Objective of the blog

The main aim of this blog is to discuss areas where government involvement makes sense. While we agree that the free and unfettered market often provides the most effective way of allocating resources, we also believe that thinking the free market can solve every economic problem is naive and even dangerous.

With our writing we wish to impress upon you the important role that the government can play in the economy. The most obvious role of government is to circumvent market failures, which are usually derived from externalities or excessive market power. Beyond this, the government has a structural role. Government regulation and investment can be used to change the structure of the game that firms compete in, to the detriment or the benefit of society.

We also believe that government failure exists. Governments may have less information then other market players, and so might make the wrong choice. Furthermore, governments may come under the control of interest groups or ideology, and may no longer follow the objective of maximizing the true social welfare function. While we may mention this type of failure, it will not be our primary focus.

It is also important to note that we do not necessarily support the current scope and role of government. We are merely stating how certain government choices could improve social outcomes. The set of policies we would support is likely to be very different then those established under any nations government.

The week in numbers

  • The NZ$ pushed through US$0.79, but couldn’t quite reach the US$0.80 mark
  • CPI inflation came in at 1.0% for the June quarter, taking annual inflation to 2.0%.
  • 11% annual growth in short-term departures from New Zealand in June. This took departures to a record 208,309
  • 4% annual growth in short-term arrivals to New Zealand indicate a lack of price responsiveness from tourists. However, they are spending a lot less once they get here.
  • There was a net migrant inflow of 590 (seasonally adjusted) in June. The year-ended net migrant inflow continued to fall, and is now at 10,078
  • Electronic Card payments were up 7.2% on a year earlier in June. This implies that retail sales will maintain the gains experienced in recent months.

The recent strength in CPI, QVNZ house price and retail sales figures will make the RBNZ feel that it has to lift rates again. It is important to note that REINZ house sales and price figures looked relatively weak.

While the market is currently pricing in a 60% chance of a rate rise in July, I think they should hold. The QES and HLFS are due out between now and September, and will give us a strong indication of whether the labour market is beginning to ease. Furthermore, two more months of house sales data could be invaluable, with the housing market at a possible tipping point.

The smoking debate redux

For the first substantive post on this blog I’ve gone with a topic
that’s an oldie (for NZers), but a goodie: banning smoking in public
places. Britain’s currently going through the growing pains of a
conversion to smoke-free public places and economist Tim Harford
thinks that the economics of the change just don’t stack up. He pulls
out the well-worn argument that if people wanted non-smoking pubs then
the market would have provided them. Well, game theory tells us that
the answer to this riddle is really quite straightforward.

Smokers want to be able to relax in a pub at night with a beer in one
hand and a cigarette in the other, surrounded by friends. Non-smokers
want exactly the same but minus the cigarette. This is a clear example
of a co-ordination game between smokers and non-smokers. Both are
better off when they go to the same pub whether that be a smoking or a
non-smoking pub. No non-smoker wants to alienate his smoking mates by
heading off to a separate pub and the same is likely true for
smokers. The fact that we’re currently co-ordinated on an equilibrium
where people go to smoking pubs rather than non-smoking pubs is an
artifact of the historical norm in favour of smoking. Thus, the
lack of non-smoking pubs shows that nobody individually has an
incentive to deviate. What it doesn’t show is that this outcome is
best or even that it is preferred by everybody.

This is where the government comes in: they must decide whether it
is welfare improving to pass laws that re-organise society around a
non-smoking norm. Certainly the non-smokers will be better off, but
what about the smokers? They may well be worse off, but not by
as much as they would like you to think.

Plenty of research on time inconsistency has shown that smokers
themselves can be made better off if the government forces them to
smoke less (see Gruber and Koszegi’s work for instance). Thus, some
reduction in their smoking is welfare improving for them as well as
for the non-smokers. Does the decreased reduction in smokers’ utility
mean that their losses are outweighed by the non-smokers’ gains? That
is a matter for empirical research, but it is likely that the British
government’s actions will be far less traumatic for British smokers
than Mr Harford anticipates.