Nobel 2010

Congratulations to Peter Diamond, Dale Mortensen, and Christopher Pissarides on being joint winners of the 2010 Nobel Prize in Economics.

I am stoked that Peter Diamond won this year – I was quietly rooting for him, especially after all this rubbish argument about whether he could be a Fed governor (of course he could be).  I avoided making him my pick for fear of jinxing him – so I happy 🙂 .  Although I have heard of Mortensen, I’ve never heard of Pissarides before – which is weird because it sounds like their best work was together!  I will make sure I educate myself this weekend.

Economist’s View (*), Paul Krugman, and Econlog have posts up.  Marginal Revolution’s coverage is excellent, with Tyler writing profiles on each of this year’s winners (Diamond, Mortenson, and Pissarides).

This year’s prize is very much a labour market prize – which is definitely topical given the seemingly unending elevated level of unemployment in the United States.  These authors have all done work describing why unemployment may not move back to its “natural rate” following a large shock – implying that we can’t necessarily expect a self-correcting process in the labour market EVEN IF we had fully flexible wages/prices.  It is an important lesson in the current environment – both in terms of trying to understand why unemployment can stay elevated, and IF there are any policies that can help the labour market in such a situation.

If the problem isn’t sticky wages, smashing unions (or even printing money) isn’t going to help us move out of a “bad” equilibrium in the labour market.  And even if you don’t care about the labour market – remember what the flip side is to higher equilibrium unemployment (in this type of situation), lower equilibrium output/income.

I imagine labour economists will be happy with this prize – I expect them to have a drink tonight to celebrate 😉

A novel solution to the student loan ‘problem’

In the 2005 election the Labour Government found itself in a very tight battle to retain power. In order to mobilise the student vote, Labour promised interest free student loans. The bribe assisted Labour in returning to Government for their third consecutive term.

At the time National called the interest free loan scheme “irresponsible”. Since coming to power in 2008, however, they have maintained the policy, presumably for similarly cynical political reasons as led to the policy being introduced in the first instance.

As a result of the policy, students have been encouraged to borrow more and pay back less. Debt has ballooned. There are obviously other factors to take into account, such as increasing student numbers during the economic downturn. Nonetheless, it is clear that when given the option of borrowing interest free money, those with student loans have limited incentive to pay anymore than the minimum from their loan, for which they might as well borrow the maximum.

What is National’s response to the perceived student loan problem? The introduction of a $50 administrative fee that student loan borrowers must pay annually. Note that National have also provided an incentive for students to voluntarily pay back their loans through a 10% discount on their loans.

I propose a rather simpler solution. Abolish the half measures currently in place and start charging interest on student loans again. Only then will the correct incentives be instilled.

Against the Paradox of toil

In a recent post Paul Krugman raises the “paradox of toil” to explain why tax cuts are silly and government spending is good during a recession:

So what’s the paradox of toil? If you cut taxes on labor income, this expands labor supply — which puts downward pressure on wages and leads to expectations of deflation, which increases the real interest rate, which leads to lower output and employment.

However, this is completely misleading.  Cutting a tax doesn’t really “shift the supply curve” (which is what expanding the labour supply means) in this way.  Lets have a little think about wages and what cutting the tax probably does.

Read more

Falling wage rates: Should we be concerned?

According to the Employers and Manufacturers Association’s 22% of job types are being done for a lower wage in 2009 then they were in 2008.  Furthermore, according to recent labour market data 1% of actual employees have received a pay cut in the past year.

At first this seems like a bad thing.  Falling wages mean falling labour income.  If other prices are unchanged such movement implies that people will be falling below the poverty line.  Furthermore, it implies greater levels of government spending – as income rebates are negatively related to income.

However, the pain the economy is experiencing is because of the recent recession, and the large shock to activity New Zealand (and the rest of the world) has experienced.  One of the reasons why we often urgently run to government stimulus during a recession is because wages and prices do not adjust to a change in the economic situation.

Specificially, nominal wages are said to be sticky.  If the nominal wage is stuck and we have a recesssion (which reduces the demand for labour) then we end up with a “surplus of labour” – or unemployment.  The less sticky wages are, the less unemployment the economy faces.

As a result, the fact that wage rates have been able to move downwards is a good thing – it suggests that the economy has been able to adjust and keep more people in work (and as a result, keep activity rolling at a higher level) then would have been the case if wage rates hadn’t been adjustable.

Chelsea’s transfer ban and the potential for player hold-up

FIFA have punished Chelsea by banning them from the signing new players in the next two transfer windows after they were found guilty of inducing Gael Kakuta, a France youth international, to breach his contract with Lens in 2007. The decision means that Chelsea will not be able to add to their squad until January 2011.

Fifa’s regulations on the status and transfer of players state in Article 17, paragraph 4: “It shall be presumed, unless established to the contrary, that any club signing a professional who has terminated his contract without just cause has induced that professional to commit a breach. The club shall be banned from registering any new players, either nationally or internationally, for two registration periods.”

How will this ban affect the incentives of current players registered with Chelsea? The club, being unable to sign new players, will be desperate to hold on to what they already have. The current players, knowing that the club cannot look elsewhere to replace them, will be in the driving seat when it comes to contract negotiation as they can effectively ‘hold-up’ the club to meet their demands.

The precedent for such bans being enforced is not strong, however, with Roma having their ban reduced to one summer transfer window (arguably the less important transfer window in a season) and Swiss club Sion currently appealing their two window ban.

Can free markets punish racists?

The Standard mentions the writings of Richard Epstein on racial discrimination and says:

A charitable reading of Epstein’s work is that he believes employment law stopping employers from putting “No Blacks or Jews” on their situations vacant ads is ineffective and counter-productive. Instead, we should allow employers to openly discriminate against people on the basis of race, age and sex because the free market will punish them for their irrational choices.

It’s a very interesting topic on which I’m no expert, so I shan’t wade into the debate on affirmative action. However, the latter sentence quoted just makes no sense from an economic perspective. Read more