Is the U.S. a less competitive environment?

There exists an open question: "Is the U.S. a less competitive environment than it was in the past?"

There are many ways of trying to answer this question.  I start by running two tests, three examinations to examine whether or not the U.S. is a less competitive environment.  The first is what percent of the total market cap (AMEX, NASDAQ, NYSE) is held by the largest 10 and 20 firms (click to enlarge).  The second is what percent of the total market cap of the top 100 firms are held by the largest 10 and 20 firms (click to enlarge).  Both show fairly clearly that inequality, in the top 100 (and across the market barring market size effects)  has reduced: any "capital" advantages held by the largest firms are smaller than they were historically.

Next I look at the 10-year change in the top-10 and top-20 firms.  That is, the chart below (after 1935) gives data on the number of new firms in the top 10 or top 20 (by market capitalization) that weren't in the top 10 or top 20 10 years ago.  Unlike the cross-sectional data on firm size, this shows a lowering of competitiveness starting around Q2 2001 and continuing for the next 13-14 years (click to enlarge).

The Middle-Class Comeback Is Under Way

Wall Street Journal op-ed "The Middle-Class Comeback Is Under Way" (February 12th, 2015) makes a painful error while trying to pin the world's woes on the Fed.

The Fed’s easy-money policies were also slamming the middle class by encouraging speculation in—and thus pushing up the price of—commodities like oil and food, which are an incidental expense for the rich and a real burden for everyone else.

Normally of the left, this sort of talk belongs in the economic dark ages (60's, 70's).  Markets are driven by supply and demand.  Speculators essentially never take delivery of their product: they purchase a contract for future delivery with the intent to sell later.  They can, of course, sell to other speculators, but eventually speculators must sell to an agent that will actually take delivery of oil.

Assume first there is no storage market.  Agents who take delivery inelastically supply oil, and demand determines price.  This price determines what the delivery agent is willing to pay, which pins down the price they are willing to buy from speculators.  Whatever heights the oil may reach during speculation is pinned down by what it will actually be worth when it arrives.  Speculation can't impact prices at the pump in this world.  (One might say: "but maybe they can sell at a higher price to the agent and he will pass it on to consumers!"  The question this raises is "if he could sell at a higher price to consumers, why wasn't he before?  They don't care about his costs, only their value and the price.")

There is little difference with a storage market.  With a storage market, speculators can actually temporarily bring up prices, but only at a loss to themselves, if they brought it up incorrectly.  Say speculators anticipate (or act like they anticipate) a demand shock: oil will be pricier, they think.  They purchase many shares and drive the price up because they think it will be valuable in the future.  This causes less oil to go on the market today, and the price at the pump to rise today, and less oil is consumed.

After this, there will be a sharp plunge in oil prices, as storage capacity is sold but demand hasn't gone up.  (That is, speculators could potentially shift supply down and then up.  If there is no fundamental demand shift, this will cause a rise, then a fall in prices, easily mappable to storage).

Inventories did not change enough, and prices were not sharply changing enough, to allow speculation to have any role in the rise in oil prices.  Instead according to Knittel and Pindyck (2013), it seems that (as economic theory would predict) speculation lead to the smoothing of oil supply over demand shocks, actually reducing the price volatility (but not changing the level: changing the level over the long run is highly unrealistic, for the reason discussed earlier).

While theory and empirics line up to tell a clear story (viz., speculators are not to blame for price rises the way you ever read in newspapers), February 12th's Wall Street Journal's op-ed page doesn't just seem to abandon coherence of multiple signals, but even a sensible signal to begin with.  For shame.

Theory: the Federal Reserve is a liberal "long con."  The idea is to drive conservatives to heights of irrationality, causing the party to twist itself in knots to blame the Fed for each new and imagined ill, bringing them to the point of making up easily refuted historical and current "facts."

Sticky Prices

From Rotemberg (2005) and reproduced in Uhlig (2010):

Menu costs are not significant.  Taylor prices and Calvo fairies are unrealistic.

Labor Unions

The death of labor unions or a rise in the efficiency of bargaining?  Thousands of work days lost due to work-stoppages or lockouts over time (click to enlarge).

On the Pulpit, Rabbis Earn More Than Christian Clergy

Normally, Corrections avoids old articles.  However, Jewish Daily Forward article "On the Pulpit, Rabbis Earn More Than Christian Clergy" (September 15th, 2010) wonders aloud why rabbis are paid, on average, more than christian clergy. It comes to no firm conclusions. Indeed, Corrections spent some time thinking on the curious problem: Catholics and Protestants appear to be paid between $25,000 and $40,000, while Reform and Conservative Rabbis appear to be paid between $137,000 and $147,000. A rather large gap.

Corrections came to the weak conclusion that the story was about opportunity cost and relative wealth status. However, the same publication came out, two weeks later, with the article "Rabbi Searches Are Tough, but Are They Illegal?" (September 29th, 2010). This article mentions nothing about pay, and merely describes the theological implications of a cartel of Rabbis:

The RA requires synagogues to enroll exclusively in its search process, filters the selection of candidates the congregations may interview, and prohibits candidates and congregations from finding each other directly. Any Conservative rabbi who seeks a pulpit outside the RA’s centralized process, and any congregation that interviews candidates from other movements, will be penalized.

