TMML: Every TV news report on the economy in one

This video parodies the format of every news story on the economy, ever. Seriously funny:

[HT: Alex Tabarrok at Marginal Revolution]

Try this: The Econ 101 Database

Big thanks to Jodi Beggs at Economists Do It With Models for developing the Econ 101 Database back at the end of January. The database includes lots of links to recent news stories, helpfully organised by topic-based tags, and each one includes a description on how it can be used in teaching. Even better, Jodi is updating it regularly with new material.

For example, this week in ECON110 we have been covering taxes and subsidies. Jodi's database points to this article from Slate, with the comment that it "Gives an example of how people not understanding marginal tax rates and how the tax system work to scare people into thinking that moving up to the next tax bracket is going to leave them with less money overall after taxes."

My students can probably expect things from the database to pop up now and again (although now that I've highlighted it on my blog which many of them read, I'll need to be selective!).

Enjoy!

Other related teaching stuff:

• MRUniversity videos
• 'We the Economy' short films
• The Economics of The Office
• 'The Economy' free e-book

Solutions to the problem of squealing children, Japan edition

Back in December last year, I wrote a post on dealing with the problems of squealing children at least cost:

Now, squealing children is a classic negative externality - an uncompensated impact of the actions of one party on a bystander. The poor residents of Stonefields face a cost that is imposed on them by the unscrupulous actions of the children. Since the children have no incentives to take into account the costs that they are imposing on the residents of Stonefields, they generate too much noise compared to the socially efficient optimum.

How best to deal with the problem of squealing children? In Japan, they use a command-and-control policy - a daytime noise limit of 55 decibels (night-time 45 decibels) in residential suburbs. That's not much louder than bird calls, i.e. a pretty extreme limit not conducive to playing children. Parents can be fined if their children exceed the noise limit, a solution to the problem that is based on the "polluter pays principle". Under this principle, the party that is responsible for the pollution is solely responsible for making restitution for the damage they cause.

However, Robin Harding reports in the Financial Times that Tokyo is considering changes to the noise regulations:

“In the past this wasn’t an issue but recently more people have been complaining to city halls, saying ‘the children are too loud, please stop them’,” says Yukie Nogami, chairwoman of Tokyo’s environment and construction subcommittee. “The law says city halls have to act.”

Ms Nogami’s committee will soon debate a proposal to carve out an exemption from the noise rules, either for children under 12 or for certain places such as parks and kindergartens.

In line with what I argued in December, the 'least cost' solution to squealing children might not be command-and-control policies like noise bans (which entail a high cost in foregone fun for the children), but sound-proofing the neighbourhood homes. Sound-proofing entails a one-off cost for each home, versus an ongoing cost of foregone fun. Of course, the cost of soundproofing every residential property (rather than just those located near playgrounds or day care centres) would likely be prohibitive.

However, once you have a command-and-control policy in place (like Japan's noise limits), it's going to be difficult to back out of. The noise limit created a new property right (the right to extreme residential quiet), and once created there is no Pareto-improving way to remove the right - that is, there is no way to remove the noise limits without making at least some people worse off. Who is going to be worse off? From the FT article:

About two-thirds of respondents to a consultation support the change but a minority is strongly against, complaining about everything from the lax upbringing of modern children to the effect on property prices.

The effect on property prices may well be real. If extreme quiet is valuable to Japanese homeowners (and prospective home buyers), then removing that property right is going to lower the value of residential homes (especially those close to playgrounds and day care centres). So at least some homeowners are right to be worried.

Moreover, the homeowners whose properties will be affected have a large incentive to protest the change in noise limits - the cost of the changes (in terms of lost property value) are likely high for each homeowner relative to the cost of protesting. Whereas the gains from the change in noise limits are spread widely among children and their parents, each of whom probably only gain a little from the changes. So expect lots of argument over this planned change, unless the homeowners can be adequately compensated. Following the compensation principle, if those who gain from the policy change (children and parents) can adequately compensate those who lose (affected homeowners), then the new policy (no, or higher noise limits) should be preferred. Since it would be difficult for children and parents collectively to compensate homeowners (free riders, anyone?), the compensation would likely have to come from taxpayers instead.

