Friday, 29 May 2015

Latest research suggests the minimum wage DOES reduce employment

The traditional first-year economics minimum wage story starts with a minimum wage that is binding above the equilibrium wage. This increases the quantity of labour supplied (more people wanting to work more hours at the higher wage), and decreases the quantity of labour demanded (fewer employers willing to employ workers for fewer total hours), leading to excess supply of labour (unemployment). Further increases in the minimum wage simply exacerbate the problem. And the early empirical research supported that story.

Then came the research that started to debunk the idea of minimum wages leading to increased unemployment, mostly involving cross-border pairs of counties in the U.S., and often focusing on teenagers or fast food workers (e.g. probably the most famous piece is this one by David Card and Alan Krueger (ungated)). In support of these findings, the argument was made that employers had monopsony power, and minimum wages would therefore increase employment (see here for an explanation of this).

Last week Adam Ozimek updated the state of research on the minimum wage. To briefly summarise Adam's summary: several recent papers, improving on the methodology of earlier contributions, have found significant job losses when the minimum wage is increased, "the lost job experience hurt workers even after they eventually found new jobs", and that "low-skilled workers move out of states that raise minimum wages" (which likely means that many research projects using macro data will run the risk of underestimating the disemployment effects of minimum wage increases).

So, those of us still teaching that high minimum wages increase unemployment can breathe a little easier, with the latest research again providing support for the disemployment effects of higher minimum wages.

[HT]: Eric Crampton at Offsetting Behaviour

Wednesday, 27 May 2015

Poisoning rhino horns to save the rhinos

Earlier this month I wrote a post about the ineffectiveness of burning ivory to save elephants. This week, out of the same file, we have the Rhino Rescue Project, poisoning rhino horns:
Hern, the co-founder of the Rhino Rescue Project, has spent the last four years “devaluing” the horns of rhinos by infusing them with ectoparasiticides — or anti-parasite drugs — and pink dye. The dye isn't visible on the outside, and the ectoparasiticides are harmless to the rhinos when injected into their horns. But humans who handle or consume the horns may not be so lucky.
“At a minimum it would start with diarrhea, nausea, vomiting, severe headaches, all the way up to nervous symptoms, which could be permanent,” Hern says. “Some ectoparasiticides also precipitate the development of cancers later on in life.”
So, the Rhino Rescue Project argues that you can save the rhinos by making it more costly for poachers to handle the rhino horns. Are the effects the same as those I noted in the earlier post about ivory burning? In part, yes. It will increase the costs to poachers (since now they face the risk of being infected by the ectoparasiticides), which decreases the supply of rhino horns. Decreased supply increases the price of rhino horns, which would encourage more poaching. Besides that, the costs to the poachers can easily be dealt with by poachers wearing gloves when handling the horns.

However, the eventual buyers of the horns may not be so lucky. Rhino horn is sought after as a therapeutic drug ingredient in lots of Asian countries - believed to cure cancer and many other ills. However, if there is a chance that your rhino horn elixir is going to make your sick, maybe you re-consider. That should reduce the demand for rhino horns. Decreasing demand is a much better solution to the problem, especially if you are decreasing the supply at the same time.

Here's my final diagram from that earlier post on ivory burning:

If demand decreases (from D0 to D1), and supply decreases (from S0 to S1), you end up with a large decrease in rhino horns traded in the market (from Q0 to Q1), with little change in price. But importantly, less trade in rhino horns means fewer dead rhinos. Although then the poachers probably move back to hunting elephants...

[HT: Marginal Revolution]

Monday, 25 May 2015

John Forbes Nash Jr., 1928-2015

Last week in ECON100 we covered game theory, including the concept of Nash equilibrium. Tragically, John Forbes Nash Jr. (for whom the Nash equilibrium is named) and his wife Alicia were killed in a car accident in New Jersey on Saturday. The L.A. Times obituary is here, and New York Times here, while the New Zealand Herald also covered the story this morning.

Nash will be best known for his work as a mathematician (rather than an economist), and in particular his PhD thesis which was just 27-pages long. It was this work that introduced the world to the concept that would later become known as Nash equilibrium, and that won him the Nobel Prize for economics in 1994. At the time of the accident, he and his wife had just returned from Norway where he had just received the Abel Prize from The Norwegian Academy of Science and Letters.

Sadly, I can't recommend any of his writing to my first-year students or regular readers because of the heavy mathematical content, but here is a great summary of his contributions from his Nobel seminar in 1994, and here is an interview with Nash from 2004.

