Sunday, 31 August 2014

Cheer up. Capitalism and free trade have made the world better

From the IEA blog comes this piece by Sam Collins,
It is easy to pick up a newspaper, watch television or look on a blog and assume the end is nigh. Between foreign affairs crises, demographic time bombs, debt icebergs and having only hours left to save the NHS (more on that another time…), it would not be unreasonable for us all to assume the world has got a lot worse – that capitalism has failed, inequality has sky-rocketed, and we are living shorter, sadder and more violent lives.

Happily, this is not so. Thanks to capitalism, free trade and globalisation we live in the most prosperous, healthy, safe, equal and free period in human existence. Across the globe, as liberal economic policy and capitalism have left communism and command economies in the dustbin of history, we are seeing remarkable falls in worldwide poverty, hunger, disease, inequality and (despite current humanitarian disasters) deaths from war and natural disaster.
and
Over the past fifty years, and particularly the last thirty as liberal economic reforms have been enacted across the world, the fall in poverty levels has improved the lives of hundreds of millions of people. More than 500 million Chinese have been lifted from poverty since Deng Xiaoping’s enactment of the Four Modernisations starting in 1978 as the economy has surged. Today the GDP of Mozambique is 60 per cent larger than it was in 2008. India, Vietnam, Peru and Rwanda have all experienced the benefits of reforms to their economies, although some still have room for reform and growth.

Despite constant questions about its efficacy, freer trade has seen more consumers around the world afford better food (for example, the level of meat consumption in China has doubled since 1991), as well as items that would have been considered luxuries only decades ago (such as the computing power that sent a man to the moon in the palm of your hand).

In human health we have seen an almost unbelievable improvement over the past fifty years. We have eradicated smallpox, cases of polio have been cut to the low hundreds (down from 350,000 in 1988), the incidence of tuberculosis has been halved (since 1990) and cases of measles have fallen 71 per cent. Infant mortality has fallen dramatically as well. There are more than 7,200 fewer infant deaths every single day compared to 2000. That is a child’s death avoided every 12 minutes.

Reason for pessimism lies not in this incredible improvement in living standards, but in governments around the world retreating from free markets and free trade. In particular, putting up trade barriers will hurt the world’s most vulnerable – protecting comparatively wealthy westerners at the expense of poor farmers from Asia and Africa.
Clearly the world is still far from a perfect place but it is getting better over time. Life is still ‘nasty, brutish and short’ for far too many people but it is such for fewer people than it was 50, 100 or 200 years ago. There is hope even for Africa, see my most recent Interesting blog bits posting for a couple of articles on economic growth there and why there are good reasons for cautious optimism about the continent's economic progress. So as Collins puts it,
[...] in the great march of human civilisation, from slavery to freedom; from castes to social mobility; from dictators and kings to presidents and parliaments, it is sometimes worth stopping and appreciating how far we have come.

Saturday, 30 August 2014

John Cochrane talks about life after "Dodd-Frank"

This video is of a talk given given by Professor John H. Cochrane at the Mercatus Center / CATO conference "After Dodd-Frank: The Future of Financial Markets."

How to misunderstand the Coase theorem 4

Continuing with the application of the Coase Theorem to reclining seats in aircraft, Jodi Beggs writes at the Economists do it with Models blog,
Assignment of property rights: To me, it seems pretty clear that the property rights belong to the recliner, for two reasons. First, there is a functional recline button on the chair- when airlines don’t allow you to recline (in front of emergency exit rows, for example), they disable the functionality as opposed to just asking you to not recline. Second, the device used to prevent the seat from reclining is banned, and it’s only a small logical jump from “preventing an activity is banned” to “said activity is allowed.”
My problem here is that just because I have a product that will do X, doesn't mean I have the right to do X. If I buy a gun, which has the ability to shoot people, doesn't mean I have the right to shoot people. As to the second point, the fact that I can't do Y to stop you doing X doesn't mean you have the right to do X. Just because I can't shoot you to stop you peeing on my foot doesn't mean you have the right to pee on my foot.

