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Libertarianism, inequality and cultural homogeneity

Andrew Norton doesn’t think much of this article by Christine Wallace in the Griffith Review, in which she argues that the Coalition under Howard has instigated libertarian policies by stealth. He calls it “a dozen or so pages of ignorance and silliness,” citing this paragraph from page 8 in particular:

The libertarian logic is that, since personal freedom and the existence of free markets are inextricably entwined, and since – as Bork puts it – “vigorous” economies are vulnerable to being “enfeebled” by particular cultural practices, then the champions of personal freedom have a licence to police cultural practices – in the interests of freedom and economic vigour. Thus libertarians can reason that difference (for example, multiculturalism, homosexuality) must be eliminated so that the economy can function better – reasoning that is absurd, to say the least.

A commenter on Andrew’s blog also highlighted this bit on the previous page:

The central difference between the Howard Government and the Hawke/Keating Governments is that the Labor governments saw a crucial role for the public sector … especially in relation to issues of economic inequality; about which libertarians are unconcerned.

First a confession: I’ve not read more than two or three pages of Christine’s article. Still, if the blogosphere isn’t a place for partially informed comment, I don’t know what is. In the interests of fairness, though, I will disagree (slightly) once with Andrew and once with Christine …

In the paragraph that drew Andrew’s ire, Christine argues that the libertarian pursuit of free markets justifies cultural homogeneity. Andrew’s implicit criticism certainly seems to make sense: why should free markets and cultural heterogeneity be mutually exclusive? But it is worth noting that Christine may – at least to some extent – have an unpleasant point. For a market to operate efficiently requires trust between its participants. A market can certainly operate without trust if institutions are sufficiently advanced and corruption-free, but the enforcement costs they impose are a classic form of market failure, along with moral hazard and adverse selection. Even with good institutions, market efficiency is optimised by increasing trust. However, as Andrew Leigh has observed for Australia [here and here] and Robert Putnam has found for the USA [here], ethno-linguistic diversity breeds mistrust. In so far as they proxy for culture, Chrstine’s point at least partially stands.

Now back to Christine. She reckons that libertarians are unconcerned about inequality. It’s obviously a generalisation, but even in general, it’s misleading. While I’m sure that libertarians are not concerned about inequality per se, I’m equally sure that they are concerned with unwarranted inequality. Classic theory of the firm suggests that in perfectly competitive markets, a person’s wage will equal the value of their marginal product. Presuming (safely enough) that different occupations have different marginal products (so an engineer will contribute more to a firm’s profits than a cleaner), if people at the top of the pile are being paid more than their marginal product and people at the bottom are being paid less than theirs, a libertarian would oppose the excess inequality that resulted.

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The man whose name is anathema

Peter Martin, currently the economics editor of The Canberra Times, has got a nice little piece on labour productivity in Australia over here.

It’s fascinating for two reasons. The first is that growth in labour productivity in Australia has stalled – it may even be as low as 0% for the current financial year – and this slow-down coincides neatly with the Coalition’s Work Choices program. I’m not convinced that one necessarily caused the other. At the very least, I would have expected some sort of lag between Work Choices coming into effect and any change in productivity growth. Nevertheless, it looks ugly for the Howard government and they’re clearly doing their darndest to avoid drawing attention to it.

The second fascinating thing is that, even though this raises the question of whether Keating’s enterprise bargaining system was better in terms of promoting productivity growth, nobody – on either side of Australian politics – will dare mention this possibility. For the coalition, this makes perfect sense. They don’t want to acknowledge anything about the previous Labor government that was “better” than under them. For the Labor party, though, it’s far sadder. They’re clearly working under the assumption that invoking the name of Keating will tar them with the 1991 recession. It’s sad, because they’re just as clearly throwing away the best piece of evidence they have for Labor’s economic-management credentials.