Sunday, 24 May 2015

Why New Zealanders face a double-whammy from the new bio-security and customs levy

One of the announcements in the Budget last Thursday was a new bio-security and customs levy of $16 for arriving passengers and $6 for departing passengers. Notwithstanding the government's reluctance to call it such, this is a tax on travellers, and has generated quite a bit of anger, not least from the tourism industry. Auckland Airport has it right when they said (in the linked article):
...the new tax could impact New Zealand's competitiveness as a tourist destination, especially for those travellers who are price sensitive.
To that I will add that it will be more significant for New Zealander travellers than for international visitors to New Zealand. Why? New Zealander travellers have no option when undertaking international travel than to pay the new levy - they will pay the $22 as part of the ticket price travelling to and from New Zealand because New Zealand is the origin of their travel. They can't avoid paying it. International visitors on the other hand have other options - they don't need to travel to New Zealand. Maybe the $22 extra cost is enough to sway them in favour of some other destination.

In terms of relative cost, the levy is probably much less than one percent of the cost of long haul travel to New Zealand so probably won't make a whole lot of difference either way for many long haul travellers. However, the addition of $22 onto a budget fare to/from Australia or the Pacific Islands is quite substantial - around five percent of the cheapest fares on offer. New Zealanders make up a larger proportion of short-haul passengers than long-haul passengers on flights to/from New Zealand (compare departures of New Zealanders with arrivals of international visitors in Statistics New Zealand data here). So, the levy is likely to be more significant for New Zealanders than for international visitors because it affects the cost of flights New Zealanders take relatively more than for international visitors, and New Zealanders have no alternative but to pay the levy. So, New Zealanders should be less price sensitive (because of having no options), but also pay a higher proportionate increase in price for fares (because of the higher proportion of low-cost short-haul fares).

However, coming back to the effects of the tax on price sensitive travellers versus those who are less price sensitive, we can illustrate the difference on a diagram. Assuming a starting price that is the same (P0) [*] and the same starting quantity (Q0), demand by price sensitive travellers is D1 and demand by less-price-sensitive travellers is D2 (note that D1 is flatter than D2). We illustrate the bio-security and customs levy using the S + tax curve (or maybe that should be S + levy?), which is the supply curve shifted upwards by the per-unit value of the levy ($22).

For price sensitive travellers, the price paid by these travellers increases to PC1, the effective price for the airlines falls to PP1 (this is the price the consumers pay, minus the levy), and quantity of tickets falls to QT1. In contrast, for less-price-sensitive travellers, the price paid by these travellers increases to PC2, the effective price for the airlines falls to PP2 (this is the price the consumers pay, minus the levy), and quantity of tickets falls to QT2. Note that the price difference is larger for the less-price-sensitive travellers than price sensitive travellers, and the change in quantity is larger for the price sensitive travellers. So, price sensitive travellers are likely to be turned off travel to/from New Zealand by the levy in greater numbers than less-price-sensitive travellers (as noted by Auckland Airport). For those of you keeping score, New Zealanders face a double-whammy here - higher proportionate increase in fares firstly (as noted above), plus higher fare increases on top of that because of being less price sensitive than other travellers.

Finally, from the diagram the deadweight loss of the levy will be relatively larger from price sensitive travellers (the area BEF is the deadweight loss for price sensitive travellers, compared with the area AED for less-price-sensitive travellers).

One final point:  Given the levy will affect travel to/from Australia disproportionately more than travel to/from other destinations, maybe this is a modest way of ensuring a reduction in net migration from Australia, while keeping those who are already here?


[*] This of course would not be true. Airlines are very effective at price discrimination, so less price sensitive travellers typically pay a higher fare than less price sensitive travellers. To see why, think about the difference between paying for a flight long in advance, versus paying a few days before the flight. Travellers paying long in advance typically have many other options for destination, route, date of travel, etc. so are more price sensitive, and pay a lower price. Travellers buying a flight a few days beforehand typically have to be somewhere in a hurry - there are few other options to them, so they are less price sensitive, and pay a higher price. However, for the purposes of this exercise let's say we deflate the price differential so that both prices are on different scales.

Tuesday, 19 May 2015

Bring back stamp duty for Auckland!

If you've a New Zealander, unless you've been hiding under a rock for the past while you have probably noticed that Auckland house prices have gotten a little out of hand. Many are calling it a crisis (see here for one (of many) recent examples).

In the last week there have been two big announcements aimed at curbing the runaway housing market in Auckland. First up, last Wednesday the Reserve Bank announced an important change which will kick in from October: home buyers who are not going to be owner-occupiers in Auckland will require a deposit of at least 30 percent to buy the house. Second, the Government chipped in on Sunday with a pre-Budget announcement of "capital gains tax lite" (all capital gains for investors who sell within two years of purchase will be deemed to be taxable income). Both are interesting options, but I wonder if there is a better option - to bring back a targeted sales tax or stamp duty. More on that at the end of the post.

