Tuesday, December 22, 2015

Most popular posts of 2015

Blog posts were not as frequent as I would have liked this year. But I did gain a much wider audience with some of the more popular posts that were widely cited. I'm proud of them. I hope my readers found some valuable insights in there somewhere. 

If you want to indulge your economic curiosity over the holiday period, here are the top ten posts of the year for your reading pleasure.

1. Improving 'Neoclassical man' with a gaze heuristic

2. Macroeconomics = Fallacy of Composition

3. Back-scratching: Do what's best for your mates and screw the rest

4. Adam Smith’s Pin Factory: Capital vs division of labour

5. The confused economic orthodoxy

6. Uncertainty and morality in a dynamic economics

7. More unpopular economic opinions

8. Unpopular economic opinions

9. Dodgy rezoning, a summary

10. How to analyse housing markets

Saturday, December 12, 2015

Humans vs Houses: Australia's perverse tax system

Investment property income beats working
I often joke that my investment property earns more than I do. Thinking more about this lead me to the realisation that my investment property has an privileged position in the tax system when compared to a measly old human.

Below I summarise some of the main tax considerations from the perspective of being a human making wages, or from the perspective of being an investment property (the property owner).

After making this comparison, our current system appears to be designed exclusively for the betterment of the property community, rather than the people community. It’s unreal. The whole thing is back to front, with all that green showing investment property to be a clear tax winner.


Let us take a closer look at the marginal effects of a dollar increase in income for a one-income family, with two school-age children earning $100,000. They are an above-median household, and a prime candidate property investor. You know. To secure the children’s future. We’ll call them the ‘Battler’ family, because in Australia if you aren’t on the property ladder, making money is a battle.

An extra dollar in wage income for the Battler family over a year attracts income tax, along with a loss of family tax and medicare benefits that together account for 60c of that extra dollar. So 40c in the pocket. The graph below, from David Plunkett, shows the effective marginal tax rates (EMTR) for this family currently in Australia.


Let us examine the case when the Battler family instead makes their extra dollar from capital gains on their investment property. Using round numbers, they buy a $500,000 home with an annual rental income of $20,000, and annual rates, maintenance and other costs of $6,000. They finance this purchase with an interest only loan attracting a $25,000 annual interest bill.

They make a loss of $11,000 over the year they own the property. Of that loss they are out of pocket only $4,400, because they have reduced their taxable income and avoided $4,000 in tax, and gained $2,200 in family tax and medicare benefits.

After one year they sell with a price after selling costs of $511,001, making $1 net over the year from the property investment project.

It’s a risky way to make $1, compared to getting a rounding-error sized pay rise. But we want to compare dollar-for-dollar the tax incentives for earning wages or earning capital gains though property speculation.

So what did the battlers get out of their $1 gain from property investment? First we factor in the 50% capital gains tax discount because they owned the property for more than a year. So they only need add $6,500.50 of the capital gains to their taxable income. With a 60% EMTR that means they keep $9,100.20 in the hand (the tax-free $6,500.50 half, plus 40% of the remaining $6,500.50).

Subtracting last year’s net loss of $4,400 gives a total net gain of $4,700.20. I summarise how this arises from the benefits tax treatment of both the losses and the gains from investment property in the table below.



With these types of advantages to making your money from lazy capital gains on investment property, rather than working for a living, it is no surprise that we have become a nation of property speculators.

We can also work backwards to see in this example case how much of a loss on property the advantageous tax treatment will cover. To break even after tax all the Battler family need to do is make $4,400 after tax on the sale, which would be situation if the capital gains were $6,286, or a sale price after selling costs of $506,286. Under this situation the property investment has made a loss of $4,714 over the year (an $11,000 income loss and a $6,286 capital gain after 12 months), yet the tax system has bailed out that loss for the family through negative gearing and the capital gains tax exemption. Add another 57c or so to the project income - so it makes a $4,713.43 loss - and you are back to the same net outcome as making an extra dollar through wage income; a 40c gain.

Policy for an even playing field
We can use this example to also see the immediate impact from tax policy changes targeting investment property. If we eliminate the capital gains tax discount and quarantine losses against property incomes, we get a different story, which is in the table below.


Here the $11,000 loss rolls over to be deducted from the future income of the property, in this case the capital gains on sale, making the net capital gain of $1. Because none of this gain is subject to the CGT discount, it all adds to personal income and is taxed at the marginal rate, along with the losses in other welfare benefits. After tax both the $1 from investment property and the $1 from the wage income now provide the same benefit.

It is certainly now time for the government to end these tax concessions for investment property. Raising the GST, the current government’s preferred tax policy, is probably the worst choice in terms of both equity and efficiency compared to the low-hating fruit of removing these property tax advantages which currently cost the budget about $11billion a year. Obviously removing them would change incentives, reduce prices, and so forth, meaning that actual budget gains from their removal will be lower. But even so, the shift of incentives across the economy would be hugely advantageous in terms of both efficiency, and equity, as these tax incentives primarily benefit the wealthy.

Update:
Because many claim that negative gearing is a ‘natural result of the tax system’*, we can leave this alone and simply concentrate on the capital gains tax discount.

In this case, the table below shows how the tax benefits from negative gearing remain, yet the capital gains taxes completely offset the tax benefits from the losses made, resulting in the same net outcome. What this means essentially is that this small part of the tax code provides very perverse incentives for investors to speculate on property, than to earn income from wages.


* To the extent that any tax system is ‘natural’. My view is that you use the system to create incentives for productive activity, whether they appear natural or not.

Wednesday, December 9, 2015

Brisbane's Queens Wharf is a gift to casino owners

Let's bet on when the consortium entering a deal to build a new casino in Brisbane will go bust.

I will bet straight after the company has paid their well-connected senior staff handsome bonuses, and right before being bailed out (probably implicitly) by the Queensland government. As the project progresses the government will bail out the consortium either voluntarily, because the Ministers and staff involved want to build trust with the consortium, or under duress, because the consortium is going bankrupt with a half-finished major project in the CBD.  

The bailout could be in the form of cash payments. But it could also be hidden in the form of an amended scope of works. Promised investment in new public spaces around the casino will mysteriously shrink as the consortium pleas that these were never part of the deal to be delivered by them. The government will be on the hook for hundreds of millions of dollars right at a time when the budget will be drying up from the downturn of the resources and property boom.

I make this bet because I have looked that the fancy images produced to sell the project to the public, and drawing on my experience in costing large construction projects, I can assure you that adding the costs of all the public works in these images cannot be justified by the casino and hotel returns alone. It just doesn't stack up.

This quote worries me 
The Queensland Government in partnership with the Destination Brisbane Consortium will deliver… 
Public-private partnerships. Notice they didn't say those words explicitly. Because they are dirty words these days as we have come to realise that the public sector simply does not have the skills or the courage to be an equal partner. Such partnerships these days mean that all risk passes to the State while all benefits flow to the private sector partner. 

I remember sitting in a meeting with Queensland Treasury in 2009 where they were trying to get rid of these arrangements from government because they always end up tilting risk towards the government and benefits towards the private sector partners. 

But no worries. Happy to do it for a casino.

If you look at the picture below it’s almost like the government wants to get a casino as close as possible to their offices; to align themselves through proximity to the interests of the casino owners. 


I can’t think of a better way to hand money from the public to selected rich, politically-connected casino owners than this. 

For those still thinking about all the external benefits from a new casino (which is adjacent to an existing casino mind you) maybe think a little harder about the international market for high-rollers. You’ve got all of Asia to choose from. The major cities of the world. Will Brisbane now all of a sudden pop onto your radar because there is a new casino next door to the old one? A very marginal proposition at best.