In case anyone is interested, here is a graph from ABS data that Peter included in his piece, showing clearly that the quarterly change in labour productivity has turned negative for the last two quarters:

Quarterly change in Australian labour productivity

Recognising the probable noise in quarterly data, Peter also includes this graph of a four-year rolling average courtesy of Saul Eslake at ANZ:

Four-year rolling average of changes in Australian and American labour productivity

Paul Keating, speaking to the ABC’s Eleanor Hall in the week leading up to the recent budget, justified enterprise bargaining over individual contracts thus:

On this floor at the ABC here, there must be 150 people. If you went out there and said to them, look we’re going to make an agreement for the next three years or four with the ABC and we want 3 per cent productivity a year out of it, or 2 per cent productivity, together you could all do something.

But if they just take Eleanor Hall by herself and say, you will give us an increase in productivity, how can you, individually? How can you? What are you going to do, talk louder? Talk more? Be at work earlier?

For reference, the latest Australian federal budget can be found here. The section relevant to Peter Martin’s commentary is Budget Paper 1, statement 4.

Update – 14 May 2007 – In response to Andrew Norton:

Andrew is absolutely right that a firm is concerned principally with profit, but there are always two ways to get more of the stuff. You can do the same at a lower cost (as he speaks of), or you can do more, with the value of the extra done being more than the extra cost it requires.

Assuming that the amount of labour employed remains the same in both cases, the first possibility does not increase worker productivity; it only shifts a greater proportion of the output away from labour and into firm profits. The second possibility increases worker productivity, with an ambiguous effect on the labour/capital shares of output.

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US Trade policy

It seems that the White House has managed to agree with some key Congressional Democrats (presumably the speaker and the Ways and Means committee) on a trade policy framework, allowing them to move forward on a number of deals. See reporting from:

It seems to include items on labour standards, environmental protection (or possibly just require the enforcement of already-agreed-to environmental standards), allowing developing countries slightly easier access to some generic medications, a guarantee that US ports will continue to be owned and operated by US companies, and increased funding for training US workers affected adversely by trade.

I’m not sure how I feel about these things. I would need to see some more specific details than the tantalising hints that the journalists drop throughout their pieces. At a rough guess without seeing the details, and reserving the right to change my opinion, I support the environmental protections, partially support the labour support requirements (I’d support the right of workers to unionise, for example, but not US-imposed minimum wages or working conditions [*]), support easing access to generic drugs and absolutely oppose restricting the operation of US ports to US companies.

[*] I do generally support minimum work condition requirements and – absent a proper tax system that can provide appropriate subsidies to the poor – a minimum wage, but I do not support the US imposing any particular work conditions or minimum wages on other countries. It should be up to the people of those countries to make up their own minds.

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Why I like Andrew Leigh

The man just talks sense. He argues that:

we can save a lot of Australians the bother of filling out an annual tax return. In August, the ATO would simply send you a statement saying what they think you owe. If you agree with it, if you have no complex income, and if you don’t want to claim any deductions, you do nothing. Of course, if you want to claim your deductions, you’re welcome to do so.
…
Simplifying tax-filing should appeal to politicians of all political stripes. Whether you think tax rates should be lower or higher, you should support lowering the compliance burden.

His primary article is here.

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Pigovian taxes or rolling-auction-cap-and-trade?

Update:  I’ve received some criticisms of this proposal elsewhere and I hope to do up a version 2.0 in the near future.

For the purposes of this post, I shall assume that climate change is real, is undesirable and, if not wholly anthropogenic in its causes, is still able to be mitigated by a decrease in emissions of greenhouse gases. The question is how best to achieve that goal. Generally speaking, there are two broad approaches to the problem: emission trading (cap-and-trade) or taxation.

The largest cap-and-trade scheme in the world is the European Union Emission Trading Scheme (EU ETS). You can read more about it at Defra or Wikipedia. Benefits of the EU scheme are:

  • It offers a “market-based” solution while still allowing control over total emission levels, which is arguably necessary to combat climate change because, in this respect, the earth is a closed system.
  • It rewards innovative companies that reduce their emissions (by allowing them to sell their excess permits).