Beggs goes on to say,
That said, this scenario highlights the fact that it’s not only the assignment of property rights that is important, but also the recognition and respect for said property rights. (When multiple parties believe that they have the property rights, you get coexisting news headlines such as “Don’t Want Me to Recline My Airline Seat? You Can Pay Me” and “Don’t Want Me to Spit on You When You Recline Your Airline Seat? Pay Me.” as opposed to effective bargaining.)
This I think is the real point. If people don't know what the rights are or if different people think the rights have been defined differently, then its as if the rights have not been defined. Without clearly defined, well known  and respected property rights the Coase Theorem doesn't apply.

Of course this just raises the question of why don't airlines delineate rights more clearly?

Interesting blog bits

A bit of interesting weekend reading:
  1. Steven G. Medema on Neither Misunderstood Nor Ignored: The Early Reception of Coase's Wider Challenge to the Analysis of Externalities
    The ‘Coase theorem’ has long been the idea most commonly associated with Ronald Coase’s analysis in The Problem of Social Cost. Yet, Coase frequently argued late in his career that he has been misunderstood, and that the central message(s) of the article lay elsewhere. Though virtually all of the discussion in decades following the publication of The Problem of Social Cost focused on Coase’s negotiation result, the fact is that Coase’s message was not, at the start, misunderstood. This paper takes up a number of the treatments of The Problem of Social Cost in the years immediately following its publication to demonstrate that Coase’s emphasis on the reciprocal nature of externalities, the importance of transaction costs, the possibility of merger solutions, the costs associated with state action, and the need for a comparative institutional approach were anything but lost on these early commentators. It was only later that the negotiation result became the major fixation of interpreters of Coase’s work.
  2. Timothy Taylor on The Secular Stagnation Controversy
    For economists, the word "secular" isn't about a lack of religious belief. Instead, it's refers to whether a condition is expected to last for a long and indefinite period--and in particular, a period not related to whether the economy is entering or exiting a recession. Thus, the concept of "secular stagnation" is the idea that the U.S. economy is not just suffering through the aftereffects of the Great Recession, but is for some reason entering a longer-term period of stagnant growth.
  3. Tim Worstall on Why Uber might be making a mistake in paying by the hour
    There’s a little technical detail about incentives that suggests that Uber might be making a mistake in their policy of paying minicab drivers by the hour. That mistake being not quite getting the difference between the income effect and the substitution effect as it affects pieceworkers (those two effects together being what gives us the Laffer Curve of course).
  4. Masayuki Morikawa asks Are large headquarters unproductive?
    Headquarters play important strategic roles in modern companies, but downsizing of headquarters is often advocated as a cost-cutting measure. This column presents evidence from Japanese firm-level data that headquarters size is positively associated with firms’ overall productivity. Moreover, the benefits of ICT are greater for companies with relatively large headquarters. Downsizing headquarters to cut costs may thus be harmful for long-term company performance.
  5. Marco Annunziata on African growth looking forward
    Africa has generated a lot of enthusiasm lately. The cynical view of the continent as a hopeless basket case has been replaced by the lofty narrative of Africa Rising. This column argues that Africa’s progress is impressive, and there is more to the story than a commodity boom. But Africa is at a crossroads. The opportunities are huge, but the road ahead is long, and will require persistent and patient effort from policymakers as well as business.
  6. Margaret McMillan asks What is driving the ‘African growth miracle’?
    Some argue that growth across Africa is fundamentally a result of rising commodity prices and that if these prices were to collapse, so too would Africa’s growth rates. This column documents substantial shifts in the occupational structure of most African economies between 2000 and 2010 and thus provides a good reason for cautious optimism about the continent’s economic progress.
  7. John Cochrane on Lazear on Labor
    Modern labor economists see employment and unemployment as a search and matching process with a lot of churn. The popular impression, echoed in most media discussion, is that there is a fixed number of jobs, and people just wait around for more jobs to be "created." That's what it may feel like to an individual, but that's not how the economy works. Lazear's column puts in one very short space some of the better ways to think about unemployment.
  8. Keith Boyfield on Privateers and the sinister threat posed by ‘patent trolls’
    Many in Britain may not be familiar with the term ‘patent privateering’ – but that may all be about to change. British courts are apparently being targeted in a forum-shopping exercise by global monopolists, who are using this technique to reduce competition and innovation in the hi-tech sector.
    Earlier in the week I discussed patent trolls here.

