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Category: microeconomics

Published on Leave a comment on Crumbling American Dreams

The observations in this masterfully written op-ed by Professor Robert Putnam are the reason why I developed a course on local public policy a few years ago. The op-ed is well worth your time. Here is an excerpt from the very poignant conclusion:

The crumbling of the American dream is a purple problem, obscured by solely red or solely blue lenses. Its economic and cultural roots are entangled, a mixture of government, private sector, community and personal failings. But the deepest root is our radically shriveled sense of “we.” 

Cue the Lorax.

Published on Leave a comment on There’s Nothing Wrong with Making Money. Keeping It for Yourself Is Overrated.

If you are wondering, this column is exemplary of why I stopped following David Brooks years ago. Commenting on an earlier piece by Dylan Matthews, he introduces the case:

Trigg is a 25-year-old computer science graduate of the Massachusetts Institute of Technology who has hit upon what he thinks is the way he can do maximum good for the world. He goes to work each day at a high-frequency trading hedge fund. But, instead of spending his ample salary, he lives the life of a graduate student and gives a large chunk of his money away. 

And here is the way Brooks introduces us to his cautionary tale:

From the article, Trigg seems like an earnest, morally serious man, who, if he lives out his plan, could indeed help save many lives. But if you are thinking of following his example, I would really urge caution.

You can read Brooks for yourself. But I note the following problems with his analysis:

First, nowhere in the original article is it even suggested that Trigg does not enjoy working at the hedge fund, yet Brooks assumes this must be the case. So he sets up a straw man.

Second, nowhere in Brooks's piece does he provide any evidence that Trigg is becoming less like his philanthropy and more like the (presumed) less appealing parts of his vocation. What life's wisdom is Brooks drawing upon to predict that utilitarianism implies corruption?

Third, and most importantly, Brooks is fighting the basic prescription of the economic theory of comparative advantage (which Trigg has understood and put into practice). In the second quote above, Brooks does acknowledge that by Trigg not working at the hedge fund, fewer people would be saved from malaria. It reads like a grudging acknowledgement. But he should also acknowledge that if Trigg went to a malaria-infested region to do field work, he would compete for resources with someone else who actually wants to do that. His competitor might be squeezed out of the opportunity entirely or simply be paid less to do it.

The effort to achieve good ends requires both human and financial resources. Why fault those who derive value from providing the latter if they have no talent or interest in the former?

Published on Leave a comment on Governor Spitzer, We Hardly Knew You

My first reaction to the news of Eliot Spitzer's demise was that I felt bad for his three daughters, for reasons discussed here. My second reaction was that I felt bad for his wife for having to stand there and face the public glare as well. I presume that she did that for her daughters if not for her husband. It is the adultery embedded in the transaction, particularly by a father of teenage daughters in the public eye, that most disturbs me.

But that's a personal judgment and a matter that may be relevant in a divorce proceeding. It doesn't necessarily have to guide public policy. What of the transaction itself, if it did not involve adultery? For a public official, the big danger is that Spitzer's desire to keep the activity secret would subject him to blackmail by those in on the secret. With the secret out in the open, there's no longer any danger in that happening, even if he hadn't resigned. Perhaps we need a disclosure policy for elected officials?

What of the transaction itself, if it did not involve adultery or a public official? Now we get to find out whether I'm a libertarian or not, I suppose. Here is a libertarian's case in defense of legalized prostitution. Here's another defense of legalized prostitution based on strengthening the legal status of women who currently engage in illegal prostitution.

What does the economist in me say? Despite the rather high price paid by Governor Spitzer ($4300 per hour), prostitution--particularly if legalized--lowers the cost to the man of obtaining more and more varied sexual activity from women. Who is made better off by this change in price?

  • Men who partake of prostitutes (buyers).
  • Women who engage voluntarily in prostitution but not other types of sex (sellers).
  • Men who do not partake of prostitutes but who face less competition in finding sexual partners from the men who are now content with prostitutes (buyers of substitutes).