Crucially, watch as the funding mechanism to capture the value uplift on the site is ignored. Gains in land value will be given away to the consortium from the inevitable government investment in public spaces and access to the area.

This will happen because the rules about paying for infrastructure are especially grey in the case of such major projects (see here, Section 6.0)
Infrastructure delivered in the PDA shall generally be funded from infrastructure charges levied on development within the PDA.
Infrastructure charges will be based on Brisbane City Council's applicable infrastructure charging document for the area or an Infrastructure Agreement.
Infrastructure delivered as part of the development may be eligible for an offset against the infrastructure charges that would otherwise apply.
The last point here is important. What it means in practice is that there is plenty of scope to negotiate that publicly accessible spaces in the casino area count towards public infrastructure, and that these might even be used to offset the standard infrastructure charge obligations under the Brisbane City Council’s plan. We have seen wiggle room like this used successfully before to get out of obligations to contribute to the public realm, with private driveways and car parks being counted as public space contributions in complete contradiction to the planning intention of these requirements. 

Essentially, the government is walking into a deal taking on a huge amount of downside risk and absolutely none of the upside. It is guaranteeing profits to wealthy casino owners in a way that is primarily a transfer to them from the rest of society. This is at a time when government revenues will begin falling, and when the city is already committing to costly projects with little to no return, such as the Kingsford Smith Drive project, where costs are likely to exceed benefits by about $200million.

But it remains possible that when the reality of the construction costs becomes apparent, the whole project might simply be canned come late 2016. 

I have no problem with government investing in public infrastructure and improvements in general, but not with the obvious intention of benefiting a select few at a cost to the rest of us. There are so many public projects out there with high benefit cost ratios waiting to be built in the city, from rail, cycle, pedestrian upgrades to improve connectivity, to the basics like stormwater and flood prevention upgrades, and so forth.

Read all about the agreement here.

UPDATE: Read all about the dodgy dealings at the blog It's Not Normal

Thursday, November 26, 2015

Economic capital is like pornography - you know it when you see it

There are two parts to this blog post. First the important stuff, clarifying the weirdness of capital and the confusion of applying economic concepts in practice. Second is a rant about where the weirdness and confusion comes from, and I point the finger at the intellectual laziness of the economics profession.

Important stuff
Read the below quote. Actually, read it twice. And think about it.
Genuine foreign investment, such as the building of factories and infrastructure, adds to the nation’s productive capacity and employment, and should be encouraged. By contrast, merely transferring ownership of an existing asset to foreign interests is akin to “selling the family jewels”. It does nothing to improve the economy and living standards, and should be discouraged.
This is from a recent post by top economic commentator Leith van Onselen at MacroBusiness. On the surface it makes sense. We want investment in new buildings, machines, infrastructure and equipment. And when foreigners want to makes those investments in Australia, that’s terrific.

But we don’t want to “sell the farm” to pay for it.

The thing is, net foreign investment in productive infrastructure, of machinery, building materials, and so forth of the type that Leith explains adds to our productive capacity, always exactly matches the net sale of domestic assets to foreigners.

The bold terms are crucial, for they reveal the accounting identity at the heart of the matter.

You see, capital account surpluses indicate that a nation sold more assets to foreigners than they bought foreign assets. A capital account surplus is balanced out by a current account deficits, which means that as a nation we imported more goods and services than we exported. Having a current account deficit requires selling assets to foreigners as payment for the net imports of goods and services which contribute to our capital stock.

As I said recently, the term foreign investment is “an idiotic and misleading term for a capital account surplus. It should be called balance of trading assets for goods and services.”

Capital in the external accounts is by definition not physical stuff. It is a set of institutionalised rights. Capital in economics, however, has been hijacked to mean physical stuff, which I show below provides very little guidance for answering important economic questions.

The rant
The blame for this confusion lies squarely with the economics profession. Not only do they routinely confuse the “capital” (K) in their models with capital in the common parlance used to describe funding and asset ownership arrangements, but they also think in terms of a world where there is no distribution or trade in asset ownership; all resource use is directed by a benevolent central planner.

At best capital is like pornography - ‘you know it when you see it’. In Christopher Bliss’s introductory comments to his book Capital Theory he notes
It is a fallacy to suppose that if we have a name for something there must be something, particularly a single something, which that name defines.
The textbooks are no help at all. In one textbook I have, by Frijters, Dulleck and Torgler, all I get is “physical capital includes machines, buildings, roads, harbours airports etc.”

Ricardo arguably began this tradition of capital as stuff stating that
Capital is that part of the wealth of a country which is employed in production, and consists of food, clothing, tools, raw materials, machinery, necessary to give effect to labour.
Or perhaps it was John Stuart Mill
What capital does for production, is to afford the shelter, protection, tools and materials which the work requires, and to feed and otherwise maintain the labourers during the process. These are the services which present labour requires from past, and from the produce of past, labour. Whatever things are destined for this use—destined to supply productive labour with these various prerequisites—are Capital.
Mankiw’s macroeconomics text has a similarly naive and brief definition, stating that capital “... is the set of tools that workers use: the construction worker’s crane, the accountant’s calculator, and this author’s personal computer.” And later, “the capital stock is the quantity of machines and structures available at a given time”.

The fundamental economic elements of capital seem to be:
  1. They must be produced physical objects that last a non-zero period of time 
  2. During that non-zero period of existence they must be an input into productive activity 
If that’s all there is to it then how can there be any non-capital goods produced? After all, food produced in one period is an input into the sustenance of productive labour in the next period. How can we walk around classifying objects as capital or consumption goods?

Look at the image below. A trained economist would call the bikes on the left consumption goods. But that same economist would turn around and call the ones on the right capital, since they are used as inputs into future production of bike hire services. Yet the ones on the left are also inputs into future cycling services as well! 


Where does that leave the core mainstream economic models? Say, the production function?

The equation below is typically used to introduce the idea of a production function, that say that output (Y) is a function of capital inputs (K) and labour inputs (L) in their strict physical economic definitions.

Y = f(K,L)

Yet if capital is everything except labour, then we can translate this equation to mean

“stuff produced is the product of labouring with other stuff”

Capital becomes merely a residual of inputs after labour (or is that just human capital?).

Once you are indoctrinated into the world of capital as physical objects, there is no where to go to explain deviations from your beliefs except in physical terms. If the model deals with physical stuff, changes in factor payments, wage levels and returns on ‘capital’ (which is quite clearly not physical stuff, since I've never seen a road or machine get paid), or even growth in output, must be the result of some mystical changes in the physical properties of stuff.

To explain these phenomena in this framework one must invoke the idea that objects have some special characteristic of being objects - a technology of objects - that allows them to transmogrify in particular ways that change their physical nature. Computers must compute more computely, and cars must drive more drively for growth to occur. And when these objects become more objecty they are then able to earn a higher ‘factor return’. Better computers bargain for better wages.

Economists are then naturally inclined to look for physical explanations of every social phenomena rather than institutional explanations. Maybe we are having a great stagnation, where objects are somehow unable to transmogrify as successfully anymore. Or maybe we are looking for physical answers to non-physical questions?

Problems with the physical object view arise in estimates of productivity (total factor or labour). The world of physical production is the fantasy world of the neoclassical production function. Some statistician is walking around pretending to measure physical quantities by looking at prices, classifying arbitrarily different objects into a stock of capital, pretending that the world rents every bit of capital from aliens, ignoring almost all the physical capital that is not in corporate accounts (like clouds, oceans, the atmosphere, mineral reserves) and stirring the Excel spreadsheet pot until a single number drops out.