Friday, 29 August 2014

How to misunderstand the Coase theorem 3 (updated)

From the comments on one of my previous posts comes this from Economists Do It With Models
Actually, one of the articles on the subject mentioned that the SeatDefender device that was used was not allowed, which would imply that the property rights are at least implicitly assigned to the recliner.
I have not seen that. But if true then the airline just has to make clear what the property right is and let bargaining take place or while the SeatDefender may be illegal it still doesn't necessarily mean that property rights have been defined. Use of the device may just be an attempt at "homesteading" legroom.

Update: Economists Do It With Models has kindly provided the source that mentions the device being banned: http://consumerist.com/2014/08/26/united-flight-diverted-after-passenger-uses-banned-seat-recline-jammer-starts-scuffle/

Also from the Environmental and Urban Economics blog comes an Update:
Yes, I am well aware that the Coase Theorem assumes that property rights are well defined and agreed upon (so some have said that the Coase theorem does not apply here) but what is interesting about this case is that the airline has not established these rules. It is also interesting that transaction costs precluded the ability of others on the plane to offer their seat to the woman who wanted to recline because this simple solution would have resolved this "crisis". Nobody gained by landing the plane in Chicago. People lost time, they had to land and takeoff one more time. The Coase theorem assumes a smooth redistribution of resources but instead resources were destroyed in this multi-player interaction. This should interest economists.

Thursday, 28 August 2014

How to misunderstand the Coase theorem 2

Following on from my posting yesterday I see that someone does get the Coase Theorem. Writing at the Wall Street Pit Donald Marron says
Somewhere Ronald Coase is smiling. He identified that answer in 1960 in his famous paper, The Problem of Social Cost.

If the little girl has the property right to recline, then you can pay her not to do so. If you have the property right, you can install a Knee Defender.
Yes, but as I noted yesterday the problem here is that property rights are not defined.

Marron goes on the say,
But who should have the property right? Coase would say it depends–some people don’t like negotiating with other passengers. Given those “transaction costs” the right ought to be given to whichever person is most likely to want it most.

I’d bet on the “reclinee” not the recliner. Which might explain why more airlines now offer the ability to pay extra for more legroom. After all, United would rather you pay them than the little girl.
This answer, extra legroom, may not be about the airline collecting the payment which would otherwise go to the recliner since a seat with more legroom is not the same thing as a seat with less legroom. The amount of the externality is not reduce by having more legroom, the recliner may still recline just as much, its just that the reclinee is no longer affected by the reclining. So seats with more or less legroom are two different goods and thus the airline may simply be selling different types of goods to different types of customers.

The Economics of World War I. 3

Another in the series of posts from The Economics of World War I project at VoxEU.org
Walking wounded: The British economy in the aftermath of World War I
Nicholas Crafts 27 August 2014
It is well-known that World War I was expensive for Britain. The indirect economic costs were also huge. This column argues that the adverse implications of the Great War for post-war unemployment and trade – together with the legacy of a greatly increased national debt – significantly reduced the level of real GDP throughout the 1920s. A ballpark calculation suggests the loss of GDP during this period roughly doubled the total costs of the war to Britain.

Wednesday, 27 August 2014

How to misunderstand the Coase theorem

This comes from Matthew E. Kahn's Environmental and Urban Economics blog:
My fellow University of Chicago economists, stop reading Krugman's latest and explain this puzzle to me. A United Flight to Denver was diverted to Chicago because of a fight between two 48 year olds over whether the person sitting in front in Economy Plus has the right to recline her chair. For details read this.