Who is made worse off?

  • Women who do not engage in prostitution (sellers of substitutes)

The last one is a pecuniary externality. Though not a threat to economic efficiency, I'm not enough of a libertarian to ignore it.

Published on Leave a comment on No LUV, or Maybe Too Much, from the FAA

As a longtime flyer of Southwest Airlines, this was not welcome news:

WASHINGTON – The Federal Aviation Administration said Thursday it would fine Southwest Airlines Co. $10.2 million for safety violations that included knowingly flying more than three dozen jets without mandatory inspections for structural damage.

Southwest, which found cracks in the bodies of six of its jets during belated inspections, said safety was never jeopardized.

The fine would be the largest ever levied against an airline, the FAA said.

When Southwest belatedly conducted the inspections, it found cracks in the bodies of six Boeing 737-300s, with the largest measuring 4 inches. Serious fractures can depressurize an aircraft and in 1988 caused an Aloha Airlines jet to rip apart, killing a flight attendant.

The FAA announced the fine a week before congressional investigators were to disclose findings from their own inquiry into Southwest's failure to meet airworthiness directives. That investigation was prompted by information provided by Dallas-based FAA inspectors who said their supervisors allowed the planes to keep flying even after Southwest reported its failure to make the scheduled inspections.

The FAA doesn't come out looking too good, either. Regulatory capture, anyone?

Published on Leave a comment on Bogus Art

The Los Angeles Times has a story this morning about the revenue loss to the Treasury from overvalued donations of works of art:

An alleged tax-fraud scheme involving donations of overvalued art to four local museums is part of a larger, unchecked problem with inflated art appraisals that has cost the federal government untold millions, a Times analysis has found.

Each year, the Internal Revenue Service audits donations claimed on only a handful of the 100,000 or more tax returns that allow art donors to reap nearly $1 billion in tax write-offs. Half of the donations checked over the last 20 years had been appraised at nearly double their actual value.

The crux of the public policy problem is the infrequency with which appraisals are checked. It makes all other remedies less effective:

A 2006 law tightened standards and increased penalties on bad appraisals. For donors, it lowered the threshold on what the law considers a bloated appraisal, from 200% overvalue to 150%. It also increased oversight of and fines for appraisers. But because the IRS checks so few appraisals, some believe that overvaluations will continue.

This is not a hard problem to solve. Every significant donation should have its appraisal checked by the IRS, and the donor should bear the cost of that process, not the government. There would be fewer small donations of art, but for major pieces, this cost of checking the appraisal would be small relative to the value of the tax deduction.

Published on Leave a comment on What Capitalism Doesn’t Need

Adjectives like "creative" to modify it.

From the Wall Street Journal today:

In a speech at the World Economic Forum in Davos, Switzerland, the software tycoon plans to call for a "creative capitalism" that uses market forces to address poor-country needs that he feels are being ignored.

"We have to find a way to make the aspects of capitalism that serve wealthier people serve poorer people as well," Mr. Gates will tell world leaders at the forum, according to a copy of the speech seen by The Wall Street Journal.

Capitalism is by its nature creative. Ask a capitalist.

If Bill wants to put an adjective in front of "capitalism," then perhaps he should consider "universal" and challenge the attendees at Davos to help establish the institutions in poor countries that will make that adjective redundant as well. That way, the billions of people living in poverty in these areas will have access to the one economic system that can meaningfully improve their plight.

Published on Leave a comment on Econophysics

Picking up on the theme of the post on neuroeconomics, another field attempting to build bridges to economics is physics, in the form of Econophysics. Quoting from its Wikipedia page, econophysics applies ...

theories and methods originally developed by physicists in order to solve problems in economics, usually those including uncertainty or stochastic elements and nonlinear dynamics. Its application to the study of financial markets has also been termed statistical finance referring to its roots in statistical physics.