It bespeaks either a deep ignorance of economics or a willing deception of their readers that the Forward did not connect the two. To note that Rabbis have a firm cartel with punitive powers on the one hand, then wonder why Rabbis are paid so much on the other is ludicrous.

Cartels artificially limit supply to raise prices. It utterly clear to Corrections that the Rabbinical Assembly is a cartel of Rabbis that artificially constricts supply and raises wages. The Rabbinical Assembly's cartel also possibly increases quality above what the market would demand to further drive up price, though there is no evidence for this either way (merely a likely possibility). A depiction of what the Rabbinical Assembly is practicing may be found graphically below (click to enlarge).

Recession Raises Poverty Rate to a 15-Year High

New York Times article "Recession Raises Poverty Rate to a 15-Year High" (September 16th, 2010) fails to acknowledge the poverty rate's intertemporally unstable nature. It compares poverty rates over time, an improper comparison due to the way poverty rates are calculated.

The share of residents in poverty climbed to 14.3 percent in 2009, the highest level recorded since 1994. The rise was steepest for children, with one in five affected, the bureau said.

One might think that individuals in the U.S. were only as well off as they were in 2004, when chained GDP/capita was approximately the same as it is this quarter. However, Corrections contends that we are actually even better than this. Below, find graphically depicted U.S. GDP over time in chained 2005 dollars (click to enlarge), and U.S. GDP per capita over time in chained 2005 dollars (click to enlarge). Note that chaining dollars is an attempt to introduce new products for comparison (otherwise, comparing cell phone prices from 1960 and today would not be well-defined).

The poverty rate from 1994 is measuring something completely different from the poverty rate in 2009. Poverty thresholds have changed multiple times, under a "sliding scale" approach. For example, in 1964, ~2.6% of U.S. households owned a color television. Circa 1994, 97% of U.S. households owned a color television. Beyond this, these televisions were not only cheaper, but were of better quality, programming, and durability.

Why is this relevant? Because increasing product quality is not properly measured, even with chained GDP. Below, we take minivans as an example.

In 2003, using Barry, Levinson and Pakes's instrumental method for demand estimation (also discussed in a previous post), Amil Petrin, in his phenomenal paper, "Quantifying the Benefits of New Products: The Case of the Minivan" (JPE 2002) estimates the value in dollars to consumers from the advent of the minivan by Chrysler in its first five years (1984-1988) as $2.8 billion in consumer surplus, and $2.9 billion in total surplus.

This surplus comes solely from an improvement in product quality that is largely unreflected in price due to monopolistic competition by competitors (GM and Ford introduced their own minivans in 1985). This sort of change will not be reflected by even chained GDP numbers. Because of increasing product differentiation (Petrin's "new goods" problem) and monopolistic competition (or competition), life is getting better than we're measuring with our best measures of product-chained GDP. Quality of life is higher.

Poverty indicators are not appropriate for "long" time spans because of innovation. Locally, we might think 2008 and 2009 are comparable. But in 1994, the internet had yet to be invented. Since then, as Austan Goolsbee and Peter Klenow estimate in "Valuing Consumer Products by the Time Spent Using Them: An Application to the Internet" (AER 2006) (gated) (ungated), the median individual gained $3000/year because of the advent (and widespread use) of the internet. The reason for this large gain is largely due to increased price competition and increased value of time. Since 1994, almost everyone in the United States is vastly better off than they were. (Another example might be how much individuals would have paid for a smart phone in 1994, given the millions that have them now and how "little" they paid for them relative for 1994 willingness-to-pay). This massive increase in consumer surplus generated from an increased value of time is unmeasured by GDP (underestimated) and poverty measures (overestimated). Use of these to compare long-run trends is ill-advised, especially when one has an ideological/Malthusian axe to grind.


Unfortunately, the notion that GDP growth generally underestimates utility gains is almost universally ignored in long-run intertemporal comparisons of utility.

F.D.A. Panel Urges Denial of Diet Drug

New York Times article "F.D.A. Panel Urges Denial of Diet Drug" (September 16th, 2010) discusses the FDA's rejection of a new diet pill and their standards without addressing the improper incentives that lead the FDA to cause the excess deaths of thousands of people a year, and cause excess pain to hundreds of thousands.

The advisers to the Food and Drug Administration voted 9 to 5 that the potential benefits of the drug, called lorcaserin and developed by Arena Pharmaceuticals, did not outweigh the risks.

Let's imagine, for simplicity, that there are two kinds of medical drugs. Drugs that save lives, and drugs that kill people.  When pharmaceutical companies test drugs, they gain a signal with error about whether or not that drug is a good drug or a bad drug. The U.S. Food and Drug Administration will then choose the cutoff. If we assume that error to be normally distributed (this is an innocuous assumption: the difference between the sample average and the true signal converges to a normal distribution by Lindeberg-Levy Central Limit Theorem).

The FDA must choose some threshold for a signal, below which they reject all drugs, and above which they accept.  They save lives by rejecting bad drugs and accepting good ones.  The FDA kills by rejecting good drugs or accepting bad bad drugs.    (Corrections is willing to discuss our precise "moral" phrasing, which we posit as accurate).

