Tag Archives: economics

and the Nobel Prize in Economics actually went to…

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The Royal Swedish Academy of Sciences has decided to award the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2016 to

Oliver Hart
Harvard University, Cambridge, MA, USA

and

Bengt Holmström
Massachusetts Institute of Technology, Cambridge, MA, USA

“for their contributions to contract theory”

Society’s many contractual relationships include those between shareholders and top executive management, an insurance company and car owners, or a public authority and its suppliers. As such relationships typically entail conflicts of interest, contracts must be properly designed to ensure that the parties take mutually beneficial decisions. This year’s laureates have developed contract theory, a comprehensive framework for analysing many diverse issues in contractual design, like performance-based pay for top executives, deductibles and co-pays in insurance, and the privatisation of public-sector activities.

In the late 1970s, Bengt Holmström demonstrated how a principal (e.g., a company’s shareholders) should design an optimal contract for an agent (the company’s CEO), whose action is partly unobserved by the principal. Holmström’s informativeness principle stated precisely how this contract should link the agent’s pay to performance-relevant information. Using the basic principal-agent model, he showed how the optimal contract carefully weighs risks against incentives. In later work, Holmström generalised these results to more realistic settings, namely: when employees are not only rewarded with pay, but also with potential promotion; when agents expend effort on many tasks, while principals observe only some dimensions of performance; and when individual members of a team can free-ride on the efforts of others.

In the mid-1980s, Oliver Hart made fundamental contributions to a new branch of contract theory that deals with the important case of incomplete contracts. Because it is impossible for a contract to specify every eventuality, this branch of the theory spells out optimal allocations of control rights: which party to the contract should be entitled to make decisions in which circumstances? Hart’s findings on incomplete contracts have shed new light on the ownership and control of businesses and have had a vast impact on several fields of economics, as well as political science and law. His research provides us with new theoretical tools for studying questions such as which kinds of companies should merge, the proper mix of debt and equity financing, and when institutions such as schools or prisons ought to be privately or publicly owned.

The Economics Nobel Isn’t Really A Nobel

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The Economics Nobel Isn’t Really A Nobel according to Maggie Koerth-Baker at FiveThirtyEight.com.

But, technically, there is no Nobel Prize in economics.2 Instead, there is the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel. It was first awarded in 1969 and is named not after a person, but after the central bank of Sweden — the Sveriges Riksbank — which funds it. The Nobel Foundation doesn’t pay out the award or choose the winner (though the winner is chosen in accordance with the same principles used by the Nobel Foundation), but it does list the prize on its website along with the Nobels, tracks winners the same as Nobel laureates, and even promotes the prize alongside its own. Members of the Nobel family have spoken out against the award.

So why does it exist? Notre Dame historian Philip Mirowski has found evidence that the economics award grew out of Swedish domestic politics. According to Mirowski, in the 1960s, the Bank of Sweden was trying to free itself from government oversight and become independent. One way to do that was to frame economics as purely scientific, rather than political — in which case, government interference could only hurt the bank. Having a Nobel Prize boosted economics’ scientific street cred. And Mirowski isn’t the only academic who is skeptical of whether there should be a Nobel-associated economics prize. Friedrich von Hayek, who won the award in 1974, used his Nobel Banquet speech to critique the prize.3 “The Nobel Prize confers on an individual an authority which in economics no man ought to possess,” Hayek said. He worried that the prize would influence journalists, the public and politicians to accept certain theories as gospel — and enshrine them in law — without understanding that those ideas have a different level of uncertainty than, say, gravity or the mechanics of a human knee.

Paul Romer and the Nobel Prize

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I write this the night before the 2016 Nobel prize in economics is scheduled to be awarded. By the time this posts it will have been awarded, so keep that in mind if what I say below seems outdated the second it posts.

City Observatory says Paul Romer deserves to win the Nobel Prize in economics.

In our view, the academy might want to closely consider giving the award to Paul Romer, recently appointed to be the chief economist for the World Bank, for two reasons.

First, in a series of papers published a couple of decades ago, Romer was responsible for some of the key breakthroughs in what is called “New Growth Theory,” which re-writes the mechanics of long-term economic growth in a fundamental and optimistic way. We described the key insights from of these theories a couple of months ago at City Observatory. Romer’s long been short-listed for the prize on account of this work, awaiting it seems, only sufficient quantities of gray hair to take his turn.