For more background, see this site or this blog. The payoff would be similar to the case of neuroeconomics--if you can link the economic problem to an analogous problem in the natural sciences that has been more thoroughly investigated, then the results of those investigations can be brought to bear in the economic problem as well. It may not be the most promising avenue of research, but academia thrives on experimentation and risk-taking in the realm of ideas.

The January 2008 issue of the Journal of Economic Dynamics and Control is a special issue on "Applications of Statistical Physics in Economics and Finance." In their introduction, J. Doyne Farmer and Thomas Lux discuss some of the reasons why the field has been slow to catch on among "mainstream" economists:

The contact between econophysics and economics has, however, been hampered by several factors. The very different culture of scientific publishing in physics and economics has generally prevented publications from econophysics in economics journals. This is partly a matter of style of presentation, but it also reflects fundamental differences in the epistemology of the two fields, in particular different views about the objectives of science. Physicists have a very different view about how work should be presented, and in particular about mathematical rigor (which they generally disdain). In addition, physics has a laissez-faire attitude about publication, believing that it is better to err on the side of letting as many new ideas in as possible, and to let the market eventually decide what is good and what is bad through a Darwinian process that selects what is useful and forgets what is not. As a result there are many econophysics papers of poor quality, which shocks economists. When combined with the fact that the best econophysics papers are published in journals that most economists never read, this body of work remains almost unknown outside the sphere of econophysics.

Communication between physicists and economists has been poor. Physicists are perhaps the only group of scientific professionals who are even more arrogant than economists, and in many cases the arrogance and emotions of both sides have been strongly on display. Many physicists have given the impression that they think that economists know little or nothing about their business, at the same time that they are asking for admission into their club. Many economists have reacted with apprehension to what they view as an attempted invasion by aliens, and have scornfully rejected any work by physicists out of hand, without bothering to have even a passing familiarity with it.

There seems to be a lot of truth in that assessment, and perhaps some of it is also applicable to the field of neuroeconomics as well. If you are interested in the links between economics and the sciences, the first article in that special issue, "Classical Thermodynamics and Economic General Equilibrium Theory," by Eric Smith and Duncan K. Foley, seems to make progress on establishing the parallels across economics and the relevant natural science. (See this working paper if you cannot access the journal directly.)

Published on Leave a comment on Tasty Clones

Speaking of unnecessary stimulus, cloning in the food supply was brought back to the fore this week, as the F.D.A. made a pronouncement on the safety of meat and milk from cloned animals. From Wednesday's New York Times:

After years of debate, the Food and Drug Administration on Tuesday declared that food from cloned animals and their progeny is safe to eat, clearing the way for milk and meat derived from genetic copies of prized dairy cows, steers and hogs to be sold at the grocery store.

There was a predictable response from consumer watchdogs:

Consumer groups immediately lambasted the F.D.A.’s report, saying that the science remains inadequate and that many consumers oppose cloning for religious or ethical reasons. Some members of Congress had sought to delay a decision until further studies were completed.

“It flies in the face of Congress’s wishes. It flies in the face of consumer wishes,” said Michael Hansen, a senior scientist at Consumers Union, the advocacy group that publishes Consumer Reports.

I don't share the same apprehensions about safety in genetic cloning as I do in genetic modification or doping. With cloning, it seems that the breeders obtain an animal that has desirable characteristics and then simply make more copies of it without modifying it. The principal advantage of cloning is summed up by this expert, who must have fun giving out his business card:

“When you buy a box of Cheerios in New York and one in Champaign, Illinois, you know they are going to be the same,” said Jon Fisher, president and owner of Prairie State Semen in Illinois. “By shortening the genetic pool using clones, you can do a similar thing.”

“It could improve the quality of meat in the supermarket,” Mr. Fisher added. “It depends if customers allow it.”

It will likely do that in areas where the quality of meat is poor. But I'm not in one of those areas, and so if I should decide that I don't want to eat meat or drink milk from cloned animals, I should have that option, too. From the article again:

The F.D.A.’s approval extends to cloned cows, pigs and goats but not other farm animals like sheep; the agency cited insufficient data on cloned sheep. The F.D.A. said meat and milk from cloned animals and their offspring would not be labeled because it was the same as conventional food and did not pose a safety risk.