The FDA can't tell the difference between good drugs and bad drugs beyond the signal they receive. The point, therefore, is what the proper cutoff should be. Whether or not the FDA should be "very cautious" and kill by denial of more good drugs than prevention of bad, or "loose" and kill by allowing more bad drugs than good drugs. The optimal "life saving" diagram is depicted graphically below (click to enlarge).

Officials at the FDA are not in the business of saving lives, however. If a bad drug gets through their screens and kills, they lose their jobs. If a good drug never gets through, no one is ever penalized, as the consequences are not graphic. Below, we depict the FDA's scheme due to improper incentives (click to enlarge):

As we can see, because the FDA is risk-averse because of its suboptimal incentive scheme, it ends up, at the margin, killing many more individuals through its denial of live-saving drugs than it saves because of the marginal life saved by limiting a dangerous drug.

Individuals often state that among the first things the government should be doing after protection from coercion internationally through the military and internally through the justice system is setting up systems like the FDA.  What is not noted is that the FDA, because of poor incentives, kills many more individuals by withholding drugs than the private market would.  

A private system would be optimally incentivized because of the long-term, monopolistically competitive nature of its brand.  For those that think this wouldn't be a viable private enterprise, consider the 14 Californian kosher-certification services, or dozens of national certification services.  These companies have been successfully serving tiny portions of the United States population for decades.  Further, these companies have reason to avoid regulatory capture (unlike the FDA) because they are competing with other companies for consumer's trust (the FDA does not have competition).  

If anything, the FDA isn't among the first things government-loving individuals should push for--instead, an altruistic government-loving individual should abolish the FDA to save lives.  Any individual with a smidgeon of appreciation for the private market should be chomping at the bit to abolish the FDA and save lives, ease the pain of those denied efficient drugs, save the money of the poor who are denied price-reducing competition, and help improve the lives of individuals who might be benefitted by diet drugs endorsed by almost everyone but an intensely risk-averse FDA.  

Trading Away the Stimulus

New York Times OpEd "Trading Away the Stimulus" (September 9th, 2010) presents a foolish analysis of trade, completely neglecting the notion of opportunity cost.

Also essential is a border tax to counter foreign export rebates. In countries with value-added taxes, those levies are returned to producers when they export their goods — which allows them to lower their products’ prices in our market. In response, we can ensure fair competition in our home market by applying a tax equal to the rebate upon a product’s entry to the American market.

COnsumers in the US are made unambiguously worse off by a tax on foreign imports. We show this in a graph depicting the US market for some good both before and after a border tax meant to counter a Chinese export subsidy. An analysis of the market in the US requires that we consider the total supply of goods, both Chinese and U.S.-made. Then, the total supply in the US market is found by adding US supply and Chinese supply. It may be that, due to a Chinese government subsidy of s per unit, Chinese suppliers are able to produce every unit more cheaply than US suppliers. This means that even with the same technology, their supply curve could lie below that of US producers. We depict the equilibrium in such a market below (click here to enlarge).

If the US counteracts the Chinese subsidy of s dollars with an import tax of t=s dollars, then the Chinese supply becomes identical to US supply, and we have a new equilibrium. We depict this market below (click here to enlarge).



Now consumer surplus (the green shaded area) is smaller than before, while US producer surplus (the red shaded area) is larger. Nonetheless, because the equilibrium price is higher in this regime, and quantity is lower, we as a country are worse off than we were without the tax. The gray shaded area shows the total loss to the US from a tax that would benefit a few marginal (high cost) producers. This again gives our rule of thumb for politics: whenever a group is pushing for more taxes or regulation, it is because they and government officials they fund are "putting one over" on consumers, taking their surplus and dividing it between them.

Who Should Provide Anesthesia Care? (Redux)

Recently, Corrections wrote on the New York Times article "Who Should Provide Anesthesia Care?" (September 6th, 2010), a post that elicited widespread interest, enough to warrant further analysis.

Corrections would like to further note that even if anesthesiologists are harmed in the short run by the law, they're unlikely to be harmed in the long run. Our reasoning is that there are substitute specialties for individuals who practice anesthesiology. While currently-practicing anesthesiologists might not quit, if there are substitute professions (for the sake of an example we name surgery), then the relevant marginal individuals are new medical school students.

Observing declining wages in one profession, they opt into the other. This consequently reduces wages into that profession until the wages equalize (assuming they are perfect substitutes) or the difference is mitigated, not by immediate exiting of the profession but instead by a lack of new entrants.

Below, we graphically depict what we would expect to happen to anesthesiologist wages, surgeon wages, and nurse wages and stock before and after nurses are allowed to practice particulars of anesthesiology (click to enlarge). The idea is as follows: the supply of nurses in the short run is fixed, and therefore their wages immediately rise. As their wages rise, more nurses are trained until, as discussed previously, their wages go back to the reservation wage of the (presumably) vast reservoir of individuals who can become nurses.

For doctors, more newly-minted doctors will be surgeons, and fewer anesthesiologists. As the number of anesthesiologists drop, their wages begin to rise. As the number of new surgeons begins to rise, surgeon wages fall, eventually rising as wages converge back to equilibrium. (Note we operate off the assumption of a vast reservoir of positions substitutable to anesthesiologist positions. Otherwise, the long run equilibrium wage would be slightly lower than the original wage).

Who Should Provide Anesthesia Care?

