Mushroom farming causes a stink

Earlier in the week, Hawke's Bay Today reported on an ongoing battle between Te Mata Mushrooms and the Hawke's Bay Regional Council (on behalf of local residents):

The owner of Te Mata Mushrooms has lashed out at Hawke's Bay Regional Council, saying its prosecution over an alleged breach of resource consent conditions amounts to a bid to have the company shut down.

The Havelock North business is facing six charges and a maximum $600,000 in fines after complaints it has failed to contain odours generated by the compost it makes to grow its mushrooms in.

Under its 2012 resource consent, odours from the mushroom farm must not waft over its boundaries but the council says it has received numerous complaints...

The mushroom farm had been on its Brookvale Rd site since 1967 and in the past few years Hastings District Council had allowed more than 160 houses to be built nearby, Mr Whittaker said.

Ronald Coase argued that externalities are jointly produced. That is, it takes two parties to create an 'externality problem' - the party that generates the externality, and the party who is affected. In this case, if there were no residents living in close proximity to the mushroom farm (as was the case until relatively recently), then the odour from the compost would not be a problem.

Since there are now nearby residents who are affected, we need to consider whether government intervention is necessary. 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).

If Te Mata Mushrooms has the right to compost on their property, then the default solution is that the residents just have to put up with the smell, or move elsewhere. The alternative solution is that the residents could pay compensation the mushroom farmer in exchange for the farmer reducing production, or altering their production method to produce less odour. The alternative solution would only be feasible if the compensation paid by the residents was individually less costly to each of them than the amount that they value the loss of enjoyment created by the odour, and the compensation was more than the lost profits of the mushroom farmer. Of course, the problem here is that getting all residents to collectively pay the farmer is difficult due to free-riding (some residents could choose not to pay, but would still receive the benefits if the farmer reduced the odours).

On the other hand, if residents have the right not to have their nostrils assailed by compost stench, then the default solution is that the mushroom farmer must reduce odours (through reduced production, or altered production method). The alternative solution is that the mushroom farmer could pay compensation to the residents for their loss of enjoyment of their property.

In this case, given that there are resource consents in place that limit Te Mata Mushroom's activities in terms of the odours it generates. So, it is clear that the residents have the over-riding rights. Even though the mushroom farm was there first, the time for the farmer to fight this battle over rights was at the time of the resource consent, not now. It is too late and they have to either comply, compensate the residents to placate them and avoid complaints, or face the consequences.

This might seem like a straightforward application of the polluter pays principle, but is also probably the least-cost solution to the externality as well. The cost to the farmer (who can presumably relocate further from residential areas if necessary) is likely to be lower (and a one-off capital or relocation cost) and concentrated in a single party, compared to an ongoing cost to many residents from the farm's activities.

Why study economics? It could make you rich...

The Independent reported last week:

New research has revealed the most lucrative subjects to study at university in order to get the highest paying salaries.

Economics graduates fair the best with earnings in the region of £45,000 five years after university.

That's right, economics graduates (and future graduates). You have the highest earnings in the U.K. five years after graduation. Similar to New Zealand results I have reported on earlier. Apparently, the data comes from Emolument, a salary benchmarking website. The data are reported in this table (available here):

Emolument says:

Degrees in Economics, Finance, Mathematics and Statistics are shown to be the best route into lucrative careers in the financial services industry. In contrast, students of humanities like Geography, History and Politics are the most likely graduates to follow careers in charities, not-for-profit organisations and the public sector.

Previously on this blog:

• Why study economics? Sheepskin effects edition
• Why study economics? NZ graduate earnings edition
• Why study economics?

The Why Axis, and the fairness of economic discrimination

Earlier in the year I read the Uri Gneezy and John List book "The Why Axis: Hidden Motives and the Undiscovered Economics of Everyday Life". I was looking forward to reading this book, and in general it was very good. The authors use their own field experimental research to demonstrate how incentives can be structured to change behaviour (among many other things). Field experiments are one of the most exciting recent developments in economics (and I've talked about some of John List's research briefly before). However, there was one section of the book that I took issue with, which is to do with 'economic discrimination'. Here's what they say on pages 116-119, in a section titled "Economic Discrimination: A Rising Problem":

...another variety of discrimination is on the rise today... Economists call this different kind of prejudice "economic" discrimination, and though it is more subtle than bigotry, homophobia, or sexism, it is increasingly widespread, multifaceted, difficult to parse, and often quite nefarious. And it's based entirely on financial self-interest and "looking out for number one."

