Archive for March, 2009
South Park’s Less-Famous Metaphor
| Dick Langlois |
One of my students sent me this link to a recent South Park episode, which not only effectively skewers the bailout but also has its own take on the nature and meaning of “the market.” A mini-Fable of the Bees for modern times.
Adam Smith’s Famous Metaphor
| Peter Klein |
The indefatigable Gavin Kennedy explains, for the umpteenth time, that Adam Smith was ambivalent about market capitalism and that the famous metaphor of the “invisible hand” was not meant as a generalized defense of the market. As Gavin points out, Smith’s detailed analysis of the market economy appears in Books I and II of the Wealth of Nations, while the invisible hand metaphor appears only once, in Book IV, where Smith defends British merchants who, despite mercantilist export subsidies, preferred to keep their capital invested at home, to the benefit of the British economy. Notes Gavin:
So inconsequential was [Smith’s] use of The Metaphor that neither he, nor anybody else until the late 19th century, commented upon it. . . .
Moreover, it was only in Chicago in the 1930s that The Metaphor was generalised into Smith’s so-called “law” of markets. Paul Samuelson (1948, 1st edition), in his famous textbook, Economics (16 editions), publicised this invention with the inevitable affect on modern economics, as tens of thousands of his readers took it on trust as true.
To be sure, the relevant passage in Smith also includes the famous lines, “By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good,” and the remark that “What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom.” But Smith’s statements need to be understood in context; he is discussing the specific problem of trade monopoly, arguing against trade and industrial policies that subsidize particular markets or industries.
Imaginary Tweets
| Peter Klein |
If Twitter had been around way back then (courtesy of Norman Chad):
Michelangelo: “Sistine Chapel ceiling larger than it looks; back is killing me.”
Christopher Columbus: “No sign of land yet.”
Robert Peary: “Man, it’s cold up here.”
And Adam Chudy imagines Obama’s tweets:
Just spent $3.5 billion …
Just spent $30 billion …
Just spent $787 billion …
Smoke break …
Just spent $285 billion …
On a related note, here’s a new stream worth following: Twecipie.
Big Bucks for Coach Anderson
| Peter Klein |
In light of our recent discussions of salaries for US college coaches (1, 2), I note that Missouri basketball coach Mike Anderson, whose team lost over the weekend to the Connecticut Huskies (good thing Dick Langlois and I didn’t have a wager on that), is likely to get a big raise this year. Anderson’s base salary is $850,000, a pittance compared to Jim Calhoun’s $1.6 million. (Indeed, Anderson’s predecessor Quinn Snyder, fired at the end of the 2006 season, pulled down $1.2 million.) Local media outlets guess that at least $1.3 million will be required to keep Anderson from bolting for openings at Georgia, Virgnia, or Arizona (and Memphis, if John Calipari takes the Kentucky job). University System President Gary Forsee, Chancellor Brady Deaton, and even Missouri Governor Jay Nixon made public statements over the weekend expressing their desire to keep Anderson. Not one mentioned the University’s delicate financial situation (a huge revenue shortfall has led to cuts in academic programs, research support, faculty and staff benefits, and other expenditures). I can understand the argument for “investing” in a big-time coach but, given the recession, wouldn’t you expect campus officials to be a wee bit more discrete when tossing around these big numbers?
New Online Books
| Peter Klein |
Thanks to the Mises Institute, the Institute of Economic Affairs, the Library of Economics and Liberty, and other organizations, great works in social science continue to appear in free online editions. Some of the newest include:
- Carl Menger’s Investigations into the Method of the Social Sciences (1883), which features the famous section (book 3, chapter 2) on unintended consequences;
- Larry White’s Free Banking in Britain (1984); and
- Hayek’s Individualism and Economic Order (1948), which contains the classic essays “Economics and Knowledge,” “The Use of Knowledge in Society,” and “The Meaning of Competition,” among others.