As we get ready to start the new academic year, here is an excellent example of the Coase Theorem not working! Who has property rights on an airplane when the person in front of you wants to recline while you care about your knees? Why was this United flight diverted to Chicago? Wasn't that a destruction of resources for everyone involved? My fellow Becker students, what is the answer? You have 10 minutes to answer this 6 point question. The Coase Theorem predicts that the recliner should have paid the person behind her? True, false, uncertain. Explain.
Kahn states "here is an excellent example of the Coase Theorem not working" and then asks "Who has property rights on an airplane when the person in front of you wants to recline while you care about your knees?" And he does not seem to notice the importance of the second point to his first point.

The Coase Theorem assumes that property rights are well defined, it doesn't matter who has those rights, but someone must have them allocated to them. The problem with the seat example, as the second point makes clear, it that property rights are not well defined and thus the theorem does not apply here. Not, at least, until the airline clearly defines seating rights.

Even sweatshop jobs can be good for you,

especially if you are female.

A new NBER working paper looks at Manufacturing Growth and the Lives of Bangladeshi Women. The paper is by Rachel Heath and A. Mushfiq Mobarak.

Heath and Mobarak note that there is very little rigorous analysis of the welfare effects of access to factory jobs - "sweatshop jobs" - for women, and the "evidence" that there is is dominated by anecdotes from anti-sweatshop activists about the negative effects of hazardous working conditions. The evidence gap is especially pertinent for policymaking in Bangladesh, where well-publicized garment factory collapses and fires and their attendant death tolls recently captured the world’s attention. In response to the disasters individual large buyers, in addition to the U.S. government, have made moves to restrict or boycott garment exports from Bangladesh but such export restrictions and boycotts come with the potential to hurt the very workers that they are designed to protect.

The manufacturing industry in Bangladesh currently employs almost 4 million workers and it was the first industry to provide employment opportunities to women on a large-scale in a country where women traditionally have not worked outside the home. In doing so to it has raised the opportunity cost of being married and having children. These sweatshop jobs require a basic level of literacy and numeracy skills and the arrival of garment factories therefore has potentially affected enrollment, employment, marriage and childbearing decisions for Bangladeshi women.

Heath and Mobarak's
[...] results suggest that the rise of the garment industry can help explain the declining fertility, increasing age at marriage, and rapid increase in girls' educational attainment during this period, both in absolute terms and relative to boys [...]. Approximately 80 percent of garment factory workers in Bangladesh are female [...] and extrapolation from our data and national surveys suggest that around fifteen percent of women nationwide between the ages of 16 and 30 work in the garment industry. The education results are particularly policy- relevant, as Bangladesh has surpassed the third Millennium Development Goal of gender equity in enrollments, a goal with which many other countries in Western Asia and sub-Saharan Africa continue to struggle. Our research design permits a study of investments in girls relative to boys, which is of considerable policy [...] and also academic interest, given the comparative advantage girls possess in skilled tasks [...]. Our results provide one hitherto unexplored explanation for the accelerated gender equity in education in Bangladesh, thus generating important policy implications for other developing countries interested in emulating Bangladesh's success.
There are, in theory, a number of different ways that access to factory jobs can alter women’s school, work, marriage and childbearing decisions.
As documented for maquiladora jobs in Mexico, older children may be induced to drop out of school to access the factory jobs [...]. Conversely, younger children (who are still too young for the factory jobs and do not face the temptation to drop out and begin earning immediately) may respond by investing in education if the availability of relatively well-paid manufacturing jobs increase the returns to education. Educational attainment might also increase through a wealth effect, if parents can now better afford to send their children to school. Both the increased enrollment channel and the direct factory employment effects would result in girls delaying marriage and childbirth.
Heath and Mobarak
[...] document that the hazard of marriage and childbirth at early ages (12-18) drops sharply for girls when they gained exposure to the ready- made garment sector. This is important because other research has documented large negative welfare implications of early marriage and early childbirth [...].
Next Heath and Mobark examine the ways by which these delays in marriage and childbirth occur.
Did girls increase their educational attainment in order to obtain well-paying garment jobs which require numeracy and literacy, which then led to a postponement of marriage due to greater educational attainment? We assess the effect of cumulative years of exposure to garment factory jobs on the total years of educational attainment (for those with completed schooling histories), adding an additional comparison to the girls’ male siblings, given that garment production is has been a much larger innovation in the labor market for girls than for boys [...]. We find that girls gain an extra 1.5 years of education relative to their brothers in the median garment-proximate village. This represents a 50% increase in girls’ educational attainment over control villages that do not have a garment factory nearby. We observe the increase in female education (relative to their male siblings) even in families where the mother or older sister never worked in a factory, which suggests that increased demand for skills in factories that offer job opportunities for women is a likely channel through which the enrollment gains are realized, in addition to any family wealth effect or changes in intra-household time allocation from other household members working in garment factories.