When you read about the fall in Australia’s multi-factor productivity, you should laugh at the incoherence of everyone who pretends to know what it means, and feel sad of those who prescribe their own ideological remedy to the problem of a made up number going the wrong way.

You see, a negative change in multi-factor productivity is a puzzle for the production function view of the world. Does it mean we are so stupid that we combine stuff to make new stuff less effectively than we did last year? Are we getting dumber? Or is our stuff transmogrifying once again, and we are to blame the residual for our woes, and label it with the flavour of the month, like Hicks-Neutral technology shocks or something just as meaningless.

We can then say such profound nonsense as “computers made workers poor”. Okay.

Rant over.

Monday, November 23, 2015

Praise the lord! Recite the Economic scriptures

One feature of economics is its uncanny resemblance to religion. When a complex question arises outside of your narrow filed of expertise, like a priest during confession, resort to the scriptures.

This is especially true for economists of a particular political persuasion, who are immune any empirical evidence that conflicts with their scriptures.

And so it is with economist polls. The University of Chicago Booth School of Business started their “experts panel”, which is the place to go if you want to see a bunch of people say that introductory economics textbooks are almost always right.

The image below shows an example. See? They all find the idea of Nash equilibrium a really powerful lens through which to view the world. I don’t. But anyway.


This craze of surveying a panel of economic experts has now reached Australia, with Monash University and the Economics Society of Australia posting tricky questions of our own high priests.

It’s so lovely that we now get our own beautiful ritual, watching the high priests periodically recite the economic scriptures.

Take the latest example. The question asks about the economic consequences of the government changing the rules around penalty rates (wage premiums) that are mandated for Sunday work (along with late night work and a range of other situations).

As you can see, 80% of the panelists agree that reducing the minimum wages for Sundays in a variety of industries will be “good” for employment and production.


From someone who agrees
This is a bit of Economics 101 that is very likely to work
And another
For many people, weekends are not what they used to be, and are just another part of the week. Given there would be a willing supply of labour, and a demand for it from those entities that currently close due to higher weekend costs, there should be a market outcome that suits many.
Sounds a lot like reciting the scriptures to me, without much consideration of the context. Basic questions like - Why are there weekends? Why do the wage rules exist in the first place? What non-market outcomes were desired?

But what about the minority? The 6.5% who didn’t recite the scriptures?
I think it will have almost no effect on overall employment, merely shifting activity from Saturday to Sunday. Its main effect will be to reduce the rent-sharing of workers and normalize Sunday as a regular working day, both to the detriment of workers but to the benefit of large employers. It is hence mainly a distributional issue.
And another
The fact that there is increasing demand for services on Sunday does not imply that workers should be paid less to provide those services. In fact, one would argue that workers should be paid even more.

if longer opening hours on Sundays imply that consumers spend more time and money at cafes and restaurants on Sundays, then the volume of business of these shops in weekdays might decline. If this happens, than the net effect on employment becomes even more difficult to predict.
Seems reasonable to me. After all, people in general have the same annual incomes and expenditure regardless of which days of the week they do the spending. And I doubt that Sunday trading is holding back investment in new equipment that would add to the nation's productive capacity. In fact it may hinder it.

You will notice that each of the economists on the panel has made a career out of showing why naive “econ101 assumptions” don’t apply to their field of expertise. Yet when asked about an issue outside their field, they resort to the scriptures, as if theirs is the only deviation from textbook case. This is lazy and not at all scientific.

In general the best way to interpret these surveys is a chance for economists to pledge their allegiance to the econ-tribe, making the whole effort a clear demonstration of economics as religion.

Thursday, November 19, 2015

More unpopular economic opinions

My last post on unpopular economic opinions was actually quite popular.

Here are some more.

1. There is no such thing as freedom. Every right has an equal and opposite obligation on the rest of society to accept that right. I want to walk around naked through the city. What type of idiotic freedom-crushing society doesn’t let me do that. Well, pretty much all of them. Because my right to waltz naked comes with the equal and opposite obligation on others to accept naked people wherever they look.



Since this "freedom=obligation identity" is always true, there are limitless examples to draw from.

My right to peaceful enjoyed of my house and property is an obligation on the rest of society not to interrupt me, to sleep in my bed uninvited, to use my kitchen, to camp on my lawn. 


2. Capitalism is successful not because it is efficient or productive. The amount of duplication of basic services, 25 types of toilet paper, the fact that over 30% of food grown is never eaten, and the massive costs invested in advertising and sales suggest that there is a fair bit of fat that could be trimmed in our economic system.

But capitalism is successful because it is inefficient. It has built in redundancy that creates enormous flexibility. A society with one large mechanised bakery that makes the daily bread for everyone might get points for productivity, but it is risky. A mechanical breakdown, natural disaster, or disease outbreak would all bring the total bread supply to a halt. In a society with multiple competing smaller, but less efficient bread-makers, these risks are greatly reduced.

As Rory Sutherland says:
Competition itself is highly inefficient. In my home town, I can buy food from about eight different places; I’m sure this system could be much more ‘efficient’ if Waitrose, M&S and Lidl were forcibly merged into one huge ‘Great Grocery Hall of The People No. 1306’. I am equally confident that after a few initial years of success, the shop would be terrible. 
So when we teach comparative advantage and specialisation as a great insight from economics, we aren't actually talking about markets and the foundation of competition in a capitalist economy, but a central planner's view of efficiency that is highly risky. One of the puzzle of the USSR was that for all it's economy troubles, it often seemed quite economically efficient in terms of the static allocation of resources.

3. Net foreign investment is an idiotic and misleading term for a capital account surplus. It should be called balance of trading assets for goods and services. 


4. Queuing is often a really good allocation mechanism. Congestion is a type of queuing. The study suggesting that serving the last person in a queue first increases efficiency is stupid. 


5. The amount of human organisation that is determined directly by prices and markets can be rounded to zero. When you consider the vast amount of services and goods that could be priced that aren’t, you realise just how small the effect of the price mechanism is on society.



Don’t believe me? Why don’t we have private property rights and markets for:



Roads. Public spaces. Air space. Oceans in all dimensions. Outer space. Mars. Antarctica. Within family production. Crime and criminal organisations. Government departments including within the military. Firm internal trade and services. All sex outside prostitution. All possible genes and animal species. Sunlight. Wind. 



Add in options contracts for all future rights for all these activities as well and we get the feeling that the story that economics of markets and prices plays a tiny role in human organisation and production. I reckon the scope of possible property rights must be thousands (millions?) of times larger than the actual property rights that facilitate priced exchanges that we have in place. 



Not only that, but prices are way too sticky to be performing the function they are suggested to do in economic theory. Coca-cola was 5c a bottle for 70yrs.

As you might have guessed, Ronald Coase is my favourite economic pioneer.


6. Writing off the $1.2 trillion of US student debt would be costless and probably a good way to stimulate the American economy. It would have the same effect of writing off any debt. 



I say it is costless because it is just a transfer from the owner of the debt to the borrower. So although the students in debt are probably above average in terms of their wealth, those who own the debt are probably even wealthier. Hence it would be a redistribution from the super wealthy to moderately wealthy as well as being an economic stimulant as those student whose debts are written off increase spending on goods and services more, relative the owners of the debt. 



The discussion of this topic on a Slate Money podcast earlier this week totally missed this point about this being an asset transfer. 


Sunday, November 15, 2015

Missing: Morality and flexibility in economic assessments


I spoke last week at the EDO LawJam about missing elements in the economic analysis of major projects in Queensland, and across Australia.