You are probably already aware of economic discrimination because it shows up in your bills. If you are a smoker, your medical insurance may cost you more because, economically speaking, you run a higher risk of contracting diseases that cost a lot to treat. If your credit rating isn't stellar, banks will charge you more for loans because you present a comparatively higher risk of defaulting on them.

Another very straightforward example is car insurance. If you are a male driver, you pay as much as 20 percent more for car insurance than a woman does for identical coverage. You might wonder if this unequal treatment is illegal, because civil rights laws clearly state that discriminating on the basis of arbitrary characteristics such as race and gender is illegal. On average, however, women have fewer driving accidents than men. The costs of insuring women are therefore less than for insuring men, so the courts have ruled that charging women lower - or men higher - rates is legal...

 But, you may ask, what is really wrong with this kind of discrimination? After all, in the real world, customers often pay different prices. Anyone who has bought an airline ticket, booked a hotel room, or rented a car has faced such economic discrimination... If you are a well-heeled businesswoman who needs to fly from Chicago to San Francisco for a quick one-day meeting, you may care less about the price than if you are a teenager on a tight budget. Why shouldn't the airline charge you, the businesswoman, more?

Gneezy and List are essentially arguing that offering different prices to different customers is unfair, noting that "most people believe that this type of behavior is unfair". I'm not sure to what extent most people do believe this is unfair, but Gneezy and List argue that it is particularly unfair when customers don't know that they are paying a different price to others. Their solution is that we, as consumers, should arm ourselves with as much information as possible, including knowing what data companies have collected about us and how they are using that data.

However, I disagree that economic discrimination (in the form of different prices for different customers) is a problem. In fact, the obvious alternative (the same price for all customers) may be more unfair. And I'm going to use Gneezy and List's own examples from the quotes above to explain why. Before I do that though, I need to distinguish two reasons why consumers may pay different prices.

First, consumers may pay different prices because there are genuine differences in the cost of providing the goods or services to different consumer groups. Consumers who are high-cost pay higher prices than consumers who are low-cost. Women typically pay more for haircuts than men because women's haircuts take longer (usually) than men's, which means more time and staff costs for the hairdresser. Similarly, from the examples above (and as Gneezy and List note), young male drivers pay more for car insurance than young female drivers. Women have fewer accidents and are therefore less costly to insure than men, so women pay lower car insurance premiums than men. If both men and women paid the same insurance premiums, then women would pay more for insurance than they do now, and men would pay less. This is a great deal if you are a young male (like the boy racer from my post earlier in the week), but a pretty poor deal if you are an older women driver. Women drivers would effectively be cross-subsidising men for the men's worse driving behaviour. It's hard for me to see how the non-discriminating solution is fairer than the economic discrimination.

Second, consumers may pay different prices because of price discrimination - where different consumers (or groups of consumers) are charged different prices for the same good or service, and where the difference in price does not arise because of a difference in cost. For price discrimination to work, you need to meet three conditions:

1. Different groups of consumers (a group could be made up of one individual) who have different price elasticities of demand (different sensitivity to price changes);
2. You need to be able to deduce which consumers belong to which groups (so that they get charged the correct price); and
3. No transfers between the groups (since you don't want the low-price group re-selling to the high-price group).

Consumers who have relatively elastic demand for the good or service will then pay a lower price than consumers who have a relatively inelastic demand for the good or service. This is the reason why, for example, students pay a lower price for movie tickets than general admission. Because the cost of a movie ticket takes up a higher proportion of the income of a poor student, students have relatively elastic demand for movie tickets (compared with the general public). Movie theatres can easily tell them apart from the general public (because students have a student ID card), so are able to use price discrimination to set a lower price for students.

Similarly, the businesswoman travelling from Chicago to San Francisco (in the example above) has few substitutes for the day or time of the flight (she needs to be there at a specific time on a specific day), so has relatively inelastic demand for a ticket (compared to a teenager on a tight budget who has more flexibility over their travel dates). So the businesswoman would pay a higher ticket price than the teenager for the same airline ticket. If all travellers paid the same ticket prices, then the teenager would pay more for their airline ticket than they do now, and the businesswoman would pay less. This is a great deal if you are the businesswoman, but a poor deal if you are the teenager on a tight budget. The teenager would effectively be cross-subsidising the businesswoman, who is clearly willing to pay more for her ticket. Again, it's hard for me to see how the non-discriminating solution is fairer than the economic discrimination.