Comparing the effects of the two policy changes is informative. I think this NZ Herald cartoon has it about right:
There are likely to be so many potential ways for the rules to be effectively evaded that they might have little to no effect, as well as likely unintended consequences.

Thinking about the Reserve Bank rules first. The rules don't apply to owner-occupiers, and presumably that test needs to be met only at the time of purchase (unless they really want banks making periodic checks that the owners are occupying the property). So, would it be possible for a savvy investor to purchase a house as an owner-occupier, then move on leaving it as a rental while they buy a second house (as an owner-occupier again), and so on? Alternatively, could a couple buy two houses (one each) as owner-occupiers, then co-habitate and rent one property out? Those are two immediate options for skirting the rules. Moreover, how many investors are likely to be caught by this in any case? Bruce McLachlan of the Co-operative Bank opined that "the new restrictions would have little impact on the market because property investors tended to have at least 30 per cent equity". And they won't apply to foreign investors who are not borrowing from New Zealand banks (though, if they are borrowing from foreign banks, they do take on some exchange rate risk).

And there may be unintended consequences. Family trusts can't be owner-occupiers, so presumably all family trusts will need 30 percent deposits for home purchases (unless there is an exemption for trusts, in which case investors will just pile properties into trusts and skirt the rules that way). Also, is the rule restricted to residential property - how will lifestyle blocks be considered? Thirty percent of a lifestyle block purchase price is quite significant. Rents will likely rise (to the extent that higher deposits raise the costs of landlords, which is debatable).

What the Reserve Bank rules will do though is reduce demand (at the margin) for homes in Auckland. As Brian Fallow points out, investors are often "the marginal buyers, who set the price, in large tracts of the market. They are buyers who don't have to be there and the prices they are prepared to pay are the prices home seekers have to outbid." Lower demand will lower house prices (though, given that many investors may be able to skirt around the rules, the effect might only be small).

As for the government's capital gains tax lite (unless you're John Key, in which case this isn't a capital gains tax), it also has some loopholes that can be exploited. First and most obviously, the two-year "bright line test" simply pushes out the minimum horizon for house sales by speculators to two years. It's unclear how many speculators were selling within two years in any case (at least, once you exclude the DIY crowd who buy, do up, and sell on), but officials estimate up to one in five houses in Auckland are sold within that timeframe. Granted the IRD will probably look closely at house sales two years plus n-days (where n is some small number), and they are getting extra funding for the property compliance programme as well (for more details on the PCP, see here).

As for unintended consequences, it appears that the new rules will exclude estates and matrimonial property settlements which is good. However, it will accidentally catch at least some people who didn't intend to make a capital gain. Consider if you bought a house, then your job changes and you move to a new city - will you need to hold onto your old home so that you don't get lumbered with the tax? The tax provides a disincentive at the margin to homeowners moving to new opportunities (which would increase the effect predicted by the Oswald Hypothesis). What about if you lose your job and the bank forecloses on your home and sells it in a mortgagee sale - will you then face a tax bill on any capital gain the bank obtains?

What this rule change (or policy change, take your pick) will do is the same as any excise tax in a market - it will increase the price for buyers, reduce the effective price for sellers (the difference between the two is the amount of the tax), and reduce the quantity of properties traded. Of course, it might have only a small effect if few speculators are caught in the first place.

Better than both options, I believe, is to (re-)introduce a geographically-limited stamp duty (or a land sales tax) - an option that I haven't really seen aired too much in the discussions over the last week (maybe that reflects my limited reading - there is one notable exception here). Stamp duty was abolished in New Zealand in 1999, but when it was in force it applied to all land sales. The Australian states have stamp duty at variable rates, with concessions for first-home buyers and sometimes for new home builds (see the tables at the bottom of this page). I would favour stamp duty over the proposed policy changes above, if it excluded owner-occupiers buying their first home. It would capture foreign purchasers (not covered by the RBNZ rules), and include both speculators and investors, and would be hard to avoid. It could be made to be progressive (with higher rates applying to more expensive homes), and apply only to the Auckland council area (though this would likely create boundary effects - better to buy a home in Pokeno or Tuakau and not pay stamp duty, than in Bombay or Waiuku where you would).

On the downside, stamp duty would increase house prices for buyers, and lower the effective prices for sellers, and reduce the quantity of homes traded - similar to the capital gains tax lite, but with larger effects as more sales would be captured. And taxes create deadweight losses. However, stamp duty would also generate revenue for the government, and that is key to my suggestion. As part of this plan, I would ring-fence the stamp duty to be used for building additional housing supply in Auckland. Assuming a 2.5 percent stamp duty, the government could add one house to the housing stock for every 40 homes sold in the city. Even if some of that revenue was diverted towards necessary infrastructure instead of home construction, it would still significantly increase housing supply and lower house prices, probably more than enough to offset the higher prices caused by the stamp duty in the first place. Without undertaking an extensive modelling exercise, I guess that this would be a much better option that either of those proposed by RBNZ or the government so far.