Of course, the better solution would have been not to have the extreme noise limit in the first place. As I noted in December (in relation to playgrounds in Stonefields):

The Coase Theorem tells us that, if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own (i.e. without government intervention). In the case of a bargaining solution under the Coase Theorem, it depends crucially on the distribution of entitlements (property rights and liability rules). Do children have the right to play and make noise? If so, then the residents would have liability to pay the children to be quiet - maybe buy them a bunch of Playstations and send them indoors to be quiet. Either that, or the children can just keep having fun in the playground and making as much noise as they like. On the other hand, do the residents have the right to peace and quiet? If so, then the children would have liability to compensate the residents for the noise of their playing. Either that, or they have to give up the playground.

Who has the rights? At the moment in Japan it's the homeowners, but I'm not convinced that was ever the least cost solution. As one respondent to the survey discussed in the FT article notes:

“To play and cry and make a big noise is a child’s right.”

Are university vice-chancellors' pay increases justified?

In the UK, the pay of university vice-chancellors' (VCs, the equivalent to president of a U.S. college) has been in the news recently. For instance, from Times Higher Education:

University vice-chancellors were paid £260,000 on average in the last academic year, a pay survey by the University and College Union shows

Neil Gorman, who was then vice-chancellor at Nottingham Trent University, earned the most in 2013-14 with his total benefits amounting to £623,000...

Seven universities paid their vice-chancellor more than £400,000 in salaries, bonuses, other benefits and pension contributions, the union said...

Sally Hunt, the UCU’s general secretary, said that the “lack of transparency and accountability surrounding senior pay and perks [was] a national scandal”.

Do university vice-chancellors deserve their high pay though? Not according to research cited by The Guardian:

The research, by economist Ray Bachan, from Brighton Business School, also looked at the extent to which the pay awards of university leaders were related to university performance measures, to shed light on whether headline pay awards were justified. In particular, it analysed vice-chancellors’ success in increasing the number of students from comprehensive schools and low-participation districts, and their record in bringing in income such as grants for teaching and research and capital funding.

It found that, while some of the pay increase could be explained by improvements in these areas, a “significant proportion” of the rise in vice-chancellors’ pay bore no relation to performance. Bachan said: “significant proportion of the sizeable annual increases are not easily explainable in terms of university performance, and this raises some concern.”

The research suggests that the presence of other high-paid staff in an institution pushes up vice-chancellors’ pay. University remuneration Remuneration committees, which set pay rates, may also seek to set the salary at a level commensurate with comparable institutions, said the study, which was published this month in the Fiscal Studies journal.

Note that The Guardian's headline is "‘Eye-watering’ salary rises for university chiefs cannot be justified, says report". The journal article by Ray Bachan (University of Brighton) and Barry Reilly (University of Sussex) in Fiscal Studies is available here (I don't see an ungated version anywhere). The authors do say something similar to The Guardian headline in the abstract:

However, even after controlling for a rich array of observable and unobservable factors, there have been sizeable increases in real pay in recent years that cannot be readily explained.

Having read the paper though, The Guardian's headline and the authors' abstract are both overstating the problem. There is nothing in the journal article by Bachan and Reilly that suggests to me that the salary rises are unjustified. I would argue quite the opposite, in fact. The authors use institutional performance as a predictor of VC salary. All three measures of 'mission-based performance measures' had positive and statistically significant relationships with VC salary, as did one of the three 'financial-based performance measures'. Other than year fixed effects, the among of funding council grants received was the most statistically significant determinant of VC salaries. So, I don't think it's correct to say that the salary rises cannot be justified - they are actually linked to institutional performance.