So, as much as I admire the research of John List in particular, I can't agree with the authors on their point about economic discrimination. To me there are a number of cases where discriminating on price is actually fairer than having one price for all.

Boy racer struggles to get car insurance

A few weeks back I read this New Zealand Herald article, about the struggles of a poor disadvantaged boy racer to get insurance for his new car:

The user posted on Reddit, an online message-board website, to ask who would insure a 20-year-old male with a 3.5 litre engine car.

Reddit user Mashayous said he had tried both AA and Tower but both had denied him because of his age and type of car.

"Can anyone help me out," he asked.

"I just got a new car a few days ago (2005 Nissan 350Z) and I'm having trouble trying to find a company that is willing to insure it.

I've tried the major ones like AA and Tower, but both have said that they can't offer any form insurance for my car."

Insurance markets are prone to information asymmetry problems, like adverse selection and moral hazard. Insurance companies have developed sophisticated means of dealing with these problems.

Adverse selection requires private information, and it requires that the informed party must be able to benefit from keeping the private information secret. In the context of car insurance, the classic explanation is that the driver knows whether they are a high-risk or low-risk driver (this is private information that the insurer doesn't know). Higher risk drivers should pay a higher premium. However, because the insurance company can't tell the high-risk and low-risk drivers apart, that leads to a pooling equilibrium. The insurance company must assume that everyone is high risk, and raise premiums for everyone as a result. This forces the low risk drivers out of the market, because the insurance premium is too high. This raises the average risk profile of insured drivers, and the insurance company raises premiums. This forces the medium risk drivers to reconsider, and eventually only the high risk drivers are left buying insurance (if insurance is offered at all).

Now, this isn't quite the situation here. The insurance company knows a bit about 'Mashayous' - they know he is 20 years old and he is trying to insure a 2005 Nissan 350Z. This reveals information about the riskiness of the insurance contract, which should allow the insurer to price the insurance contract appropriately. Given that he was denied by AA and Tower, they must believe that he is too high risk to even bother with, probably because of moral hazard.

Moral hazard is the tendency for someone who is imperfectly monitored to take advantage of the terms of a contract (a problem of post-contractual opportunism). Drivers who are uninsured have a large financial incentive to drive carefully and avoid accidents, because if they have an accident they must cover the full repair cost themselves (not to mention the risk to life and limb). Once a car in insured, the driver has less financial incentive to drive carefully because they have transferred part or all of the financial cost of any accident onto the insurer (though the risk of injury remains, of course). The insurance contract creates a problem of moral hazard - the driver's behaviour could change after the contract is signed. And this is a particularly big problem if the driver is young, inexperienced, and driving a fast car. So no surprises that the insurance companies are passing on the opportunity to insure him.

Previous posts on insurance, adverse selection and moral hazard:

• Could technology eliminate moral hazard in car insurance?
• Is there adverse selection in the life insurance market?
• Big trees, home insurance and adverse selection

More on game theory and the penalty shootout

A couple of weeks ago I wrote a post on game theory and penalty shootouts:

The penalty shootout is an excellent example of a game with no Nash equilibrium in pure strategy - where the equilibrium is a mixed strategy equilibrium. That is, it is best for the players to randomise their strategy choice...

Notice that there are no outcomes (cells) where both players are playing a best response, so there is no Nash equilibrium in pure strategy. To work out the mixed strategy equilibrium, we would need to know a bit more about the probability of success if both goalkeeper and shooter chose the same (here we assume there was a 0% chance of a goal), and the probability of success if they chose differently (here we assumed there was a 100% chance of a goal). 

Mark Johnston (HOD economics at King's College in Auckland) pointed me to several blog posts he has written on penalty shootouts. This post in particular gives us the probability of success or failure depending on which way the kicker shoots and which way the goalkeeper dives (the data comes from Ignacio Palacios-Huerta's book Beautiful Game Theory):

In the table above, NS represents the kicker's 'natural side' (to the right for a right-footed kicker), and OS represents the kicker's opposite side. Solving for the mixed strategy equilibrium requires some algebra. Let p be the probability that the kicker kicks to their natural side (and 1-p will be the probability that the kicker kicks to the opposite side). And let q be the probability that the goalkeepers dives to the kicker's natural side (and 1-q will be the probability that the goalkeeper dives to the kicker's opposite side).