More from my blog on Auckland housing:

Wednesday, 13 May 2015

Pigovian taxes vs. tradeable pollution permits when clean technology becomes available

This week in ECON110 we covered externalities, and pollution. One of the aspects we covered is the difference between Pigovian taxes and tradeable pollution permits. MRUniversity has a useful video describing tradeable permits, and why they are a good idea:

In short, tradeable permits solve the problem of pollution at the least cost, because the producers that could reduce pollution at low cost would do so, and sell their permits to the producers who could only reduce pollution at high cost.

Anyway, in this post I wanted to compare taxes and permits. Alice Lepissier and Owen Barder at CGD wrote a quite detailed post on this comparison last year. I want to take a different tack to them, and think about what happens when clean technology becomes available.

The diagram below describes the simple model for the optimal quantity of pollution. You might think that the 'optimal' quantity of pollution is zero, but with no pollution we would essentially have no production which wouldn't make us better off at all (or at the extreme, no pollution means no breathing, since we all exhale carbon dioxide). Anyway, the MDC curve is the marginal damage cost (the cost to the environment of each additional unit of pollution) and is upward sloping - this is because at low levels of pollution, there is relatively less damage because the environment is able to absorb it. The capacity for the environment to do this is limited, so as pollution increases the damage increases at an accelerated rate. The MAC curve is the marginal abatement cost (the cost to society of each unit of pollution abated, or reduced) and is upward sloping from right to left. This is because, as more resources get applied to reducing pollution, the opportunity costs increase. Also, less suitable resources (meaning more costly resources) have to begin to be applied to pollution reduction. The optimal quantity of pollution occurs where the MDC and MAC curves intersect - at Q*. Having less pollution than Q* (such as at Q1) means that MAC is greater than MDC. In other words, the cost to society of reducing that last unit of pollution was greater than the cost in terms of environmental damage. Having pollution at Q1 must make us worse off when compared with Q*.

Now consider Pigovian taxes. With a Pigovian tax every firm must pay the government for each unit of pollution they generate. This effectively sets a price for pollution. The optimal price of pollution (which would lead to exactly Q* units of pollution in the diagram above) is P*. Firms would not pollute more than Q*, because the tax (P*) is greater than the MAC - it is cheaper to reduce pollution than it is to pay the tax. On the other hand, firms would not pollute less than Q* either, because the MAC is greater than the tax (P*) - it would be cheaper to pay the tax than to reduce pollution further than Q*.

What about tradeable pollution permits? With tradeable permits, the government sets the number of permits (pollution rights) that are available to the market - one permit allows a firm to emit one unit of pollution. The optimal quantity of permits is Q*, and the market will set the price exactly equal to P*. The price will not rise higher than P*, because then MAC would be less than P* and firms could reduce pollution for less cost than the price of a permit.

So, it is easy to see that both taxes and permits are theoretically equivalent in terms of the market for pollution. Taxes set the market prices, which (if the price is set correctly) results in the optimal quantity of pollution. Permits set the optimal quantity, which leads to the market price. At this point, the argument becomes which system (taxes or permits) would be less costly to administer and which would provide better incentives to adopt cleaner technology - possibly taxes in both cases. Or perhaps the argument is about which system is less risky, which Lepissier and Barder argue is permits.

Now, think about what happens if a new clean technology becomes available that makes it cheaper to reduce pollution. That lowers the marginal abatement cost, so MAC moves to MAC1 in the diagram below. The diagram demonstrates what happens with a Pigovian tax. The price of pollution is fixed at P*, so when MAC decreases to MAC1, the quantity of pollution falls greatly (to Q2). However, Q2 is too little pollution (relative to the new optimal quantity Q1), and at that point MAC is greater than MDC - the cost to society of reducing the last unit of pollution was greater than the cost in terms of environmental damage. We reduce pollution too much, leading to a deadweight loss (the area BEF in the diagram).

The next diagram demonstrates what happens with pollution permits. The quantity of pollution is fixed at Q*, so when MAC decreases to MAC1, the price of pollution permits falls (to P2). Now Q* is too much pollution (relative to the new optimal quantity Q1), and at that point MAC is less than MDC - the cost to society of reducing one more unit of pollution would be less than the cost in terms of environmental damage. We don't reduce pollution enough, leading to a deadweight loss (the area GHJ in the diagram).

So in both cases, when a new clean technology becomes available we end up with a deadweight loss. In this case though, you probably want the clean technology to lead to less pollution rather than the same quantity, so I would argue that this favours taxes over permits, unless it is easy for the government to reduce the number of permits. And when you consider climate risk, it is probably better to over-shoot on pollution reduction, rather than under-shoot.

