The price of entry to Venice

This article in The Conversation earlier this week by Sameer Hosany (Royal Holloway University of London) was interesting to me:

Venice’s history, art and architecture attract an estimated 20 million visitors every year. The city, a Unesco World Heritage site, is often crammed with tourists in search of special memories.

But for the people who actually live there, this level of tourism has become unsustainable. So from 2024, day-trippers will be charged a €5 (£4.31) fee as part of an attempt to better manage the flow of visitors.

The city’s mayor has described the charge – which will be implemented on 30 particularly busy days in the spring and summer – as an attempt to “protect the city from mass tourism”.

Will a €5 fee to enter Venice make a difference? Hosany seems skeptical:

But some have expressed doubts about whether the €5 fee – the price of a coffee or an ice cream – will be enough to dissuade tourists from travelling to this iconic ancient city. One city politician commented that the charge means Venice has become “a theme park, a Disneyland,” where “you get in by paying an entrance fee.”

Certainly the charge is a lot less than Bhutan’s (recently reduced) “sustainable development fee” of US$100 (£82) per night, which applies to all tourists, and was introduced to encourage “high value, low impact” tourism. Research also indicates that strategies aiming at persuading tourists to come at less crowded times do not reduce numbers at peak periods, but actually end up increasing overall demand.

Demand curves slope downwards. That means that, when the price of something increases, consumers demand less of it. When the price of a day trip to Venice increases by €5, fewer tourists will go to Venice. The key question isn't whether the fee will deter some tourists, but rather how many tourists will be deterred. That is something that we don't really know, and won't find out until the fee has been implemented. And even then, we don't know for sure what the counterfactual (the number of tourists who would have visited if there hadn't been a fee) is.

However, we can infer from what we know about tourism and the price elasticity of demand, how big an impact the fee will have. As Hosany notes, €5 is the price of a coffee or an ice cream. That is hardly going to be much of a deterrent to a tourist who may have already paid hundreds, or thousands, of dollars to get to Italy in the first place. Tourists' demand for going to Venice is likely to be quite inelastic, because the price of the €5 fee is only a small proportion of the total cost of going to Venice.

So, it would likely take a much larger fee than €5 to deter tourists, especially international tourists, and even more especially tourists from outside Europe. In other words, if the Venetian government are worried about over-tourism, then a €5 fee is unlikely to make much, if any, difference at all. Bhutan has the right idea here, with their fee of US$100 per night. Similarly, the Galapagos Islands charges a national park fee of US$100 for every person visiting the islands (although I think that fee might still be the same as it was when I went there in 2010).

Setting a low fee for entry is not the solution. A better understanding of elasticity would help Venice to better price their entry fee in a way that would actually reduce tourist entries, if that is the goal.

The evils of academic bureacracy and bullshit work

Every now and again, you read something and feel like screaming out: "Oh my God, yes!". That was my reaction to this article in The Conversation a few weeks ago, by Meg Elkins (RMIT University), Ananta Neelim, and Robert Hoffman (both University of Tasmania). They open the article with:

Are you spending more and more time at work doing paperwork and filling in forms rather than the thing you were trained and hired for? Does this busy work often seem to resist rational purpose or questioning? Does it kill your productivity, initiative, motivation and, frankly, your self-worth and sanity?

At that point, I am thinking, you should talk about academia. In fact, that was their go-to example:

Although stories of creeping bureaucracy abound in many industries, evidence – and our own experience – suggests nowhere has the problem of red tape exploded as much as it has in universities.

Staff complain the time they have for teaching and research is being eaten up by filling in forms and writing reports of questionable value. But this gripe goes beyond the inefficiency of bureaucratic excess. Some rules demotivate because they are interpreted as patronising.

I encourage you to read the entire article, especially if you are a current student and you're wondering why academic staff aren't always as fully prepared for lectures or assessments as you would like, aren't always available, or don't always spend the time to have the time to give you all the one-on-one attention that you need. It's not because they don't care. It's literally because there are so many bureaucratic roadblocks, and so much bullshit work that gets in the way (and I loved that Elkins et al. referenced David Graeber's excellent book Bullshit Jobs, or rather the article that led to the book [*]). Time and energy are limited resources, after all.

As for me, I don't find it all that demotivating, dealing with all the bullshit work, just frustrating. I would much rather spend my time on teaching and research activities, than filling in forms, attending meetings (especially meetings about meetings), and completing formative research evaluations (as practice for real research evaluations).

The problem here is one of negative externalities. The bureaucrats and academic managers who devise the systems and processes that academics must follow only face a small proportion of the total cost of their systems and processes. Those systems and processes instead impose most of the costs on academic staff (and academic administration staff). The total cost of the systems and processes (the marginal social cost) far exceeds the small costs that the bureaucrats and academic managers face themselves (the marginal private cost). And so, we end up with more complicated, onerous, and unnecessary systems and processes than would be optimal. The optimal quantity of form-filling is much less than the unrestrained quantity - notice the similarity to the negative externalities I wrote about last week.

Is it time for academics to fight back against bullshit work? Sadly, Elkins et al. don't have much to offer on that. Their main hope appears to be that academic leaders will learn from the experience of others in cutting red tape. Unfortunately, that would mean that someone would have to lead the way. I don't see too many exemplars of that in practice.

As a group, academics are not powerless. However, the staff unions seem unconcerned with the unending rise of bullshit work, at the expense of teaching and research. They are more focused on fighting continuing below-inflation increases in salaries, and increasingly precarious work conditions. The irony is that there might be more funds for paying higher salaries, and more job security, if so many of us weren't spending so much time on bullshit work.

Individually, some academics are able to negotiate around a small proportion (but definitely not all) of the red tape, perhaps by having academic administrators or junior academic staff complete some of the tasks that would otherwise fall to them. Unfortunately, that has the effect of increasing the inequality between senior staff and top researchers (who can negotiate those deals) and junior and emerging staff (who cannot, and may end up carrying some of the burden for senior staff). Those senior staff really need to stand up for the junior staff who are being burdened with bullshit work, but the individual incentives to do so are all wrong. The principle is sort of like this:

Except, senior academic staff are forgetting the part about helping others. It is time to start.

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[*] I reviewed David Graeber's book here.

A potential 'tragedy of the commons' for water services entities

My ECONS102 class covered common resources (sometimes called common pool resources) last week. Common resources are goods that are rival (one person's use reduces the amount of the good that is available for everyone else) and non-excludable (if they are available to anyone, they are available to everyone). Fish in the open ocean are one of the examples I use in class. Every time a fisherman takes a fish, there are fewer fish available for everyone else. And, it is difficult (if not impossible) to prevent fishermen from fishing in the open ocean.

