect relatively small number of) people who would fall through the cracks if the changes in 1, 2, and 3 above were made.

For more of my thoughts on HSAs, including an example, see this FH post.

UPDATE - Joshua Hendrickson at Ole Miss pointed me toward this article on health insurance by John Cochrane at U Chicago. I recommend checking it out.

Health Care Costs

It stands to reason that one primary cause of high insurance costs is that the care itself is expensive. All sorts of laws restrict the ability of consumers to find primary care at affordable rates: certificate of need laws (which put the power to increase the quantity of medical care facilities up to a state-level board consisting of hospital administrators; discussed here and here on FH), scope of practice laws (which restrict the ability of nurses and nurse practitioners to provide routine care, thus decreasing the supply of care and increasing costs), restrictions on direct primary care (a fee-based service that connects doctors and patients directly without the use of "comprehensive care insurance"), and a whole host of other things I'm probably missing.

In my mind, whatever happens at the federal level, we will continue to see states move away from their restrictive laws and increasingly allow doctors and patients to make decisions about health care on their own. As this article notes, monthly fees for all-inclusive primary care through a "direct primary care" physician can be as low as $25 per person thanks to the reduction in bureaucratic paperwork. This podcast interview has more information. Thanks to innovative medical entrepreneurs, there's even a surgery center in Oklahoma that posts all-inclusive prices for all the procedures they perform on their website. I assume I don't need to tell you that their prices are far below what a typical hospital would charge an insurance company for the same procedures. Imagine that; the price system works to provide care at low costs when it is not chained down by bureaucracy.

As Milton Friedman said, there are no panaceas. Health insurance and health care will never be free and some people will have a tough time taking care of their medical bills. This is true regardless of the institutional structure; the world isn't perfect. However, I think the points discussed above would improve outcomes across the spectrum, especially for those in the bottom two income quintiles. Reduce restrictions on health care providers, allow doctors and patients to interact directly without excessive red tape, level the playing field for HSAs and catastrophic insurance plans (i.e. actual insurance), and provide cash assistance or some other means of helping those who fall through the cracks. As a result, we'll get lower costs, more choice, and far less deadweight loss. What are your thoughts?

Friday, May 5, 2017

Bryan Caplan on Pricing and Market Power

by Levi Russell

Previously on the blog, I've shared Bryan Caplan's interesting perspective on monopoly and market power. He recently wrote another post that is at least as interesting as the first one I discussed. Below I reproduce the first half of his post.
In the real world, prices often seem far above marginal cost.  Yesterday, for example, I bought a pair of tweezers for $14.99.  But it's hard to see how the marginal cost - metal, electricity, transportation, miscellaneous - could even reach $1.00.  That's a markup well in excess of 1000%.  If you're steeped in the perfectly competitive model, where price always equals marginal cost, it's easy to feel "ripped off" whenever you make a purchase.

The obvious rebuttal is to point to all the fixed costs of production.  While the marginal pair of tweezers costs pennies to produce, the first pair plausibly costs millions.  Factoring in fixed costs, tweezer producers are probably roughly breaking even.  So how is that a "rip-off"?

But on reflection, this greatly understates what a fantastic deal we consumers get.  To see why, I often invoke my Consumer Gratitude Heuristic.  Here's how it works.  When I bought my tweezers, I asked myself, "How much would it have cost me to make these tweezers all by myself?"  On reflection, the answer is... more than my lifetime wealth!  I'd have to spend years learning the basics of mining and metallurgy to acquire minimal competence.  And after a lifetime of training, I still probably wouldn't have the skill to make a single tweezer as good as the one I bought at Wegmans.  $14.99 versus more time than I have on Earth: that's what I call a bargain.
Caplan goes on to note that this is not an exceptional case. Indeed it isn't; Leonard Reed's famous "I, Pencil" is really a great example of what Caplan is getting at as well. If you're interested in more technical economics on this, I suggest a (tragically forgotten) paper by Armen Alchian (short summary at the end of this FH post) on fixed cost and marginal cost.