Of course the model doesn't explain all of the increases in VC pay - it has an R-squared of nearly 0.7, so the model explains nearly 70 percent of the total variation in VC pay. That leaves some 30 percent unexplained. But for an econometric model, that is really rather good. You might argue that not being able to explain all of the variation in VC pay means that the salary rises are not justified by performance. However, the models are not complete - there may be performance-related variables not included in the model that are important and might explain some of the remaining variation in VC pay. Indeed, the authors note themselves that:

Modelling the relationship between CEO pay and performance in the public sector is not an easy task. Estimating the relationship between VC pay and performance is also fraught with difficulties given data constraints. Our results suggest that institutional performance, external benchmarks and internal pay structures or tournaments play an important role in the pay-determining process. Nevertheless, if more detailed data on internal university pay structures (such as the pay of professors or other highly-paid staff) are made accessible or if compatible performance data on other aspects of performance not covered in this research (such as teaching and research) become available, more fruitful insights into this pay–performance relationship may be gleaned.

One further point to note is that the authors find that the proportion of staff earning more than £70,000 has a large positive and statistically significant effect on VC pay. They attribute this to tournament effects, which we have just finished discussing in my ECON110 class.

With tournament effects, a small group of highly successful workers get paid high salaries (VCs in this case), while many others accept lower salaries in exchange for the chance to become one of the highly successful few in the future. The high salaries at the top need not be related to performance of those at the top - instead, high wages at the top incentivise those lower down (e.g. other top executives) to work hard in order to ‘win’ the tournament. So, high VC (and CEO) salaries may motivate pro-VCs (and deputy CEOs) and others further down the organisational ladder who aspire to reach the top. And if the salaries of those lower down the ladder are high, the VC pay would need to be even higher to create an effective incentive. Which is essentially what the authors found.

Of course, not all academics are motivated to become VCs. The academic tournament is somewhat different  than the tournament for academic administrators (and I've blogged on that earlier - see here).

So, are the recent increases in vice-chancellors' pay justified? The research doesn't really answer that normative question fully, but possibly yes - at least, the research shows that increases in pay are linked to increases in performance. As to whether the tournament effects are 'justified', I leave that up to you to decide.

How my views on inequality have evolved over the last year

I've been teaching about poverty and inequality for a number of years, but that teaching (at both undergraduate and graduate levels) focuses on the measurement of poverty and inequality, particularly using income as a metric (although my graduate class did cover multidimensional poverty approaches and classes at both levels were introduced to Sen's capabilities approach). The focus on measurement has meant that differences in the problems associated with poverty and inequality (as separate issues) are somewhat muddied. This isn't helped of course by one of the main tools used to reduce poverty - income redistribution through progressive taxation, transfers, etc. - also reduces inequality. Yesterday I did a guest lecture for a second-year social policy class, which gave me an opportunity to reflect on how I've changed my views on inequality over the last year or so, which I thought I would share here.

In the last year, my thinking about inequality has come almost full-circle. Initially I was of the opinion that greater inequality created problems of unequal access to basic needs such as healthcare, education, etc. and lower social cohesion (more crime, etc.), lower economic growth, and lower happiness (or subjective wellbeing, in economic parlance). These views were based on a range of research that I have read over the years.

Then I read the Max Rashbrooke-edited book "Inequality: A New Zealand Crisis". This book changed my views greatly, but not in the way that the contributing authors would have intended. Almost every chapter of the book described the 'problems of inequality' as pertaining to low-income households. As I read the book I realised they were often conflating 'problems of inequality' with 'problems of poverty'. Max Rashbrooke was clear in the introduction on the reason for this:

If incomes do matter, the question remains: why put so much stress on a relative issue, the difference in incomes between various groups? Why not focus simply on the fact that some people are too poor to get by, in a basic material sense?

The short answer is that poverty is not just a problem for the poor; it concerns and involves everyone, including the very well off. In these pages, we describe the levels of poverty now found in New Zealand as a crisis for the society as a whole.