Common resources lead to a problem that we call the 'tragedy of the commons', named after a 1968 article by the biologist Garrett Hardin, even though the key ideas go back to William Forster Lloyd in 1833. Lloyd's description of the problem goes something like this:

Consider a small medieval town. Many of the families in the town own flocks of sheep, and these flocks all graze on the land surrounding the town (called the Town Common). The town owns the land collectively.

As the years pass and the town’s population grows, so does the number of sheep on the Town Common. Eventually the land is grazed so heavily that it becomes barren.

The problem here is that the private incentives for each individual farmer (which are to increase the size of their flock in order to gain additional profits) are different than the social incentives for the farmers collectively (which are to manage the total size of the flock in a sustainable manner).

Most of the examples of common resources that we use in teaching relate to natural resources. However, those are not the only examples that are possible, where goods are rival and non-excludable. On the Asymmetric Information substack earlier this year, Dave Heatley provided an interesting example related to the New Zealand government's proposed water services entities:

The Water Services Entities Act 2022 created 4 water services entities (WSEs). Each WSE will be responsible for reticulated water supply, wastewater and stormwater infrastructure and services over a defined region of New Zealand.

Under the Act, mana whenua (tribal or extended family groups with authority or other customary rights or interests in an area...) may issue a Te Mana o te Wai statement for water services to the WSE (s143)...

There are many potential issuers of these statements — perhaps hundreds in North Island WSE areas. Each WSE must respond to all statements it receives, including publishing a plan of how it intends to “give effect to” the statement “to the extent that it applies to the entity’s duties, functions, and powers” (s144(2))...

The Act does not constrain the number and scope of statements. Individually, they could stretch from the small, reasonable and relatively costless; to the large, unreasonable or unworkably expensive.

The Act creates a commons, in which the capabilities, attention and assets of the WSE is the common-pool resource.

No WSE can give effect to all potential statements. Their ability to do so will be quickly exhausted. I fear they might, at best, only give full effect to the first few they receive.

The capacity of water services entities to give effect to statements is a good that is rival (one group issuing a Te Mana o te Wai statement reduces the amount of capacity for a water services entity to give effect to other statements) and non-excludable (any iwi or hapū may issue a Te Mana o te Wai statement). The capacity of the water services entities to deal with these statements could quickly be exhausted.

The 'usual' approach to solving a problem of common resources is to somehow make the good excludable. The government could grant property rights over the common resource (or keep the property rights itself). For example, the government created property rights in the form of tradeable fishing quotas to deal with the common resource problems in fisheries. However, that isn't going to work in this case, since it would involve limiting the iwi or hapū that are entitled to issue Te Mana o te Wai statements, and the legislation explicitly doesn't do this.

The other potential solution comes from the Nobel Prize winning work of Elinor Ostrom. Ostrom argued that, if enough of the affected community can work together (common governance), then the problem of common resources can be solved without government intervention. In this case, that would require iwi and hapū to work together to prevent overwhelming the water services entities. However, Heatley doesn't believe that this is feasible:

What are the chances of Ostrom-style communal management of these commons? Each claimant faces a prisoner’s dilemma... All claimants would be collectively better off if every statement was restrained, and if these statements were, in total, within the ability of the WSE to deliver. But every claimant runs the risk of another claimant lodging a statement before they do, and that such statements might be less restrained than necessary to achieve the collective optimum.

In this situation every claimant faces a very strong incentive to get in first with expansive statements. I doubt communal management can overcome this, as every potential claimant would have to trust every other potential claimant not to file a statement before collective agreement was reached. And further, each would have to believe that collective agreement was possible, given the likely quantity and diversity of claimants and statements.

Ostrom’s conditions for communal management, as summarised above, appear to be very difficult to meet in this instance.

I'm not so convinced that this problem is unsolvable with a collective approach. Ostrom's common governance solution required a few conditions, which I think can be met. First, the boundary of the resource and the group of users must be well-defined. These are clear and defined in the legislation that gives iwi and hapū the right to issue a Te Mana o te Wai statement. Second, the user community must be able to form a homogeneous group (within which trust is high), with common goals (and norms) for protecting and allocating the resource. All iwi and hapū have a common goal of protecting water quality and availability (at least, we hope that is their goal), so the common goal condition is met. Is there trust? That is something I cannot answer. There are notable conflicts between hapū (for example, see here), but there can be conflicts between people and groups that nevertheless maintain trust in each other.

The tragedy of the commons can be solved. If iwi and hapū recognise that there is the potential for a common resource problem here, then they may be able to work together to prevent it. The obvious way may be to issue joint rather than individual Te Mana o te Wai statements (which are allowed under section 143 of the Act). Or perhaps just wait and see, as National has indicated that they will repeal the Water Services Entities Act if they are elected next month.

Using a Pigovian tax to correct for a negative (consumption) externality

In my previous post, I demonstrated that, if left alone, a market with a negative externality produces too much of a good, and creates a deadweight loss. At the end of that post, I noted that, if we wanted to reduce the quantity that is traded in the market, we could use a tax. Such a tax is called a Pigovian tax (named after 20th Century economist Arthur Pigou), and is the focus of this post.

Consider the same market as that previous post (the market for fireplaces, or fireplace use), as shown in the diagram below. The market operates at the point where supply (S) meets demand (D) - that is, the quantity traded will be QM (and the price of fireplaces, or fireplace use) will be PM. Consumer surplus is the area ACPM, producer surplus is the area PMCF, the welfare cost of the negative externality is the area ACHG, and total welfare (which is the sum of consumer surplus and producer surplus, minus the area of the negative externality) is equal to the area (GEF-ECH).[*]

Now consider what happens when the government imposes an excise tax on fireplaces (or fireplace use). We will assume that the per-unit cost of the tax is exactly equal to the marginal external cost (MEC), and that the tax would be paid to the government by the sellers of fireplaces (or fireplace users). We represent the tax with a new curve, S+tax, which is exactly the same distance above the supply curve as the MSB curve is below the demand curve (that's because the tax is exactly equal to MEC). The price that consumers pay increases to PC. The effective price that producers receive (after paying the tax to the government) decreases to PS. The quantity of fireplaces (or fireplace use) decreases to QS.

What happens to economic welfare? The consumer surplus is the area ABPC, and the producer surplus is the area PSEF. The government receives tax revenue equal to the area PCBEPS (this is part of total welfare, because the government can use that revenue to provide services like schools or hospitals). The area of the negative externality is the area ABEG. Total welfare with the tax is equal to GEF. [**]

In other words, the Pigovian tax not only reduces the quantity of fireplaces (or fireplace use), but leads to an increase in total welfare (in fact, it leads to total welfare being maximised and the deadweight loss being eliminated). Economists aren't often in favour of excise taxes, but this is one case where an excise tax can make society better off.

Read more:

• The welfare impacts of a negative (consumption) externality

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[*] For the explanation of these welfare areas, see my previous post.