Monday, May 1, 2017

Review of Sunstein's Latest Book

by Levi Russell

I came across a review of Cass Sunstein's latest book The Ethics of Influence: Government in the Age of Behavioral Science by Michael D. Thomas in Public Choice. It's a great review that provides a succinct summary of each chapter. Since I'm often critical of Sunstein's "nudge" theory, I thought I'd share the last few paragraphs of the review. The review itself is, unfortunately, behind a paywall.

The Ethics of Influence appeals to the reader interested in the scope of government. It challenges Buchanan’s (2004) response to Warren Samuels about the “status of the status quo”. One could respond to Sunstein’s analysis by adding Buchanan’s observation that pure rent seeking results when the status quo is simply one among many possible outcomes. Another view would be that the status quo emerges tacitly over time. Here a defense of customary and common law could include writings by Hasnas (1995) on the emergence of law.

In dealing with Sunstein’s treatment of Hayek, it is important to respond not only to the explicit claims about how emergent law works, but also to his characterization of Mill’s harm principle. This is where public choice must defend the epistemic argument in Mill. The individual is not justified because he is a rational chooser, as Sunstein puts it. Instead, Mill says, “Men are not more zealous for truth than they often are for error…” (2009, p. 31). Multiple choosing groups do not preserve the truth, but the possibility for recovering lost truths. Readers might incorporate theories of discovery here, such as those developed by Kirzner (1985). Sunstein’s choice architects, on the other hand, form law through the inclusion of popular sentiment which reduces competing truth claims to one.

Since this book was published before the most recent presidential election, one wonders if such a view is weakened by the dramatic shift in popular sentiment and large changes in policy. Public choice concerns over who wields the power of this ever increasing authority gain additional profile from these recent events. The Ethics of Influence is a must read because it lays out many issues that are important for the next round of debates in public choice.

Tuesday, April 18, 2017

A Video Primer on Public Choice

by Levi Russell

The video below is a great introduction to Public Choice economics. It's about an hour long and is delivered by Ivan Pongracic, a professor at Hillsdale College who studied under Jim Buchanan.
Here are some of the topics covered:

The Public Interest View
Precursors to Public Choice
Voting and Group Rationality
Rent Seeking
Constitutional Political Economy

At certain points, Pongracic gets a bit too ideological for my taste, but the video is still good if you ignore those bits.

Monday, April 17, 2017

Sam Peltzman on Antitrust and Humility

by Levi Russell

Over at the ProMarket blog, there's a great interview of Sam Peltzman on industry concentration. The whole thing is worth reading, but I thought I'd reproduce what I think are probably the most controversial of Peltzman's responses.

Q: Which industries should we be concerned with when we look at questions of concentration?

The traditional answer, embedded in the merger guidelines, is “be concerned if concentration increases in an already concentrated industry.” The evidentiary basis for this is thin. A much older literature struggled vainly for years to find a broad pattern whereby adverse effects of concentration could be localized to highly concentrated industries. I am unaware that the state of knowledge on where we should be concerned—or indeed if we should be concerned—has improved much. Basically, antitrust policy relies more heavily on beliefs rather than a strong consensus about facts.

Q: The five largest internet and tech companies—Apple, Google, Amazon, Facebook, and Microsoft—have outstanding market share in their markets. Are current antitrust policies and theories able to deal with the potential problems that arise from the dominant positions of these companies and the vast data they collect on users?

See my answer to [the question above]. It is hubris to believe that economists and antitrust officials can predict the future, which is what you need to do in this sector. Who remembers that free web browsers were once thought to be a dangerous threat to competition?

Q: President Trump has signaled before and after the election that he may block mergers and go after certain dominant companies. What kind of antitrust policies should we expect from him? Pro-business, pro-competition, or political antitrust?

See [the questions above]. I prefer humility to hubris.

