jamesz

Why does the realism of assumptions matter?

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From Rogeberg on rational addiction:

Theories of rational addiction make assumptions concerning the choice rule, preferences and beliefs of people, and derive the resulting consumption plans. … Some economists claim support from the famous as-if methodology of Friedman 1953 … which explicitly identifies prediction as the only aim of “positive economics.”…[Such] explanations may prove excellent predictive devices as long as the empirical regularities they describe remain stable… [but] this defense comes at a cost: Since someone acting as-if he was rationally solving some decision problem would not behave optimally unless this was the actual decision problem he faced, assumptions matter when we turn to welfare analysis. Nor can as-if theories claim to explain in the sense of describing the mechanism or causal process underlying a phenomena, their aim is just to relate observable quantities in the simplest, most empirically successful way. To use a metaphor… an as-if theory of a car would be of no help to a mechanic if the car broke down.

The reference point for optimality depends upon the model you’re using. If it’s not a good causal explanation of the problem then it cannot tell you about the optimality of the agent’s decision.

It’s just another reminder that we need to be really careful when moving into the realm of welfare economics because it implies numerous additional assumptions that we don’t need elsewhere.

jamesz

Cost of legislation

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A paper out of Otago university finds:

Every time Parliament passes a new act it costs the country an average of $3.5 million, according to a new study. And… even just a piece of regulation costs around $530,000…
Researchers in Wellington and Otago came up with the figure by analysing the number of acts and regulations passed between 1999 and 2010, and looking at the costs of running Parliament and getting policy advice.
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The price range for a new act was from $2 million at the low end, up to $6.2 million.
“This is because the size of new legislation varies greatly, from just a few pages to hundreds. So when considering both acts and regulations, we calculated the average cost per page of legislation at $45,000.”

They included the cost of Parliamentary time and the cost of the policy analysts’ time.

jamesz

Why economics helps everyone

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From the philosopher Jon Elster in a trenchant critique of Gary Becker’s approach to everything:

If Gary Becker didn’t exist, we would have to invent someone like him. For close to four decades he has been taking economic theory beyond its usual domain of applications, almost single-handedly creating the economics of discrimination, human capital theory, the economics of crime and punishment, and the economic theory of the family.
…
Although I disagree sharply with much of it, it has raised the level of discussion enormously. Before Becker, most explanations of addiction did not involve choice at all, much less rational choice. By arguing that addiction is a form of rational behavior, Becker offers other scholars the choice between agreeing with him or trying to identify exactly where he goes wrong. Whatever option we take (I’m going to take the second), our understanding of addiction will be sharpened and focused.

Even if you don’t like the argument, the conclusions, or the framework, we can all agree that using a consistent analytical framework is a good thing!

Matt Nolan

April 12 Aussie unemployment rate drops: What about NZ migration?

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There seem to be concerns about the number of New Zealanders permanently heading over to Australia.  In the year to March 53,237 people permanently left NZ for Aussie, up 12,331 from March 2011.  To put this in perspective Australia accounted for 61% of all permanent departures – and annual departures to other countries were actually down 1,106 from a year earlier.  This is all via good old Stats NZ.

To me this is all much of a muchness – however one thing I do know is that the level of the Australian unemployment rate, and the gap between their UR and NZ’s has a strong impact on the level of permanent departures over there … unsuprisingly.

As a result, the drop in the Australian unemployment rate to 4.9% in April should be seen as a signal that we will see departures stay high for a while yet.  We can easily see this by just comparing the unemployment rate figures (which you can grab simultaneously off the OECD site):

In this environment, people are moving overseas to find work.  It’s not surprising, and in of itself doesn’t lead to any policy conclusions – we need to add a few more pieces before we can really start to say anything.  So this is just a little thing to keep in mind.

jamesz

Bad business decisions by CEO Key

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Asset sales are in the papers again today:

If New Zealand’s Government were a business, it would have no case to sell stakes in its energy generation firms… Sustento director and economist Raf Manji said. It was admirable for the Government to lower debt, but the numbers around selling stakes in energy firms to do so did not add up, he said.
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No more important public good existed than energy, as it was essential to people and businesses, so it was dangerous to raise the firm’s focus on profits.

Much like Raf, I’m not ideologically opposed to the government selling assets. However, we clearly disagree about the rationale for selling energy assets. He makes two points: it’s a bad business decisions, and energy is a public good so public provision is required.