Which would be great, if that's what the authors did. I didn't see anywhere in the book where they clearly made the case for why poverty is a problem for the well-off (other than through general concern for the wellbeing of others). Which brings me back to the difference between 'problems of poverty' and 'problems of inequality'. To understand the difference, consider the following thought experiment:

Let's say you rounded up all of the richest people in an area, took 10% of all of their wealth, and burned it. What would happen to poverty and inequality?

If we took this action, it would reduce the wealth of the rich, but it does nothing for the wealth of the poor. Clearly burning part of the rich people's wealth must reduce inequality as the wealth difference between rich and poor has narrowed. However, it wouldn't affect poverty at all, as it doesn't give the poor any more resources. So, if you're wondering whether a problem is primarily related to poverty or primary related to inequality, you need to ask: Would the problem be reduced by burning 10% of the wealth of all of the richest people?

If the answer is yes, then the problem probably stems primarily from inequality. Otherwise it is more likely to be primarily a problem of poverty. For example, say you are concerned about the large number of parents unable to feed their children a nutritious breakfast before school. It seems unlikely that burning wealth would reduce the problem, so it is more likely a poverty problem not an inequality problem.

The difference between problems of poverty and problems of inequality may appear to be semantic, but the policy prescriptions for reducing inequality and for reducing poverty need not be the same. For instance, an unconditional basic income is argued as a means of reducing absolute poverty, but would do little or nothing to reduce inequality as it simply shifts up the whole income distribution.

Anyway, reading the Rashbrooke book left me feeling a little bit unsettled and wondering a bit whether there were any problems associated with inequality that weren't inherently poverty issues, given the authors focused on poverty issues rather than inequality issues. So I followed it up by reading "The Spirit Level", by Richard Wilkinson and Kate Pickett. This book has been roundly criticised by economists and others (especially see Christopher Snowdon here), but I didn't think it was all that bad. I had two main takeaways from the book. One was negative, and I'll blog about that separately later. The other was summed up nicely by the following passage from the book:

We concluded that, rather than telling us about some previously unknown influence on health (or social problems), the scale of income differences in a society was telling us about the social hierarchy across which gradients in so many social outcomes occur. Because gradients in health and social problems reflect social status differences in culture and behaviour, it looks as if material inequality is probably central to those differences. (Wilkinson and Pickett, p.28).

In other words, the observed relationship between inequality and social problems reflects (in part) differences in social status between groups. Since inequality perpetuates differences in social status between groups (particularly when social mobility is low), this makes inequality self-reinforcing. This self-reinforcement of inequality relates to an argument that social distance makes us more accepting of inequality (as Wilkinson argues in his earlier book, "The Impact of Inequality", and incidentally is also raised in the chapter by Paul Barber in his chapter in the Rashbrooke book), and recent research that higher levels of inequality make us more accepting of inequality. So, because inequality is self-reinforcing this leads to increasing segregation by social class, reducing social cohesion. So, I felt a little better as I had re-discovered at least one problem that related to inequality but not necessarily to poverty.

Finally, at the start of this year I read the Robert Frank book "Falling Behind: How Rising Inequality Harms the Middle Class". I'm a big fan of Robert Frank and he brought a different perspective on inequality to the other two books. In this book, he highlights that the actions of high income individuals change what is deemed socially acceptable in terms of housing and other 'positional goods' (positional goods are goods that signal the owner's relative social standing - similar to conspicuous consumption that I have discussed before here). Frank makes the case that there is competition by middle class families for houses in desirable areas, close to good schools, where public safety is higher, and closer to work and amenities, etc. This competition drives the price of those positional goods higher, leaving less income for middle class families to spend on non-positional goods. As Frank describes:

Increased spending at the top of the income distribution has imposed not only psychological costs on families in the middle, but also more tangible costs. In particular, it has raised the cost of achieving goals that most middle-class families regard as basic.