Now, for each player we set the expected values of their two strategy choices to be equal, but those expected values depend on the probability that the other player chooses each strategy (this is analagous to our definition of Nash equilibrium, where both players are doing the best they can, given the choice of the other player).

So, for the kicker:
EV[natural side] = 0.7q + 0.95(1-q) = 0.95 - 0.25q
EV[opposite side] = 0.92q + 0.58(1-q) = 0.58 + 0.34q
0.95 - 0.25q = 0.58 + 0.34q
0.59q = 0.37
q = 0.627

And, for the goalkeeper (remembering that the payoffs to the goalkeeper are the complement of the payoffs to the kicker):
EV[natural side] = 0.3p + 0.08(1-p) = 0.08 + 0.22p
EV[opposite side] = 0.05p + 0.42(1-p) = 0.42 - 0.37p
0.08 + 0.22p = 0.42 - 0.37p
0.59p = 0.34
p = 0.576

So, the mixed strategy equilibrium is for the kicker to kick to their natural side 58% of the time (p = 0.576) and the goalkeeper to dive to the kicker's natural side 63% of the time (q = 0.627). Which makes sense - the kicker has a higher probability of scoring on their natural side, and knowing this the goalkeeper should go to that side more often.

For more on solving for mixed strategy equilibrium, try this video by William Spaniel:

Johann Hari on the war on drugs

Fivebooks.com has an interview with British author and journalist Johann Hari, who talks about the global failure that has been the war on drugs, and our misunderstandings about addiction. There's lots of interesting bits (I encourage you to read it all), but some parts in particular caught my attention, like this bit:

Then, after Prohibition really kicks in, what Henry Smith Williams sees is two massive crime waves. Firstly, drugs are transferred from people like him to armed criminal gangs. These gangs are violent and jack up the price massively — I think the figure is 1000% — because you have to pay people a premium to take the risk of going to prison in order to sell it. Then, to pay these massively inflated prices, you get the second crime wave, which is people who previously bought their drugs at low prices from pharmacies suddenly stealing or prostituting themselves to pay for it. He also notices a huge increase in the death rate among addicts. So all sorts of changes happen, and, having previously been very unsympathetic to addicts, he starts thinking, ‘We’re really destroying these people.'...

The other fascinating thing about Drug Addicts are Human Beings is that he talks about why drugs were banned in California. The loophole of doctors being able to prescribe drugs to addicts is shut down state by state, and California was one of the last holdouts, partly because politicians there were quite brave. Henry Smith Williams reveals the story of why it was eventually shut down. I went and looked at the archives of the court case involved. It turns out the Chinese drug gangs in California were really pissed off, because in Nevada they had shut down medical prescription, and so drug addicts had to go to the drug gangs to get their drugs. In California they could still go to the doctor, so the drug gangs bribed the narcotics police to introduce the drug war in California. What this tells us is that, right at the start of the drug war, criminal gangs were paying for it to be introduced because they’re the only people who win from it. They’re the beneficiaries.

For me, it was fascinating seeing the same dynamic at the end of the drug war, when I interviewed the people who led the Colorado marijuana legalisation campaign. They would make the case that we should legalize marijuana because it would bankrupt the cartels. But Steve Fox, one of the leaders of the campaign, explained to me that people in Colorado were really scared, they thought the cartels would threaten them or even kill them if they made that argument publicly. It’s fascinating to see, both at the beginning and end of the drug war: Who wants it? Who wins from it? Who benefits from it? It’s armed criminal gangs. For everyone else, it’s a disaster.