Second, in the past few weeks, Romer has turned the economic world on its head with a scathing critique of deep flaws in the past two decades of macroeconomic theorizing. In a paper entitled, “The Trouble with Macroeconomics,” Romer indicts the state of macroeconomics, and its growing detachment from the real world.

I happen to like Paul Romer. I saw him speak in person a few years ago and thought he was impressive. His message that human knowledge and creativity drives long-term improvements in the quality of our lives is a hopeful one in a world where we can’t just keep extracting, consuming, and dumping more and more forever.

 

facts and figures on illegal immigrants

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The Week has some surprising facts and figures on illegal immigrants in the U.S. Just for fun, I’ll state it in the form of a quiz:

  1. About how many illegal immigrants are there, and what percentage of the U.S. population is that?
  2. What percentage of illegal immigrants here now have been here for more than 10 years?
  3. Is the number of illegal immigrants increasing or decreasing?
  4. What percentage of illegal immigrants are Mexican?
  5. Obviously, “illegal immigrant” means they crossed the border illegally, right?
  6. What percentage work? What percentage pay taxes? What percentage are receiving public assistance?
  7. What percentage have committed criminal offenses?

Answers (and I’ll repeat the questions, because it would be annoying if I didn’t):

  1. About how many illegal immigrants are there [Answer: 11 million], and what percentage of the U.S. population is that [Answer: 3.5%]?
  2. What percentage of illegal immigrants here now have been here for more than 10 years? [Answer: 66%]
  3. Is the number of illegal immigrants increasing or decreasing? [Answer: decreasing, from a peak of about 12 million in 2007. ]
  4. What percentage of illegal immigrants are Mexican? [Answer: 50%]
  5. Obviously, “illegal immigrant” means they crossed the border illegally, right? [Wrong: about 60% did, but 40% entered legally and overstayed their visas]
  6. What percentage work? [Answer: 73%] What percentage pay taxes? [Answer: 50%] What percentage are receiving public assistance? [Answer: 0% of adults, although children who are not citizens may receive public schooling and emergency medical care]
  7. What percentage have committed criminal offenses? [Answer: 7.5%]

Nixon and basic income

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In 1969-70, Richard Nixon made an attempt to guarantee a basic income to all families in America.

Richard Nixon was not the most likely candidate to pursue the old utopian dream, but then history sometimes has a strange sense of humor. The same man who was forced to resign after the Watergate scandal in 1974 had been on the verge, in 1969, of enacting an unconditional income for all poor families. It would have been a massive step forward in the War on Poverty, guaranteeing a family of four $1,600 a year, equivalent to roughly $10,000 in 2016…

According to Nixon, this generation would do two things deemed impossible by earlier generations. Besides putting a man on the moon (which had happened the month before), they would also, finally, eradicate poverty.

A White House poll found 90% of all newspapers enthusiastically receptive to the plan to pay an unconditional income to all poor families. The Chicago Sun-Times called it “A Giant Leap Forward,” the Los Angeles Times “a bold new blueprint.” The National Council of Churches was in favor, and so were the labor unions and even the corporate sector. At the White House, a telegram arrived declaring, “Two upper middle class Republicans who will pay for the program say bravo.” Pundits were even going around quoting Victor Hugo – “Nothing is stronger than an idea whose time has come.”

It seemed that the time for a basic income had well and truly arrived.

“Welfare Plan Passes House […] a Battle Won in Crusade for Reform,” headlined The New York Times on April 16, 1970. With 243 votes for and 155 against, President Nixon’s Family Assistance Plan (FAP) was approved by an overwhelming majority. Most pundits expected the plan to pass the Senate, too, with a membership even more progressive than that of the House of Representatives. But in the Senate Finance Committee, doubts reared. “This bill represents the most extensive, expensive, and expansive welfare legislation ever handled,” one Republican senator said. Most vehemently opposed, however, were the Democrats. They felt the FAP didn’t go far enough, and pushed for an even higher basic income. After months of being batted back and forth between the Senate and the White House, the bill was finally canned.