However, Representative Rosa DeLauro, Democrat of Connecticut, has introduced legislation to require labels on cloned products, and consumer groups suggested that labeling would be a battleground in the near future.

As with other food production processes, I am in favor of allowing producers who do not use a particular technology to label their products as such, regardless of whether the F.D.A. requires those who do use the technology to label their products as such.

Published on Leave a comment on In Defense of (Some) Neuroeconomics

Earlier this week, Alex Tabarrok was not too impressed by a recent neuroeconomics paper that examined the neural responses to typical marketing actions for consumed goods. In this case, the authors showed that telling subjects that a wine was expensive changed the way the brain processed the experience. (Here's a popular press article on the paper. Alex provides a link to the published paper.)

I saw one of the paper's authors, Antonio Rangel, present the paper at Econopalooza this month. I had a similar reaction to Alex--this is probably not the most critical use of fMRI technology to enhance our understanding of economic behavior. However, I should also point out that there are hundreds of sessions to attend at the ASSA meetings, and two of the ones I chose to attend were the ones on neuroeconomics that featured Antonio and David Laibson. They are two of the most creative and insightful researchers in our profession, and I would make similar choices about which sessions to attend given the same menu next year.

Seeing a number of papers presented, I think David's work on hyperbolic discounting provides a better illustration of how the new technology can enhance the field of economics. In several theoretical and empirical papers over the last decade, David and his co-authors have investigated the tendency of people to act as if they have very high discount rates for choices in the near future, such as a preference for $1 today versus $1.20 tomorrow, but fairly low discount rates for choices in the more distant future, such as a preference for $1.05 in 11 years versus $1 in 10 years. This introduces a time-inconsistency problem, since what I will actually do in year 10 changes when it arrives. This is a departure from the classical model of consumer behavior. (I think the most important consequence is that it makes illiquidity a feature, not a bug, of a long-term savings account like a 401(k)). David has argued his case very persuasively, and his research is having a large impact on the way academics and policy makers think about saving.

Can neuroeconomics help him make the case? In this article in Science, he and his co-authors show:

When humans are offered the choice between rewards available at different points in time, the relative values of the options are discounted according to their expected delays until delivery. Using functional magnetic resonance imaging, we examined the neural correlates of time discounting while subjects made a series of choices between monetary reward options that varied by delay to delivery. We demonstrate that two separate systems are involved in such decisions. Parts of the limbic system associated with the midbrain dopamine system, including paralimbic cortex, are preferentially activated by decisions involving immediately available rewards. In contrast, regions of the lateral prefrontal cortex and posterior parietal cortex are engaged uniformly by intertemporal choices irrespective of delay. Furthermore, the relative engagement of the two systems is directly associated with subjects’ choices, with greater relative fronto-parietal activity when subjects choose longer term options.

The research shows that two different neural systems, which evolved for very different purposes in the human brain, deal with the two decisions. When a part of the brain is activated during a particular decision, we can infer that the decision is similar to other choices or behaviors that activate that part of the brain. The more primitive part of the brain is activated with the near-term choice. This is what gives Laibson's argument credibility. We have already learned from observation of individual choices that behavior departed from the classical model. Without the brain imaging, there could have been a number of competing theories for why this is so, many of which would not cause us to dramatically rethink the underlying model. With the brain imaging, we give substantially greater weight to the theories like Laibson's that are predicated on different decision frameworks for different types of intertemporal choices.

Published on Leave a comment on Econopalooza Blogging

I am in New Orleans for the ASSA meetings, or what my wife calls "Econopalooza." I am not on Dartmouth's recruiting committee, so I am soaking up as much as I can from the sessions on neuroeconomics and matching theory, two interesting fields where I've got a lot to learn.

This is my first trip to post-Katrina New Orleans. Compared to the last time I was here, it feels quite empty.