Assessment of the merits of such projects typically require some kind of cost-benefit analysis. This analysis is intended to take into consideration the vast array of externalities and second round effects of major mines, ports, rail, and other projects, like casinos, subdivisions, and so forth.

One major problem with these assessments is the sheer ambiguity of the requirements, and hence the quite extreme level of discretion in how to undertake the assessment. Project proponents employ economic guns-for-hire who use whichever method of assessment gives the desired answer. Not surprisingly, benefits alway greatly exceed costs.

My fellow speakers in the night - Rod Campbell and Sean Ryan - shared examples of mining companies sourcing bogus economic reports to massively overstate the social benefits of their proposed operations, only to find them thrown out of court during appeal cases. This has lead to some projects having multiple economic reports; the first commissioned to give an outrageous answer, the next to give an answer that might stand up in court.

There is clearly a problem of outrageous flexibility in the regulations when the same company can commission two economic assessments and get two totally different answers to the social costs and benefits of the same project. In one case the net job creation estimate was inflated by 1,000% compared to their second round report, while the value of State royalties was inflated by 1,800% ($22billion compared to $1.2billion).

But this is not an accident. Major mining and property development projects are the playground of politically connected insiders. Take this example of a mine neighbouring NSW Minister for Primary Industries, Lands and Water Niall Blair’s property, which has “this remarkable dogleg around the minister's property by the mine site”.

Political connections get outcomes in this game, and to keep the game going requires considerable flexibility in the assessment regulations.

Apart from this political element, I spoke about two main points.
  1. The neglected moral foundation of economic analysis 
  2. Ignoring the value of flexibility 
My point about neglected morality is that any estimate of costs and benefit necessarily makes moral judgements about whose costs and benefits are worth considering. Why only humans? Why only Australians? Also, there are hidden moral judgements about the dollar-for-dollar equivalence of cost and benefits affecting different groups of people in different ways. Undertaking economic assessment without acknowledging these foundations is deceptive.

My second point is that major developments, particularly open cut mines, are irreversible commitments. If at some future point in time it turns out that the site is more profitably and socially beneficial for use in agriculture, or some other use (say a solar electricity generation plant), then we cannot change the use from open cut coal mine back to these alternatives.

But if we stick with agriculture, we keep open the option for alternative high-value uses at future points in time. Thus, when comparing the social costs and benefits of a project like a mine, with a baseline alternative of agriculture, we must value the inherent flexibility of agricultural uses to allow for alternative future uses of the site.

My presentation can be viewed and downloaded from here.

Thursday, November 12, 2015

Unpopular economic opinions

1. School is mostly about indoctrination into the national identity. It is also about child care, and for older children, about keeping them out of the labour force. If we were honest we could talk about education policy with this in mind, though no one does (okay, there are some exceptions).

2. Gossip is a fantastic coordination device, allowing us to find like-minded others by bitching about particular issues or other people. The underlying idea here is that “my enemy’s enemy is my friend”, so if someone wants to have a good bitch, they are likely to be similar to you. Could be one factor in homophily observed in social networks. Again, rarely discussed.

3. The tax debate is 99% about distribution, 1% about growth. Don’t let economists fool you with their models that they don’t even pretend capture real phenomena. When they say lower corporate taxes increase growth they are modelling a world without assets where all profits are devoted to new investments in capital equipment.

4. Microeconomics is no more scientific than macroeconomics, particularly when it comes to theory. When people say there is progress in micro they mean in applied psychology, where experiments are widely used, and in empirical work where new data is helping to answer localised questions.

Most microeconomics though is still about markets, where aggregation of individuals is still a huge problem - it’s just a different level of macro.

5. Farmers are one of the wealthiest groups in the country and we shouldn’t prop up their businesses or lifestyles (see chart below). They are not charities and will jack up prices when they can. We can protect food production as an industry by protecting the degradation of the land from incompatible and irreversible uses like mining, housing developments and so forth. But some farm businesses will go broke from time to time and that is not a problem. We also are a massive food exporter, so there is really no “Australian food security” argument. 


6. Speaking of food security, we really overlook the main cause of malnourishment is poverty, not a lack of food production in the aggregate. Making poor people richer by taking from the top few percent of wealthiest and giving to the bottom 20% of the world would solve food security, amongst many other social ills.

7. Redistribution of global wealth is clearly the most obvious policy for a utilitarian. Bloody obvious.

8. Open borders to me seems like a way to pretend to be serious about global poverty and inequality. It allows supporters to pretend that the borders of private property within a nation are moral, yet the borders between nations are not. Somehow if I am denied, through accident of birth, to make a living from my share of the land in my own country, this is a radically different thing to Alex Tabarrok’s view, where he asks “How can it be moral that through the mere accident of birth some people are imprisoned in countries where their political or geographic institutions prevent them from making a living?”

As I have said before, even the wildest proponents of open borders agree that

“…open borders could not on its own eliminate poverty and that international migration could only help the relatively better off among the global poor”

Then what is it really for?

Thursday, October 29, 2015

Two-child China, and population ageing myths

China abandoned its one-child policy yesterday. Just about everything I’ve read since explains that this policy shift is a result of fears about dependency ratios; the ratio of the number of non-working age people in the population (children and the elderly) to the number of working age people. As shown in the chart below, China, like most countries, is seeing the start of an uptick in this ratio due to an ageing population.


But the simple fact is that increasing fertility rates isn’t a solution to this problem.

The reason population growth doesn’t solve this problem is that a growing population relies on
  1. more children, and hence a higher youth dependency ratio, or
  2. more immigrants, who become elderly themselves, delaying the problem. 
The only way population growth can ‘solve’ the age dependency problem is if the growth rate itself continues to grow in a grand human Ponzi scheme.

To make this point clear I have poached the data from a great study way back in 1999 by Peter McDonald and Rebecca Kippen. They simulate a number of Australian population scenarios that represent some of the political views at the time ranging from Harry Recher’s view of a one-child policy coupled with zero immigration, to Tim Flannery’s view that a sustainable long term population target is 12million, to Jeff Kennett’s view that immigration can solve the coming uptick in the dependency ratio.

I show in the graph below the dependency ratio[1] based on the various population projections in their simulations (final populations in 2100 are in brackets).


A few things should be noted.

First, the lowest population projection, the Recher model, gets Australia’s population to 5million by the end of the century and reaches a peak dependency ratio (DR) of about 2.2. The highest population projection, the Kennett immigration solution, reaches a population of 929.5million (yes, a billion) in 2100, relying in a population growth rate of over 4% to keep the DR at it’s 1998 level of about 0.7.

In between these two extremes we have population paths that lead to populations between 12 and 50million by the end of the century, all of which result in a DR between 1 and 1.5 by this measure.

But here’s the thing. That 0.5 difference in the DR for what are radically high and low population projections can be totally offset by changing the retirement age by just one year - shifting the population at age 66 from dependent to working age.

At the moment the Australia pension age is shifting two years - from age 65 to 67. If social norms of employment change to accompany this, than any ageing problem is already solved.

In short, what seem like insurmountable demographic shifts are actually relatively slow and minor changes in economic terms. Not only does a declining youth dependency ratio offset much of the increase in the age-dependency ratio, but from the perspective of the economy as a whole the potential costs of ageing are minor compared the economic and environmental costs associated with rapid population growth necessary to suppress this ratio.

[1] In these scenarios the dependency ratio is weighted so that a child accounts for 3/4 of a person, and a retired older person (above age 60) accounts for 5/4 of a person.