In the following year, Nixon presented a slightly tweaked proposal to Congress. Once again, the bill was accepted by the House, now as part of a larger package of reforms. This time, 288 voted in favor, 132 against. In his 1971 State of the Union address, Nixon considered his plan to “place a floor under the income of every family with children in America” the most important item of legislation on his agenda.

But once again, the bill foundered in the Senate.

June 2016 in Review

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3 most frightening stories

  • Coral reefs are in pretty sad shape, perhaps the first natural ecosystem type to be devastated beyond repair by climate change.
  • Echoes of the Cold War are rearing their ugly heads in Western Europe.
  • Trump may very well have organized crime links. And Moody’s says that if he gets elected and manages to do the things he says, it could crash the economy.

3 most hopeful stories

  • China has a new(ish) sustainability plan called “ecological civilization” that weaves together urban and regional planning, environmental quality, sustainable agriculture, habitat and biodiversity concepts. This is good because a rapidly developing country the size of China has the ability to sink the rest of civilization if they let their ecological footprint explode, regardless of what the rest of us do. Maybe they can set a good example for the rest of the developing world to follow.
  • Genetic technology is appearing to provide some hope of real breakthroughs in cancer treatment.
  • There is still some hope for a technology-driven pick-up in productivity growth.

3 most interesting stories

Brexit

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Well, I suppose I have to write a Brexit post. The main argument seems to be that the combined UK-EU economy, with free trade and movement of people and money, was larger than either the UK or EU will be separately, and that is going to hurt both while also emboldening Russia. It seems to me that they could just negotiate some treaties to keep most of that in place, at least free movement of trade and capital if not people, but it sounds like politics may get in the way of that because some in the EU will think if they do that, it will embolden others to leave. But there is at least an argument that it could strengthen the EU in the long term.

In the immediate future, the EU will face a serious dilemma. If it allows Great Britain to withdraw from common structures only to a limited extent, it would signal to all Euroskeptics that they can do as they please. But if EU leaders impose high costs on the UK – namely, by restricting its access to the single market – Europe could end up cutting off its nose to spite its face.

The tragedy of today’s situation is that the EU could still save itself and come to its senses. It could compensate for the losses caused by Brexit by transforming the current crisis into an opportunity for true integration – something that up until now had been blocked by the UK. Such an exercise in renewal would demand that EU institutions be granted real authority to create common fiscal, defense, and energy policies, while at the same time pursuing democratization (along the lines of “one citizen, one vote”).

Under this scenario, Europe could finally emerge as a strong actor in international affairs. It could be the world’s third-largest country, with English, ironically, as its administrative language – the United States of Europe. But, sadly, the political will to achieve such an outcome is unlikely to emerge – if it ever does – until conditions in Europe become considerably worse than they are now.

Philadelphia soda tax

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Taxes on sugary drinks have been tried and failed in a few cities, partly because the soda industry has mounted big ad campaigns against them. Now a tax has passed in Philadelphia, partly because Michael Bloomberg funded a pro-tax ad campaign. I watched this unfold in Philadelphia in real time and never heard about the Bloomberg thing until I read it in the national media just now. I guess it’s a victory over special interests, of sorts. I generally support the idea of taxing things that hurt people and using he revenue to help people. That should be what taxation is all about. It should replace less productive taxes on good things like work, saving and investment. That’s not the case in Philadelphia. They just keep raising and raising and raising, and it can’t go on forever.

Runaway Inequality

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Les Leopold is a guy who wrote a book called Runaway Inequality: An Activist’s Guide to Economic Justice. Here’s an excerpt from an interview about the book:

In the late ’70s, roughly, a new economic philosophy really caught hold in both political parties. It originally came from the right, from Milton Friedman and the free marketeers. Academics call it neoliberalism; in the book, we call it the “Better Business Climate.”

It basically was kind of a simple model. Cut taxes, cut regulations, cut back social spending so people will be more eager to find work and be less dependent on the government, and basically undermine the power of labor unions so the economy would run more on market principles and have less inefficiencies in it. There would be more investment and profits, and therefore, all boats would rise. It would lead to kind of a boom economy. That was the theory. I was in graduate school when that was going on, and it was pretty strong, even more liberal economists were sort of giving up on Keynesianism and going in this direction.