New York Times article "Who Should Provide Anesthesia Care?" (September 6th, 2010) discusses the ability of a nurse to deliver anesthesia without supervision. It brings in the American Society of Anesthesiologists without properly discussing their stake in government regulation requiring anesthesiologists to supervise nurses.

The two studies — hotly disputed by the American Society of Anesthesiologists — essentially concluded that there is no significant difference in the quality of care when the anesthetic is delivered by a certified registered nurse anesthetist or by an anesthesiologist. The studies were paid for by the professional association for the nurses, a potential conflict of interest, but were conducted by researchers at respected organizations.

The Times notes the conflict of interest of nurses, but not of anesthesiologists.  As Corrections sees it, anesthesiologists have a readily identifiable conflict of interest, while it isn't immediately clear that nurses do, upon further inspection.

The American Society of Anesthesiologists has motivation to artificially constrict supply of anesthesiologists to raise their own wages.  It may do so by raising the quality of new anesthesiologists (more than patients would prefer), reducing the number of residents trained in anesthesiology, or encouraging a general suppression in the number of doctors through the American Medical Association. Their strategy is depicted graphically below (click to enlarge).  They price as monopolists, reducing quantity and increasing price.

One might say nurses have a similar motivation--if nurses can do more, demand for nurses rises, and nurses are paid more.  However, Corrections posits that unlike doctors, there is a vast reservoir of possible nurses; nurses are elastically supplied.  If their wage increased, new nurses would train and bring their wage back down.  Corrections depicts this possibility graphically below (click to enlarge).

Economic grounding gives Corrections reason to believe that while anesthesiologists have a conflict of interest influencing their argument, nurses do not.  This grounding offers a re-statement of a rule of thumb: when an organized group is pushing for governmental regulation, they're likely to be "pulling one over" on consumers.  

Some interesting economic side notes are that it would be possible for anesthesiologists wages to increase because of this (for the same reason that if a law that requiring them to build their own cars, or walk to work, was abolished, they'd have more free time to do the things they are paid a large amount for).  This counterintuitive result, that anesthesiologist wages could increase, while the wages of nurses would not is an interesting curiosity, but not likely given opposition by the American Society of Anesthesiologists.

Second, we note that either way, consumers should be better off (even were nurses and anesthesiologists were worse off).  The reason behind this is that they may prefer a different cost-quality combination for anesthesiology than they can get being constrained by government regulation--unconstrained maximization is always greater than or equal to constrained maximization.  

After Bargains of Recession, Air Fares Soar

New York Times article "After Bargains of Recession, Air Fares Soar" (September 4th, 2010) ignores the global phenomenon in air fares to concentrate on the recent.

The increase in fares is the result of a remarkable discipline shown by the airlines, which have generally not added more flights this year even as the economy has improved and demand has picked up. For the airlines, flying fewer and fuller planes has paid off.
Passengers are paying the price. For leisure travelers, domestic fares have increased by more than 20 percent in the second quarter compared with a year earlier, according to data compiled by the travel Web site Orbitz.

Steven Berry and Panle Jia examine the changes in air fare demand between 1999 and 2006, finding in their recent article "Tracing the Woes: An Empirical Analysis of the Airline Industry" in American Economic Journal: Microeconomics (ungated working paper) (gated published), that, quoting their abstract:

Compared with 1999, we find that, in 2006, air-travel demand was 8 percent more price sensitive, passengers displayed a stronger preference for nonstop flights, and changes in marginal cost significantly favored nonstop flights. Together with the expansion of low-cost carriers, they explain more than 80 percent of legacy carriers' variable profit reduction.

This analysis (identified with BLP assumptions) occurred on a span of time before the recession pushed down further prices. As its its wont as the flagship of the left, the New York Times then turns around as soon as prices rise after declining for a dozen years and uses weasel words to describe Airline executives: "Airline executives have since been preaching the need to reduce the number of seats they offer."

It rather seems a joke, considering airline companies costs have gone down, low-cost carriers have become more prevalent, tickets have become competitive due to the internet, nonstop tickets are more common. When efficiency rises, marginal costs go down, quantity rises, and profits fall, it's difficult for consumers not to be massively better off (consumers that aren't New York Times consumers should be neutral when it comes to competitive profits--the reason they're relevant here is because when efficiency rises, overall surplus increases--if profits haven't risen, we know consumers have received all of the increased surplus).

Below, Corrections graphs out a way to indicate three stylized facts from Berry and Jia: prices fall, elasticity of demand increases, supply increases, and quantity supplied increases (click to enlarge). This is not the only way to depict these facts, and these are not the only facts from the paper, but they are suggestive enough that a first pass analysis seems to completely identify the direction of consumer surplus (coloring from blue to red, it unambiguously increases).

U.S. Farmers Wary of Gaining From Russia's Woes

New York Times article "U.S. Farmers Wary of Gaining From Russia's Woes" (August 19th, 2010) offers a series of quotes from U.S. farmers that simply do not make sense when taken at face value. Specifically, wheat prices have gone up because Russia, a large producer of wheat, appears to have banned exports in the coming year. The New York Times quotes confused farmers that appear to suggest that they don't want to plant wheat, due to uncertainty about Russia's next moves:

Mr. Schroder said he feared that wheat prices were being driven by speculators, as was the case a few years ago, just before the recession, when the price soared and then crashed.

“What is this wheat market? I don’t have a clue, and I’m a professional wheat farmer,” he said. “There’s a complete lack of transparency.”

