Reducing excess demand at the Great Barrier Reef

Late last year, I wrote a post about excess demand for New Zealand's Great Walks:

When a good or service has no monetary cost, there will almost always be excess demand for it - more consumers wanting to take advantage of the service than there is capacity to provide the service. Excess demand can be managed in various ways - one way is to raise the price (as suggested by Sanson). Another is to limit the quantity and use some form of waiting list (as is practiced in the health sector). A third alternative is to degrade the quality of the service until demand matches supply (because as the quality of the service degrades, fewer people will want to avail themselves of it).

The Great Walks are not the only tourist attractions that are subject to excess demand. As Michael Vardon (ANU) wrote recently in The Conversation, the Great Barrier Reef is another example:

The Great Barrier Reef is one of the world’s finest natural wonders. It’s also extraordinarily cheap to visit – perhaps too cheap.

While a visit to the reef can be part of an expensive holiday, the daily fee to enter the Great Barrier Reef Marine Park itself is a measly A$6.50. In contrast, earlier this year I was lucky enough to visit Rwanda’s mountain gorillas and paid a US$750 fee, and the charge has since been doubled to US$1,500...

I understand that some people instinctively object to the idea of trying to put monetary values on things like the Great Barrier Reef. But I think valuation helps, on balance, because it offers a way to assimilate environmental information into the economic processes through which most decisions are made. Money makes the world go around, after all.

However this should be done on the proviso that the valuation is systematic and based on sound environmental and economic data.

Vardon's article is mostly about environmental accounting (and is worth reading if you want to learn a little more about non-market valuation of natural resources). That is, it is about placing a value on the Great Barrier Reef to justify a higher visitor fee. However, it isn't necessary to estimate the Reef's value in order to reduce the tourist pressure on it. If you are worried about there being too many visitors, you simply need to raise the visitor fee. Higher prices reduce excess demand. It is really as simple as that, and if we want to protect these natural resources (Great Walks, Great Barrier Reef, or other natural resources with names that don't start with Great), then higher prices are a simple and reasonably effective way to do so.

Book Review: The Instant Economist

Tim Taylor's The Conversable Economist blog is one of several blogs that I wish I read more often. I usually find it quite insightful and interesting, but for whatever reason I have never added it to my feed. Perhaps I should, especially after reading his 2012 book, The Instant Economist. The book is essentially a Principles of Economics text dressed up as a paperback pop economics book. In the introduction, Taylor describes his hope for the book that it:

...will impart a working understanding of both micro- and macroeconomics, not enough to prepare you for setting up your own economic forecasting business, but enough that you can read and speak about economics topics with greater confidence and conviction.

Mostly, the book succeeds in this goal. It is more readable that a standard economics textbook, and uses interesting examples to illustrate the concepts. It doesn't get too bogged down in theory, and mostly Taylor avoids using diagrams (although an obligatory supply-and-demand diagram or two did sneak their way in!). It's also much more affordable than an undergraduate economics textbook (more on that in a future post).

Highlights of the book include the chapters on money and banking, and corporate and political governance - the latter being a topic that isn't covered in much detail at all in your standard economics textbook. It also has some great quotes, like this one from the chapter on economic growth:

Saying that globalization creates poverty is kind of like saying that exercise makes you overweight because you don't do it. If you're not participating, then the activity in which you are not participating is probably not causing the problem, either.

I guess that must be one of his pet hates. And unfortunately, Taylor's book runs into one or two of my own. Globalisation and trade are not synonymous, but the book treats them almost interchangeably. Trade in goods and services is just one aspect of a wider interconnectedness that characterises globalisation. Health and education are not public goods, because public goods are non-rival (one person's use doesn't reduce the amount available for everyone else) and non-excludable (a person cannot be prevented from consuming the good or service). Health and education are both rival (because doctors and teachers don't have unlimited attention to spend on patients and students respectively) and excludable (you really can exclude people from healthcare and education). I'm not convinced on his characterisation of a negative income tax either.

But those gripes aside, this is an excellent book for someone who doesn't know any economics and wants a primer that will help them to understand a good range of key concepts and topics that they may encounter. It probably won't be much use for a current or former economics student, but might be an interesting read if you want a refresher on things you learned in your economics degree but haven't touched since then.