We next use retrospective data on the entire history of annual school enrollment decisions for each girl to test whether the effects of the garment industry on schooling are strongest for younger girls. We find that young girls (aged 5-9) are more likely to stay enrolled in school hen factories open close to their village compared to girls in comparison villages in the same sub-district that are not located within commuting distance of factories, relative to earlier years (before the factory opens), and relative to male siblings of the same age.
While there is a positive effect on education for young girls, what about those a bit older?
Our data also indicate that the delays in marriage and childbirth we estimate likely also stem from girls in garments-proximate villages choosing to work in factories when they are about 17-23 years old, instead of getting married (or staying in school). Factory job access has a small negative effect on school enrollment of 17-18 year olds (unlike the positive effect for younger girls). More importantly, girls who are exposed to factory jobs when they are between 10 and 23 years old (which is the critical age group at risk for early marriage in Bangladesh) are 17 percentage points more likely to have done wage work outside the home, and this is a 79% increase over the control group.
In summary,
[...] access to factory jobs significantly lowers the risk of early marriage and childbirth for girls in Bangladesh, and this is due to both the girls postponing marriage to work in factories, and the girls staying in school at earlier ages. We benchmark the magnitude of the effects of the garment industry against the effects of a large-scale (US$15 million per year) conditional cash transfer for schooling intervention run by the Bangladesh government with multilateral donor support. The program has paid for 2 million girls to remain in school, conditional on remaining unmarried. The dramatic improvement in girls' outcomes in Bangladesh in the past 30 years has 5 frequently but casually been attributed to the FSP, but our estimates suggest that the rapid expansion of the garment sector has been a much more important reason for the decreases in earlier marriages and fertility and the closing of the gender enrollment gap in Bangladesh.
While sweatshop jobs are not great jobs, by our standards, they do come with positives for those people in poor countries who can get them. The anti-sweatshop groups should keep this in mind when attacking such forms of employment. Sweatshops are the first step down the road out of poverty.

Video of Alvin Roth talking on "Repugnant markets and prohibited transactions"

This is a 30 minute video of Alvin Roth's recent lecture at Lindau, on Repugnant Markets and Forbidden Transactions.

Tuesday, 26 August 2014

The effects of patent trolls

There is a new organisational form, called the non-practicing entity (NPE), in the world of intellectual property. NPEs have recently emerged as a major driver of IP litigation. The idea is that NPEs amass patents not for the sake of producing any actual product, but rather they aim to prosecute infringements of their patent portfolios. (rent-seeking?) The rise of NPEs has sparked a debate regarding their value and their impact on innovation. Proponents argue that imperfections in the legal system implicitly reward large, well-funded organisations, enabling them to infringe at will on small innovators’ IP and that NPEs are there to protect small innovators from such abuse. Opponents cast NPEs as organisations that simply raise the costs of innovation by exploiting the fact that an imperfect legal system will rule in their favour sufficiently often—even if no infringement has actually occurred—that the credible threat of the legal process can yield rents from producing, innovative firms.

So what are the effects of these "patent trolls"? A new NBER working paper, Patent Trolls: Evidence from Targeted Firms by Lauren Cohen, Umit Gurun and Scott Duke Kominers, tries to find out. Cohen, Gurun and Kominers add to the debate on NPEs by providing the first large-sample evidence on precisely which corporations NPEs target in litigation, when NPE litigation occurs, and the impact of NPE litigation on the targeted firms’ innovative activity.