The war on drugs increases the costs of supplying the market, due to the risks of imprisonment or fines for sellers. This in turn substantially raises the equilibrium price of drugs. Another reason for the increase in the costs of supply is the risk to sellers being a victim of murder or violence (more likely from other sellers than from buyers or the police). As Hari explains:

The best way to explain it is like this: if you or I go to the local off-license [liquor store], and try to steal the beer or vodka, the owner will just call the police. He doesn’t need to be violent or intimidating. If we go up to the local coke dealer or the local weed dealer and try to steal their product, they can’t call the police, because the police will arrest them. So they do have to be violent and intimidating. The sociologist Philippe Bourgois says that prohibition creates a culture of terror. Charles Bowden, who wrote Murder City, talks about the war on drugs creating a war for drugs. Because drug dealers have no recourse to the law, they have to establish a reputation for being intimidating and violent, so that no one will dare to take them on. This massively increases the murder rate, as they have to establish and maintain their patch by force. Milton Friedman, the Nobel prize-winning economist, calculated there were an additional 10,000 murders each year in the United States because of this dynamic.

The article has a lot more of interest, including on drug decriminalisation and rehabilitation in Portugal:

In 2000, Portugal had one of the worst drug problems in Europe. 1% of the population was addicted to heroin, which is mind-blowing. Every year they tried the American way more: they arrested more people, had more people in prison and the situation just got worse. One day the prime minister and the leader of the opposition got together and said, ‘We can’t go on like this, what can we do?’ So they set up a panel of scientists and doctors to figure out what would genuinely solve the problem. They agreed in advance that they would do whatever the scientists recommended, because it took it out of politics.

The panel went away for a year-and-a-half and came back and said: Decriminalise all drugs, from cannabis to crack, but — and this is the crucial thing — take all the money we currently spend on arresting and imprisoning drug users, and spend it on the lessons of Rat Park. Let’s turn addicts lives around, let’s help them to reconnect.

Decriminalisation lowers the cost of supply, while rehabilitation decreases the demand. Overall the price of drugs will fall (which substantially lowers the incentive for criminal gangs to be involved in distribution), but we can't say a priori whether the quantity of drugs traded will increase or decrease. One study (PDF) by Caitlyn Hughes (UNSW) and Alex Stevens (University of Kent) finds increases in drug treatment, decreases in drug-related deaths and public health improvements, as well as "a shift in drug use patterns, with increasing use of cannabis and decreasing use of heroin", which supports the lack of a clear pattern in changes in quantity.

Again, I encourage you to read the whole interview with Johann Hari.

Update: I almost missed the obvious tie-in to Paul Quigley (emergency doctor and clinical toxicologist at Wellington Hospital) calling for the legalisation of MDMA (the main ingredient in the drug ecstasy). Can we hope to follow Portugal's lead?

[HT: Marginal Revolution]

More on the war on drugs:

• Why your anti-drug policies just might annoy your neighbours

Because crushing ivory is so much better than burning it

Last month I wrote a post on burning ivory:

This week the governments of the Republic of Congo and Chad burned five tons of ivory seized from poachers... 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... The equilibrium price of ivory increases as a result... 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.

Not wanting to miss out on the party, now the Chinese are in on the act. Nature reports:

“Like a funeral for elephants.” That’s how Lishu Li, who works on the wildlife trade programme for the Wildlife Conservation Society China in Beijing, described the crushing of over 650 kilograms of confiscated illegal ivory last week. It was “quite dusty”, he said. “I think I inhaled a lot of ivory.”

No prizes for guessing the effects of this, and the effects of the accompanying controls on the 'legal' trade in ivory. Lower supply raises prices, and increases the incentives for poachers to produce more ivory. The end result is that more elephants are killed.

The much better approach is to try to reduce demand, as I noted in this post on poisoning rhino horns a couple of weeks ago. Reducing the demand for these goods lowers the price, and reduces the incentives for more poaching. The problem isn't solved entirely, but at least your solution isn't working against you.

How to reduce the demand for ivory? How about hefty fines (or imprisonment) for possession of ivory? That reduces the net benefits of owning ivory - as a buyer you face the risk of future punishment. Of course, the effect of fines (or imprisonment) depends on the size of the punishment as well as on the probability of being caught. So, enforcement costs would probably be relatively high. And given that these types of enforcement are already in place in many countries, it doesn't seem to be working too well.

I suppose you could legalise and place a high tax on ivory sales. This pushes the price up for consumers, reducing their demand for ivory. At the same time it reduces the effective price that sellers receive (since they receive the higher price from the consumers, but then must pay the tax to the government), which reduces the sellers' incentive to sell ivory. Of course, regulating and taxing the market also involves bureaucratic costs, and if the tax is high there would be high enforcement costs as well, as buyers (and sellers) would have incentives to try and avoid the tax.