Principal-agent problems among Sicilian firefighters

In the first week of ECON110, we talk about unintended consequences. One of the examples I ask students to consider in class is what would happen if firefighters were paid for each fire they start, rather than bulk funded. Inevitably, someone always suggests that the firefighters might start fires themselves, in order to increase their funding. I always point out that seems unlikely, and that firefighters would more likely simply spend less effort on prevention activities. It turns out though, maybe those students were right. The Guardian reported back in August:

Fifteen volunteer firefighters have been arrested in Sicily on suspicion of starting wildfires and reporting non-existent blazes so they could earn €10 (£9) an hour for putting them out.

Police in Ragusa province, in the south of the Mediterranean island, said the fire department became suspicious when it emerged that the auxiliary brigade had responded to 120 incidents compared with just 40 tackled by other volunteer teams over the same period...

Most of the team were under investigation for fraud, with several also suspected of arson, Ansa said. The island is plagued by fires in summer and auxiliary firefighters are paid €10 an hour by the state to help extinguish them.

This is also a good example of a principal-agent problem (a type of moral hazard). In this case, the fire department is the principal, and it engages the volunteers (its' agents) to fight fires. However, the fire department probably doesn't want more fires, so the incentives of the fire department (less fires) and the volunteers (more fires, so that they get paid more) are in conflict. The agents will take advantage of the fact that they are not being closely monitored by the principal, in this case by lighting fires themselves.

There are four main ways to deal with moral hazard problems (including principal-agent problems):

1. Better monitoring of the agent (just keeping an eye on the volunteers to make sure they aren't up to no good, I guess - this appears to be what has happened in this case)
2. Efficiency wages (paying a wage that is higher than the equilibrium wage, so that if the agent is up to no good, then have an incentive to behave themselves or else they lose the higher-paying job and have to work somewhere else for a much lower wage)
3. Performance-based pay (paying based on some metric of output - probably this is where things went wrong in this case, since the volunteers were paid for each fire they fought!)
4. Delayed payment (holding back some part of the agent's wages until it is clear whether they did a good job - this works for contractors, but it might not be appropriate in this case).

Performance-based pay is not always the right solution to every moral hazard problem. In this case, it might well have been the cause of the problem in the first place!

[HT: Marginal Revolution]

The returns to education for mobsters

There is a long history of research demonstrating positive returns to education. That is, the benefits of education typically exceed the costs of education for most students in fairly standard education (primary, secondary, vocational or higher education). A 2016 paper (ungated version here) by Nadia Campaniello (University of Essex), Rowena Gray (UC Merced), and Giovanni Mastrobuoni (University of Essex) and published in the journal Economics of Education Review adds to the evidence, but in a fairly unique direction. Campaniello et al. use data on 712 mobsters from the Federal Bureau of Narcotics and compare them with various samples from the 1940 Census. They found that there were:

...large returns to education within the mafia, no matter the model, or the outcome variable, that we use. This shows that private returns to education exist not only in legitimate but also in the illegitimate activities that imply a sufficient degree of complexity. Mobster returns (in terms of income) to a year of schooling are around 7.5-8.5 percent, compared to 9-10 percent for the neighbor sample and 10.5-13 percent for the U.S. born and U.S. citizen samples. Interestingly, mobster returns are substantially larger than we find for the immigrant and, especially, the Italian immigrant, samples, while they are only about one percentage point higher than we find for second-generation Italians. Moreover, for mobsters who, according to the FBN records, were involved in white-collar crimes or in crimes that require running an illegal business (i.e., racketeering, loan sharking, bootlegging, etc.) we find returns to education that are about three times as large as for those who are involved in violent crimes (i.e., robberies, murders, etc.).

The key points to take away are that the returns to education in illegal activities are very similar to the returns to education in legal activities (based on the other samples the authors looked at), and that the mobsters earn higher returns than other Italian immigrants. The latter result is best explained by thinking about the optimal level of education, being where the marginal benefit of an additional year of education (through higher lifetime earnings) is equal to marginal cost of an additional year of education. For a mobster, the annual earnings premium for education needs to be higher because they will expect to spend fewer years 'working', due to the likelihood of prison time for their illegal activities.

The title of the paper asks "Did going to college help Michael Corleone?" Based on these results, I guess it probably did.

[HT: Marginal Revolution, back in January]