Update:
Slight mistake above. I don't know what I was doing with my calculations, but around 1% of people are age 65 at the moment, meaning that shifting the retirement age up a year has a much smaller impact than I first estimated. I have an updated graph below that shows the effect of shifting the retirement age from 65-67, which is current policy in Australia. My point holds that if there is a dependency ratio problem from ageing, we have solved it better by this single policy than what we could under anything but the most extreme population Ponzi (green line in the simulations below, with a population of a billion in 2100).



Sunday, October 25, 2015

Queensland will ignore better planning

I wrote a submission during the consultation on reforms to the Queensland planning system. As you are probably aware, my research in this area focusses mostly on teasing out statistically the amount of favouritism happening in high value rezoning decisions.

My submission also focuses on the scope within the proposed Planning Bill for continued favouritism. But I also raise the point that we should enshrine at the highest level that governments of all levels, from Councils upwards, be able to capture the land value created by their planning decisions. As it stands the Bill suggests the opposite should be the case - that Councils are liable for compensation should they downgrade the value of land uses at a location (subject to the land being currently used for that purpose).

In no other area of government do we give away property rights for free, so often. It's a multi-billion dollar annual ritual of gift-giving from the public to politicly-connected landowners.

If you want to listen to a terrific podcast covering the types of mechanisms available to recover value gains from government policy I recommend last week’s Renegade Economist episode, which is the source of the below image as well.

You can download my submission here.


Saturday, October 24, 2015

Explaining everything explains nothing: Economics

The below comic probably hits a little close to home for most economists. Poking fun of economists’ naive attachment to their particular brand of rationality, and it’s immense body of hidden assumptions, usually gains responses that are merely signals of tribal loyalties and ignore the substance of the critique.

My colleague Vera te Velde made an improvement on the comic which is also included below, and my reading is that she wants to gain loyalty from the tribe more than defend rationality assumptions in economic models.

While it is certainly true that her improvement is consistent with core economic theories, it really highlights in my mind that these theories are essentially vacuous if they can explain anything and everything imaginable.

In response to the ability of other economists to fit everything within their model (meaning nothing can be excluded), simply because of creatively reversing out a set of preferences that explain the observed behaviour (or as Vera concludes De gustibus non eat disputandum), I wrote
There was simply no phenomena he could not explain with his beloved utility theory. But if the theory explains everything imaginable, then it predicts nothing. I resolved that the theory as it stands, in the revealed preference form, was not falsifiable, though he didn’t seem to understand why that would matter.  
Sure, humans often make calculated decisions, but the more I learn about the nexus between individual behaviour and how we behave in groups, the more I see very little value in rational-individualist views of economic systems that see all behaviour arising from God-given personal tastes. Without acknowledging the necessity of group-coordination mechanisms intrinsic in our behaviour, we are missing the main story.

Wednesday, September 30, 2015

How to analyse housing markets

Housing costs are typically 30% of household income, while about 43% of household savings are tied up in the value of owner-occupied dwellings. There is really no more important market for the general public when it comes to their cost of living and their ability to save for the future.

But simply talking about the housing market as if it is some monolithic beast will lead you to the error of conflating three distinct markets that must be considered independently if you want to really understand what is happening. These markets are

1: The land asset market
2: The housing service market (annual occupancy from rent or ownership)
3: The residential construction market

When you buy a home on the second hand market (rather than build yourself), you are actually buying a bundled good which includes a land asset along with a durable housing product which lasts the life of the building. A close analogy would be buying a car bundled with an equity share in the vehicle manufacturer - you get the vehicle for its useful life, and the equity asset in perpetuity.

So when we talk of high demand for housing, home prices increasing, and housing bubbles, we must be clear about whether we are talking about the market for the land asset component of the bundled housing good, or the market of occupying homes themselves. Conflating these is the most common error in housing market analysis, and it leads to conclusions that make little sense in reality.

For example, take the frequent commentary about the effect of population growth on home prices. To me it is utterly confusing. If we are talking about the land asset market, the question then arises about why we don’t talk about the population effects on equity and debt markets, derivatives markets, and other asset classes that could equally see effects. The reason being that more people means more buyers AND sellers of the same assets.

You can see from the graph below that population effects don’t seem to be driving the growth in land asset prices, or at least can’t be a major contributor if areas with a 10-15% population decline can still see 70% growth in home prices.


Of course like other asset markets the reason for the land price increases has a lot to do with the systematic reduction of interest rates in the past 20 years. Asset prices are just the capitalised value of future claims on incomes, and a lower interest rate increases that asset value compared the value of the future incomes. This means that comparing prices of the bundle of house and land asset to incomes makes no sense at all. It would make just as much sense to compare the price of an equity share in Woolworths bundled with a kilos of bananas as a way to measure food inflation. Why not measure the food itself?

Luckily, we do have a market for housing as a produced good that we consume on an annual basis quite apart from the land asset; the rental market. If we measure how much of our incomes we spend on rent, and the quality of the homes we reside in (in terms of sqm per person), we can apply the supply and demand model to the market. If there really is something going on with population and housing production, it must be observable in the rental market. Looking at the chart below we can see that in fact the rent to income ratio declined all the way through the land price boom of the early 2000s, as did the occupancy rate (fewer people per home) indicating that in fact we were building more new homes than new people.


So sure, use your supply and demand analysis on the market for produced durable housing goods, but remember that home prices aren’t the price in that market. Rents are the price in the housing market, while home prices mostly reflect prices in the land market.

Lastly, we can look at the construction market, which is driven by trends in other markets, including speculation on land markets. Here the idea of supply and demand also works fine, as periods of high demand for new construction result in increasing construction prices (as demand shift to the right against a resource-constrained upward sloping supply curve for construction services). But again, the construction market and construction prices are not the contributor to growth in home prices. In fact, higher construction costs will decrease the value of the land asset, as they provide an additional cost to capturing future income flows.

The situation now in Australia is that asset market dynamics, including lower interest rates, international buying, and simple cyclical timing of investments, are driving up land prices in some capital cities. In some areas, when this asset buying occurs in new homes it also increases demand for construction, pushing up prices in that market as well. And in the housing service (i.e. rental) market, the additional supply is suppressing rents.

This is the way to analyse housing markets. Don’t be drawn into the monolithic view by conflating behaviour in these distinct markets.

Thursday, September 10, 2015

Doing the housing supply maths

Laurence Murphy is a top property economist at the University of Auckland. I met him last night after a presentation in Sydney where he took on the myth that planning constraints are a major determinant of current home prices in Australia and New Zealand.

He said it is very easy to demonstrate mathematically how little impact even a large increase in the rate of supply would have on prices. But when he shows this analysis to government officials, planners, and engineers who have bought into the supply-side narrative their response is often

“I see you calculations. I follow the logic. But I don’t believe it!”

So I wanted to try the ‘basic supply-side maths’ for myself on the blog to see what sort of effects radical changes to the rate of new housing supply could have, and see if I generate some of the same responses.

Here’s how the maths work. I take the number of new dwelling completions from the ABS for the past 20 years, which is shown in quarterly figures in the blue line of the chart below. Since 1995 new housing supply has been 146,546 dwellings per year on average, which is about a 2% increase in the stock annually, though this moves with the business cycle.


I then add 10% to this number every year to generate a counterfactual world where supply has been much higher over a sustained two-decade period (green line). Then I add 20% just to take an extreme scenario (yellow line). Note that in this exercise I don’t ‘elastify’ supply, which would have higher construction in boom periods, and lower construction in slump. When I run the numbers of more elastic supply that responds to both booms and slumps more I get fewer home built compared to what actually happened! This is because when completion rate falls, it falls faster, offsetting all of the gain from the previous boom. I show a twice as elastic scenario in the next graph in red, which actually results in 8,000 fewer dwellings built in the past 20 years. ‘Elastifying’ supply can’t really be what is desired by those advocating for supply-side reforms. 