The process starts when sharply higher incomes prompt top earners to build larger mansions. To the extent that middle-income families even notice these mansions, there is no evidence that they are offended by them. On the contrary, many seem to derive pleasure from seeing images of them in magazines and on television.

But for those just below the top, the new mansions alter the frame of reference that defines what kind of house is considered necessary or desirable. Perhaps it is now the custom to host one’s daughter’s wedding reception in the home, or to host larger dinner parties. And when the near rich, in turn, build larger houses, others just below them find their own 10,000-square-foot houses no longer adequate, and so on all the way down the income ladder.

People who live in less expensive houses not only feel relatively deprived (a psychological cost), but also miss out on good schools, safe neighbourhoods, and face more expensive and time-consuming commutes to work (also costs). So rational people trying to avoid these costs can't easily opt out of the battle for positional goods. All of which links inequality to relative deprivation, and to lower happiness.

So, in the end that short journey through three books has brought me back more-or-less to where I started the year. At least, in the sense that inequality is a problem because of lower social cohesion and lower happiness (and lower economic growth, see this OECD report (PDF) from late last year).

Of course, I reserve the right to change my position again, and I have a few more books on inequality that I'd like to read. But more on those later.

The economics of slave redemption

I was really disappointed when the chapter on the economics of slave redemption was dropped from more recent editions of The Economics of Public Issues (the required textbook for my ECON110 class). Slave redemption has features of unintended consequences, coupled with supply and demand, which made it a really useful application early on in the course.

To understand the problem, it is worth starting with this video, which sets the scene nicely:

Now, the problem is that these well-meaning charities, who want to reduce the number of slaves by buying them and releasing them (referred to as slave redemption), simply increase the demand for slaves. Increased demand for slaves (as shown in the diagram below from D0 to D1) increases the price of slaves (from P0 to P1), and importantly increases the quantity of slaves traded (from Q0 to Q1). So slave redemption increases the quantity of slaves traded - the opposite of what was intended.

To make matters worse, the actions of the slave redeeming charities creates some other perverse incentives. Since slavery is now more profitable than before, and we're talking about a poor country like the Sudan where per capita income in 1990 in the middle of the Second Sudanese Civil War was about US$242 (in 2000 US$), one way that non-slavers could increase their income was to pretend to be slavers. Here's how it worked: A bunch of people would gather together, and one of them would pose as a slaver and the others as slaves. Then when the well-meaning Western slave redeemers show up, the 'slaver' pockets the money, the 'slaves' are freed, and they could meet up afterwards to split the proceeds. Rinse and repeat. So, the slave redeemers might not have even be freeing 'real' slaves at all.

Anyway, MRUniversity has just released a video on Elasticity and the Economics of Slave Redemption, which extends the analysis to consider the impact of elasticity:

As Tyler Cowan notes in the video, the number of extra slaves (including 'fake' slaves) traded will depend on the price elasticity of supply of slaves, as illustrated in the diagram below (which is not drawn to scale). If supply is relatively inelastic (the supply curve is steep, like SSR), then the number of additional slaves for a given increase in demand (from D0 to D1) will be small (quantity increases from Q0 to Q1), and the price of slaves will increase greatly (from $15 to $300). In contrast, if supply is relatively elastic (the supply curve is flat, like SLR), then the number of additional slaves for the same increase in demand (from D0 to D1) will be large (quantity increases from Q0 to Q2), and the price of slaves will not increase by much (from $15 to $50).

According to this article in the Atlantic from 1999, the actions of the slave redeemers increased the price of slaves from around US$15 to US$300 (as shown in the diagram above), so it seems likely that supply was relatively inelastic (SSR) initially. However, prices fell later (to US$100 then to US$50), showing that supply is more elastic in the long run (SLR) than the short run. This is because in the long run slavers have more time to adjust to the increased demand by increasing the intensity of their slaving activity (by enslaving more people). And non-slavers take time to recognise the opportunity and gather a group of friends to take advantage of the incentives to sell 'fake' slaves.