On the first point, economists have long argued that the country is not a large company and shouldn’t be treated as such. If we wanted governments to be highly leveraged investors to return a profit then they should probably stop taxing high productivity people and giving the money to people with lower productivity. I’d ditch the welfare system, too: a loss-making business if ever I saw one! Obviously the government’s not an investor trying to turn a profit so let’s focus on what can do to improve social welfare and equity. Raf’s second argument seems to implicitly acknowledge that by appealing to the government’s role in providing public goods.

The public goods argument is far stronger because it is widely acknowledged that public goods are under-provided by the public sector. The reason is to be found in the two defining characteristics of public goods:

  • One person’s use doesn’t decrease the quantity available for everyone else. For instance, however much I enjoy clean air in New Zealand, there is no less for you.
  • You can’t stop people from using it, so property rights over it become fairly meaningless. You can’t own clean air here and sell it, so there’s no private incentive to generate it. That’s why we need environmental regulations to deal with pollution.

What’s striking about these two characteristics of public goods is that energy fits neither of them! When I use energy, you can’t use that energy. When I don’t pay my power bill the power company can cut me off. So energy isn’t a public good and the arguments for public provision that apply to public goods don’t apply here.

Update: Matt and I have written about asset sales previously, as have Paul Walker and Seamus Hogan.

Matt Nolan

On supermarket petrol vouchers

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Yesterday I received a phone call asking why New Zealand supermarkets offer petrol vouchers with purchases, and whether consumers are really paying for it all anyway!

(Update:  I’ve been informed that they were actually discussing this on Close Up yesterday, and they were trying to say that for some reason people pay “more” – because people who don’t use the vouchers are cross-subsidising people who do use the vouchers.  This sort of issue fits into point 2 below – and I’m not convinced that we are seeing a welfare loss due to this, in fact I think even this view would lead to better outcomes for consumers … ignoring point 3 below which strongly shows why this is likely to be the case.)

I decided the best way to answer the question was to try and understand the reasons why supermarkets and petrol companies would set up an agreement where these vouchers are offered and there is some (unknown) transfer between supermarkets and petrol companies.

Now remember, for the supermarket and petrol companies to come to an arrangement, it must be in both of their interests.  They must decide that offering a voucher to consumers who shop at the supermarket increases the sum of total profit in both markets – if that occurs, then they can negotiate over any “surplus” gained when they set up the contract.

At first brush we might say that it must somehow make consumers worse off, because profits are higher then they were without the supermarket and petrol company coming to that arrangement.  But if we think a little deeper, we are going to find out this is not the case 😉

Off the top of my head I can pick out three reasons why this agreement exists:

  1. Assume a monopoly supermarket and petrol station to start with.  The first reason may be weird behaviour by consumers.  For some reason, the fact the voucher is offered gets them to spend more at supermarkets and petrol stations overall.  This is the least compelling explanation in my opinion – but it is the only one that could create the result of consumers genuinely being worse off.
  2. Price discrimination:  Stick with our monopolies.  Lets remember that some people drive, and some don’t.  People who don’t drive tend to live in big cities, and are often environmentally conscious – both factors correlated with higher incomes, and more inelastic demand for supermarket goods.  This tell us that, by offering petrol vouchers our monopoly supermarket can then increase prices – thereby imposing a form of implicit price discrimination.  And of course, price discrimination shouldn’t be seen as a bad thing!
  3. A prisoner’s dilemma:  Now our assumption of a monopoly has been ridiculous – we actually have a duopoly in the supermarket industry in New Zealand, and even greater competition in the fuel industry.  This gives us another way to justify the use of vouchers – competition.  Take our two supermarkets – if neither supermarket agreed set up a deal with a petrol station, they would both sit there making tidy profits.  However, if one of them offers vouchers, a lot of customers would go to that supermarket – making the supermarket offering the vouchers heaps better off, and the other one much worse off.  If both offer vouchers, then consumers once again don’t really care where they go – so the supermarket does better than in the case when their competitor offers vouchers and they don’t, but worse than in the case when no-one offers vouchers (due to the cost of the voucher).  In this case, it is in the supermarket’s interest to enter the scheme – as they make a higher profit by offering vouchers no matter what the choice of the other supermarket is.  But the existence of the scheme makes consumers undeniably better off!

Overall, this suggests to me that the existence of the petrol vouchers is adding to consumers welfare – and we should encourage any sort of scheme that increases competition in the marketplace 🙂