[**] Note that this is the same total welfare as occurred at the quantity QS in my previous post. To recap, that's because the area of the negative externality ABEG cancels out some of the total welfare that was in the combined consumer and producer surpluses and government revenue (ABEF), leaving the area GEF.

The welfare impacts of a negative (consumption) externality

As I noted earlier this week, an externality is the uncompensated impact of the actions of one person on the wellbeing of a third party. A positive externality makes the third party better off, while a negative externality makes the third party worse off. They are called externalities because they lie outside the original decision, i.e. some of the costs or benefits are external to the person whose action creates them.

The most common example that economists use to explain negative externalities is pollution. For example, from this New Zealand Herald article from earlier this year:

Two air pollutants are quietly contributing to thousands of premature deaths in New Zealand every year, shows a new analysis that’s prompted fresh calls for tougher regulations.

While New Zealand’s air quality is generally considered good by international standards, Stats NZ’s newly updated indicator has linked pollution from vehicles and fireplaces to around nine times more early deaths than last year’s road toll.

People running vehicles or fireplaces are creating a negative externality for other people - an increased risk of death from poor air quality. Let's focus on fireplaces and show that, left alone, the market will lead to too much use of fireplaces. Consider the market for fireplaces (or fireplace use) as shown in the diagram below. The market will operate at the quantity where supply (S) meets demand (D) - that is, the quantity traded will be QM (and the price of fireplaces, or fireplace use) will be PM.

However, the fireplace users create a negative externality for other people. Since this externality arises from the buyers of fireplaces (or fireplace users), we show this externality on the demand side of the market - we refer to it as a negative consumption externality. [*] This means that the benefits that fireplace users receive themselves from operating their fireplaces are higher than the benefits that society receives from those fireplaces - the difference is the negative benefit that is imposed on other people through air pollution. We show this on the diagram by differentiating between the marginal social benefit (MSB) and the marginal private benefit (MPB). The MPB is the benefit that fireplace users receive for themselves. The MSB is the marginal private benefit, minus the cost of the externality - the marginal external cost (MEC).

Now, society prefers the quantity of fireplaces (or fireplace use) to be the quantity where marginal social benefit (MSB) is equal to marginal social cost (MSC) - I'll explain why a little later in this post. That is the quantity QS, and one way to get to the quantity QS is if the price of fireplaces (or fireplace use) decreased to PS (because then, sellers would not be willing to sell so many fireplaces). Notice that in the diagram, relative to the quantity that society prefers (QS), the market produces too much (QM). There are too many fireplaces (or too much fireplace use).

Why does the market prefer QS (the quantity where MSB = MSC)? It's because that's the quantity that maximises economic welfare. Economic welfare is the sum of all of the net benefits arising from the market. First, the consumers receive some net benefit from participating in the market. Consumer surplus is the difference between the amount that consumers are willing to pay (shown by the demand curve), and the amount they actually pay (the price). In the diagram, at the equilibrium price and quantity, consumer surplus is the area ACPM. Second, producers receive some net benefit from participating in the market. Producer surplus is the difference between the amount the sellers receive (the price), and their costs (shown by the supply curve). In the diagram, at the equilibrium price and quantity, producer surplus is the area PMCF. Third, the third parties are negatively affected by the market. The welfare cost of the negative externality is the area in-between marginal social cost and marginal private cost, up to the quantity of fireplaces (or fireplace use) traded (in this case, QM). That is the area ACHG, and it is subtracted from total welfare. Total welfare is the sum of consumer surplus and producer surplus (which is the area ACF), minus the area of the negative externality (ACHG), and is equal to the area (GEF-ECH). [**]

Now consider the market operating at the quantity QS (with the price PS). The consumer surplus is the area ABEPS, the producer surplus is the area PSEF, and the area of the negative externality is the area ABEG. Total welfare at QS is equal to GEF. [***] Notice that this total welfare is larger when the quantity is QS than when the quantity is QM. If the market is left alone, there are too many fireplaces (or too much fireplace use), and this decreases total welfare by the area ECH. That area ECH is the deadweight loss of the externality.

Since the market produces too much, a relevant question is how could we get the market to produce less? A Pigovian tax (named after 20th Century economist Arthur Pigou) is one option, since taxes reduce the quantity of a good that is traded (for more on that, see this post). Requiring permits for fireplaces would be another way to limit the number of fireplaces to QS. Of course, determining the optimal quantity QS is difficult in practice. However, we can be sure that it isn't the quantity that is provided by the market.

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[*] In contrast, when producers produce pollution as a consequence of manufacturing other goods (for example), that is a negative production externality, which we would show on the supply side of the market.

[**] Notice that the area of the negative externality ACHG first cancels out all of the total welfare that was in the area ACEG, leaving the area ECH left over. That's why only GEF is left, while ECH is left subtracting from total welfare.

[***] Notice that the area of the negative externality ABEG cancels out some of the total welfare that was in the combined consumer and producer surpluses (ABEF), leaving the area GEF.

New Zealand banks' resistance to open banking and bank account number portability

Earlier this year, open banking was in the news. For instance, take this NewsHub article from March:

Amid pressure for the Government to do a deep dive into banks and their profits, there are calls to make it easier for Kiwis to switch banks.

That is on its way with open banking legislation and Newshub can reveal how the Government wants to pay for it: fees and another tax.

Remember back in the day when phones were bricks? And if you changed your mobile provider you couldn't take your number with you?

Well that changed, and when number portability came in, Tex Edwards used it to set up 2degrees. Now he wants the same thing for bank accounts.

"It would be a lot easier to change banks," he said. 

Changing banks can be an arduous process but there's a push to make that a whole lot easier.

"Elsewhere in the world you have bank account number portability and that has created more competition and its brought prices down, mortgage rates down and term deposits up," said Sam Stubbs, the managing director at Simplicity.

Bank account portability is on its way as part of open banking, which is two-ish years away.

The banks are in no hurry though.

It should be no surprise that the banks are in no hurry. Open banking increases their costs. However, one particular aspect of open banking, being bank account number portability, is probably the real issue for them. That's because a lack of portability generates profit opportunities, because of switching costs, and customer lock-in.

Switching costs are, unsurprisingly, the costs of switching from one good or service to another, or from one provider to another. Switching costs can be monetary (for example, a contract termination fee), or they can be non-monetary (for example, the time and effort required to make the switch). When bank account numbers are not portable, the switching costs of changing banks are quite high. If a customer wants to change banks, they need to set up new direct debits for all of their regular payments, change their banking details with their employer, with Inland Revenue, and with every other organisation that needs the customer's bank details. Changing all of those details is onerous for the bank customer, constituting a high switching cost.