The problem the Times is pointing out is that farmers only know the current price, while their planting decisions should be based on prices in the future. They are subject to a large variability of even autoregressive prices. Corrections depicts such a movement graphically below, along with 95% error bands (click to enlarge).

A naive Times writer might instinctually think this represented a market failure. This is incorrect. Indeed, commodities futures markets, perennially despised by market-opposing individuals, are the market solution. However, the good news for farmers is that they do not have to bear any of the turbulence or non-transparency in the market at all. All they have to do to look at futures prices to plan their planting patterns. Why might this be?

Historical knowledge that appears to have been lost, even by some ideologically-motivated economists, is the very reason commodities markets, and commodities futures markets, were created. The Chicago Board of Trade (CBOT), to Correction's knowledge the oldest still-operating futures market, was created in 1848 to help farmers cope with fluctuating wheat prices.

The problem was as follows: farmers are often poor and unwilling to bear the risk of producing wheat and holding it until it is to be sold at some unknown price. What the Chicago Board of Trade did, and still does, is homogenize a good--in this case, sort wheat into bundles of the same quality, and allow a futures contract between speculators/investors, who are willing to bear the risk farmers don't want, and farmers, who are able to lock in the current price for their wheat. In this manner, all a farmer has to do is sell a futures contract in order to take all market-based uncertainty out of his decision to plant wheat--in selling the contract, he has, in effect, paid someone to bear the his risk. This allows him to plant the most valuable crop, even if its future prices are highly variable.

Therefore, farmers now only need to look at current futures prices--they should not care about the current price or what they think might happen to the price, only what the current futures price is. If we examine CBOT's wheat futures prices for July 2011, we see that the current futures price of corn is elevated (click to enlarge).

Farmers can lock in this price now. No risk necessary. It is important to note that a very large proportion of farmers do this every year, creating the massive derivative markets we have today. The only "risk" that a farmer would take is that he might miss out on higher prices now. Indeed, this is precisely the example the Times gives:

Another brake on any irrational exuberance over wheat will be farmers’ own suspicions, despite the incentives of higher prices.

Some think they are being played, and that the big run-up is partly, or largely, just market manipulation — like the increase in 2007 and 2008 that drove wheat prices more than twice as high as they are now before a gut-wrenching crash during the global recession.

'I hate to sound negative, but I’ve been burned so many dang times on wheat that I think I’m done,' said Olea McCall, who farms about 4,000 acres near the Kansas border, mostly in corn, wheat and sorghum. Mr. McCall said his attitude was not helped by missing out on the new rise in prices.

'I sold at 4, and three weeks later went to 6,' he said, referring to the price in dollars per bushel.

The Times continues:

“It took 20 years to sort the market out after [the similar 1972-73 Soviet Union crop failure],” Mr. Stulp said of the 1972-73 price bubble.

As much as the Times might write about "irrational" "bubbles" harming farmers, it supports the ridiculousness of the concept with its own quotes. Farmers need not fear any bubbles--they need only to lock in their high prices with futures contract and allow speculators to bear any "bubble" that might be present.

Academic Bankruptcy

New York Times OpEd "Academic Bankruptcy" (August 14th, 2010) makes the argument that colleges are spending too much, without really considering the economic landscape for such institutions.

Rather than learning to live within their means, Columbia University, where I teach, and New York University are engaged in a fierce competition to expand as widely and quickly as possible.

The article continues, mustering projections for future tuition without considering the forces at work:

With unemployment soaring, higher education has never been more important to society or more widely desired. But the collapse of our public education system and the skyrocketing cost of private education threaten to make college unaffordable for millions of young people. If recent trends continue, four years at a top-tier school will cost $330,000 in 2020, $525,000 in 2028 and $785,000 in 2035.

The "paying customers" of a college are its students. As the figures below make clear, college enrollment has continued to increase over time (click to enlarge 1, 2).

Given the acknowledged increase in the price of tuition, and the increase in the amount of college degrees purchased, we can conclude with certainty that demand for education has been increasing over time, as supply-and-demand are partially identified.

In addition, a high tuition price does not make education "unaffordable." When students see that the returns to skill are high (that education is valuable), they can borrow against their future earnings until it is not worthwhile to do so. What determines the price of education? In a human capital model (rather than a signaling model), the price of education will be equal to the value of the increase in productivity it provides students. This increase is determined largely by faculty quality. While talented faculty are scarce, but provide students with a high increase in productivity, the price of tuition will remain high.

Nothing in the article ties the price of education with increases in the productivity of students. If students see that they are not learning anything, and so realize that their future wages will not increase enough to justify tuition, they will not attend college. An aggregation of such decisions will decrease the demand for education and cause tuition to fall.

Sorry, Kid: No License, No Lemonade

New York Times article "Sorry, Kid: No License, No Lemonade" (August 6th, 2010) offers a concise display of the deeper, recurrent misunderstanding of economics the Times represents. The article discusses a child's lemonade stand shut down by County health inspectors.

Julie Murphy, a 7-year-old Oregonian, set up a lemonade stand on July 29 at an art fair in northeast Portland. County health inspectors shut her down, however, telling Julie and her mother, Maria Fife, that they needed a temporary restaurant license, which costs $120. The penalty for selling food without a permit, they warned, was $500.