[Update: Replaced diagrams to fix x-axis labels]

Monday, 11 May 2015

Financial literacy among teenagers

Diana Clement used some of my recent research in an article in the New Zealand Herald on Saturday about teenagers and money. Diana writes:
The University of Waikato tested the financial literacy of more than 300 students at Hamilton secondary schools. It showed that the longer teens had held a bank account the more financially literate they were, says co-author Michael Cameron, a senior lecturer in economics.
We did evaluate the financial literacy of 15-year-olds in Hamilton in 2013, using a New Zealand adaptation of the U.S. Financial Fitness for Life survey. This resulted in two publications: (1) comparing financial literacy between students in Japan, the U.S., and New Zealand (here; ungated earlier version here); and (2) identifying the factors associated with financial literacy (here; ungated earlier version here). Co-authors included Steven Lim, Ashleigh Cox, and Richard Calderwood (all from the University of Waikato), and Michio Yamaoka (Waseda University, Japan).

The first paper can essentially be summarised in a sentence: New Zealand teenagers' financial literacy is similar to those in the U.S., but not as good as those in Japan. In this blog post, I'll elaborate a bit on the second paper, which has some interesting results.

In our sample of Hamilton teenagers, we found that financial literacy was lowest among financially poorer students, those with less English ability, and those with less mathematical ability. We also found that older students, those who had studied economics or business studies, and those who had held a bank account for longer, had higher financial literacy. The data came from a cross-sectional survey, so these are correlations - we can't directly attribute causality here. However, I'm going to speculate on what the results mean nonetheless.

Students with less English ability have more trouble interpreting written questions in general - so it is unsurprising that they perform less well in the multiple-choice financial literacy test (we see similar results with international students in our test of economic literacy in ECON100 - see here for example; ungated earlier version here). Similarly, students who have studied economics or business studies and those with higher mathematical ability are likely to be more able students - so their higher financial literacy scores probably reflect a greater test-taking ability (much as we might hope that high school economics or business studies instills students with financial literacy, student ability is more likely to be driving these results).

The other results are more interesting from a policy or intervention perspective - students from households in richer parts of the city (a proxy for parental wealth), those who are older, and those who have held a bank account for longer, have higher financial literacy. There are plausible causal mechanisms here, even if we can't say so definitively. If richer parents are better at managing their money (that might be a big 'if'!), then that might pass onto their children - particularly if the parents are modelling good savings behaviour (another big 'if'). So, having parents and their children in joint financial literacy education programmes (such as this one based in Tauranga), especially if they are parents from more deprived areas, may be a useful way to increase financial literacy in both groups. Having parents understanding saving and budgeting better can hardly be a bad thing in any case.

Older students and those who have held a bank account for longer have probably been interacting with the market and managing (to some extent) their own finances for longer, developing useful skills and financial understanding along the way (hopefully!). The effects were small (an additional year of having a bank account was associated with 0.2 additional correct questions out of 50 in the financial literacy test), but highly statistically significant. Getting teenagers to take responsibility for (some of) their finances is probably useful, particularly while the environment can be easily controlled by parents. Diana writes:
Bart Frijns, director of AUT's Centre for Financial Research, says that children learn more about money by setting up and using a bank account than they do in a general education programme on savings.
I agree with Bart - financial literacy programmes for teenagers have shown a remarkable lack of success (e.g. see here (PDF)). Probably it is better to just get on and let teenagers take on some responsibility, make some (relatively minor) mistakes, and then provide them with guidance and education when they need it. Want a credit card? Want to take out a student loan? Or a car loan? Or a mortgage? Complete this short course on how best to handle credit. Such a just-in-time learning approach for financial literacy means that it is less likely that the learner will forget before they go to apply their knowledge. This is handy for credit, but might not be as useful for savings. Which is what I am working on now - what do teenagers really know about savings? More on that in a later post.

Friday, 8 May 2015

An open peer-review of the report "Understanding behaviour in the Australian and New Zealand night-time economies"

One of the areas where my research has gained a lot of traction in recent years has been in the area of alcohol policy (in particular, alcohol outlet density). My research (with Bill Cochrane and others) was cited by the Law Commission in their review of the Sale of Liquor Act, and our more recent research has been used by local councils in the North Island in developing Local Alcohol Policies. Our research consistently shows that bars and night clubs are significantly associated with violence, property damage, and police activity more generally (see here as well, gated).

So, it was with some interest that I read about a new anthropological study on behaviour in the night-time economies (PDF), by Anne Fox (an anthropologist and consultant from the UK). This study was pointed out to me by Peter Miller (Deakin University), who is a collaborator on a research project (along with Matt Roskruge) looking at how well (or not) people can estimate their own breath-alcohol content (more on that in a later post). Peter has addressed the study in two pieces online (see here and here), but I thought I would take a slightly different angle.