Switching costs create customer lock-in. They make it unattractive for customers to switch to other providers, because customers would have to first face the switching cost. For banks, this customer lock-in means that bank customers tend to stay with their existing bank for longer than they otherwise might. Banks can then exploit their locked-in customers through higher prices for services (higher interest rates, or higher banking fees), or by selling them complementary products (like credit cards or insurance). Having locked-in customers is incredibly profitable for banks. If their customers weren't locked in, the banks would have to work harder to keep their existing customers, to avoid them being lured away by other banks. And that is why New Zealand banks are so resistant to open banking.

Forestry slash, externalities, and the Coase Theorem

This week my ECONS102 class is covering externalities. An externality is the uncompensated impact of the actions of one person on the wellbeing of a third party. Externalities can be negative (they make the third party worse off) or positive (they make the third party better off). We call them externalities because they lie outside the decision that created them - that is, some of the costs or benefits are external to the person whose action creates them.

An example of a negative externality from earlier this year was the damage caused by forestry slash. As Bryce Edwards summarised in the New Zealand Herald in February:

The weather events of January and February have caused a horrific toll, yet much of it was avoidable. The destruction caused by the storms was made much worse by the way forestry operations have changed the land in places on the East Coast of the North Island.

One of the biggest problems is the litter foresters leave behind when they harvest pine trees. The industry terms the branches and debris left to rot on the hillsides as “slash”, and in large storms this litter is prone to be washed down rivers, causing mayhem. The debris forms dams and diverts the flow of water, flooding towns and farms, and knocking out bridges and roads. In Cyclone Gabrielle the impact of slash was enormous...

The Herald’s Fran O’Sullivan wrote in the weekend about the logging problem, concluding “what we have observed over the past fortnight simply puts New Zealand in the Third World category”. This is because in other developed countries, the slash problem is better regulated or even banned. It’s a problem that has been known about for many years, and yet in New Zealand, the politicians have done virtually nothing about it, leaving society to pay for the damage caused by it.

The fact that the forestry companies can cause such great damage without being held accountable for the cost has astounded many. After all, citizens can be fined up to $5000 under the Litter Act 1979, and if the litter endangers anyone, the fine increases and can include imprisonment.

One way of understanding the forestry slash situation, and the options available for dealing with the negative externality, is to apply the Coase Theorem. This theorem, named after 1991 Nobel Prize winner Ronald Coase, states that if private parties can bargain without cost over the allocation of resources, then they can solve the problem of externalities on their own (that is, without government intervention).

The Coase Theorem forces us to recognise that both parties (the one causing the externality, in this case the forestry operators; and the one affected by the externality, in this case the affected property owners) have rights. In this case, the forestry operators have the right to operate their forestry business as they wish (which includes leaving slash on their land). The affected property owners have the right to the quiet enjoyment of their property, which includes the right not to face the risk of damage from forestry slash. These rights are in conflict with each other.

The solution to the externality problem under the Coase Theorem crucially depends on the allocation of entitlements - that is, which rights (those of the forestry owners or those of the affected property owners) are overriding - the overriding rights are those that receive the higher protection under the law. The solution to the externality problem will be different depending on whether the overriding rights belong to the forestry owners or the affected property owners. Let's work it through from both possible perspectives. However, remember that any agreement here would have had to have been made before the cyclone caused the damage.

First, let's say that the overriding rights belong to the affected property owners - their right to quiet enjoyment (and protection from the risk of forestry slash) will be protected. The default solution is that the forestry owners must not allow slash to affect other properties. They must dispose of it in some way, or otherwise prevent it from moving off their property. The alternative solution is that the forestry slash stays, but the forestry owners agree to compensate any affected property owners for the value of the risk that their property might be damaged by forestry slash. Notice that this is about the value of the risk of damage, as evaluated by the property owners. It will depend on the probability that forestry slash causes damage, and the cost of the damages that would be suffered if forestry slash causes damage. For simplicity, let's refer to it as the expected damage. The amount of compensation that the forestry owners would have to pay would have to be at least as much as the expected damage (otherwise the property owners wouldn't agree, and they don't have to, since under the default solution there would be no risk). However, the compensation also has to be less than whatever the forestry owners value the savings to be had from leaving forestry slash on the property rather than removing it or preventing it from moving off their property (otherwise, the forestry owners would be better off dealing with the forestry slash, rather than paying the compensation).

Now let's look at it the other way. Let's say that the overriding rights belong to the forestry owners - their right to operate their forestry business as they wish will be protected. Now, the default solution is that the affected property owners have to put up with the damage from forestry slash, or maybe they buy insurance to protect themselves. The alternative solution is that the affected property owners pay the forestry owners to dispose of the forestry slash (or prevent it from moving off their property). In this case, the amount of compensation would have to be at least as much as whatever the forestry owners value the savings to be had from leaving forestry slash on the property rather than removing it or preventing it from moving off their property (otherwise the forestry owners wouldn't agree, and they don't have to, since under the default solution the property owners just has to put up with the risk from forestry slash). However, the compensation also has to be less than the expected damage (otherwise, the property owners would be better off putting up with the risk, rather than paying the compensation).

The Coase Theorem tells us how a bargaining solution could arise when there is an externality problem. However, it requires both parties to reach an agreement, and in this case the agreement would have to have occurred before the cyclone. That didn't happen, and for very good reason. The solutions that the Coase Theorem proposes rely on the absence of costs. That means no bargaining costs (the costs that parties incur in the process of agreeing and following through on an agreement) and no monitoring and enforcement costs (the costs of ensuring that the agreement is followed through with). In this case, the bargaining costs would be prohibitively high, particularly because of coordination problems - there are so many potentially affected property owners that it would be difficult for all parties to agree on a solution.

So, with no bargaining solution in place, we were left with the default solution. The allocation of entitlements here appears to have been that forestry owners had the overriding rights, because it appears that the property owners were simply asked to put up with the damages, or await payouts from insurance or from the government. Moreover, there has been no expectation of compensation from the forestry owners. When private bargaining solutions fail to develop, then dealing with an externality problem necessarily falls to the government.

And this is what has made people angry. The negative externality was foreseeable (in fact, it wasn't even the first time this has happened). It existed even before the cyclone struck, although merely as a small risk of damage. However, the allocation of entitlements, which gave the forestry owners overriding rights, only became obvious after the cyclone struck. In other words, the allocation of entitlements didn't seem to matter, until it did. In hindsight, banning forestry slash from being left on properties would have been one potential public solution to deal with the problem.

This should make us wonder how many other similar situations exist, where innocent property owners might suddenly find themselves facing damages arising from other property owners doing currently lawful things. There are likely to be many such situations where bargaining costs are too high to allow a private solution to emerge to deal with the negative externality of expected damage. Forestry slash is easily frowned on in hindsight, but other situations may be even less clear as to the need for government intervention. However, as severe weather events become more common, these situations are likely to arise more often over time, and public solutions to the externality problem will only become more important.