Discussing this degree of regulation, the Times only gives an open-ended, if suggestive, quote.

The Health Department employees were doing their jobs, he said, and “there’s a reason those laws exist,” but “a 7-year-old selling lemonade isn’t the same as a grown-up selling burritos out of a cart.” As for the health inspectors, Mr. Cogen said he had “engaged them in a conversation” about professional discretion.

There are indeed reasons that such regulations exist, but they aren't the safety of the public. Health regulations that involve heavy lump-sum taxation are inevitably supported and enhanced, if not created, by business interests, rather than consumers. The New York Times, as a liberal flagship, offers the standard idea: organized government protects non-organized consumers from organized business interests. The Stiglerian economic analysis offers instead: organized government and organized business combine to fleece non-organized consumers through the destruction of competitive forces. Indeed, even regulatory agencies that may have been created in response to market failures are subject to "regulatory capture," eventually corrupting the very organizations intended to "police" them.

The manner in which such lump-sum regulations impact a market with quantity is displayed graphically below (click to enlarge). With fixed-price heterogeneity and increasing marginal cost of production. As we can see, the quantity provided is reduced and price is increased. Both consumers and businesses are hurt, as their surplus is reduced.



This is not necessarily the end of the story. Product quality may be endogenous, chosen along a spectrum of production price-quality combinations. Instead of a supply-and-demand analysis, we might look at quality being distorted rather than quantity, with similar utility impact. The distortion is the focus, rather than its dimension.

We might add that the "professional discretion" Mr. Cogen refers to is the source of the sort of corruption Corrections is referring to. To extend a quote of Gary Becker's to one of our own, discretionary power is the most corruptive sort of government power.

Corrections thinks the lesson to be learned is that, as a rule, whatever power created by a government for whatever reason will inevitably be used to destroy competition and harm consumers in the long run. The only stable source of benefit to consumers is through competition, not government regulation, which inevitably destroys competition.

A Sin and a Shame

New York Times editorial "A Sin and a Shame" (July 30th, 2010) offers another installation of Bob Herbert painfully writing about concepts he does not understand, and quoting figures that do not support his point.

The recession officially started in December 2007. From the fourth quarter of 2007 to the fourth quarter of 2009, real aggregate output in the U.S., as measured by the gross domestic product, fell by about 2.5 percent. But employers cut their payrolls by 6 percent.

Herbert then suggests that these figures mean that "cruel, irresponsible, shortsighted policy" has taken hold in American corporations. However, using a simple bread-and-butter real business cycle model involving investment-specific technological change, solved with Matlab program Dynare (this is a DSGE model, or Dynamic Stochastic General Equilibrium Model), we can show the relative movements can the result of far-sighted optimizing behavior, rather than the result of capital in the hands of individuals destined for the Fourth Circle of Dante's Inferno for their avarice, as Herbert perpetually suggests in various columns.

Below, we plot the impulse-response functions of one such model, in which firms maximize profits from a Cobb-Douglas production function, households have log-preferences, capital depreciates, produced goods are either invested or consumed, and both technology and quality of investment good are independent stochastic first-order autoregressive processes. (For the interested, this flavor of model is prototypically described in "The Role of Investment-Specific Technological Change in the Business Cycle", published in the European Economic Review (2001) by Greenwood, Hercowitz and Krusell). We examine what happens when we have a negative investment quality shock. The impulse-response functions to a are plotted below (click to enlarge):

How should we interpret these figures? First, for those unfamiliar, impulse-response functions plot the response of all other related variables to an exogenous shock over time. Here, we plot the reactions of all other variables in percentage points of their own standard deviations to a one-standard deviation negative shock to investment good quality. The "direction" of reaction can be seen by comparing the black line, which is the reaction of a variable to our shock, to the red line, which is a "baseline." We forgo concern about the size of the shocks and focus on the qualitative reactions of each variable.

Specifically, we see that when investment in durable goods this period gives less (lower quality investment goods), we see a decline in both production and labor (increasing back to steady state (or stable growth path) over time), while seeing an increase in productivity, precisely the sort of reaction Herbert pretends is irrational. This is a product not of shortsighted policy, but of perfect foresight (though not perfect information).

Indeed, one doesn't need to examine even simple real business cycle models to explain why we should see productivity rise, labor fall, and production fall by less than labor in the short run. In the United States, labor can be treated as a consumable good. Labor is more flexible than durable goods. In a simple analysis, we can hold capital as fixed and labor is flexible in the short run, while in the long run, both are flexible.

We might imagine our aggregate production function is Cobb-Douglas, using labor and capital, depicted graphically below (click to enlarge). We also denote a dark black line, indicating a schedule for production given fixed capital. Therefore, we might consider any point on this graph viable combinations for inputs and corresponding output in the long run, while considering only the dark black line viable in the short run (were we to have that specific level of capital, .5 in this case).