Wednesday, April 12, 2017

Blue Apron Blues

by Levi Russell

Blue Apron released a very nice-looking ad back in January that I'm certain appeals to their audience. Unfortunately, it perpetuates some wrongheaded ideas about food systems. Yes, I know this is an ad and that it's sort of silly to criticize an ad, but I think there's some value in explaining what is wrong with the sort of thinking put forth in ads like this. Now that I've "poisoned the well," here's the ad:

After mischaracterizing the US food system as a grayed-out assembly line factory, the narrator describes an ideal food system in which "chefs and farmers would plan crops and recipes together to make farm land healthier and grow ingredients that taste better." He then complains about the current system's supermarkets, food transit, and waste. Instead, in the ideal food system, food would be delivered fresh, straight to your door!

All of this sounds great, but what does it cost? Certainly Blue Apron isn't suggesting that literally the entire food system of the US could be replaced by their model. How much does Blue Apron cost? About the same as a meal at a fast-casual restaurant.

Yes, there are problems with food waste, lack of freshness, etc in the current food system. However, specialized production and large supermarkets feed the poorest among us quite well. At its current prices, there's simply no way Blue Apron could do that.

Sunday, April 9, 2017

A Discussion of Cost-Benefit Analysis

by Levi Russell

One of my favorite economics blogs is Cafe Hayek. Don Boudreaux, professor of economics at George Mason University, does a great job of using the economic thought of Alchian, Buchanan, Coase, Demsetz, and others to criticize popular fallacies and the perspectives of other professional economists.

Recently Boudreaux posted a couple of discussions on cost-benefit analysis. Below I reproduce key segments of these posts.

Boudreaux is clearly a fan of cost-benefit analysis, but he has a unique take on precisely who is best positioned to conduct such an analysis:
In this light, the benefit of moving consistently in the libertarian direction is that, to the extent that this movement is successful, one result is that both the number and the reliability of cost-benefit analyses increases. In the absence of the FDA and its prohibitions, each individual – with or without the consultation of his or her physician (as he or she chooses) – would make a series of personal cost-benefit analysis, throughout time, regarding various medical options.

This decentralized process of cost-benefit analyses would be on-going. Every hour of every day, each of many individuals would be doing his or her own cost-benefit analysis. And because each of these cost-benefit analysts would, unlike those who conduct cost-benefit analysis on government programs, (1) have more of his or her own money on the line, and, more significantly, (2) have his or her own health at stake, the results of these countless cost-benefit analyses would be much more reliable than are the results of unavoidably only occasional and information-thin cost-benefit analyses conducted on the overall effects of FDA policies and other government actions.

So, yes, by all means let’s have more – and more trustworthy – cost-benefit analysis. One of best means of achieving this happy result in matters of Americans’ health care is to abolish the FDA. To support the retention of the FDA – to support the retention of this agency’s current ability to prevent Americans from using whichever medical products they individually choose – is to oppose maximum possible cost-benefit analyses.
He follows that post up with another example:
Let me put this last point somewhat differently: if the income gains, from a minimum wage, captured by some people are to be counted as ‘benefits’ to be weighed against the losses of other people – and if these gains can in principle be so high relative to the losses that the minimum wage passes a cost-benefit test that then is used to support the minimum wage – then there is flung open a Pandora’s box of utilitarian horrors.

For example, someone (call him CB) might propose that the state prohibit the employment of all blacks under the age of 20. CB would correctly point out that, while his policy would obviously have some losers, it would also produce winners – namely, the wages of non-black, mostly young workers will increase as a result. And he’d be correct. I can also imagine that, in reality, the measured increase in the aggregate pay of this policy’s winners would be larger than the measured decrease in the aggregate pay of its losers (especially if we confine “losers” only to the black teenagers who lose jobs). Yet who would counsel that we should, therefore, withhold judgment on CB’s proposed policy until a cost-benefit analysis is conducted? Who would think it to be “libertarian” or “one-sided” or “unscientific” to prejudge as unacceptable a policy of prohibiting the employment of blacks under the age of 20?
Here are a couple of related short posts:

This one, by Jon Murphy, one of Boudreaux's PhD students, tackles the issue of aggregation in cost-benefit analysis. Another by Roger Meiners at the Property and Environment Research Center examines the use of cost-benefit analysis by the Environmental Protection Agency.