However, it suffers from several problems:

  • The allocation breakdown between countries is negotiated politically rather than on the basis of need or economic efficiency.
  • The allocation breakdown within countries is decided by the government, which makes it susceptible to political vagaries.
  • Incumbent firms do not incur a cost for the bulk of their emissions, but only for those in excess of their allotment.
  • Because allotments are decided for several years at a time, the system raises a barrier to entry in the affected industries and so stifles innovation. This is because new entrants (who don’t receive any allotment) will have to pay for all of their permits in full. Worse still, they have to buy them from the incumbents!
  • In the lead-up to allocations being made, it is optimal for both firms and governments to exaggerate – or worse, actually increase – their emission levels in an attempt to capture a higher share of the total permits and thus extract rents from others.
  • It would be extremely cumbersome and invasive to spread the idea of emission permits down to the level of the individual consumer for pollution that is created by acts of consumption (e.g. burning gasoline by driving your car) rather than acts of production (e.g. burning coal to produce electricity).
  • The government’s sole incentive to enforce the system is environmental altruism, which may at times take a back seat to political expediency.

As an alternative, various people advocate Pigovian taxes on greenhouse gas emissions (particularly Greg Mankiw and his Pigou Club, which boasts some pretty big names). I first want to acknowledge some of the key benefits that taxes offer in this regard:

  • The infrastructure for taxation and tax auditing is already well established.
  • Taxation can readily be applied to all sources of pollution, both in production and consumption.
  • The revenue can be used to offset taxes that are distortionary.
  • The government would have two incentives for enforcing the system – environmental altruism and protection of a revenue stream – making it more likely to be done thoroughly.

Next, the downsides to using taxes to reduce greenhouse gas emissions:

  • As a general rule, the government is in no position to decide which industries are best able to innovate to reduce their emissions, but this is exactly what the government would in effect be doing when it decided tax rates on a product-by-product basis. Tax rates of X% on gasoline, Y% on aviation fuel and Z% on coal-fired electricity production include an implicit government bias in which industries ought to change.
  • Because the price elasticities are not known, it is impossible to know the optimal level(s) of taxation.
  • Even if the optimal tax level were known, all taxes are subject to political compromise, not just when introduced but on an on-going basis in much the same way that the allocation of permits is under the EU system.

If forced to choose between them, I would personally favour Pigovian taxes over an EU-style cap-and-trade system.

But before Professor Mankiw adds me to his club, I want to stress that if given true freedom to choose, I wouldn’t go with either of them. I would choose what I (rather cumbersomely) call a rolling-auction-cap-and-trade system. Here’s how I imagine it working:

  1. An independent government agency would perform the following roles:
    1. Decide on the total number of permits to be allocated to the economy as a whole.
    2. Auction permits on a rolling basis (say, monthly) on the open market.
    3. Declare the market average amount of greenhouse gases emitted by products used in acts of consumption.
    4. Enforcement, with random audits and the ability to impose (effectively) infinite penalties.
  2. Permits would be freely tradable between private agents.
  3. Any firm that pollutes in the act of production must possess permits for the greenhouse gases that it emits.
  4. Any firm that that produces a product which will cause pollution in the act of consumption (e.g. gasoline) must possess permits for the market average amount of greenhouse gases that will be emitted.
  5. Full reporting of points 3 and 4 would be required under Generally Accepted Accounting Practices (GAAP) and must be certified by an independent auditor.

So far as I can tell, this system essentially offers all the benefits of both the EU ETS and Pigovian taxes without any of the downsides of either. It effectively places a cap-and-trade system on the entire economy (consumption and production) without forcing a burden on individual consumers to purchase and keep track of their permits. It minimises government interference and with it, the chance that the system might be picked apart by well meaning but short sighted politicians in the years to come. It offers up revenue which helps encourage the government to maintain the system and allows them to offset distortionary taxes. It does not create incentives for agents to exaggerate or alter their behaviour to “game” the system. It does not try to second-guess the market in terms of where innovation might most easily occur, nor does it impose any barriers to entry or innovation. Innovative firms benefit two-fold, by lowering their costs and – by passing at least some of those savings on to their customers – increasing their market share.