Cohen, Gurun and Kominers argue that there are two reasons that patent trolls can prevent welfare-increasing innovation from being brought to market.
  1. innovators with profitably commercialisable inventions but with a high enough probability of being sued to be deterred from production
  2. innovators that decide not to commercialise because the ex ante expected profitability of becoming a patent troll is higher than that of commercialisation
In their empirical work Cohen, Gurun and Kominers
[...] link patent-level data on NPEs and their activities to data on all publicly traded firms. Using this linked data, we show that NPEs behave opportunistically; that is, typically acting as patent trolls. Specifically: NPEs target firms that are flush with cash (controlling for all other characteristics) and firms that have had recent, positive cash shocks.

Indeed, a one standard-deviation increase in cash level increases the probability of being sued by an NPE by 11% (t = 6.84). Given that the mean probability is 2%, this is more than a fivefold increase.

In fact, NPEs even target conglomerate firms that earn all of their cash from segments having nothing to do with the allegedly infringing patents. For example, an NPE is likely sue a firm regarding a technology patent even if the firm is earning all its revenue from a lumber division entirely unrelated to the allegedly infringing technology patent—even if the division holding that patent is unprofitable. Indeed, we find that profitability in unrelated businesses is almost as predictive of NPE infringement lawsuits as is profitability in the segment related to the allegedly infringing patent.

Consistent with our model, we also find that NPEs target firms against which they have a higher ex ante likelihood of winning. We demonstrate this fact using multiple measures of ex ante likelihood of lawsuit success. First, we show that NPEs are significantly more likely to target firms that are busy dealing with a number of other litigation events unrelated to intellectual property. Being tied up with outside litigation roughly doubles the probability (t = 2.87) of being sued by an NPE. Moreover, we show that, controlling for all other characteristics, firms with larger legal teams have a significantly lower probability of being targeted by NPEs, consistent with large legal teams serving as a deterrent.

Of course, the true prediction of our model is on the ex ante expected profitability of NPE litigation. To capture this, we interact our measures of expected cash payouts with our measures of expected lawsuit success. We find that, as the model predicts, NPEs systematically target those firms for which the ex ante expected profitability of litigation is large. In particular, the payout probability interaction terms are significant and economically large. Our finding suggests that nearly all the firms targeted by NPEs have large pools of cash for potential payouts and are ex ante more likely to pay off in some form (either an out-of-court settlement or an in-court loss). To further explore this connection, we construct a measure of the ex ante expected outcome if a targeted firm were to go to court. This measure relies on the assumption that defendants often make predictions about the likely outcome based on observations of other firms in the same industry and location. We find that the interaction term of this expected outcome and expected payout is again large and significant, providing further evidence that NPEs choose targets based on expected profitability: suits with high probability of payoff against firms with deep pockets.

Non-practicing entities don’t have a monopoly on IP litigation. Practicing entities (PEs), such as IBM and Intel, also sue each other for patent infringement. If our results are simply picking up general characteristics of IP litigation, then we might expect to see PEs behaving in much the same way as NPEs. In order to compare PE and NPE behavior, we hand-collected the universe of patent infringement cases brought by PEs against other PEs in the same period (2001–2011). However, we find the opposite. If anything, PEs are slightly less likely to sue firms with high cash balances and less likely to sue firms with many ongoing cases. All of the other determinants of NPE targeting have (statistically and economically) no impact on PE litigation behavior. This comparison suggests that our results on NPE litigation behavior are not just reflections of general characteristics of IP litigation. Rather, our findings are consistent with agent-specific motivations for NPEs in targeting firms flush with cash just when favorable legal outcomes are more likely.

Lastly, we examine the real impacts of NPEs’ litigation activity. Comparing firms that are sued by NPEs and go to court (and in this way controlling for selection of firms targeted by NPEs), we find that firms that lose in court have significantly lower post-litigation patenting activity and fewer citations to their marginal post-litigation patents, relative to firms whose cases are dismissed. Furthermore, after losing to NPEs, firms significantly reduce R&D spending—both projects inside the firm and acquiring innovative R&D projects outside the firm. Our evidence suggests that it really is the NPE litigation event that causes this decrease in innovation. Prior to litigation, firms that subsequently lose to NPEs are identical to those that subsequently have suits dismissed. They have the same R&D, patenting, and patent quality. Moreover, patents of firms developed pre-litigation continue to accrue citations at exactly the same rate after litigation, whether or not the suit was dismissed. This is in stark contrast to the divergent amount of citations of firms’ post-litigation patents.
In short, NPEs behave as patent trolls.