As a totally different approach, what about farming elephants and flooding the market with cheap farmed ivory? The problem with wild elephants is that they are a common resource - rival and non-excludable. Rival goods are those where one person's use of the good reduces the amount available to everyone else, i.e. in this case one poacher killing an elephant reduces the number of elephants available to everyone. Non-excludable goods are those where you cannot easily prevent a person from obtaining the benefit from them, i.e. in this case it is difficult to stop the poachers from hunting. Farmed elephants (rather than wild elephants) would be private goods - rival and excludable. The farmers would (in theory) be able to exclude others from obtaining the benefits from the farmed elephants, and would have an incentive to sustainably manage their elephant herd. Farming as a solution for elephant poaching has been suggested before - see this piece by Shaun Jenkins last year as one example. Of course, others have criticised the suggestion (see here in response to the Jenkins article).

Criticisms of innovative suggestions or not, one thing is clear. Current approaches to saving elephants are just not working.

More on endangered species:

• Poisoning rhino horns to save the rhinos
• This couldn't backfire, could it?... Ivory burning edition

CEO pay and tournament effects

The New Zealand Herald released its annual executive pay survey results today. There was nothing surprising in the results:

The bosses of New Zealand's biggest companies enjoyed an average pay rise of 10 per cent last year, their biggest bump since 2010.

The increase for those at the top dwarfs the 3 per cent of growth for the average wage and salary earner in the year to June 2014.

So the folks at the top of the income distribution are earning more than ever, reflecting the recovery in business performance (on average at least). Of course, the pay increases and the differential in pay between the average worker and the top-paid CEOs have drawn sharp criticism as expected, not least for Theo Spierings (the CEO of Fonterra, in the news recently for its poor financial performance). However, what struck me was this commentary from Liam Damm, the Herald's business editor:

The NZX 50 index rose 18 per cent last year generating considerable wealth for shareholders including good returns for millions of KiwiSaver investors.

Chief executives typically have a large part of what they earn tied to performance targets. Last year most of those targets will have been met.

There will always be outrage from some quarters about the seemingly exponential scale of executive salaries. But we live in a free and global market where supply and demand set the pricing for talent.

Actually, that last bit is not true. The remuneration of chief executives is mostly NOT determined by supply and demand. It is determined by what are termed tournament effects. With tournament effects, a small group of highly successful workers (in this case CEOs) get paid high salaries, while many others (other executives, middle management, etc.) accept lower salaries in exchange for the chance to become one of the highly successful few at some point in the future.

The high salaries of CEOs need not even be related to their performance - instead, high wages at the top incentivise or motivate those lower down (e.g. other top executives) to work hard in order to ‘win’ the tournament. This explains why we might see CEO pay remaining relatively high even when the firm is performing poorly (like in the case of Fonterra - but to be fair, its poor performance isn't entirely down to its own doing, as I have pointed out here).

The pay of other executives and the size of the firm matter too. For instance, if the salaries of those lower down the ladder are high, the CEO pay would need to be even higher to create an effective incentive for the other top executives. And CEO pay would also need to be higher in larger organisations, where the chance of 'winning the tournament' is lower (because there are a larger number of managers competing).

So, high CEO pay is not determined by supply and demand but by tournament effects, which are also prevalent in other markets.

Previous posts on tournament effects:

• When is an academic like a drug dealer?
• Are university vice-chancellors' pay increases justified?

Trade unions drive up wages in L.A., but not for their own members

A couple of weeks ago, I posted about the latest research on the minimum wage, demonstrating that minimum wages do reduce employment. At about the same time, the Los Angeles city council voted to raise its minimum wage from $9 to $15 per hour. That isn't the most newsworthy bit though. As The Economist reports, the Los Angeles County Federation of Labour (a labour union) lobbied for a last minute change to the law, that would make unionised firms exempt from the higher minimum wage.

Yes, read that last sentence again. The trade union was lobbying for lower wages for its members. Why would they do that? The Economist explains:

Indeed, by exempting unionised businesses from the minimum wage, unions are creating more incentives for employers to favour unionised workers over the non-unionised sort. Such exemptions strengthen their power. This is useful because for all the effort unions throw at raising the minimum wage, laws for better pay have an awkward habit of undermining union clout. Britain’s minimum-wage law in 1998, for example, precipitated a decline in union membership. Once employers are obliged to pay the same minimum wage to both unionised and non-unionised labour, workers often see less reason to pay the dues to join a union.