The clean energy transition is about to cost more

The Financial Times reported on the market for electricity cables (such as those that connect between countries) back in July (paywalled):

Demand for interconnectors and other energy infrastructure such as wind turbines is growing rapidly, putting unprecedented strain on supply chains for electricity cable and the converter stations needed for connection to the grid. 

Supplies of both are concentrated among relatively few companies, with high barriers to entry. The potential difficulty of securing raw materials such as copper, and a lack of skilled labour needed for factories, risk putting a brake on new supplies.

Manufacturing slots are booked up, and costs are climbing. “You’re in a dogfight”, says one senior wind industry executive, describing a scramble for converter stations.

Many countries are trying to increase their renewable energy generation, as well as interconnecting electricity infrastructure between countries. All of this requires high-capacity electricity cables and associated equipment. The effect of this increasing demand on the market for electricity cables is shown in the diagram below. The market started at equilibrium, where the supply curve S0 met the demand curve D0. The equilibrium price of electricity cables was P0, and the quantity of cables traded was Q0. With demand increasing to D1, then there are two possibilities. First, if prices are kept at the original price of P0, then the quantity of cables supplied remains at Q0, but the quantity of cables demanded increases to QD. There will be a shortage of electricity cables. Alternatively, the market adjusts, and the price increases to the new equilibrium price of P1 (where the supply curve S0 meets the new demand curve D1), while the quantity of cables traded increases to Q1. Of course, the electricity cable suppliers would prefer the price to rise, since that means higher profits for them.

These dynamics apply not just to the electricity cables, but also to the other equipment and infrastructure required for the clean energy transition. So, with increasing demand for electricity cables, it seems likely that the infrastructure required for clean energy transition is going to cost more.

Certification as a barrier to entry for doggy daycare centres

This week, my ECONS102 class covered monopolies. Monopolies arise because of barriers to entry - there is something that stops other firms from getting into the market and competing with the monopoly. Not all markets with barriers to entry result in a single firm operating (a 'pure' monopoly). However, all markets with barriers to entry convey some market power on the firms - the firms can set a price that is above their marginal cost, and make a profit.

One way that barriers to entry arise is when the government grants an exclusive right to produce and/or sell some good or service, or where being a seller requires a license. Patents are an example of an exclusive right granted by the government, while occupational licensing (like the licenses required to practice medicine, or to be a teacher or taxi driver) is an example of the latter.

A slightly weaker (but similar) form of barrier to entry to occupational licensing is created by a certification regime. Certification doesn't keep sellers out of the market, but it does convey some information to consumers. It is a form of signal of the quality of the seller. For signals to be effective, they must be costly (and a certification involves a cost to the seller who wants to be certified), and costly in a way that low-quality sellers would not want to attempt. Certification may impose restrictions on the practices of sellers, like requiring them to follow a code of practice, having a third party audit the operations of certified sellers, and/or having a public register of certified sellers, as well as a record of sellers who have lost their certification. Any of these characteristics of the certification regime would make becoming certified costly for low-quality sellers in such a way that they wouldn't want to become certified in the first place. And because the certification limits the number of willing sellers, it creates a barrier to entry.

Which brings me to this article from the New Zealand Herald from February:

New Zealand’s one and only SPCA-certified doggy daycare in Whangārei is urging other daycare centres to sign up so owners can start to “expect the best” for their pets.

The Grooming Lounge & Daycare is the first doggy daycare to join the SPCA-certified programme, which lets dog owners know of businesses willing to be independently audited to maintain high animal welfare standards.

Owner Rebekah Thompson said she signed up after a futile attempt to find daycare standards and guidelines when starting her business in 2020.

“There’s no guidelines or certification for doggy daycares, it’s completely unregulated as an industry...”

Currently in New Zealand, anyone can set up a doggy daycare facility with no minimum experience or qualifications.

SPCA developed a set of voluntary standards so businesses could raise the bar and help pet owners choose centres that put animal welfare first.

It costs $800 a year to get certified and businesses get audited twice a year. One of the visits is scheduled and the other is unscheduled.

“I went with it to show my customers I have nothing to hide, and that a third party is validating what we’re doing,” Thompson said.

Notice that the certification, as described in the article, corresponds almost exactly to the case I laid out at the start of the post. It provides a signal that "lets dog owners know of businesses willing to be independently audited to maintain high animal welfare standards". The signal is costly ($800 a year), and the twice-yearly audits will make the certification unattractive for low-quality doggy daycare centres, since it would reveal the real quality of the centres to dog owners.

What happens next will be interesting though. This could be just the start of a creeping regime of regulatory capture. The SPCA and certified doggy daycare operators could start lobbying government for mandatory regulation of the sector - note the scare quote in the article: “There’s no guidelines or certification for doggy daycares, it’s completely unregulated as an industry...” The government might introduce licenses for doggy daycare centres. That would make the barrier to entry into the doggy daycare market a bit higher. Who better to manage the licensing regime than the SPCA? Then, the requirements for getting a licence can be gradually raised, in order to "put animal welfare first". Again, the barrier to entry gets a bit higher.

Will we end up with high barriers to entry into the doggy daycare sector? If it was up to the SPCA and the already-certified operators, then yes. Watch this space.

Fuel prices and (un)fairness

Fuel prices have been in the news again this week. As the New Zealand Herald reported:

Whangārei motorists have been paying some of the highest average fuel prices in the country, but the reason why has remained unanswered despite a recent Commerce Commission report.

The revelation comes after fuel reached $3 per litre overnight on Monday in the Whangārei area, a price that is becoming all too familiar.

Questions have been raised as to why prices are so high despite international shipping and local transport costs being lower due to the Marsden Point terminal being situated nearby.

The prices for Regular 91 in Whangārei were comparable to other regions in the June 2022 quarter, however, the prices were the most expensive when compared countrywide for the last three quarters.

As the Commerce Commission will well know, costs are not the only determinant of price. In a supply and demand model of the market, costs only represent the supply side of the market. Demand matters too, and in particular the shape of demand. When there is less competition, consumers have fewer alternative options to choose from (fewer substitutes), and demand will be less elastic. Sellers can raise prices with less concern about their consumers going elsewhere. As I have noted before, competition matters for retail fuel pricing.

However, I want to pick up on this other part of that New Zealand Herald article:

People in the area who are struggling to make ends meet are frustrated and confused by the prices and notable unfairness.

Mother-of-three Amy Cullen said she is living “pay cheque to pay cheque”, despite having two incomes.

“I’m on my [fuel] light most of the time. I never really fill up full; I try to do it when there are fuel discounts on,” she said.

Cullen said her family has been budgeting “really hard” to make ends meet, forfeiting certain things and letting bills go into arrears so she can prioritise what is getting paid for.

She said she didn’t understand why prices were so high compared to other regions, despite Marsden Point being nearby.

“It’s frustrating,” she said.