Relative Prices Matter
| Peter Klein |
Hate to keep flogging a dead horse, and perhaps preaching to the choir, but the point can’t be made often enough: relative prices matter. The childish Keynesianism of people like DeLong and Krugman, like Bernanke and Geithner, understands only aggregate concepts like “national output,” “employment,” and “the price level.” A consistent theme of this blog’s rants is that resources are heterogeneous (1, 2) and, consequently, relative prices must be free to adjust to changes in demand, technology, market conditions, and so on. When government policy generates an artificial boom in a particular market, such as housing — drawing resources away from other parts of the economy — the key to recovery is to let resources flow out of that market and back to the sectors of the economy where those resources belong (i.e., to match the pattern of consumer demands). It’s quite simple: home prices should be falling, interest rates should be rising, savings rates should be going up, and debt levels should be going down. The Administration’s policies, like that of the last Administration, are designed to achieve exactly the opposite. Why? Because relative prices don’t matter, the allocation of resources across activities doesn’t matter, all that matters is to keep any sector from shrinking, any prices from falling, any firms from failing, any consumers from reducing their consumption. A child thinks only about what he can see. The unseen doesn’t exist.
Here are some excellent posts on the subject. Craig Pirrong notes that Sherwin Rosen had a colorful way of emphasizing relative price effects. Mario Rizzo (1, 2) points to data on the housing market and the Fed’s continuing attempt to keep resources from flowing out of this bloated sector. And here’s a snippet from Israel Kirzner’s short book on Mises explaining that insolvent financial institutions should be liquidated, not rescued. Good reading for grown-ups.
Public Entrepreneurship
| Peter Klein |
A surprising aspect of the recent growth in the entrepreneurship literature is the number of papers, projects, courses, centers, etc. studying entrepreneurship in non-market settings: “social entrepreneurship,” “cultural entrepreneurship,” “environmental entrepreneurship,” and so on. At my own university students can take entrepreneurship courses not only in the Colleges of Business or Engineering but in the College of Agriculture, the School of Natural Resources, the College of Journalism, and even the School of Social Work. (One of my colleagues organized a conference last year aimed at cattle ranchers seeking to market their, um, byproducts as fertilizer, with the classic title: “Manure Entrepreneurship: Turning Brown into Green.”
Translating concepts, theories, and research methods from the entrepreneurship literature to non-market settings raises challenging issue, however. How is entrepreneurship defined? What corresponds to entrepreneurial profit and loss? What is the entrepreneur’s objective function? Are there competitive processes that select for the better entrepreneurs? None of the classic writers on entrepreneurship — Cantillon, Say, Schumpeter, Knight, Mises, Kirzner — wrote explicitly on entrepreneurship in non-market settings, as far as I am aware. Mises, in fact, distinguishes sharply between “profit management” (or entrepreneurial management) and “bureaucratic management,” identifying the former with initiative, responsibility, creativity, and novelty and the latter with rule-following within strict guidelines (see Bureaucracy, 1944, and chapter 15, section 10 of Human Action, 1949). (more…)
Literature Review Bleg
| Dick Langlois |
One of my graduate students has been working on an idea to formalize Henry Hansmann’s approach to the ownership of enterprise. Hansmann thinks about the ownership margin — which set of “patrons” in the nexus of contracts should own the residual rights of control and of income? The idea of this work would be to think simultaneously about the Coasean margin, the boundaries of the firm, which should be determined endogenously along with ownership. That means that firms would have different levels of vertical integration depending on which patrons own them. One interesting question: what happens to the level of vertical integration of banks if the government comes to own them?
We need to locate this idea in the literature and to find out if anyone else has done anything along these lines. So, if you know of anything remotely related, please send it along.
The Economics of Prehistory
| Dick Langlois |
Greg Dow at Simon Fraser is organizing a conference this summer on “Early Economic Developments.”
This conference is a meeting for scholars interested in economic aspects of prehistoric events. The organizers welcome proposals for papers on topics at the boundaries among economics, archaeology, and anthropology. Topics can include economic prehistory, the economics of human biological evolution; pre-industrial economic history; and the evolution of economic, social, and political institutions.