We could simply graph the dark black line in two dimensions (click to enlarge). This represents production along a fixed capital stock, as we would see in the short run:

On this graph, we can see our whole story: output, labor supply, and productivity. Marginal labor productivity, which may be defined as $$\Delta$$output/$$\Delta$$labor, is the slope of any point on this line. Average productivity is simply the ratio of output to labor. We can see that any time we shift downward along the supply schedule, labor will, on average, be more productive. Note that this is not true in the long run, because capital will shift as well (this Cobb-Douglas is constant returns to scale in the long run, decreasing returns to scale in the short run). We can display this on the same graph, also writing out productivity below two sample points (click to enlarge):

All this is to say that if we make less, our average productivity increases when we are in a regime with decreasing marginal returns to scale. It appears Bob Herbert's real complaint is about decreasing marginal returns, or his ignorance of economics, rather than "corporate greed" or "shortsightedness."

As a last point, Crypto-Marxists like Herbert appear to adopt the poor understanding of capital and labor that Marx shared with Malthus. The belief that capital (land, in Malthus's case) is fixed, and labor is elastic (people have more children and "soak up" any wage higher than subsistence living).

Productivity tells the story. Increases in the productivity of American workers are supposed to go hand in hand with improvements in their standard of living. That’s how capitalism is supposed to work. That’s how the economic pie expands, and we’re all supposed to have a fair share of that expansion.

Corporations have now said the hell with that.

This is incorrect. If corporations could always just say "to hell with that" and not pay workers as much, they would have done so at some point in the past 150 years. Over the last 150 years, the return on invested capital has remained unchanged, while real wages have continued to rise. The mistake that Marx, Malthus and Herbert make is to believe that capital is fixed (inelastically supplied) while labor is flexible (elastic), and so capital gains all benefits from a shift in productivity.

To be clear, the mistaken idea is as follows. Society has a productivity gain. There is a large excess pool of labor that will compete away any higher wages, while capital remains fixed. Therefore, because labor competes all gains away, capital gets all the benefits of a productivity gain.

The reason this idea is mistaken is that there is a large excess pool of possible capital--its primary "input" is simply foregone consumption, and that can be supplied rather easily, if the real interest rate is high enough. Real wages have gone up over time, while real return on capital has not.

The opposite is true--capital is elastic, while labor is relatively inelastic, explaining why real wages have been the claimant on all increases in productivity over the last 150 years.

The Cheap Cost of Cheating the Lowest Paid

New York Times editorial "The Cheap Cost of Cheating the Lowest Paid" (June 25th, 2010) makes a series of economic missteps in its analysis and diagnosis of wage injustice against immigrant workers.

Academic studies estimate that unscrupulous employers in New York City keep an extra billion dollars a year by defying New York State’s weak labor law and cheating timorous and ill-informed immigrant workers.

That doesn't mean they profited from it. Profit equals revenue minus cost. In a competitive market (which back-alley shops certainly are) producers make no profit--they compete it away. Even though employers may have saved a billion dollars in labor costs by cheating the law, more enforcement of the law would almost certainly just lead these employers to hire fewer immigrants. Most would agree that being paid $6 an hour leaves a worker better off than he would be without a job. If this many illegal workers are to be hired at all, they will be paid a low wage rate. Whether the net benefit to immigrants of an artificially higher wage is positive of negative remains an empirical question.

The article displays a general misunderstanding of what's good for immigrants. New immigrants will be attracted to a city in which they can find work, not to a city that already has a surplus of labor. So, if enforced, New York laws are not immigrant-friendly. A city without labor limits will attract the most new labor.

A smart bill to fight smoking

Los Angeles Times editorial "A smart bill to fight smoking" (June 22nd, 2010) offers another endorsement of another paternalistic bill that would increase deadweight loss in society. Specifically, it advocates the coverage of anti-smoking programs. It offers two ludicrous claims.

Some people might object that smokers choose their unhealthful habit. But since insurance covers the cancer and emphysema that result from cigarette use, it makes sense to help smokers when they decide to quit.

We should note that the above statement, while sounding innocuous, has an unintended consequence: it makes becoming addicted less costly. Corrections conjectures some subset of people who do not smoke, or try drugs such as heroin, because they fear the consequences of becoming addicted. If cigarettes were no longer addictive, then the cost of becoming addicted would be lifted, and we would observe more smoking from this crowd. Whether or not it is larger than the number of people who would stop smoking is an empirical question. Obviously, an insurance program serves the same purpose.

We can discuss whether or not more people being able to smoke would be a good thing--Corrections posits that if it were, then competitive insurance companies or cigarette companies would be willing to set such a thing up, and therefore our system is clearly less efficient, but the point is tangential.

We should further add another point the Times offers that is empirically contentious.

Less smoking means less chance of catastrophic illnesses that are much more expensive to cover; lower rates of disabilities that taxpayers end up footing the bill for; less secondhand smoke; and even less litter.

The first claim, that less smoking means lower insurance is unclear. Indeed, for the people who would quit because of the lower premiums, we should have seen them already quit, if insurance companies can discriminate on smoking behavior--this would therefore make the statement of the Times patently untrue. People who smoke also die younger and more quickly, and the costs/benefits to society appear to be a wash (for example, they pay to social security but do not collect as much as were they a nonsmoker).

We should finally add that such coverage is not free. Individuals will have to pay for it. The Times appears to pretend that by requiring insurance companies to pay for these new treatments, they are somehow "free" to consumers. Prices will rise, and there is no such thing as a free lunch.

Corrections recognizes that the set of benevolent or honest paternalists is zero--if Rothbard noted that government was "a band of thieves writ large," we would be benefitted by noting that paternalists are, to coin a phrase, "slavemasters with a smile." In articles such as this, the Times earns its paternalist credentials.