Wednesday, April 5, 2017

Big Ag Antitrust Blog Symposium

by Levi Russell

Recently I was part of a blog symposium put together by the International Center for Law and Economics at the Truth on the Market blog. The posts were quite diverse in terms of subject matter and perspective, so I think they're worth a read if you want to get a better understanding of what is going on with the Bayer/Monsanto, Dow/DuPont, and ChemChina/Syngenta mergers and acquisitions. There were some great contributions from the lawyers and economists on the panel and I was humbled to be invited to be a part of it. Below are links to the posts in order of the authors' last names.

Shubha Ghosh - Patents and mergers

Allen Gibby - Conglomerate effects and the incentive to deal reasonably with other providers of complementary products

Ioannis Lianos - Finding your way in the seeds/agro-chem mergers labyrinth

Geoffrey Manne - Innovation-driven market structure in the ag-biotech industry

Diana Moss - Mergers, innovation, and agricultural biotechnology: Putting the squeeze on growers and consumers?

Nicolas Petit - Antitrust review of ag-biotech mergers: Appropriability versus cannibalization

Levi Russell - Contestability theory in the real world
                        Effects of gene editing on ag-biotech antitrust

Joanna Shepherd - Understanding innovation markets in antitrust analysis

Michael Sykuta - Innovation trends in agriculture and their implications for M & A analysis

Friday, March 31, 2017

More Demsetz on Externalities

by Levi Russell

I recently ran across a lecture by Harold Demsetz presented at the Property and Environment Research Center in Montana back in 2011. Unfortunately, the video isn't online anymore, but I did find a written version. It's fairly short as lectures go, so I recommend you read it. If you don't have time to read 11 pages, check out the excerpts below.

Demsetz starts off by discussing the perfect competition model (which he calls the "perfect decentralization model"). This provides the backdrop for his discussion and critique of Pigou and Coase.
Consider Pigou’s method of argument first. He constructs examples of divergences between private and social cost. These examples differ circumstantially but in their nature s they are all the same. A favorite example involves the misallocation of traffic between two roads that connect the same terminal points. One road is subject to considerable congestion because it is narrow; the other road is wide and escapes much of this congestion but takes longer to transit because it lacks the directness of route of the narrow road. Pigou claims that the equilibrium number of autos using the narrow road will be inefficient. This is because drivers using this road do not take account of the costs of increased congestion they impose on others who use the road.  But what Pigou fails to do is show that the se example s are consistent with the presumptive conditions set down in the perfect decentralization model.  Frank H. Knight (1924), in a brilliant article on social cost, criticizes Pigou’s two -¬‐ road example. He notes that Pigou allow s free access to the two roads. Presumably, then, these roads are publicly provided and managed and, as such, cannot be a basis for criticism of private re source allocation. Knight argues that these roads, had they been private, would have been priced (in a competitive setting) so as to achieve an efficient allocation of traffic; price to use the narrow road would have been raised to levels higher than to use the broad road. Pigou’s examples do not uncover a logical flaw in the neoclassical model, since virtually all are based on an absence of private ownership. This is not to say that all resources in a real economy are privately owned but that Pigou’s work is properly interpreted in terms of the consequences of an absence of private ownership (or, more provocatively, as the presence of mismanaged public or collective ownership) than as inefficiency deduced within the context of the neoclassical model.
Coase noted a defect in Pigou’s argument that in its nature was much like that seen by Knight but which was not based on the absence of private ownership. Coase pointed to Pigou’s failure to recognize that the cost of using the price system disrupted the ability of a market-¬‐based price system to face users of resources with the full consequences of the uses they chose. Free use of the price system was implicitly assumed in the neoclassical model, since it treats prices as known to all who would use them. Coase’s complaint about neoclassical economics is empirical error, not logical error. The empirical error being that its model abstracts from an important aspect of the real world. As described above, Pigou gave no explanation for why a separation between private and social cost should exist in an economy that conforms to the conditions of perfect decentralization. Coase also offers no reason; instead, he openly modifies the perfect decentralization model to accommodate the fact that positive costs must be incurred to engage in exchange. The modified model allows him to rationalize the existence of a separation between private and social cost, or so he thinks. Just what this cost consists of remains somewhat vague, but I adopt Coase’s general notion.
Coase demonstrates the importance of transaction cost by way of two contrasting cases. The first shows that no difference between private and social cost can exist if the cost of transacting is zero, since, in this case, all who would bear costs from someone’s actions can bring these costs into that person’s calculations by making him or her offers to desist or modify the intended actions; similarly, this person can require revenues from those who would benefit from these actions. Nothing is left unaccounted for as long as legal rights of actions are in place. Coase’s argument is correct in this case. His presentation of the second case, involving positive transaction cost, claims that inefficiency may arise because some of the negotiations required to account for all costs and benefits cannot surmount the barrier put in place by transaction cost even if legal rights of action are in place. And here, Coase makes an error that still goes unappreciated by economists. 
Coase has treated the legal system and its courts as if they are parts of the economic system that was modeled by neoclassical economists, but, as already noted, their model assumes that all resources are privately owned and that ownership is fully respected; there is no place in it for the courtroom drama imagined by Coase. Moreover, real social systems in fact design courts so as to insulate them the influence of the marketplace. Offers and acceptances of payments to the court for desired decisions are illegal, and court survival is not made to depend on earned profit from decisions rendered. The neoclassical model of an economy and the conclusions drawn from it are confined to economic institutions, to firms, buyers, sellers and so on. The model draws no conclusions about resource allocation which results from actions taken by non-¬‐market institutions like courts and legislatures. In any case, Pigou did not base his examples of inefficiency on ownership ambiguity or court mistake.