Looks interesting. Abstract deadline is April 15, which I guess isn’t tax day in Canada.
The Danish Mortgage System to the Rescue?
| Nicolai Foss |
As many O&M readers will remember, George Soros recommended a “Danish fix” for the US mortgage crisis. The American Enterprise Institute is sponsoring a whole-day event today on the related, if more cautious, topic, “Can Elements of the Danish Mortgage System Fix Mortgage Securitization?” Here is the wiki on the Danish mortgage system.
New Friedman Book
| Nicolai Foss |
K. Puttaswamaiah has edited Milton Friedman, Nobel Monetary Economist: A Review of his Theories and Policies (Isle Publishing Co., 2009). I only know the names of a few of the contributors, but I do recognize a certain Samuelson, who recently “remembered” Friedrich Hayek in a scandalously superficial and misleading note published in the pages of the Journal of Economic Organization and Behavior. Ones hopes that Friedman isn’t up for a similar treatment, but perhaps he is: One of the chapters in the volume is titled, “Milton Friedman: A Late and Overestimated Master of Sophistry.”
Management Innovation Conference
| Nicolai Foss |
There are reasons to think that changes in organization designs, administrative systems, and managerial technologies are important sources of firm-level value creation. It is also quite conceivable that changes that amount to innovations in organization design, etc. may give rise to sustained competitive advantages. Business history, popular management writing, and some academic papers offer examples, notably the introduction of the M-form, TQM, the Oticon spaghetti organization, the HRM practices of Lincoln Electric, and so on. And yet, very little systematic, research-based knowledge exists about such “management innovation.” The first conceptual and theoretical treatment of management innovation as a subject deserving of focused inquiry is Julian Birkinshaw and Michael Mol’s paper in the Academy of Management Review — which was published in 2008!
To further research on management innovation, the Center for Strategic Management and Globalization at the Copenhagen Business School is arranging a conference on management innovation later this year (3-4 September 2009). Keynote speeches will be delivered by Julian Birkinshaw, Ed Zajac and Richard Burton. Details on the conference homepage (version 1.0). Submit a paper!
Selection, Meritocracy, and Educational Quality
| Dick Langlois |
We have all heard complaints about the decline in the quality of students over, say, the second half of the twentieth century. The usual interpretation is that this has to do with decline in the quality of schools, especially high schools, or in the curriculum delivered in those schools. I always like to point out to people (that is, to non-economists) that much of the perceived decline is likely a matter of demographic and selection effects. Access to secondary and higher education expanded tremendously after World War II, which changed the underlying distribution of abilities of students finishing high school and attending college. (This is also relevant to discussions of the quality of American college students versus Europeans or others — the fraction of students going on to college is higher in the U. S. than elsewhere, so comparing just the mean is misleading.) Education also became more meritocratic after the War, in that colleges and universities began to screen students by academic ability rather by other characteristics (like income).
I just ran across an interesting new paper by Lutz Hendricks and Todd Schoellman that analyzes these issues in a thorough and illuminating way. Here is the abstract:
Student Abilities During the Expansion of U.S. Education, 1950-2000
Since 1950, U.S. educational attainment has increased substantially. While the median student in 1950 dropped out of high school, the median student today attends some college. In an environment with ability heterogeneity and positive sorting between ability and school tenure, the expansion of education implies a decrease in the average ability of students conditional on school attainment. Using a calibrated model of school choice under ability heterogeneity, we investigate the quantitative impact of rising attainment on ability and measured wages. Our findings suggest that the decline in average ability depressed wages conditional on schooling by 31-58 percentage points. We also find that the entire rise in the college wage premium since 1950 can be attributed to the rising mean ability of college graduates relative to high school graduates.
This has a number of significant implications. As the authors point out, average ability has declined at all levels of schooling. This should color our interpretation of the much-touted fact that real wages haven’t increased much since 1960. At the same time, the wage gap between low and high levels of educational attainment has increased over time — because improved sorting has selected people of higher ability into college and selected people of lower ability out of college.