Any supply-side housing initiative should simply aim to get more homes built, year in, year out. This is what I capture in my counterfactual scenarios of 10% and 20% higher construction over two decades.

So here is question. How many more houses would there be now in these counterfactual worlds? And what would the price impact be?

Well, if we had built 10% more new home each year for the past 20 years Australia would have around 300,000 more homes. At a 20% higher rate of completions that's 600,000 more. Sounds terrific! That must have a massive impact on prices.

Well. No.

You see Australia’s current housing stock is somewhere above 9million homes. Around 8.8million occupied, and many second homes, holiday homes, and so forth that are traditionally about 8% of the housing stock. Let’s say that there are 9.3million dwelling in the country right now. These additional homes in my 20 year supercharged supply scenarios represent just a 3.2% and 6.4% increase in total stock respectively.

The price impact of a 3% increase in supply is a 3% reduction if demand elasticity is unity. That’s it. The price reduction could be less if there are countervailing income effects that lead to outbidding for superior locations.  So twenty years of supercharged supply provides somewhere between 0% and 3% lower prices, which suggests to me that focusing on the supply side is close to a waste of time. In the 20% higher housing completions scenario the effect is somewhere between zero and 6%. About the same as two and a half years of rental price growth.

To put it another way, after 20 years of a 10% higher rate of new supply, rents today would be then same as they were in early 2014.

We can alternatively look at raw measure of the gains to the amount of floor space per person. Taking  average floor size of homes, which is about 180sqm, and add 3%, and assign it to the average of 2.6 occupants, to get an additional 2sqm of floor space per person.

Or alternatively we can think of it in terms of occupancy rates, which would be 2.51 instead of 2.6 with the same size homes under the 10% higher supply scenario.

That’s all you get for 20 years worth of sustained housing supply stimulus. And you get none of that simply from more elastic supply only.

The point being that current massive price increases, in the order of 17% per year in Sydney and Melbourne, simply cannot be explained by anything like unresponsive supply. Not only that, any supply-side effect on prices takes many decades to have any effect, and only enters the price equation via effects on rents.

If we want cheaper housing we need to reform legal structures to shift bargaining power to tenants from landlords, curb speculation through financial controls (and keep stamp duties!), and stop rewarding political parties who promise housing supply as any sort of solution to current prices.

Unfortunately, very few people actually want housing to become more cheaper. Around 70% of households are homeowners, around 30% are property investors who come from the wealthier part of society, while most politicians also have a huge share of their wealth tied up in residential property. It suits all of these interests to point the finger at supply because they know it sounds attractive in a naive economic way, but won’t actually reduce the value of their housing portfolios.

As Professor Murphy explained, the consensus around new housing supply as a solution to housing affordability problems is a political construct. This unfortunate political reality is best summarised in this tweet. 
  
Dear reader I hope you see my calculations, follow the logic and believe it!

Monday, August 31, 2015

So, about the inefficiency of stamp duties…

Australia’s economic commentariat is now almost unanimously on board with the idea that stamp duties on property transactions are immensely inefficient and should be abolished in favour of land taxes.

I’ve long held the view that land taxes are the best form of taxation. I certainly agree with that. But the idea that stamp duties are exceptionally bad is not clear cut. The key reference point for this belief is from the various modelling exercises of economists looking to estimate the welfare losses from these taxes.

The main problem, however, is that there are no transactions in equilibrium economic models, so there is no way to model a transaction tax. Equilibrium models are ‘pre-solved’ by the Walrasian auctioneer to determine the distribution of goods to a single representative agent.

Here’s what the Australia Treasury had to say when they tried to model the welfare effects of stamp duties.
It is inherently difficult to capture this type of capital transaction tax in a model with a single representative agent. The approach adopted here treats real estate services as an investment good which improves the productivity of the firms, including the housing sector. One way of thinking about this is that real estate agents play a valuable role in finding producers that value the capital the most. Therefore a potential owner will be willing to pay a real estate fee equal to the profit they will enjoy over the previous owner. Within this setting the conveyance duty is treated as a tax on the value of investment and subsequent productivity gains facilitated by the transfer of land and structures.
Translated it reads “our model can’t capture transaction taxes so we’ll just assume the tax is something else to fit it into the model we do have.”

The best micro-level analysis comes from Davidoff and Leigh, who find that the main impact of higher stamp duties is to reduce frequency of home sales, and of those home sales, some will be from people relocating. 

Yet it is not clear that the welfare effect of reduced home sales is negative if some of those sales are merely fuelling speculation in the housing market. The basic result of all transaction taxes in asset markets hold - if some of the transactions are simply speculative churn, than there can be positive welfare effects from reducing turnover through transaction taxes. 

So I urge caution about calls to cut stamp duties, even if those calls are accompanied by the proviso that such a change must be accompanied by higher land taxes, and especially if those provisos are likely to be ignored.

Tuesday, August 18, 2015

Nanny state submission

Australia's new libertarian Senator David Leyonhjelm has called for a Senate Inquiry into Australia's creeping 'nanny state' regulations of individual behaviour. The conflicted Senator, who's main claim to fame so far is to agitate for increased regulations on wind farms despite his apparent principles of freedom, is one of those characters who at least shakes up the dreary world of politics. By coincidence I do often agree with him on personal freedoms, though on economic freedoms and issues about the distribution of wealth and social support, we disagree quite starkly. The Inquiry is, however, a useful catalyst for considering the evidence of individual-level harm-minimising regulations.

My submission is reproduced below, and available in full here.

Background
This “nanny state” inquiry is a timely chance to reconsider the relationship between personal choice and legislated responsibilities, and to consider the evidence that exists of the effectiveness nanny state policies in terms of their intended social impacts.

The Terms of Reference for the Inquiry are:
  • the sale and use of tobacco, tobacco products, nicotine products, and e-cigarettes, including any impact on the health, enjoyment and finances of users and non-users; 
  • the sale and service of alcohol, including any impact on crime and the health, enjoyment and finances of drinkers and non-drinkers; 
  • the sale and use of marijuana and associated products, including any impact on the health, enjoyment and finances of users and non-users; 
  • bicycle helmet laws, including any impact on the health, enjoyment and finances of cyclists and non-cyclists; 
  • the classification of publications, films and computer games; and 
  • any other measures introduced to restrict personal choice 'for the individual‘s own good’. 
I respond to each in turn by taking a practical approach informed by research in these areas. An overarching message is this. It should not be okay to ‘do something’ about a social issue without a rigorous assessment of whether that ‘something’ will even address the issue at hand. Many nanny state regulations are a knee-jerk political response and not policy made with clear assessable objectives.

A second message is this. Healthier citizens need not lead to lower health care costs in general as any disease or injury prevention simply allows another disease to cause that person’s death, and it will also have associated health care and ‘end of life’ care costs.