Research by Nobel Prize winner Daniel Kahneman (and described in his book Thinking, Fast and Slow as well as Richard Thaler's Misbehaving: The Making of Behavioral Economics, which I reviewed here) shows that consumers are willing to pay higher prices when sellers face higher costs (consumers are willing to share the burden of the higher costs). They see those higher prices as fair. However, consumers are much less willing to pay higher prices when those higher prices result from higher demand - they see those price increases as unfair. This likely extends to higher prices that result from lower levels of competition that grant firms more market power. Consumers likely see those higher prices as unfair as well. Fairness is important, as I have noted before (see here and here, for example).

So, while higher fuel prices in Whangārei are explainable by lower competition, that doesn't excuse those higher prices in the eyes of consumers. What will be interesting will be whether those higher prices are excused in the eyes of the Commerce Commission, which are now keenly focused on them.

Read more:

• The shocking truth about retail fuel pricing has been revealed!

Drought in Central America, and prices in Australia

In an article in The Conversation last month, Stephen Bartos (University of Canberra) wrote that:

What does a drought in Central America have to do with Australia’s cost of living? Quite a lot, if the drought affects the Panama Canal.

The 425 square kilometre Gatun Lake was built in the early 1900s to store water for the Panama Canal. Water is needed to float ships so they can navigate the canal. Now drought has severely affected the lake’s water levels.

Because of this the Panama Canal Authority has had to cut the number of ships using it. Hundreds of ships have queued up to wait their turn...

Delays mean higher costs. These in turn flow on to prices charged by wholesalers and retailers. We see it in the prices we now pay for the goods we buy.

Supply chain disruptions are only one of the many reasons why the cost of living is going up.

To see how the shipping delays caused by the low water levels in the Panama Canal affect prices of goods in Australia, consider the market for some good that is produced in Europe (or the East Coast of the US) and then transported to Australia, as shown in the diagram below. Initially, the market operates at equilibrium, where the demand curve D0 intersects the supply curve S0. The equilibrium price of the good is P0, and Q0 of the good is traded. The delays increase the costs of supplying the good to consumers in Australia. This is represented by a decrease in the supply of the good from S0 to S1. As a result, the equilibrium price of the good increases to P1, and less of the good (Q1) is traded.

So, while the Panama Canal is far from Australia, the low water levels there flow through into higher prices in Australia. This won't affect all goods directly, as many goods (and basically all services) don't require transport through the Panama Canal. However, as Bartos notes:

Yes Panama, at 1,000 kilometres north of the equator, is in the northern hemisphere. For trading, it is more important to America and northern Asia.

But Australia will still be affected by the disruption. Our supply chains are connected. Ripple spread through supply chains through prices. Even if products we buy or sell are not physically in the affected part of a supply chain, when their prices increase ours do too.

Bartos offers a solution to these higher prices:

Strategies for dealing with the unavoidable impacts on supply chains include diversifying.

This would mean having more suppliers, all using different chains, so that if one fails, we have other options.

Shortening chains by using more local suppliers where possible, would also help, as would embracing the joy of substitution – if one product becomes more expensive or unavailable, often there is another just as good.

Of course, none of those solutions really solve the problem of higher prices, because they must be higher-cost options than the existing transportation of goods through the Panama Canal. If they weren't higher cost, then someone would be using them already! As for substituting for other goods (such as those produced locally), that will increase the demand for those substitute goods. This is shown in the diagram below. Initially, this market operates at equilibrium, where the demand curve DA intersects the supply curve SA. The equilibrium price of the good is PA, and QA of the good is traded. The increase in the demand from DA to DB leads to an increase in the price of the substitute goods to PB, and an increase in the quantity of the substitute good traded, to QB.

So, the prices of goods transported via the Panama Canal increase, and the prices of substitute goods also increase. Overall, higher prices seem almost inevitable - all that Bartos is really suggesting is that Australians have a choice over how they end up with those higher prices.

Nate Silver on the 'Indigo blob', media and politicians

In my ECONS102 class last week, we covered the economics of information. One aspect of that topic is to look at media bias. So, I was interested to read this post by Nate Silver from last month (which I only caught up to read this week). Silver notes at the start of the post that his core hypothesis is:

In American media and political discourse, there has been a fundamental asymmetry during the Trump Era. Left-progressives, liberals... centrists, and moderate or non-MAGA conservatives all share a common argumentative space. I call this space the Indigo Blob, because it’s somewhere between left-wing (blue) and centrist (purple). The space largely excludes MAGA/right-wing conservatives — around 30 percent... of the country.

The rest of the post is about the causes and consequences of the 'Indigo blob', and I encourage you to read the whole post. However, I want to focus in on this bit:

This graphic from a paper by Magdelena Wojcieszak, et. al. reflects the ideological position of different groups of Twitter users from 2016-2019. There’s a lot going on, so let me show you the figure first and then we can talk our way through it. 

Among politicians on Twitter, we see a traditional bimodal distribution with liberal and conservative peaks corresponding to the Democratic and Republican parties. But everything else is left-skewed. There’s not a clear distinction between left-wing and centrist news organizations — they’re all part of the Indigo Blob — and the right-wing media isn’t terribly well-represented. The same holds for journalists, although the right flank is even more attenuated. And Twitter’s users during this period skewed heavily left too, with liberals outnumbering conservatives roughly 3:1, according to Wojcieszak. Anyone who was active on the platform during this period knew that content satisfying to progressives and Democrats was more likely to be rewarded with likes and retweets.

I believe this contributed to the misestimation of the political preferences of the American public by journalists, Twitter-savvy politicians and others who were active on the platform.

I want to co-opt that figure to go in a slightly different direction, because it highlights two key facts about bias among journalists. These two key facts are well explained by some simple models of media bias. I'm not going to explain those models here, but they are described in this article I published earlier this year in the Journal of Economic Education (ungated earlier version here).

First, notice that the mass of journalists is mostly to the left of the centre. There is an overall bias in the media towards the liberal side of the spectrum (in that there are more media outlets and more journalists on the liberal blue side than on the conservative red side). However, notice that this follows the overall profile of Twitter users, albeit imperfectly. There are more Twitter users on the liberal blue side than on the conservative red side. So, to some extent it is understandable that journalists and media would be biased in this way. It reflects the characteristics of demand from the consumers of media. If there are more liberal media consumers, then there will be more liberal media suppliers.

Second, there is a distribution of media across the spectrum. Some media outlets and journalists lean liberal, and others lean conservative. Collectively, media outlets and journalists cover the range of views, but each media outlet (and to a lesser extent, each journalist) targets a relatively narrow audience within the spectrum. They don't tend to appeal to media consumers with views that are far from their own, because media consumers tend to prefer to consume news that accords with their own views - a behavioural economics concept known as confirmation bias.

