Month: December 2007

How To Spend It

Have you ever read that FT supplement and wondered how and why the mix of products is changing with increasing income inequality?  Anna Yurko tackles this question:

distribution of consumer incomes is a key factor in determining the structure
of a vertically differentiated industry when consumer’s willingness to pay
depends on his income. This paper computes the Shaked and Sutton (1982) model
for a general specification of consumers’ income distribution to investigate
the effect of inequality on firms’ entry, product quality, and pricing
decisions. The main findings are that greater inequality in consumer incomes
leads to the entry of more firms and results in more intense quality competition
among the entrants. This is due to the elasticity of consumer demand for
quality being higher in more inegalitarian economies. More intense quality
competition among firms causes them to locate their products in higher ranges
of the quality spectrum, closer to each other, decreasing the degree of product
differentiation. Competition between more similar products tends to reduce
their prices. However, when income inequality is very high, the top quality
producer chooses to serve only the rich segment of the market, and the low
price elasticity of demand of these consumers allows him to charge a higher
price. The conclusion is that income inequality has important implications for
the degree of product differentiation, price level, industry concentration, and
consumer welfare.

My version of the argument is this: growing income inequality means greater elasticity of demand, thus causing quality competition to displace price competition for some market segments.  More concretely, there is often more profit from serving the very top, who will always pay more for something just a wee bit different or a wee bit better.  So stay away from producing the mid-level cheeseburger, where price elasticity of demand will kill your profits.  You can’t charge the rich very much for it, and the presence of the poor keeps the price down for the middle class.  Here is the paper.  Anna is currently a job market candidate at the University of Texas, here is her CV.

The girl with the X-Ray eyes

"She must be some kind of Russian fraud," was the first thing I said to Yana and Natasha.  We were riding in a bus through rural Mexico and they played a Discovery Channel show about Natasha Demkina, a girl who claims to be able to see through human bodies and diagnose their medical conditions.  Here is Wikipedia on the girl.  I found this article revealing:

…a lot of text messages were being sent between her and her companions during the test, something the scientists had expressly forbidden.

Here is another skeptical account, and here.  Here is a good Bayesian discussion.  Here is the Amazing Randi.  No, I do not believe in the paranormal, nor is her record even close to perfect, but still the girl seems to have a remarkable ability to read clues from ailing human beings.  (She doesn’t seem to be interested in seeing through animal bodies or for that matter inanimate objects.)  I am glad to hear she wants to become a doctor.  What I find odd is her apparently unique ability to pull off this fraud; is there not free entry into the sector?  I also find it interesting that the Discovery Channel finds this story "true enough" to broadcast in some countries, but not others.

In Praise of Uncertainty

Writing in the comments, David R. Henderson asks me to list three policy areas where my views are uncertain.  Since this blog (or at least this author) has been streaming uncertainty for over four years, this strikes me as an odd request.  But perhaps it is useful to have such a list in one place, so here goes:

1. We must address the looming crisis in medical care costs but how?  I am uncertain as to how much means-testing Medicare will ease future budgetary pressures.  I do favor means-testing, mostly through lack of better ideas, but it is a) notoriously difficult to enforce, b) often unfair (do we measure income or wealth? current or lifetime?) and c) an implicit hike in marginal tax rates.  And if you could talk me out of means-testing, I am not sure which recommendation would come next.

2. I favor further experimentation with school vouchers, but to what extent?  There are many good school districts that probably would not be improved much if at all, and the resulting political hand-wringing would be costly and also could give vouchers a bad name.  Should vouchers be isolated experiments or implemented on a near-universal basis?  Near-universal vouchers run the risk of becoming the new middle class entitlement.

3. I don’t see a Social Security "crisis" in the numbers, but I do believe we should be fiscally conservative with the program, most of all because of forthcoming Medicare expenditures.  Yet this view would be wrong if the growth rate of the economy exceeds the real rate of interest.  We could then spend as much on Social Security as we wanted to.  (Growth-optimistic conservatives rarely emphasize this conclusion, I might add.)  I do not expect such a result, but I give it a probability of about 30 percent.

4. I am uncertain how much the United States should "move first" with costly anti-global warming measures, assuming that China and other nations are not very cooperative.

5. To what extent is the ongoing loss of biodiversity a very serious problem?  I suspect in the long run this will prove a more important issue than global warming, but I am not sure.  I also don’t know what to do about it; property rights and better quotas for fishing is a good idea but that only dents the larger problem.

6. I favor legalizing or decriminalizing many drugs, but I am not sure how far this process can go when so many actual and potential drug customers are under eighteen years of age.  Can we really sell crack cocaine in the 7-11, provided there is an ID check for every buyer?

7. I am pro-immigration relative to either current policy or the median voter, but I am uncertain how many immigrants the United States could take in.  I’m not just whinging about not knowing where the decimal point goes.  More generally, we don’t know when the social and political fabric will start to crack in counterproductive fashion.

8. I am highly uncertain about most of the major questions in foreign policy, for a start try Pakistan or the Koreas or nuclear proliferation.  Even if you think we shouldn’t have gotten involved in the first place, that doesn’t mean immediate withdrawal is our best option.  And while I know more about economics than foreign policy, I find that the more I learn about a given foreign policy area, the more uncertain I become.

9. Virtually any question in water policy.  This is a good, complex area for shaking up policy preconceptions.

That’s a lot of uncertainty.  I could go on, but that’s already most of the major policy issues today.  Don’t forget this: even if your view is the one "most likely to be right," in absolute terms your view, like mine, is probably wrong relative to the sum of competing views. 