The research is quite clear that this is the case, particularly for smokers. The following academic results are typical (my emphasis).
Health care costs for smokers at a given age are as much as 40 percent higher than those for nonsmokers, but in a population in which no one smoked the costs would be 7 percent higher among men and 4 percent higher among women than the costs in the current mixed population of smokers and nonsmokers. If all smokers quit, health care costs would be lower at first, but after 15 years they would become higher than at present. In the long term, complete smoking cessation would produce a net increase in health care costs, but it could still be seen as economically favorable under reasonable assumptions of discount rate and evaluation period.
And from here
Until age 56, annual health expenditure was highest for obese people. At older ages, smokers incurred higher costs. Because of differences in life expectancy, however, lifetime health expenditure was highest among healthy-living people and lowest for smokers. Obese individuals held an intermediate position.
Therefore when making policy decisions in the interests of improving individual health, an informed government should not naively justify such decisions on the grounds of reducing the resource burden of public health care, as this argument rarely holds. Decisions must be made on other grounds, of which there are many legitimate ones, such as externalities (in the case of passive smoking in some public areas), information failures, market or political power of interest groups.

Underlying this inquiry is also a question as to the current Australia legal situation in terms of duty of care. Take as an example children’s playgrounds in public parks. Surely a part of the trend towards excessive padding and safety is the result of legal pressures and past legal cases against “negligent” councils. The same happens with cracked footpaths (see this example, and there are many others), and other personal injuries that seem to overstep the bounds of a common sense duty of care even on private property (see this example). I believe a key part of the process of decreasing ineffective and costly nanny state regulation requires looking abroad, perhaps to Europe, at how the legal interpretations of duty of care are quite different and allows for governments the legal comfort to go without nanny-state regulations.

Tobacco choice
Legislation restricting tobacco sales, purchasing, and smoking location has had a large impact on smoking in the past two decades. As the below graph from the Australian Institute of Health and Welfare shows, smoking is declining in the general population in response to a combination of policy changes intended to have this effect. Now the rise of vaping as a alternative nicotine indulgence has attracted some attention as its growth in recent years is at odds with the continued long run decline in tobacco smoking in traditional forms. 

 
Questions about tobacco choice must centre on externalities of consumption, and information failures. Is smoking impinging on the freedom of others to enjoy a smoke free environment, and are smokers fully informed about the products they are consuming?

On the first question it seems clear that previously introduced limitations on smoking locations have addressed the majority of externalities associated with tobacco consumption. On the second, one could argue that the pubic awareness campaigns of the past decades have addressed this issue as well, and that plain packaging rules and other changes have little claim to be further addressing information failures, though there is a very light argument that it reduces the power of tobacco brands because of lower community awareness.

The rise of vaping must also be considered. Vaping is specifically designed to minimise externalities from consuming tobacco in public and enclosed spaces, and hence any regulation of vaping should focus on ensuring consumers are fully informed of the product being consumed and its personal health effects.

Alcohol choice
There is no doubt Australia, like many countries, has high levels of alcohol related violence and a binge drinking culture. Australia has some shocking ‘alcohol related violence’ statistics
  • 1 in 4 Australians were a victim of alcohol-related verbal abuse 
  • 13 percent were made to feel fearful by someone under the influence of alcohol 
  • 4.5 percent of Australians aged 14 years or older had been physically abused by someone under the influence of alcohol 
But all the scientific research says that alcohol has absolutely no effect on aggression, and in fact impairs coordination.

One must be clear about what social problem taxes on alcohol and other regulations limiting sale are targeting; the binge drinking that arguable creates externalities on others, or drinking alcohol in general? Clearly it is the rowdy culture and late night violence in cities and suburbs that is a problem.

Yet it is not clear that “sin taxes” on alcohol are an effective way to change the binge drinking culture, and in fact might have the opposite effect. Those who choose to drink alcohol may change their patterns of consumption to only drink to get drunk. Why pay so much for alcohol unless you are going to get drunk?

Anecdotal evidence across countries suggest that countries with binge drinking cultures also have the more expensive alcohol, such as the Scandinavians and the UK. While in Mediterranean countries where wine is part of the dining culture, cheap enough to consume with most meals, the binge drinking culture is less prevalent. In fact the weight of evidence now points to regular small quantities of alcohol being beneficial to lifetime health.

So what sort of policies would reduce our violent binge drinking culture? I have a radical proposal.
  • Remove taxes on alcohol (revenues can be made up with land taxes) 
  • Reframe the public alcohol messages. 
  • Reduce the drinking age to 16 
  • Allow alcohol to be sold in supermarkets in States where it is not 
  • Remove liquor licensing rules and simply retain responsible serving of alcohol requirements. 
Essentially such changes would make alcohol boring and integrate it into everyday life.

Public health messages might have a grandma drinking Bundy Rum diluted with cold water after dinner, who then falls asleep on the couch. Or we could do a complete reversal and really drill home the point that rowdy drunks are puppets of their social environment and that they can’t blame alcohol. If you are a tool when you are drunk, you are a tool. Embarrass them into less binge drinking.

As anthropologist Kate Fox explains
I would like to see a complete change of focus, with all alcohol-education and awareness campaigns designed specifically to challenge these beliefs – to get across the message that a) alcohol does not cause disinhibition (aggressive, sexual or otherwise) and that b) even when you are drunk, you are in control of and have total responsibility for your actions and behaviour.
Yet at the moment we have alcohol messages that seem to reinforce the message that alcohol is an excuse for disruptive behaviour, with phrases such as “alcohol is responsible for..”. Actually, no. Would you seriously say ‘tea is responsible for…”.

As I have discussed before, culture is often a good explanation of social and economic phenomena. The more we understand culture, and get over our simplistic ‘Pigouvian taxes can fix everything’ mentality, the more we can strategically intervene in highly effective ways to change behaviours that are having negative effects on others.

Marijuana choice
The same arguments discussed above in relation to tobacco smoking and alcohol apply to marijuana. It is mostly through historical happenstance that marijuana consumption is fully prohibited while tobacco and alcohol is not, and certainly prohibition of various types of drugs have a complex social history.

The main comment is that modern experiments with legalisation of marijuana have showed that there is little social disruption to such changes, and that legal and police resource devoted to the current illicit marijuana industry can be much better employed elsewhere.

Bicycle helmet choice
Australia is globally unique in our laws about compulsory bicycle helmet for all riders. As discussed in the background section of this submission, the argument that injured cyclists will be cared for in public hospitals, and as such create externalities on other through the costs of public health care, is rubbish.

Moreover, even if one believed this argument it would also justify helmet wearing for drivers and pedestrians, who on average account for the overwhelming majority of head injury hospitalisations.

As a general observation the helmet laws has been a knee jerk policy without a clear assessable objective, and has for nearly 30 years been an excuse to ignore investing in urban cycling infrastructure because ‘something’ has already been done for cyclists to keep them safe.

Again, the overwhelming research findings are that helmet laws reduce cycling, make cycling less safe for this who do, and decreasing health of those who opt out of cycling. Being a world outlier in this area should be enough of a signal that this law is not achieving any particular goal of reducing externalities or improving information failures for cyclists, and if anything does the opposite by making cycling appear more dangerous that what the statistic show.

Media classifications
Unlike most of the items int he ToR, media classification do serve to address an information failure, in media and games, where viewers are unable to judge the content until after they have experienced it. The simplest way to view media classification is as a type of labelling, similar to that in the food and groceries, which allows customers to easily access additional information about the product.

In an ideal world media classifications would be simple and their design would imply self-evident feature of the media content in terms of violence, sexual content, language and themes. The main use of these classification is for parents of children who are taking responsibility for their child’s exposure to particular types of media, and hence for these parents some form of classification tools appears to address a possible information failure.

Sunday, August 2, 2015

The confused economic orthodoxy


Last year I presented the idea that perhaps an firm objective function of maximising their rate of return on all costs is more consistent with the stylised facts about firm cost curves.

I want to document here two things. First, the two mutually exclusive responses from editors and referees during the reviewing process, which to me reveals the general ignorance of what the core concepts in economics really are (opportunity cost anyone?).