The takeaway message from those two facts is that the media are biased. This isn't necessarily something to fear, but it is something to acknowledge and recognise. Possibly we should worry a bit more about the bias in the politicians? [*]

[HT: Marginal Revolution]

*****

[*] Of course, we should note that the population of Twitter users will not necessarily be representative of the population overall. So, perhaps media are biased relative to the population as a whole, and politicians are less biased than the media?

Shareholders of dating apps should be freaking out right now

My ECONS102 class has been covered the economics of information this week, including asymmetric information and signalling. So, it is timely to revisit the topic of online dating (which I have discussed earlier this year, here and here), particularly given the rise of artificial intelligence. As the Financial Times reported last month (paywalled):

Terrible news from the world of online dating. As if a parade of dubious romantic prospects and dead-end chats wasn’t bad enough, artificial intelligence has dipped its toe into the dating pool.

Eleven years ago, Tinder helped to turn dating into a series of quick-fire interactions on the internet. But for some jaded users, even writing “Hi” to a romantic prospect is now too much effort. Tech start-ups such as Rizz and YourMove AI are gaining a foothold in the sector by offering AI assistance in creating witty opening lines and appealing profiles.

Meeting strangers on the internet is by nature a random affair. Artificial chat is at least a less sinister way to help that process along than asking users to swab the insides of their mouth, as DNA-dating app Pheramor once did. But a proliferation of AI-assisted conversations suggests that eventually dating apps will simply be full of computers trying to woo other computers.

One start-up even offers the chance to watch this exact premise unfold. Teaser AI asks users questions about themselves and their personalities and then crafts AI-generated chat that is designed to mimic them. When individuals match, they can sit back and watch as their chatbots try to chat each other up.

I'm sure I wasn't the first to point out that we would eventually find ourselves in a world where one instance of ChatGPT was chatting up another instance of ChatGPT, with no humans involved. On top of being a somewhat amusing situation, there is a downside in this development. It will simply make it more difficult for someone genuinely looking for love to find a match online.

To see why, we need to discuss adverse selection. Adverse selection arises when one of the parties to an agreement (the informed party) has private information that is relevant to the agreement, and they use that private information to their own advantage at the expense of the uninformed party. In the case of online dating, the private information is the quality of each potential date. They know if they are high quality or not, but no one else knows. That could lead to a pooling equilibrium, where every online dating subscriber assumes that everyone they are matched with is low quality (because they can't tell the high quality and low quality dates apart, and assuming that every match is high quality is a recipe for disaster). High quality dates don't want to be treated as if they are low quality, so they drop out of the online dating market. Eventually, the online dating market only has low quality dates. The 'market' for high quality dates fails.

Of course, the market typically hasn't failed. People find love in online dating, so clearly the online dating apps are doing something to reduce the adverse selection problem. One thing that they do is offer the ability for subscribers to chat with the people they are matched with. Chatting allows the subscriber to work out (albeit imperfectly) who is high quality and who is low quality. When applied by the uninformed party, this is referred to as screening.

It also allows the high-quality dates to signal that they are high quality. To be effective, a signal must meet two criteria. First, the signal must be costly (otherwise everyone, even those who are lower quality dates, would provide the signal). And second, it must be costly in a way that makes it unattractive for the lower quality dates to attempt (such as being more costly for them to engage in). Engaging in witty and flirty conversation (or whatever type of conversation a subscriber is looking for, if not witty and flirty) on a dating app is costly - it takes time and effort. It will also be less costly for high-quality dates, for whom the desired type of conversation may come more naturally. It is much easier to be yourself in conversation than it is to pretend to be someone you are not. So, conversation on dating apps is an effective signal, albeit an imperfect one.

The problem with AI is that it eliminates the signalling value of conversation on the app. An uninformed subscriber should no longer find the conversation on the app to be a credible signal of the quality of the match they are engaging with. They can't use the conversation for screening either. After matching, the best option is likely to be, as I suggested earlier, in-person meet-ups.

The shareholders of online dating services should be freaking out right now. Their business model, which is built on providing high-quality matches, is under threat by AI. Once the novelty of watching their AI wingman chatting up their match's AI wingman wears off, subscribers will realise that paying for the dating app has become a waste of time. In fact, here's the share price performance over the last six months of the three biggest dating app companies, Match Group (MTCH) in blue, Bumble (BMBL) in black, and Grindr (GRND) in green (original data taken from here):

While Match is up 10.4 percent over that time, Grinder is down 19.5 percent, and Bumble is down 25.3 percent. It's not looking good.

Read more:

• Who loses status, and who gains status, with ChatGPT
• AI may be the killer app, as well as the killer of (dating) apps

Drip pricing and quasi-rational behaviour

In an interesting article in The Conversation last month, Ralf Steinhauser (Australian National University) explains the idea of drip pricing:

You see a fantastic offer, like a hotel room. You decide to book. Then it turns out there is a service fee. Then a cleaning fee. Then a few other extra costs. By the time you pay the final price, it is no longer the fantastic offer you thought.

Welcome to the world of drip pricing – the practice of advertising something at an attractive headline price and then, once you’ve committed to the purchase process, hitting you with unavoidable extra fees that are incrementally disclosed, or “dripped”.

Drip pricing – a type of “junk fee” – is notorious in event and travel ticketing, and is creeping into other areas, such as movie tickets. My daughter, for example, was surprised to find her ticket to the Barbie movie had a “booking fee”, increasing the cost of her ticket by 13%.

Steinhauser then goes on to explain why consumers are susceptible to drip pricing, blaming present bias and loss aversion:

In the case of booking that hotel room, you could abandon the transaction and look for something cheaper once the extra charges become apparent. But there’s a good chance you won’t, due to the effort and time involved.

This is where the trap lies.

Resistance to the idea of starting the search all over again is not simply a matter of laziness or indecision. There’s a profound psychological mechanism at play here, called a present-bias preference – that we value things immediately in front of us more than things more distant in the future...

Beyond the challenge of starting over, there’s another subtle force at work when it comes to our spending decisions. Drip pricing doesn’t just capitalise on our desire for immediate rewards; it also plays on our innate fear of losing out.

This second psychological phenomenon that drip pricing exploits is known as loss aversion – that we feel more pain from losing something than pleasure from gaining the same thing...

Imagine you’re booking tickets for a show. Initially attracted by the observed headline price, you are now presented with different seating categories. Seeing the “VIP” are within your budget, you decide to splurge.

But then, during the checkout process, the drip of extra costs begins. You realise you could have opted for lower-category seats and stayed within your budget. But by this stage you’ve already changed your expectation and imagined yourself enjoying the show from those nice seats.

Going back and booking cheaper seats will feel like a loss.

In my view, Steinhauser is absolutely correct that drip pricing exploits consumers' quasi-rationality (that is, that consumers are subject to biases in their decision-making). However, he is not fully correct about the sources of the quasi-rational behaviour.