What they didn’t teach us and what they never discussed is that it’s one thing to deregulate trucking or airlines or telecommunications, but it’s quite another thing to deregulate the financial sector… In 1980, about two percent of a company’s profits were used for stock buybacks. By 2007, 75 percent of all corporate profits were used to buy back their own shares. Forget about R&D, forget about workers’ wages, forget about all that kind of stuff. All that matters to a CEO today is raising the prices of the shares through stock buybacks.

The mantra makes some logical sense – capitalism is about competition to create better products at better prices and operate efficiently in the short term, and a necessity to innovate if you want to compete in the long term. Consumers are supposed to win. Profit and stock price are supposed to be the score card that determines which companies are winning, and the possibility of winning is the incentive to play the game. This all makes some sense, unless and until people are gaming the system to such an extent it is not really competition any more.

Sanders’s socialism

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According to the New York Times, “left leaning economists” say Sanders can’t pay for his proposed programs. (For an alternative viewpoint, see BillMoyers.com which says the NYT irresponsibly cherry-picked experts with ties to the Obama/Clinton administration).

Mr. Sanders’s plan includes a new, across-the-board 2.2 percent income tax to help pay for his single-payer, government-run health plan for all. But progressive economists and business groups say middle-class taxpayers would pay more for the European-style social welfare state that Mr. Sanders envisions.

They dispute his contention that all but the richest Americans would be better off, on balance, with higher wages and benefits like expanded Social Security, free public colleges and, most of all, free health care. His policy director, Warren Gunnels, dismissed the critics in an interview, saying, “They’ve picked sides with Hillary Clinton.” The campaign has a list of 130 endorsees, including some economists.

“If, at the end of the day, people don’t believe that we can achieve the same savings as Canada, Britain, France, Japan, South Korea, Australia are achieving on health care, then we have a fundamental disagreement,” Mr. Gunnels said, naming countries with single-payer systems.

There’s that cynicism again. It works everywhere else but it can’t work here because…why exactly? Because we choose to be cynical, for one. And because we let the medical and insurance industry buy politicians and write laws in its favor and at everyone else’s expense.

I will say, though, that I am attracted to the idea of a well-functioning market setting prices rather than the government setting them. We live in a world of finite resources, so if you truly have no price signal – no premiums, no co-pays, no bills of any kind – then people can’t be allowed to choose any amount of health care they want, because our collective wants will always exceed what we can collectively afford. Then you have to have government rationing and price controls. That is what single-payer is. It is an efficient system to deliver some amount of health care the experts think is affordable and cost-effective. It’s equitable because it can deliver the same rationed amount to everyone, rich or poor. It is not a market-based system.

What could a hypothetical pure market-based system look like? First, the U.S. political system would have to not depend on contributions from the medical, insurance, and finance industries, so politicians would have no incentive to favor the profits of these companies over the interests of voters. Then people would have the option, or perhaps the requirement, to save a portion of their incomes in a health savings account. Then they would use their own money to purchase health care. Government would make copious amounts of education and information available on what medical services are available and how much they cost and what outcomes are being achieved, in terms simple enough for anyone to understand, so that true apples-to-apples comparison shopping would be possible for anyone, even under the stress of serious or sudden illness. Prices would settle at a level where supply and demand are in harmony given what the society can afford in aggregate and what other goods and services people are willing to give up in exchange for health care. Companies would have to compete based on price and outcome, and would have to innovate over time or else lose their edge.

The above might be an economist’s utopia, but it would not be remotely equitable, because the rich could afford much more than the poor. Government could do a few things to help. The savings accounts could be tax-advantaged, obviously. The savings could be matched by government, and the match could be larger for the poor and gradually phased out for the rich. Basic preventive care and maintenance care for chronic conditions could be provided for free (i.e. by taxes), because we know that is cost-effective. Catastrophic insurance could be provided for the big expenses, because we know those are back-breaking for all but the super rich, and when the poor show up in emergency rooms we end up treating them (poorly) at enormous taxpayer expense. With these policies in place, people are now using their savings only to make those decisions in between preventive and catastrophic, the things you could argue they want but don’t necessarily need. The rich would still be able to afford more, but hey, that is the nature of a market economy unless you want a true socialist utopia. I assume we still want some incentive to work or start a business.