One of the problems with the Fox report is that it hasn't undergone a thorough peer review. I thought I would fill that gap here. I have a fair amount of experience in peer review - I have been a reviewer for over twenty journals over the last several years, and not all in economics (they include Australian and New Zealand Journal of Public Health; PLoS ONE; Psychology, Health and Medicine; and Sociological Methods and Research). And of course I have plenty of experience with alcohol research. So here goes.


The report "Understanding behaviour in the Australian and New Zealand night-time economies: An anthropological study" looks at an important issue - the problem of drunken behaviour by (predominantly young) drinkers in the night-time economy, and how to address the problem. As signalled in the title, the report takes an anthropological approach and much of it is quite fascinating to read and consider. The author uses a variety of methods including participant observation, interviews, and focus groups, and concludes that "it is the wider culture that determines the drinking behaviour, not the drinking. You can't change a culture by simply changing drinking" (p.95). The report finishes with 25 recommendations on how to "tackle the true, underlying cultural causes of violence and anti-social behaviour" (p.95).

I see several major issues with the report, and a number of more minor issues. The major issues could be addressed by the author and the report would still provide a useful narrative on the night-time economy in Australia and New Zealand. With two exceptions (that I will address later), the recommendations are fine, and are in most cases complementary to existing public health initiatives. However, it could be argued that cultural change is an extremely long-run solution to a problem that has immediate consequences so more immediate solutions (while not addressing culture) should remain a preferred approach.

The first major issue with the report is that it is unnecessarily constructs straw man arguments to score cheap points against non-existent arguments and support the central conclusion that culture is the dominant driver of behaviour.

This is exemplified by the following quote from page 15 of the report: "Drunkenness and drunken comportment are most often regarded as being directly proportional to the amount of alcohol consumed". The author provides no citation to back up this claim, and if it is indeed "most often regarded" to be the case, then there should be ample potential citations available. I'm unaware of who is saying that drunkenness is "directly proportional to the amount of alcohol consumed", but it isn't in any of the literature I have read.

Also on page 15 the author writes: "First, the very same person on the same dose of alcohol can react in myriad different ways on different occasions and in different settings. This simply would not happen if we were talking about a purely physiological response." Again, I don't know anyone who is claiming that the relationship between alcohol and behaviour is based on a purely physiological response. Moreover, you could re-write those two sentences equally to argue against the reports central theme of culture being the primary driver of behaviour, i.e. "First, the very same person in the culture can react in myriad different ways on different occasions and having consumed different doses of alcohol. This simply would not happen if we were talking about a purely cultural response."

Similarly, on page 43 we find "There is a relationship between alcohol and violence, but it not such a straightforward one as many would have us believe." Again, I'm not sure who is saying the relationship is straightforward, and the assertion is not supported by citations. Again, on page 45 we find "If alcohol alone makes people violent..." Now I'm fairly sure no one says that alcohol alone makes people violent, and again there is no citation to support that anyone is saying this. Moreover, the author writes (again on page 45) that "If alcohol alone makes people violent... We would also expect to find an equal incidence of violence among drinkers in all societies, but we don't". Again, these sentences could be re-written to argue against culture as the sole driver of violence: "If culture alone makes people violent... We would also expect to find an equal incidence of violence among all people in the culture, but we don't".

On the whole, the author really needs to moderate their language. Alcohol is not the only driver of violence, but as far as I am aware no one is asserting that alcohol is the only driver. Similarly, it would be misleading to claim that culture is the only driver of violence.

The second major issue is related to the first. The author makes a large number of (often bold) assertions that are completely unsupported by any evidence. Or at least, the author makes no formal reference to any evidence that supports the assertions that are being made. Some examples of this include:
- On page 13, "At Galahad, we tested this 'placebo effect' in an experiment..." If we are to believe this experiment, then have the results been peer reviewed and published somewhere?
- On page 55, "Violence-reinforcing cultures tend to share the following features..." Who says they share those features? What is the evidence to support this? Following on page 56 by "It is beyond the scope of this report to analyse fully the extent to which each of these features is embedded in Australian and New Zealand society, but we can be find fairly solid evidence for the presence, to a greater or lesser extent, of features 1-9". So the author provides no evidence, and then states that they're not providing any evidence, but want the reader to believe their assertion anyway?

Similarly, there are a number of places where the evidence provided is extremely dated. In a lot of cases the literature has moved on from the 1980s and 1990s, but the author is still citing old literature in support of their assertions. There is one particularly laughable example of this on page 87, where the author writes: "Many alcohol and drug education packages are based on false and outdated assumptions about the nature of peer pressure. Several studies have concluded that the influence of peers is not necessarily a factor in the adoption of unsafe or reckless drinking habits and that, in fact, the very opposite can occur: peers can exert a stabilizing and controlling influence on the drinking behaviour." Then cites a paper published in 1985. It's hard to make a convincing case that others are using outdated assumptions when your supporting citation is 30 years old.