Second I want to spend a moment showing the incoherent ways profit-maximising is used in economics, and reiterate Joan Robinson’s critique of profit-maximisation as it is still highly relevant.

Part 1: Challenging the scriptures

The basic idea of my alternative objective function is that maximising the absolute value of something is universally a stupid thing to do. We need a denominator in a world where what matters at an individual or firm level is relative performance.

I’ve had both the following responses. First is the more common response that the paper is wrong because it doesn’t look at profit maximising firms. Basically, this response involves re-explaining the standard result of profit-maximisation. To borrow Steve Keen’s favourite analogy, we are like Copernicus explaining what a model of the Earth revolving around the Sun predicts, and the response is to explain the predictions of the Ptolemaic orthodox model where the Sun revolves around the Earth. The comments on my first blog post about the paper were mostly along this line.

The second response from editors and reviewers is the opposite. We’ve also been told that return-seeking is natural and implied in the standard model of profit-maximisation.
Your paper argues that firms do not maximize instantaneous profit but instead choose to allocate resources in a way that maximizes return on investment. I don't think that this assumption would surprise or bother anybody.
Actually, yes, it surprises and bothers all your economics colleagues. Maybe you should sit down together and interrogate your own models with some objective clarity and see what they really say.

Even if you dismiss this bizarre series of responses as the outcome of time-poor editors looking for excuses to reject papers they don’t like the look of, you’ve just revealed an acceptance of the non-scientific nature of economics and the lack of openness to anything outside the accepted scriptures (and yes, this is a general social science problem).

Part 2: Sticking with inconsistent beliefs

This is my main problem with economics. Despite a long history of critiques of the core models from inside the discipline, including the impossibility of a representative agent (and it’s full information), the conflation of uncertainty with risk, the Walrasian auctioneer, the impossibility of aggregating capital quantities, and many others, somehow the core survives.

So let me add to this long history of critiques with another of my own.

Consider the short-run profit maximising model, where profits are revenues minus costs. By definition the short-run has a fixed factor of production, usually called capital, which can be any arbitrary set of inputs. What that implies is that the short run profit maximising output actually is more generally represented as

profit = (revenue - costs) / fixed capital amount

Magically we have an implied denominator, which we might consider sunk costs. But then we have another different set of costs in the numerator, the variable costs. Exactly how is this distinction between types of costs made in practice? More importantly, where do the funds come from to pay these variable costs?

Consider the standard short-run price-taking model in equilibrium. Demand then increases. Increasing output requires the imposition of greater costs for each additional unit (being on the upward-sloping part of the ATC), the firm must conjure these costs from somewhere. If they require a new investor (or the same investors to reinvest earnings), they are diluting the rate of return on all the other investors.

As I have explained before, no current investor would allow the rate of return on their share of the firm to be diminished by adding additional investors. Essentially the core short-run profit-maximising model is one of maximising profits per capital owner.

But then we have a long-run profit maximising model which typically looks like this

profit = quantity * price - (labour units * labour unit cost + capital units * capital unit cost)

The denominator has disappeared. All of a sudden firms don’t care how much it costs to make a profit. If there is a choice between spending $100 to make $40 in profit, and spending $200 to make $41 profit, you choose the latter as a profit maximiser.

But as a return-seeker you first take the $100 investment. You don’t ignore a 40% return because a 20.5% return is available elsewhere. Never.

There is much more to this story, particularly around the ability to leverage. But the biggest story is about how value is gained from high return investments. If I can get my 40% return on costs, I can later sell that firm based on the discounted value of net cash flows. If that discount rate is, say, 10%, then my $100 investment gains $27 in value immediately. I can then sell my firm for $127.

In any case, the point here is that profit-maximisation is, in the words of Joan Robinson, meta-physical doctrine. The empirical record is against it, yet it persists as a signal of membership to the economics tribe. And what is worse, it seems that very few economists at the top of the discipline are clear about the crucial and often hidden underlying assumptions of their models, and continue to teach a fairy-tale view of the core models.

Tuesday, July 7, 2015

ACE 2015: Day 1

This week I'm attending the Australian Conference of Economics.

The main event today was a debate on the topic that economics education needs saving. To me the debate revealed that the desire for change is widespread amongst the old and young alike within the discipline. What is not clear is agreement on an alternative - everyone wants to do 'something else', but agreeing on what that something else might be is a task never quite tackled systematically by potential reformers.

In my mind Rethinking Economics and Post-Crash have most clearly articulated an alternative pluralist, dare I say it, scientific, core. But few seasoned economists are willing to make such radical change. Opening the doors to cross-disciplinary research is scary. Alternative methods might just prove superior to the equilibrium representative agent models that dominate economics.

As a small example of just how hesitant even the relatively ope minds are in economics, when discussing that direct surveys of firm managers and anthropological-style observational studies of firms are a valid method in micro-economics (ala Alan Kirman) I was faced with the following response:
But how do we know that respondents would tell the truth? That's the power of models and various regression tools. We know the assumptions being made
But of course, most data that gets into these estimations is the result of a survey asking people to self-report their views, their income, their expenditure, and so forth. This response (from someone I respect white a great deal who is an excellent experimenter) simply reveals the narrowness of economics training.

To ram home the point, when Alan Blinder did actually send researchers to go and ask questions of firm managers and observe their decisions, his results, summarised in his fantastic book Asking About Prices, has had little relatively little impact on the profession. As Steven Keen writes in his review on Amazon
The chief author of this book is Alan Blinder, once a Vice-President of the American Economic Association, a Vice-Governor of the Federal Reserve, and currently President of the Eastern Economic Association. He is, in other words, no maverick, but firmly within the mainstream of economic thought. And yet the research he reports in this book challenges many of the accepted tenets of both micro and macro economics. 
The publication should therefore be taken seriously by the economics profession, and raked over carefully to find out whether what Blinder reveals is really the case, or simply a product of poor research. 
It speaks volumes for the way that economics handles contrary evidence to accepted beliefs that this has not happened. Blinder's book has instead simply been ignored. The book languishes around the 750,000 mark in Amazon's "best sellers" list, and this review will be the first ever given of it. Meanwhile Mas-Colell's Microeconomic Theory, published three years before Blinder's book, which states the accepted neoclassical microeconomic canon in excruciating mathematical detail, ranks in the mid 100,000s, and has over 80 reviews--most of them from economics PhD students and highly laudatory.
We'll see what Wendy Carlin, author of INET's CORE Economics project, has to say about it all on Friday.

Another productive chat was whether the core economics program could do away with supply and demand diagrams and market equilibrium altogether. Thinking this far outside the current norms are what is really required for change. So you know, two of us believed an economics course could be even more valuable the current standard courses by doing away with supply and demand as currently formulated altogether.

In another session on how to improve your academic writing some quality advice was offered
Focus on the problem of interest, not the method.
This resonated with me. I've long come to the realisation that economists have a small simple toolkit comprising equilibrium models of representative agents, who take that method to new problems, adopting the method across its infinite possible contortions to fit any problem - from reproductive choice, to education, and more. Even when vastly superior alternative are available. The simplicity itself, despite its irrelevance, seems to be quite attractive.

I had expected to be exposed more to new methods and new ideas but came away very much with the impression of the continued dominance of the core. One of the respected elders of the professions suggested we work together on a model of housing markets, but as soon as he talked about equilibrating forces of supply and demand I realised he hadn't actually thought about the housing market (crucially, the timing problems due to the real option nature of housing investment for landowners). Instead he was taking the method to a new area (for him at least).

More updates to come tomorrow.