So maybe it's not as crazy as it at first sounds. In ECON110 we talk about the effect of trade unions pushing wages above the equilibrium wage and increasing unemployment, and that this unemployment tends to be concentrated among non-unionised workers (who lack collective bargaining power and the job protections of union members). We refer to this as the insiders-vs.-outsiders problem. However in this case, the insiders (trade union members) are pushing up the wages for the outsiders (non-members) but not their own wages.

If unionised employers are exempt from the higher minimum wage, then their labour costs will be lower than non-unionised employers. And if unionised employees are more likely to be offered employment, then workers will be more likely to join the union. A win-win for employers and trade unions, as well as for non-union employees who receive the higher minimum wage. Trade unions are likely to be especially happy - trade union density has been declining for years (to a low of 10.8 percent in 2013 according to OECD data; or 16.3 percent in California in 2014 according to BLS data).

So, if there are so many winners, who loses from this proposal? While some non-union employees may be better off initially (from the higher minimum wage), available jobs for these employees are likely to reduce substantially. Why would employers employ a non-union employee for $15 per hour, when they can employ a union employee for much less? So, non-unionised workers are going to be made worse off. Which, according to BLS data (PDF) probably means the youngest and oldest workers, latinos, and women. Unless they are incentivised to join up to a trade union - which was likely the union's goal in the first place.

Uber vs. Taxi Federation (lobbying in the wild)

I've had some interesting conversations with my students this semester about the lobbying activities of firms. Some of them expressed surprise and wondered to what extent lobbying occurs in New Zealand, given that lobbying is estimated to cost more than US$800 million per year in the U.S.

In ECON100 and ECON110 we discuss lobbying as a form of rent-seeking, where the monopolist uses some of its profits (its economic rents) to protect its privileged monopoly position (such as by maintaining barriers to entry into their market). We can extend this to any firm (or firms) in imperfect competition, where they are making high profits. However, firms may also lobby government in order to remove barriers to entry into the market, in order to allow them to compete where they would otherwise be locked out of the market.

A recent example for New Zealand is the ongoing showdown between Uber and the Taxi Federation. Both sides are lobbying government - the Taxi Federation wants to keep high barriers to market entry, and Uber wants to remove them.

How is this lobbying playing out? The Taxi Federation is conducting "an unrelenting campaign to see [Uber] shutdown...", including attacking Uber on safety and crime, and pricing. Obviously, it's in the Taxi Federation's best interests to minimise competition - this ensures that they maintain cosy control over the number of registered taxi operators (although see my 2013 post on market competition among taxis in Wellington).

On the other side, Uber is employing specialist lobbying consultants Saunders Unsworth to pitch to government the benefits of increased competition, and to reduce the barriers to market entry, which currently include each driver needing three endorsements on their licence, with total costs upwards of $1500. Without lower entry barriers, it will be difficult for Uber drivers to compete in the market.

Who will win the lobbying battle? It's anyone's guess, and will ultimately depend on who does the better job of bending the politicians' ears, particularly given that consumers themselves don't appear to be particularly vocal on this issue.

Game theory and the penalty shootout

The week before last in ECON100 we covered game theory. New Zealand is currently hosting the FIFA U20 World Cup, and Christoph Schumacher and Nigel Espie from Massey University have been writing a series of articles in the New Zealand Herald, linking the World Cup to business. Last week they wrote about penalty shootouts:

Seen through a game theory lens, a penalty shootout is a game that involves two players - the striker and the keeper. To simplify matters, let's assume that both players have three options. The striker can choose to make their shot to the right, centre, or left of the goal. Similarly, the keeper can elect to dive to the left or right, or defend the centre of the goal.

Let's also assume the striker is equally good at taking shots to all three areas in the goal and the keeper is equally good at saving balls kicked to the three sections of the goal. So what would be the best strategy for a goalkeeper in this situation?