The third major issue is that some parts of the report are simply misinformed. On page 90, the author notes that "Parents need reliable, non-judgmental, unbiased and scientifically accurate information" about a number of issues. There already exists resources for this, produced by the Health Promotion Agency. Similarly, Recommendation 15 states that "Programs should be developed for high-school and first-year university students". Clearly the author is unaware of life skills programmes that already operate in high schools in New Zealand. And again, Recommendation 18: "Educational materials on designing drinking environments should be developed to support hospitality operators in improving their establishments". These resources are already available from the Health Promotion Agency.

On a related note, the author might want to check her data. On page 55, she asserts that Australia and New Zealand rank in the world's top ten countries for income inequality. However, in the OECD report that is cited, New Zealand is 12th out of the 34 OECD countries included, so clearly not in the world's top ten countries.

Fourth, the methods are not described in enough detail. How were respondents selected for interviews or focus groups? How was the data analysed? Was there a framework for the data analysis? Was the data analysed thematically, or using some other method? If thematically, how were the themes selected? How was the literature review conducted? (Given the dated nature of many of the references, this would seem important). Did the field research undergo an institutional review process? If so, where was it approved? If not, then how can the reader be sure that the research was undertaken to a high standard of research ethics?

There are also a couple of more minor issues.
- On page 44, the author tries to convince us that the incidence of violence is so low that alcohol could not be a contributing factor. She writes "If alcohol were a prescribed medication, a side-effect that was reported in only 0.11% of cases would not be considered to have been caused by the drug." This is clearly false - side effects are classified as rare if they affect between 0.01% and 0.1% of patients, but they are still caused by the drug. Moreover, I would consider a 0.11% incidence is quite high. If violent incidents were evenly distributed among the night-time public, then a person who went out three nights a week for a year has about a 1 in 6 chance of being a victim of violence. How is that acceptable?
- On page 54, in comparing rates of general violence and 'alcohol-related' violence between countries, the author states that: "The difference of course is the culture". But of course, that isn't the only difference between countries.

My overall recommendation for this report is that it requires major revision to meet generally accepted academic quality standards.

Monday, 4 May 2015

The cobweb model and the boom-bust cycle in the NZ dairy market

In ECON100 we teach the cobweb model of supply and demand, which is rarely taught in other courses at first-year level (see this paper by Steven Lim and I in New Zealand Economic Papers for a discussion of our overall approach to ECON100; or an ungated earlier version here). Students often ask whether the cobweb model is relevant to the real world - do suppliers really get 'tricked' by prices in markets with production lags?

It turns out they do. This New Zealand Herald article about the dairy sector from last week notes:
Fonterra has fallen into line with market expectations after oversupply and extreme volatility on world dairy markets prompted the co-operative to once again lower its farmgate milk price forecast for 2014/15.
The co-operative yesterday cut its forecast farmgate milk price for the current season to $4.50 a kg of milk solids from $4.70, having shifted it to that level in December from $5.30, and lowered the advance rate of scheduled monthly payments to its farmers. The 20c downward revision alone was estimated to lower farm incomes by about $370 million.
Fonterra said it now expected to produce slightly more milk this season despite the effects of this year's drought...
ASB Bank rural economist Nathan Penny said local production had suffered a lag effect of the season starting off at $7 a kg - at the time offering a green light for cashed-up farmers to produce more and spend more on supplementary feed - which pushed up output.
The cobweb model of demand and supply applies to markets where there is a production lag - where suppliers make a decision about how much to supply today (based on expectations about the price, which might naively be the observed price today), but the actual price that they receive is not determined until sometime later. The supply of dairy products in New Zealand fits this assumption - farmers make their production decisions today, but the dairy cooperatives (Fonterra, Westland, etc.) don't make a final decision on the price farmers will receive until close to the end of the season.

So, what has happened? At the start of the milking season, farmers' expected price was $7.00 per kg of milk solids (unless they had prescience), so they based their production plans on that price. In the diagram below, say that D0 and S0 are the initial demand and supply curves, respectively, with demand for dairy products relatively high. Farmers, who expect the price P0 ($7.00), produce Q0 units of dairy products (this is the quantity supplied on the supply curve S0, with the price P0). By the end of the season though, demand has fallen to D1. When the farmer cooperative tries to sell Q0 dairy products, the price falls to P1 ($4.50; this is the price where the quantity demanded, from the demand curve D1, is exactly equal to Q0).