While adopting the neoclassical perspective of market behavior, which sees ownership and markets as instruments by which resource values are maximized, Coase has relied on court decisions to assess the efficiency of the economic system. The implication he draws, that the economic system has made a mistake in allocating resources, is quite wrong. The court may have made its choice of owner for reasons different from maximization of market value or it simply may have made a mistake because it is not guided in its decisions by a market-¬‐based calculus. These reasons may seem good to some and bad to others, but they are irrelevant to the externality problem whose proper domicile is wholly within the economic system. Indeed, although there are good reasons for not creating a different legal system, if the court were to be transformed into a market institution and allowed to survive only by revenues secured from petitioners who buy its services and decisions, control of a resource would go to the person who can put it to its highest value use.

The economic system simply takes the court’s decision as an exogenously imposed constraint on its operations, much as it takes a decision by the State to tax or redistribute wealth. An efficient economic system is one that makes the most of scarce resources within the constraints handed down to it by courts and legislatures. Efficiency requires the market to block the transaction between the two claimants discussed above if the cost of their transacting exceeds the increase in value expected to be realized from a change in ownership of the resource.
There is no difference between transaction cost and other costs in this respect. The amount of soot from the production of steel may remain greater than is desired by the owner of a nearby laundry because the cost of transacting between laundry and mill owners is too great to make a transaction worth undertaking or because the launderer and steel mill owner believe that the cost of substituting hard coal for soft is greater than the cost borne by the launderer as a result of soot. In both cases, more soot descends on the laundry than if the cost of reducing soot were smaller. If we do not think resources are misallocated in the case in which hard coal is too costly to use, why should we think resources are misallocated in the case in which transaction cost is too costly to bear? Both situations are compatible with efficient resource allocation, and, after all, it is efficiency that is sought; neither negotiations nor hard coal are sought in and of themselves. Indeed, one can rewrite the neoclassical model with transaction cost included. This just shifts supply curves upward (or demand curves downward), but it carries no implications of inefficiency at equilibrium values of price and output.

I emphasize that none of what is written above denies the possibility of inefficiency in a competitive, private ownership economy. My message is that this possibility is not a result of positive transaction cost. Our reliance on a transaction cost rationale has caused us to exaggerate the scope of what externality problem might remain.