First, present bias would tend to work against drip pricing, because (using Steinhauser's example) consumers are weighing up the cost of the tickets (which they face now) against the benefit of the concert they will attend (which is in the future). If consumers weigh the present more heavily than the future, then the costs weigh more heavily than the benefits, which would work against the consumers paying the junk fees.

Second, Steinhauser is correct about loss aversion, but for the wrong reason. Nobel Prize winner Richard Thaler noted that people engage in mental accounting related to particular decisions. People like to keep their mental accounts in positive balances, and are reluctant to give up on something if the mental account has a negative balance, because that would result in 'booking a loss'. Since people are loss averse, they will only want to close mental accounts that have a positive balance.

What does that mean for a consumer buying a concert ticket? They have spent some time and effort selecting their seats and completing most of the booking process. That puts their mental account for the concert into a negative balance. So, facing a small additional fee seems like a good deal, when compared to closing the mental account with a loss. The consumer pays the fee. They don't necessarily feel happy about it, but it is better than the alternative. The only way to get their mental account for the concert into a positive balance is to attend the concert.

A related way of thinking about the process of buying concert tickets with junk fees is the concept of switching costs. Switching costs are the costs of switching from one seller to another, or from one good or service to another. In this case, for a quasi-rational consumer who is running a mental account for the concert, giving up on buying the ticket when they are faced with the junk fees creates a switching cost - the loss in their mental account. When consumers face high switching costs, they can become locked in to buying a product. The seller can then take advantage of their locked in consumers by increasing the price (which is what the junk fees effectively do).

If you are a strong believer in the tenets of neoclassical economics, then the consumer response to drip pricing seems somewhat at odds with rational behaviour. For a purely rational consumer, the time and effort spent on the booking process up to the time that they face the additional of the junk fees is a sunk cost. It shouldn't affect the decision about whether to proceed with buying the ticket or not, because that decision should depend only on the costs and benefits of attending the concert. If the junk fees increase the costs of attending the concert to such an extent that they are higher than the benefits of attending the concert, a purely rational consumer would stop the ticket-buying process at that point. However, a quasi-rational consumer, who is running a mental account for the concert, would be more likely to proceed with the purchase even when presented with the junk fees.

So, overall, drip pricing leads to more sales if consumers are quasi-rational than if consumers are purely rational. It's lucky (and very profitable) for the ticket sellers that so many of us are not purely rational consumers.

Agricultural labour and the market for agricultural land

Back in 2021, I wrote a post about a shortage of agricultural labourers on Australian farms. Australian farmers were offering incentives to attract New Zealand farm labourers to move to Australia. I want to revisit that post, but this time from the perspective of the New Zealand markets for agricultural labour and agricultural land.

First, consider the market for labour, as shown in the diagram below. The market starts in equilibrium, where the demand curve D0 meets the supply curve S0. Equilibrium agricultural wages are W0, and Q0 agricultural labourers are employed. As Australian farmers attract New Zealand farm labourers to cross the Tasman, this decreases the supply to S1. That pushes the equilibrium agricultural wage up to W1, and decreases the quantity of agricultural labourers employed to Q1.

How does that affect the market for agricultural land? The demand for agricultural land depends on the value of the marginal product of land. With fewer agricultural labourers available to work the land, the marginal product of land (the amount of production from the next hectare of land) will decrease. That means that the value of the marginal product of land will also decrease - land is not providing as much value to farmers. Now consider the market for agricultural land shown in the diagram below. The market starts in equilibrium, where the demand curve DA meets the supply curve SA. Equilibrium land rents are RA, and QA agricultural land is being utilised. As the value of the marginal product of land decreases, the demand for land decreases to DB. That decreases the equilibrium land rent to RB, and decreases the quantity of agricultural land being utilised slightly, to QB.

It is little wonder that New Zealand farmers were worried about Australian farmers attracting New Zealand farm labourers to leave. Even without considering farm profits directly, not only would it increase farm wage costs, but it would decrease the value of land (which is, as you may expect, related to the rental value of land).

Read more:

• This is how the market responds to shortages of agricultural labour

National's tax policy and the goals of government

In my ECONS102 class, we talk in the first week of class about decision-makers' goals. The goal of people is to maximise utility (satisfaction, or happiness). The goal of firms is to maximise profits. So far, so good. 

The goal of government is not so straightforward. The starting point is that the goal of government is to maximise the wellbeing of the population. When we're talking about markets, that translates into maximising economic welfare (what economists refer to as allocative efficiency). However, we must always remember that government is made up of legislators who are people, who have their own individual goals (they are trying to maximise utility). One way that legislators may maximise their own utility is by maximising their chances of getting re-elected. Maximising re-election chances may not be consistent with maximising the wellbeing of the population. That tension is one of the key insights of the theory of public choice.

One example where political goals trump allocative efficiency is when some of the economic welfare generated by a market goes to non-voters. Since, by definition, non-voters don't vote, legislators may feel much less inclined to protect those market participants from harm. Taking that point even further, if government can find ways of capturing welfare from non-voters and transferring that welfare to voters, that might be a good option for the legislators themselves, by increasing their chances of re-election.

Now, consider National's new tax policy proposals in light of this. As this article in The Conversation from earlier this week, by Jonathan Barrett and Lisa Marriott (both Victoria University of Wellington), notes:

The National Party’s newly released tax package makes a clear and politically prudent play for the middle-income vote. Proposing to alleviate the financial pain of this “squeezed middle”, it may be key to determining who forms the next government...

To ensure the package is revenue neutral, four new taxes will be introduced. If the policy is aimed at those who vote, then three of the new taxes are aimed at shifting the tax burden to those who cannot vote.

The Foreign Buyer Tax (FBT) will be levied at a flat rate of 15% on residential properties worth more than NZ$2 million bought by non-residents.

A second stream of revenue will come from a tax on offshore gambling.

And a third will be from cost recovery from immigrants to cover public spending on the immigration system. To be competitive, charges will not exceed 90% of corresponding Australian immigration charges.

These proposals would cost voters very little, but increase the tax revenue generated from non-voters. Additional financial benefits can then be transferred to voters:

National has announced four key initiatives as part of its tax plan, with implications for those on middle incomes, as well as those at the top and bottom of the income spread:

• shifting income tax brackets to compensate for inflation

• expanding tax credits to reach more modest income earners

• introducing the “FamilyBoost” childcare tax credit (while ending Labour’s extension of 20 hours’ early childhood education for two-year-olds that was scheduled to start in July 2024)

• increasing Working for Families tax credits for working families (from July 2024).

It will be interesting to see how well these proposals are received by the electorate. An overall package that costs voters little, but benefits them financially, could be a winning strategy. Of course, there are limits to how much tax non-voters are willing to bear, but National may not care so much about that. On the other hand, there are other issues with the proposal, and the foreign buyers tax has come in for specific criticism already. Ultimately, we'll find out how successful this strategy is on Election Night in October!