The penalty shootout is an excellent example of a game with no Nash equilibrium in pure strategy - where the equilibrium is a mixed strategy equilibrium. That is, it is best for the players to randomise their strategy choice. As Schumacher and Espie put it:

With no past knowledge of the striker's penalty history, you would expect the striker to randomly select their shot. Game theory would suggest that the best option for the keeper is to also randomly select an area of the goal to defend. This maximises the likelihood of saving a goal while preventing the opposing team from discerning any preference by the keeper.

To see why, let's set up the game as we would in ECON100. It's a simultaneous game, because even though the shooter makes their choice first, it's unlikely that the goalkeeper has enough time to properly observe the shooter's choice before choosing their own strategy. So, we can represent the game in a payoff table (see below). The shooter has three strategy options (left, centre, right), and the goalkeeper has three strategy options (left, centre, right). To keep things simple, let's assume that if both players choose the same strategy then the goalkeeper saves the shot (the goalkeeper receives a payoff of +1, and the shooter receives a payoff of -1), and if both players choose different strategies, the goal is scored (the goalkeeper receives a payoff of -1, and the shooter receives a payoff of +1). The payoff tables looks as follows:

To confirm that there are no pure strategy Nash equilibriums, we can use the 'best response' method. To do this, we track: for each player, for each strategy, what is the best response of the other player. Where both players are selecting a best response, they are doing the best they can, given the choice of the other player (this is the definition of Nash equilibrium).

For our game outlined above:

1. If the shooter shoots to the left, the goalkeeper's best response is to dive to the left (since +1 is better than -1) [we track the best responses with ticks, and not-best-responses with crosses; Note: I'm also tracking which payoffs I am comparing with numbers corresponding to the numbers in this list];
2. If the shooter shoots to the centre, the goalkeeper's best response is to remain in the centre (since +1 is better than -1);
3. If the shooter shoots to the right, the goalkeeper's best response is to dive to the right (since +1 is better than -1);
4. If the goalkeeper dives to the left, the shooter's best response is to shoot to the centre or to the right (since +1 is better than -1);
5. If the goalkeeper remains in the centre, the shooter's best response is to shoot to the left or to the right (since +1 is better than -1); and
6. If the goalkeeper dives to the right, the shooter's best response is to shoot to the left or to the centre (since +1 is better than -1).

Notice that there are no outcomes (cells) where both players are playing a best response, so there is no Nash equilibrium in pure strategy. To work out the mixed strategy equilibrium, we would need to know a bit more about the probability of success if both goalkeeper and shooter chose the same (here we assume there was a 0% chance of a goal), and the probability of success if they chose differently (here we assumed there was a 100% chance of a goal). Moreover, these probabilities might be different depending on whether it was to the left or right. The equilibrium would therefore not necessarily be random and symmetric.

Sports are filled with mixed strategy equilibriums. Think about tennis serving (down the centre, into the body, out wide), or American football offense (pass vs. run), to name just two. In these (and many other cases), it is best to randomise your actions, because if you become too predictable, your rival can take advantage of that.

ECON100 Video Project (2015 A Semester)

I've been a bit quiet on the blog this week, as I'm been sick. But I have a bit of a backlog of things I want to write about, so regular readers can look forward to a few days of consecutive posting.

Today we had the ninth ECON100 Video Awards, our regular end-of-semester ceremony/revision session where we celebrate the best of the semester's student videos. Students had been asked to create a 3-4 minute YouTube video and this semester we didn't have a theme. Instead we asked students to illustrate some of the economic concepts from class.

The judging was quite challenging again, but we were able to narrow the field to a selection of finalists. The seven finalists were shown in class, with students voting for their favourite.

The overall winner for best video, and winner of the Oscar trophy, was the group of Tessa Jenkins, Cade Fleming, Grace Macgillivray, and Christian Kelleher, with the video Farmonomics:

The award for students' choice for best video went to the group of Nathan H'Ng, Grace Burnett, Taina Nicholas, and John Vanderwee for this video:

I personally congratulate all of the award winners, and all the students who created videos, on their efforts. The standard of videos this semester was high as always.

Also, congratulations to Joseph Climo, who walked away from the final class with ZIM$10 trillion, as the winner of "Who wants to be a 10-trillionaire" (for those in the know, I couldn't offer $100 trillion this semester, as I couldn't find one on Trademe!).

Links to the winning videos will be put up on the Waikato Management School's Facebook page tomorrow (along with photos of the winners). Tell us what you think about them!