In other words, it is hard for me to see why, in these and many other areas, we should be highly certain of the views we hold.

At some point I’ll give you my take on "What I Think We Should Be (Nearly) Certain About."  But I am not yet sure what should go in that post.

Addendum: Here are Arnold Kling’s certainties and uncertainties.

The good news is…

In 2005, the two state airlines – Mexicana and Aeroméxico – were hived off for privatisation and permits were granted for five new low-cost carriers. The following year, the number of air passengers grew by almost 12 per cent, more than in all the previous five years combined.  Flights from Mexico City to Cancún now can be had for less than $100. Previously it had been cheaper to fly to Cancún from New York.

The bad news is

…huge swathes of the economy – beer, oil, soft drinks, cement, television, electricity and telephony to name a few – are still dominated by one or at most two big companies.

Legally protected companies for the most part, I might add.  If you are listing the major problems of Mexico, we have:

1. Drug trade and corruption and crime, all rolled into one big package.

2. Bad educational system for most of the country, and bad cultural norms for education.  Most people are literate but you don’t see many people reading.

3. State-sponsored monopolies.

Going back to the bright side, the numbers of the Mexican middle class continue to grow, grow, and grow.  The shopping malls in Puebla and Veracruz are excellent, and they are not just for a fair-skinned minority elite.  They are packed with middle class people, shopping, and turning Mexico into a middle class country.  It really is happening, and I see it more and more each time I visit.

What if Paul Krugman were right about trade and wages?


That is Paul Krugman, here is more.  I have yet to see the evidence that trade has a significant negative impact on middle class wages, but for sake of argument assume it is true.  However benevolent it may sound, strengthening the social safety net would not be my policy recommendation number one.  After all, if Samuelson-Stolper factor price equalization is the main mechanism at work, wages would have a long way to fall downwards and if anyone in the middle class is to keep working, the safety net must eventually be cut, not increased.  You might think we can fund all these trade-losers by taxing capital but of course the incidence of taxes on capital sometimes falls on labor, not to mention that at some point the Laffer Curve kicks in. 

Is not the appropriate policy recommendation to create a budget surplus, create a U.S.A. Sovereign Wealth Fund, and invest the resulting capital in the corporate winners from this entire process?  In other words, we would be giving the trade-losers a more direct share in capital.  Since output is rising and wages are falling, the return to capital must be rising; let’s make money off of that.

You might not trust the government with such investments but it is awkward for Krugman to push that argument too hard.  Alternatively, you might think that share prices already have capitalized these gains, but that is hard to square with the view that Krugman is reporting a new result about trade.  Share prices are driven by liquidity to some extent, and if you know something about the returns to labor and capital that the rest of the world does not, there ought to be a way to make money.  Why spend more on consumption (a stronger safety net today) if the rate of return on investment is rising so high and we are going to need even more of a safety net in the future?

The costs of media bias

A majority of Americans view news organizations as politically biased, creating a strong incentive for firms to try to present themselves as impartial. This paper argues that the desire to appear unbiased leads to information loss.  In the formal model, firms withhold information in an effort to appear neutral. It is shown that information loss is exacerbated by competition, policies that regulate content are welfare reducing, and that regulating the size of the market can increase the amount of information revealed. Finally, the introduction of imperfectly informed sources of news, such as blogs, can decrease the incentives for traditional news outlets to provide information, yet they may also enhance welfare when information is being suppressed.

That’s from Jeremy Burke of Duke, who is on the job market this year.  Paul Krugman often makes this complaint, namely that newspapers often prefer a "He said, he said" story over simply telling the truth.  One message of this paper is that the problem isn’t so easy to stop.  Newspapers aren’t just being lax, rather they are maximizing their profits and reputation.  The discussion of blogs starts on p.22 of the paper; it is basically pro-blog but the ability of the blogosphere to speak truth can substitute for the requirement that newspapers do so, rather than forcing newspapers into truth.

Speak English, lower taxes

Megan McArdle writes:

It is hard for high levels of taxation to survive a right of exit;
Europe has mostly been protected (so far) by its many languages, which
make it harder to move. But as the EU increases labor mobility, expect
to hear more about harmful tax competition.

The story is about skilled Danes leaving the country so as to avoid higher taxes.  The last time I was in Denmark I was struck how many service workers could not speak Danish (will a Spaniard or Hungarian really learn that language?) and in the workplace communicated in English.  Greater policy competition is one of the most important results of so many Europeans speaking good English.  High taxes and differential incomes, in turn, increase the incentive for people to learn good English, thereby creating a self-reinforcing dynamic.  I’ve long thought that Europe will become more like the United States than vice versa, most of all through mobility and diversity, but I don’t think that is a very popular view.

Why is New Zealand poorer than Australia?

Via Craig Newmark, here is one short article. the conclusion:

"Prosperity does not come by accident,” Mr Rennie said.  "Australia has a stronger political consensus around policies for growth, which contributes to investor confidence.”

Sorry but I can’t buy it.  Throughout the 1990s New Zealand economic policy probably "led" Australian policy, yet Australia has gained on New Zealand since that time.  I’ll instead cite booming resource prices (there is more gain in selling minerals to China than agricultural products), economies of scale from having a larger country, and most of all the Kiwi brain drain.  In percentage terms, many more of the smartest New Zealanders leave their home country — often for Australia I might add — than vice versa.