I’d welcome any comments or criticism.

p.s. I have previously wondered whether the revenue raised ought to go to the Central Bank (rather than the government) so that they could then reissue the revenue raised into the money supply. I believed back then and at least suspect now (the intuition is the same, but I’m more cautious now) that this would be the ultimate sterilised environmental policy. The money supply would remain unchanged and since the money would never go near the government, there would be no change to the government’s macroeconomic position or impact on the economy. Without attempting a model to “prove” it, I think the general equilibrium result would be a redistribution from firms and individuals that were above-average polluters to those that were below-average polluters, with the market deciding who and how much at both ends of the transfer.

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Games consoles: four phases of sales

March figures for game console sales in the USA have been released. Sony’s PS2 is still the biggest seller, with 280,000 units sold. Then comes the Nintendo Wii with 259,000, Microsoft’s Xbox360 with 199,000 and the Sony PS3 with 130,000.

Most discussion will, no doubt, centre on the continuing sales success of the Wii and many commentators will probably suggest that their success is due to the price differences between the consoles. This made me think … I reckon that there are four broad phases in sales for a games console.

In the first phase we have the early adopters, for whom price is of no real concern. They may bitch and moan about it, but they’re always going to buy at pretty much any price. This is when Gabe and Tycho from Penny Arcade buy their systems.

In the second phase, both price and branding/public-perception/coolness-of-the-games come into it, but price is the dominant determinant because the console hasn’t been around long enough to build a reputation. This is when the cool (i.e. rich) kids buy them.

In the third and probably longest phase, reputation and coolness-of-the-games dominate price in determining demand. This is when the poorer (but not dirt-poor) kids, sick of being ostracised by their peers for being terminally uncool, ratchet up the whining until their parents crack.

The fourth phase, which not all consoles reach, is determined entirely by the staying power created by the variety and quality of games. This is when the poorest of the poor decide to give themselves a treat by buying a console that is clearly out of date, but still looks like being worthwhile.

I’d suggest that the consoles are currently:
PS2 – Recently entered the 4th phase
Wii – Recently entered the 2nd phase
360 – Been in the 2nd phase for a while now
PS3 – Approaching the end of the 1st phase

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Modelling bribery in elections

This article on Reuters about Chinese villagers complaining that they were no longer receiving bribes from candidates in local elections got me thinking about how best to model bribery in an election process.  I’ve not done any research at this point, so I wouldn’t be the least bit surprised if someone had already done this in considerably more detail, but here are some initial thoughts …

Assume that the local government offers no public goods or public services to the voters, but instead acts either as a gatekeeper for business permits or as a guide through an externally imposed beauracracy. In either case, further assume that elected officials make a lot of money through bribery and in particular, more than their outside options.

The candidate that hands out the most to the voters wins the election and gets the bribes from business. Without a credible commitment between the candidates to not give handouts, the incentive will always be to give a handout and the only stable equilibrium will be for everyone to give a handout.

If the size of the bribe from business is universally known ex ante, or if it is uncertain but it’s expected value is commonly known and the candidates are risk-neutral, the candidates will all give handouts until their expected return matches their outside options. The result (a coin-toss since all candidates handed out the same amount) will be that the guy who wins the election gets a bucket of money, the voters each get a bit and the other candidates all lose money. e.g. Outside option for all candidates = 0, (Expected) Bribe from business = 100, Number of candidates = 4, Number of voters = 1000. Each candidate will give each voter 0.025 (so each voter will get 0.1 and the total handouts to voters will be 100). The candidate who wins will get 75 (100 – 25) and the candidates who lose will get -25.

I’ve assumed above that all candidates are the same in a) their risk aversion; b) their expectation of the value of the bribe from business; and c) their outside option. If the expected bribe and outside options are common but candidates vary in their level of risk aversion, the least risk averse candidate will win. If candidates vary only on their expected bribe, the candidate with the largest expectation will win. If candidates vary only in their outside option, the candidate with the lowest outside option will win.

Obvious extensions would be to include not just ex ante handouts but promises of handouts ex post and to suppose that some (or all) of the candidates also owned the businesses that would have to pay the bribes.