So there you have it - the economics of slave redemption. And amazingly, despite the unintended consequences, slave redemption continues today.

Safer driving and offsetting behaviour - Golden Gate Bridge edition

Having just covered unintended consequences and offsetting behaviour in ECON110, recent changes at the Golden Gate Bridge provide us with a graphic example. As John King at the San Francisco Chronicle reports:

The California Highway Patrol announced Thursday that it is stepping up enforcement of speed limits on the Waldo Grade in Marin as well as at the bridge and toll plaza. The reason is that in the days since the more secure movable median barrier was installed, the average speed of drivers on the approach from the north has jumped even though the speed limit was lowered from 55 to 45 miles per hour.

“We’re really seeing unreasonable speeds on the bridge, much faster than before,” said Priya David Clemens, a representative for the Golden Gate Bridge District. For whatever reason, including the possibility that drivers feel safer knowing a car won’t come barreling at them from the opposite direction, “we’ve noticed speeds going up,” Clemens said. “That’s why we asked the CHP to help us.”

I've written before about safer cars and offsetting behaviour, but I will reprise some of that material here:

Rational (or quasi-rational) drivers weigh up the costs and benefits of driving faster. The benefits include less time wasted on the roads (an opportunity cost - you give up some time you could spend doing something else). Moreover, the marginal benefits probably decrease the more a driver speeds (because opportunity costs increase the more time is wasted). The costs of driving faster include an increased risk of a serious car accident - this cost is made up of two parts: (1) the probability of a serious accident occurring; and (2) the health and other costs of the accident itself. The marginal costs increase as speed increases, because the probability of an accident and its seriousness both increase.

If they are optimising, the driver will choose to drive at the speed where the marginal benefit (MB) of driving faster is exactly equal to the marginal cost (MC0). This occurs at S0 in the diagram below. At this point, driving a little bit faster entails a higher additional cost than the benefit they would receive (which is why they will drive no faster than S0).

When driving is made safer (such as by installing a median barrier on the Golden Gate Bridge), this changes the incentives that drivers face. The cost of driving fast falls (since the chance of being involved in a head-on collision on the bridge is reduced). So, in the diagram above, marginal costs of speed are lower (MC1). This increases the optimal driving speed to S1. What we would observe then is drivers driving faster because of the perceptions of greater safety, with probably an overall increased chance of being involved in accidents (but fewer head-on accidents because of the median barrier). Indeed, according to the SF Chronicle article:

An uptick in minor accidents has been seen at the toll booths, she said, though exact numbers are unavailable.

Economists term changes in behaviour like this "offsetting behaviour", because the actions of the drivers act to offset the benefits of increased safety on the bridge. It's also referred to as a Peltzman effect, after Sam Peltzman who showed in this paper (JSTOR gated) that mandatory safety devices on cars, such as seat belts, do not reduce traffic deaths, and actually increase the number of non-fatal car accidents.

[HT: Marginal Revolution]

Economics majors have the most sex!

Given the title of my blog, I couldn't really let this pass for too long without some comment. Last month, Ninja Economics pointed out this report on Students and Sex 2012 (PDF) from the UK (see Huffington Post too). According to the report's 'Inter-course League' table (no, I'm not making that up), students studying "Economics and related" courses have had on average nearly five sexual partners. Second was "Social work, community care and counselling" and third was "Marketing". "Environmental Science" and "Theology and comparative religion" are at the bottom of the table. Take from that what you will.

We've been talking about opportunity cost in ECON100 and ECON110 this week. The opportunity cost of something is defined as "its cost measured in terms of the best alternative foregone". When thinking about the best alternative foregone when attending lectures, this bit from the report becomes interesting:

Of course, that's all students not just economics students, but maybe it goes some of the way to explaining low lecture attendance at the end of O-week - is the opportunity cost of lecture attendance too high?