Dutch Treat
| Peter Klein |
There’s only two things I hate in this world. People who are intolerant of other people’s cultures, and the Dutch. — Nigel Powers
Karel Davids’s new book, The Rise and Decline of Dutch Technological Leadership: Technology, Economy, and Culture in the Netherlands, 1350–1800 (Brill, 2008), provides an interesting look at knowledge flows within and between regions, an important idea in the modern literatures on economic geography and regional innovation. Writes EH.Net reviewer William TeBrake:
According to Davids, the northern Netherlands, the territory encompassed by the Dutch Republic, was the technological leader during much of the seventeenth and eighteenth centuries, before relinquishing that role to England by 1800, and in the process of explicating the rise and fall of Dutch technological leadership, he has called into question a number of commonplace assumptions found in the historiography of the period in question. . . .
One of the most interesting features of his study is the attention he pays to the truly remarkable concentration during the seventeenth and eighteenth centuries of literally hundreds of industries powered by windmills in the Zaan district, just across the IJ/harbor from Amsterdam, forcing the reader to reconsider how revolutionary the English Industrial Revolution really was. Further, there are several important areas in which he has significantly revised current understanding of the course of technology, economy, and society during the late-medieval and early-modern periods. . . . [For example], Davids makes clear that technological leadership in the Dutch Republic was much less tied to economic advancement than is usually assumed. Indeed, the Republic’s technological leadership began to peak only when the economy of the Dutch Republic already had begun to decline, during the late seventeenth century, and such leadership continued for another century thereafter, before giving way to England only after 1780. Finally, Davids makes a compelling case for locating the causes of technological leadership (and its decline) not only in market forces but also in institutional and cultural conditions, including the relative openness or secrecy of economic, cultural, and political life.
Oliver Hart: Hon Doc at CBS — and O&M Reader
| Nicolai Foss |
Every year in April the Copenhagen Business School confers honorary doctorates to prominent management theorists, finance scholars, economists, sociologists, etc. Oliver Williamson, James March, and Jay Barney have all received honorary doctorates. This year’s honorary doctors included no less than six scholars, of which one should be familiar to O&M readers, namely Professor Oliver Hart of Harvard University (Hart’s Harvard site is currently down — too many hits? ;-)). Hart is, of course, one of the authors of the seminal 1986 paper, “The Costs and Benefits of Ownership,” and the author of numerous other papers that build on this paper. His property-rights approach to the theory of the firm (really, the theory of the boundaries of the firm) is the dominant approach in economics.
Although I have met Hart on previous occasions, I didn’t expect him to recognize me. However, not only did he recognize me, he also greeted me with “You blog a lot!!” (I confess I didn’t disclose that it is Peter who blogs a lot ;-)). It turned out that Hart was well aware of O&M and apparently also likes it!
Another Attack on Outrageous Bonuses
| Mike Sykuta |
For the second time in a week, the Obama Administration attacked what it referred to as “outrageous” bonuses paid during a time of economic struggle for so many Americans. The announcement came as a reaction to Walmart’s announcement that the Arkansas-based retailer paid almost $1 billion in bonuses to its employees. Adding in profit-sharing, 401K contributions, and employee discounts, the total giveaway is closer to $2 billion, according to company officials.
The White House reacted strongly to such “corporate largess” less than a week after reports that bailout target AIG paid millions in bonuses to its employees. “At a time when so many Americans are losing their homes and unable to put food on their tables, it is unconscionable that a retailer that has benefited so much from consumers should be paying out such astronomical sums in bonuses to its employees. To make matters worse, we understand these bonuses were not even contractually obligated, as in the AIG case,” stated White House spokesman Robert Gibbs. “Obviously Walmart’s ‘Every Day Low Prices’ are not as low as they should be.” Congressional Democrats said they are considering legislation to tax Walmart employees’ bonus payments and to force the retailer to lower its prices further. (more…)
Railway Gauges and Path Dependency
| Dick Langlois |
You’ve all read the viral email asserting that the railroad gauge we have today — and, in some versions, the size of the space shuttle fuel tanks, which had to be transported by rail — is a direct result of the wheel gauge of Roman chariots. Not surprisingly, the real story is more complex, and many gauges coexisted (and to some extent continue to coexist) in the U.S. and around the world. My former colleague Doug Puffert tells this story in full detail in his new book, Tracks across Continents, which has just appeared from the University of Chicago Press. The book is a useful addition to the catalog of case studies of path-dependent technology.