As always, any thoughts or comments are welcome.

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The benefits and perceived costs of immigration

This article discussing migration to Britain, the benefits it brings and British reaction to it, was recently on the front page of the FT. Some key points:

Britain’s willingness to absorb migrants … have brought “undoubted economic benefits”, John Reid, home secretary, said last year. By helping to fill skills shortages and keeping a lid on wage inflation, immigrants have helped produce stronger economic growth.

[However,] 47 per cent of Britons believe migration by workers within the EU has been negative for the economy and only 19 per cent think it has been good. Asked whether there should be stricter controls to prevent workers from central and eastern Europe entering the country, 76 per cent of Britons agreed.

A friend of mine questioned whether these two sentences from the article were contradictory:

The Bank of England believes that the large influx of migrant workers has contributed to lower inflation by helping to contain wage growth. David Blanchflower, a member of the Bank’s monetary policy committee, said last month there was little evidence that immigrants from eastern Europe had depressed the wages or employment chances of British workers.

They’re not – they’re saying that migrants have caused wage growth to fall (first sentence) but it has remained positive (second sentence), meaning that wages themselves are not falling – but it does raise a key point in understanding why people feel economically cheated in an environment of high immigration.

Suppose that Price Inflation tomorrow is equal to Wage Growth today minus a bit related to “real” growth in the economy (which is plausible), but when considering their Wage Growth today, workers compare it to Price Inflation today. Then we might have (all figures are percentages):

Inflation today: 2

Without immigrants
Wage Growth today: 3
Perceived benefit: 3-2 = 1
Inflation tomorrow: (3-n)
Actual benefit: 3 – (3-n) = n

With immigrants
Wage Growth today: 1
Perceived benefit: 1-2 = -1 (!)
Inflation tomorrow: (1-n*)
Actual benefit: 1 – (1-n*) = n*

If you also suppose, as the BoE clearly believes, that the ‘n’ actually increases with immigration (n* > n), then people are unambiguously better off with immigrants coming in, but believe that they are worse off.

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Carbon taxes vs. Carbon credits

I don’t know for sure, but I think that I disagree with an explicit carbon tax. Why should the government be any good at deciding which industries have the best chance of improving their energy efficiency (which they are doing when they set the tax rate on a product-by-product basis)?

I suspect it would be better to go for carbon-credit trading system. Have a (declining) aggregate quota of completely tradable carbon credits, issuing them by open-market auctions on a rolling basis throughout the year. To be economically neutral (that is, non-distortionary), the issuer of carbon credits would need to government-independent (although operating within boundaries set by the government) and either work closely with the central bank or be a new branch of the central bank itself.

This last point would be necessary because if the proceeds from auctioning the credits were not going to be treated as government revenue (and in order to avoid being distortionary, that would need to be the case), any money paid for the credits would need to be recycled back into the economy by the central bank. This would ultimately have the equivalent effect of raising interest rates on carbon-intensive parts of the economy and lowering interest rates for the carbon-free sections while keeping the aggregate rate (and thus, in theory, the overall effect on GDP) unchanged.

In practice, I suspect that we would see some increased volatility in market interest rates and inflation pressures, with both settling down over a few years.

I could be entirely wrong on all this, though. It’s just the result of 20 minutes of thought. I’d welcome any corrections.

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History of US Legislative and Executive power

Following the recent (midterm) US elections and looking at this article over at the Economist, I was fascinated by the graphic they provided at the bottom detailing periods of Democrat and Republican control over the House of Representatives and the Senate. The obvious missing information was on presidential control, so I did one up myself. You can grab it (as an Excel spreadsheet) here.

It’s interesting to note that since 1901, the Democrats have generally been dominant in the House of Representatives (64.8% of overall control) and the Senate (57.4%), but the Republicans have maintained a slight upper hand in the Presidency (48.1% Democrat).

Americans do seem to prefer having just one party in control at a time (59.3% of the time all three are under the control of the same party rather than the 25% that would have been expected by pure chance).

Update: I have redone this following the 2008 election here.