By now, the reader must suspect me of playing a word game. In part I am, but the game is not my doing. ‘Externality’ means nothing if it does not suggest something apart from a reckoning. Yet, a non-¬‐trivial component of what is written above makes a case that there is no ‘apartness’ from the market calculus. Something rationally not ‘worth’ taking into account is not equivalent to error or to inefficiency. That it is not taken into account is a reckoning if it follows from an anticipation that it is not worth taking into account. An explicit accounting for everything would be inefficient in a world in which knowledge is not free. 

Supply and demand as interpreted by the neoclassical model are expressions of true willingness to cooperate in a world that is highly dependent on specialization for its wealth. The neoclassical model faces buyers and sellers with given, non-­‐negotiable equilibrium market prices, determined on markets that cannot be influenced by individual bargaining. The model is not designed to treat strategic action, yet examples such as climate change and atmospheric quality represent problems that arise from the attempt to get others to settle for a smaller share of the surplus made available through cooperative behavior.

A close reading of Pigou and Coase does not reveal concern about strategic behavior. The distribution of traffic between Pigou’s two roads is inefficient because no price is charged for using them, not because drivers deceive each other. The failure to realize maximum value from available resources in Coase’s court room drama is a problem of legal error, not one of false testimony.

What advantage does the State bring to the resolution of strategic problems? It brings legitimate power to coerce; in these instances, the power to coerce people to pay for a public good. Just as we find that the State’s ability to coerce makes it a desirable agent in helping to maintain law and order, so we may find it a desirable agent in helping to finance production of goods and services that are important and are subject to serious strategic bargaining problems. It is possible in some instances to remedy the problem through a proper set of private rights –substitute a toll way for a free way. In other instances, the effective use of coercive power might require direct implementation by the State. People will value the alternatives of coercive State and voluntary-­‐dealings markets differently, depending on the confidence in which they hold the State and on the value they attach to personal freedom, but I see no reason to classify these important problems as externality-­‐caused inefficiencies. This now seems to me to be a classification without content.

Thursday, March 23, 2017

Should We Fear Tech-Driven Price Discrimination?

by Levi Russell

Writing at Bloomberg View, mathematician and author Cathy O'Neil walks through several ways in which new retail technology could enhance businesses' ability to engage in price discrimination. I recommend reading her piece, as it makes some good arguments in favor of being concerned. However, I think there are reasons to believe price discrimination either 1) is sometimes beneficial or 2) can be easily avoided.

What is price discrimination? It's the practice of charging people different prices for the same good based on their ability or desire to pay. O'Neil mentions that rules are in place that outlaw this practice, except in the cases of coupons, memberships, or bulk orders. But there are other cases. Senior citizen or military discounts are common. These discounts are based on the general idea that significant segments of these populations have relatively low incomes. Yes, there are well-paid soldiers and many, many people over 65 are quite wealthy, but these discounts apply to enlisted soldiers and elderly retirees on fixed incomes.

Coupons, membership deals, bulk discounts, and discounts for military and seniors are generally thought of in a positive light. People who have lower incomes but more time to cut out coupons will pay lower prices. Those willing to give shopping information to retailers get discounts. Some of us pay higher prices so that soldiers and seniors, who might have lower incomes, can still enjoy goods and services at prices they can afford.

Moving to online shopping, O'Neil explains how retailers collect data on their (potential) customers and are able to prey upon the desperate or cavalier by charging higher prices. Here are some examples with potential solutions in italics:

Retailers collect shopping and other data based on your IP address or browser "cookies."
Clear your browser's cache regularly.
Use the Tor browser, which makes it very, very difficult for you to be identified by websites

Retailers collect data based on user's individual profiles.
Many online retailers allow you to purchase without creating an account.

Personal assistants like Google Home or Alexa might pick up on behavioral cues that allow them to charge high prices.
 Just don't buy one. 

A common theme on this blog is that, as Harold Demsetz pointed out decades ago, comparing the real world with all its faults to a perfect ideal "alternative" isn't necessarily a good guide for policy. So, if advances in retail technology allow retailers to adjust prices based on income or stress or other factors, should something be done to slow these advances? Does it make sense to forego the benefits of improved technology to avoid these potential costs? I don't know the answer to that, but I'm interested in reading your thoughts.