The book came out of Doug’s thesis at Stanford, where he worked with Paul David and Brian Arthur. He was a visitor at UConn in the 1988-89 academic year. I can still remember his seminar presentations, which involved simulating the evolution of railways on a Macintosh of the era. (One thing you probably won’t learn in Doug’s official bio is that, before coming to UConn, he won a car on Wheel of Fortune. I always tell students about this when I teach the QWERTY story — a student of Paul David who really knew his letter frequencies.)
New AEA Journals
| Lasse Lien |
The AEA has recently introduced no less than four new journals. AEJ: Microeconomics, AEJ: Macroeconomics, AEJ: Applied Economics and AEJ: Economic Policy. I’m sure all four will all be great journals, but judging from the first issue, I think AEJ: Microeconomics will be my favorite. Here are two examples why:
Reputational Incentives for Restaurant Hygiene
Ginger Zhe Jin and Phillip Leslie
How can consumers be assured that firms will endeavor to provide good quality when quality is unobservable prior to purchase? We test the hypothesis that reputational incentives are effective at causing restaurants to maintain good hygiene quality. We find that chain affiliation provides reputational incentives and franchised units tend to free-ride on chain reputation. We also show that regional variation in the degree of repeat customers affects the strength of reputational incentives for good hygiene at both chain and nonchain restaurants. Despite these incentives, a policy intervention in the form of posted hygiene grade cards causes significant improvements in restaurant hygiene.
The Geography of Trade in Online Transactions: Evidence from eBay and MercadoLibre
Ali Hortaçsu, F. Asís Martínez-Jerez and Jason Douglas
We analyze geographic patterns of trade between individuals using transactions data from eBay and MercadoLibre, two large online auction sites. We find that distance continues to be an important deterrent to trade between geographically separated buyers and sellers, though to a lesser extent than has been observed in studies of non-Internet commerce between business counterparties. We also find a strong “home bias” for trading with counterparties located in the same city. Further analyses suggest that location-specific goods such as opera tickets, cultural factors, and the possibility of direct contract enforcement in case of breach may be the main reasons behind the same-city bias.
Sarasvathy Slides
| Peter Klein |
Saras Sarasvathy has kindly agreed to share the slides from her recent presentation on effectuation.
Thoughts on AIG
| Peter Klein |
Nothing has annoyed me more in the last 24 hours than the constant parade of angry, self-righteous, and ill-informed denunciations of AIG coming from Capitol Hill and the mainstream media. No one, of course, likes the thought of a failing, taxpayer-supported firm paying large bonuses to executives. But let’s talk some common sense here.
- The main lesson is that AIG should never, ever have been bailed out with taxpayer dollars. I said that at the beginning, and I stand by it even more today. AIG should have declared bankruptcy. Under bankruptcy there are well-established, orderly procedures for winding down a firm, distributing the remaining assets among the various legal claimants, and so on. Injecting taxpayer money without any serious thought about the implications of government subsidy and/or ownership for management and governance is just plain dumb. Naturally, that’s what Congress and the last President — people who know exactly zilch about what companies do and how they are run — did.
- Performance-based pay is a complicated subject. There are dozens, if not hundreds, of theoretical and empirical studies on the effects of performance-based pay on company performance, the benefits and costs of various compensation formulas, and the like. As Jensen and Murphy wrote back in 1990, “It’s Not How Much You Pay, But How.” Of course, the people screaming the loudest right now haven’t a clue about any of this. (more…)
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