Now, going into the next season farmers observe the low price P1 ($4.50) and expecting that low price to persist, they produce Q1 units of dairy products (this is the quantity supplied on the supply curve S1, with the price P1). Come the end of the season, the farmer cooperative finds that they can sell the Q1 dairy products for the much higher price P2 (this is the price where the quantity demanded, from the demand curve D2, is exactly equal to Q1). Now the price is high, farmers produce more but at the end of the season, the price falls... and so on. Essentially, the market follows the red line (which makes it look like a cobweb - hence the name of the model), and eventually the market gets back to long-run equilibrium (price P*, quantity Q*).

Will this always be a problem for the dairy sector in New Zealand? It seems likely. Farmers base their production decisions on the farmgate price forecasts of Fonterra, or AgriHQ, or their forecaster of choice. None of these forecasters have perfect foresight. So if the price forecast at the start of the season is too high relative to demand then prices will fall, and will fall further than the new equilibrium price would be, because farmers will be over-producing. And if the price forecast at the start of the season is too low relative to demand then prices will rise, and will rise further than the new equilibrium price would be, because farmers will be under-producing.

The moral of the story is that the New Zealand dairy production model locks us into a boom-bust dairy commodity cycle: any time global (read: Chinese) demand for New Zealand dairy products falls, the price in New Zealand will crash, while any time global demand for New Zealand dairy products increases, the price in New Zealand will skyrocket. And it seems unlikely that producing higher value-added products would adequately shield us from the cycle either - in years with high dairy prices, the cost of producing value-added products increases. I'm with Lyn Webster when she says: "a high milk price and a big return on value added products are mutually exclusive".

Reducing the extent of the boom-bust cycle may be possible if farmers can better smooth the price fluctuations - perhaps by making more use of forward contracts or dairy futures (see useful discussion here). That way at least, when the demand for New Zealand dairy products rises, farmers won't be 'tricked' into over-supplying (or under-supplying when the demand falls).

Saturday, 2 May 2015

This couldn't backfire, could it?... Ivory burning edition

This week the governments of the Republic of Congo and Chad burned five tons of ivory seized from poachers (see the Daily Mail article here), to send a message to elephant poachers. But what message are they sending, really?

Burning ivory decreases the available supply of ivory in the market (in the diagram below, the supply decreases from S0 to S1). The equilibrium price of ivory increases as a result (from P0 to P1). Higher ivory prices increase the potential profits from poaching, and incentivise more poachers to hunt elephants and existing poachers to hunt more intensively. That hardly seems like a recipe for saving elephants.

A better approach is to target the buyers of ivory, through import bans, fines, imprisonment, etc. If buyers were targeted rather than sellers, that decreases the demand for ivory (from DA to DB in the diagram below). That lowers the equilibrium price of ivory (from PA to PB). The lower prices decrease the potential profits from poaching, and many poachers will find other more attractive activities to engage in (maybe they start poaching rhinos instead).

Is it that easy? Probably not. Under current rules, elephant ivory that originated before the current ban on sales of ivory is allowed to be sold (see here, for example). To make matters worse, as Stephen Gallagher from City University Hong Kong noted in this 2013 article from the South China Morning Post:
Policing the illegal ivory trade has been complicated by the introduction of an exception for ivory originating from countries which claim to have viable elephant populations. In certain circumstances, ivory in its raw state may be exported under licence from Botswana, Namibia, South Africa and Zimbabwe...
Prosecutions may be further complicated by the sale of products in Hong Kong which may be carved from hippopotamus or walrus teeth, both specified species in Appendices I of CITES, or even mammoth ivory, a material obviously not covered by CITES as the species is already extinct. 
So, a policy of penalising buyers of ivory would have to deal with legal sources of ivory. On top of that, it would need some way of dealing with falsified credentials attached to illegal ivory, a situation which would surely arise. The U.S. has already moved to make domestic ivory trading more difficult by making buyers prove how and when ivory was imported. U.S. moves alone are likely to be insufficient though - the Chinese are the largest buyers of ivory, and enforcement of any penalties against buyers would need to include those in China. The Economist noted last year that:
a ban on ivory sales combined with clever advertising might work. A campaign supported by stars to wean Chinese consumers off shark fin nudged their government into dropping it from state banquets. Overall demand for the traditional delicacy has since fallen by half.
So, it may be possible to save the elephants through reduced demand. Ultimately though, the best approach may be to target both buyers and sellers. Reducing both the demand and supply of ivory (as in the diagram below, demand reducing from D0 to D1 , and supply reducing from S0 to S1), reduces the quantity of ivory traded by more than either reducing demand or supply alone would. The effect on price would be ambiguous - it depends on the relative size of the reductions in demand and supply (the diagram shows what would happen if the demand shift were larger in magnitude, with prices falling from P0 to P1).