We Might Decide to Fly

New York Times editorial "We Might Decide to Fly" (June 3rd, 2010) suggests that government regulation may improve the flying experience for consumers. Perhaps, but consumer surplus will fall.

The Obama administration’s new consumer protections for beleaguered airline passengers — including higher compensation for travelers bumped from oversold flights and prominent disclosure of all service fees — are much needed.

The airline industry is widely considered competitive, so airlines do not make profit, but instead charge each consumer the cost of providing his seat on the airlplane. If the government increases this cost, by requiring them to invest resources into making sure fewer customers are bumped from flights, for example, then the airlines will have no choice but to pass this cost increase directly to consumers. As shown in the graph below, total consumer surplus--the sum of benefit that all consumers receive from flying, will decrease from the entire shaded triangle to the yellow shaded triangle.

Even if we allow for the argument that airlines have some monopoly power, regulation may harm consumers more than it helps them. This is because monopolies also pass some portion of any cost increase to consumers. The amount of this increase depends on the response of demand to price changes. Again, as depicted below, consumer surplus will decrease. This will overwhelm the gains in service to consumers, due to the mechanics of monopoly profit maximization.

The propaganda campaign against Obama's tougher fuel economy rules

Los Angeles Times editorial "The propaganda campaign against Obama's tougher fuel economy rules" (May 26th, 2010) offers a diatribe in favor of higher fuel economy for cars. Within its arguments, it offers a pecuniary externality:

To recap the benefits of fuel economy: Consumers win by saving money on gas; public health improves because cars emit fewer toxic pollutants; the nation becomes less reliant on foreign oil; and greenhouse gas emissions drop.

The first is false. If the government imposes higher fuel economy, Corrections suggests that it is a fact of competition that they will lose more money/utility on their more expensive cars than they will on fuel economy. If a car company could produce cars that has savings that consumers want, then they could make money off it. The fact that car companies are not making it now indicates that the "saving money" argument is fallacious--were it worth it for consumers, the profit motive is there, and it would already be being done.

What ever became of welfare moms?

Chicago Tribune article "What ever became of welfare moms?" (May 17th, 2010) offers the suggestion that no-one believes that potential jobs exist for individuals who are looking for them. Corrections isn't so sure.

No one sane assumes that today's unemployed are loafing, that jobs are 'out there' for them or that getting married would solve their problems.

The suggestion is that somehow, all individuals who are not unemployed due to minimum wage simply cannot get a job because there are no jobs out there for them. This idea is displayed graphically below (click to enlarge). The figure isn't copacetic with the empirical reality as Corrections sees it. Here, an increase in labor supply will only decrease wages while creating no extra jobs.

However, they still appear to be "voluntarily" unemployed, insofar as there are jobs they are unwilling to take. Let us examine job openings, layoffs, and the unemployment rate from the Job Openings and Labor Turnover Survey (for job openings and layoffs) and the Current Population Survey (unemployment rate). displayed graphically below (click to enlarge). All figures are seasonally unadjusted and relate to private job openings and layoffs.

As we can see from the figure, there is no giant increase in the availability of Summer jobs, and little discernible seasonal variation, save a spike in January layoffs. From this we might conclude the entire job market was being determined by demand-side economics--when firms want to hire, unrelated to the desire of individuals to work.

However, if we examine the teenage job market, we might expect a large supply shift during the Summer, because the cost of working has declined (they are no longer in school). If this is the case, and our first figure holds for teens, teen wages should go down but no more teens should work. However, this is not the case. We can see this through replication (note: our axes are different) of Figure 4 in Casey Mulligan's 2010 NBER Working Paper Simple Analytics and Empirics of the Government Spending Multiplier and other "Keynesian" Paradoxes (click to enlarge). The figure displays the total deviation in teen employment on yearly trend (in thousands). It clearly indicates that this Summer appears to be similar to past Summers in terms of employment--in spite of a supposedly inelastic labor demand. This suggests that labor demand is not in fact inelastic--it is elastic enough to support a large (million strong) (Summer) increase in labor supply.

As we see, teen employment in the two "crisis" Summers was almost exactly the same as it was from 2003-2007. That labor markets were this flexible for teens even while seasonally unadjusted job openings were not spiking dramatically. For Corrections point that labor demand is not inelastic to hold, the above is all that is required--earnings are not necessary (though preliminary examination of quarterly data indicates support for our claim). It should be quite clear that the increase in jobs is largely due to supply-side factors of workers rather than demand-side factors of firms.

However, in the interest of further making our point, we display "monthly" deviations from December-to-December trends of weekly earnings for our three relevant periods--2003 to 2007, 2008, and 2009 (click to enlarge). We note this is a bit artificial, as we use quarterly data with monthly trends. The general shape shouldn't change much, and it illustrates our point well.



There does not appear to be a consistent summerly (3Q) effect. No significant downward shift for the average of 2003-2007 and 2009, negative for 2008. If anything, this further indicates to Corrections that labor demand is relatively elastic, rather than inelastic. Were it inelastic, we would expect a Summer wage effect consistent across 2008 and 2009, due to the large increase in labor supply.

Corrections concludes that there do appear to be jobs out there for those who are willing to supply them--the labor demand of firms appears to be elastic enough to cause a positive employed individuals.