But what is the point?

From the TVNZ website we learn that
The New Zealand dollar dropped sharply in mid morning trade today, shedding half a US cent in about five minutes and prompting speculation of Reserve Bank intervention.

The kiwi fell, from 9:15am when it was trading at 83.96 US cents, to 83.40 US cents at 9:21am. The local currency subsequently touched a six-month low of 83.36 US cents and was recently trading at 83.44 cents.
Let us assume that it is intervention by the RB that caused this, What is the point? As soon as the intervention stops the dollar will go back to where it began, assuming other factors haven't changed. And if other factors have changed to bring the dollar down, there seems no point to any intervention. To keep the dollar "low" the RB would have to keep on intervening and it can't do that, so what does the RB get for its effort?

The TVNZ article goes on to say,
New Zealand's Reserve Bank has previously said the local currency is too high and raised the possibility it could intervene in the market by selling kiwi in an attempt to push it down.
Which brings us back to the old question of what does "high" or "low" even mean? After all the exchange rate is just the price of foreign exchange and like all freely determined prices, they are what they are. "High" or "low" has little meaning.

Econtalk this week

Daphne Koller of Coursera talks with EconTalk host Russ Roberts about online educational website Coursera and the future of education both online and via bricks-and-mortar. Koller, co-founder of Coursera with Andrew Ng, explains how Coursera partners with universities, how they try to create community and interaction, and the likely impact of widespread digital education on universities and those who want to learn. The conversation includes a discussion of why Koller left a chaired position in computer science at Stanford University to run a for-profit start-up in a crowded field.

A direct link to the audio is available here.

Monday, 25 August 2014

Competition and productivity

An obvious and important question in industrial economics is does competition raise productivity and if so, through what mechanism? In a 2010 working paper, Does Competition Raise Productivity Through Improving Management Quality?, John Van Reenen sets out to answer that question. He writes,
I discuss recent empirical evidence from both large-scale databases and specific industries which suggests that tougher competition does indeed raise productivity and one of the main mechanisms is through improving management practices. To establish this, I report on new research seeking to quantify management. I relate this to theoretical perspectives on the economics of competition and management, arguing that management should be seen at least in part as a transferable technology. A range of recent econometric studies suggest that (i) competition increases management quality and (ii) improved management quality boosts productivity.
Thus Van Reenen's argument is that competition does indeed increase productivity and a major mechanism for this is via improved management practices. He says that management is a transferable technology and that competition fosters the adoption of better management practices through both selecting out the badly managed firms (reallocation) and giving incumbent firms stronger incentives to improve their management practices. He argues that this perspective is supported by a range of new evidence both from new ways of measuring management and from more robust forms of identifying the causal impact of competition changes on productivity outcomes.

This has important implications for a small trading country like New Zealand. Given our small internal market how do we increase competition? One way is to open our markets to foreign trade and investors. Yes, allow foreigners to trade here and to buy assets here. Yes I know, certain political parties will not be too pleased with this idea.

Allowing foreign companies to trade here increases competition in our market in general and thus forces improvement in terms of management on local firms. But as my previous posting on the example of France showed foreign ownership can also improve a firm's productivity. Foreign investors are more likely to takeover firms that are currently under-performing and thus are open to productivity improvements. Such investors are more likely to buy firms that aren't working, right now, as well as they have in the past. The targets of foreign buyouts normally had experienced substantial productivity decline in the years prior to the foreign takeover. The foreign buyers then use their expertise, including improved management practices, to correct things and thus increase productivity. Of course this performance improvement puts additional pressure on other firms to up their game as well.

Thus foreign trade and ownership can both improve productivity by increasing competition in the local market and thus putting pressure on local firms to improve the quality of their management.