Return migrants are willing to accept lower wages in exchange for better institutional quality

Last year, I wrote a post about how return migrants to Vietnam prefer areas with higher-quality institutions. The post was based on the research of one of my PhD students, Ngoc Tran, myself, and Jacques Poot. Ngoc recently submitted her PhD thesis for examination, which is a great achievement. Along the way, she completed four research papers (see here, here, here, and here), and also has a forthcoming book chapter. In this post though, I want to focus on the fourth research paper, as it is the most novel.

In the paper, co-authored between Ngoc Tran, Jacques Poot and I, we looked at the intensity of migrants' preferences to high-quality institutions back in their home country. In other words, we asked how much things like absence of corruption, political stability, and the rule of law, mattered for migrants' decision-making about potentially returning home. To measure the intensity of preferences, we used a novel application of the contingent valuation method.

To do this, we first recognised that there are compensating differentials for working in different locations - in areas with higher-quality amenities (such as higher-quality institutions), wages will be lower than in areas with lower-quality amenities (such as lower-quality institutions). We can exploit this to work out what higher-quality institutions are worth, by looking at how much a migrant's income would have to change to make them indifferent between the area with lower-quality institutions and the area with higher-quality institutions.

We did this by asking Vietnamese migrants in New Zealand two questions:

1. Given your perceptions of the difference in institutional quality between New Zealand and Viet Nam, what would be the smallest level of weekly income before tax in Viet Nam where you would be happy moving back to Viet Nam permanently?; and
2. Now imagine that the institutional quality in Viet Nam changed so that it was equal to New Zealand in all ways (and everything else remained the same). If this happened, what would be the smallest level of weekly income before tax in Viet Nam where you would be happy moving back to Viet Nam permanently?

The first question allowed us to estimate the compensating different based on the current differences in institutional quality and other amenities between the two countries, as well as migration costs. The second question modifies the institutional quality in Vietnam so that it is equal to that in New Zealand, holding everything else (including migration costs) constant. The difference between the answer to Question 1 and the answer to Question 2 provides an estimate of the willingness of the migrant to accept lower wages in exchange for improved institutional quality in Vietnam.

Our estimates show that willingness to pay for an incremental unit improvement in institutional quality in Viet Nam is, on average, NZD 79.80 per week (approximately 33 percent of the average weekly wage in Viet Nam for the same period). Moreover, older migrants are willing to pay more, as are migrants who perceive institutional quality to be more important for the repatriation intentions.

As far as we know, this is the first paper ever to use contingent valuation to measure the intensity of preference for institutional quality, certainly among migrants if not among any population group. Notwithstanding the continuing debate on the use of the contingent valuation method (which I've written about here, here, and here), this was a really innovative piece of work.

Congratulations again to Ngoc on submitting her PhD thesis!

Read more:

• Return migrants to Vietnam prefer areas with higher-quality institutions

Alcohol minimum pricing vs. taxes

Let's say that there was some good, where the government thought the market provided too much. Consumers consume too much of this product, compared to some socially efficient level. Economists call this a demerit good. The government might want to find some way of reducing consumption of the good. A tax seems like an obvious solution, and has the bonus effect of increasing government revenue - a double win!

But now let's consider a specific demerit good - alcohol. If the government taxes alcohol, the effects on the market are shown in the diagram below. The price that the consumers pay increases from P0 to PC, and the effective price that the producers receive (after paying the tax to the government) falls to PP. The quantity traded (and consumed) decreases from Q0 to Q1. Notice that the demand curve is quite steep (inelastic), so the tax doesn't reduce consumption by much. Notice also that, because the demand curve is steeper (more inelastic) than the supply curve, the price consumers pay goes up by a lot, while the effective price that producers receive falls by only a little. That means that consumers end up facing the burden of the tax. But, at least, the tax has reduced alcohol consumption, which was the aim.

But will the tax really reduce alcohol consumption? Maybe consumers notice the higher prices and simply switch from higher quality (and more expensive) alcohol to lower quality (and less expensive) alcohol. Then, they could continue to drink the same amount as before (but they would just be drinking lower quality beverages). This argument has been made by Eric Crampton (see here, for example).

If the government is concerned about consumers switching to lower quality alcohol, an alternative is to introduce minimum pricing (which I have discussed before, here). Indeed, that is what Northern Territory is about to do, as John Boffa noted in The Conversation this week:

From October 1, 2018, one standard drink in the Northern Territory will cost a minimum of A$1.30. This is known as floor price, which is used to calculate the minimum cost at which a product can be sold, depending on how many standard drinks the product contains...

 The implementation of the minimum floor price is the result of legislation, recently passed to minimise alcohol-related harms in the NT. From October, the NT will become one of the first places in the world to introduce a minimum price for alcohol.

What effect would minimum pricing have on the market? Here's what I wrote back in 2016 on the same topic (but I've updated the diagram to match the diagram above):

The effect is shown in the diagram below. Without minimum pricing, the market equilibrium price is P0, and the quantity of alcohol sold (and presumably consumed) is Q0. But with a binding minimum price (above the equilibrium price) of PC, the quantity of alcohol demanded falls to Q1. In other words, alcohol consumption falls.

Notice that the effect is to reduce alcohol consumption, which is what the government wants. Eyeballing the data in Boffa's article, it definitely shows an increase in price, and it seems that there is the decrease in quantity sold, but the decrease might not be statistically significant. Although Boffa notes:

As expected, the ban on cheap cask and fortified wine led some drinkers to turn to other types of alcohol. But while there was a 70% increase in the consumption of more expensive full-strength beer, the decline in the consumption of cheap alcohol more than offset this. This led to the overall 20% decline in consumption.

An added benefit of minimum pricing is that consumers can't switch between categories to essentially minimise the effect of the policy on their drinking, since a minimum price has a greater effect on low-quality (and therefore cheaper) drinks.

Now let's consider another good that some people would like to see the government act to reduce consumption (although it is arguable whether it is a demerit good) - sugar. A tax on sugar-sweetened beverages (which I've previously discussed here) would have similar effects to the tax on alcohol described above (although whether demand for sugar-sweetened beverages is as inelastic as alcohol is a separate issue). It would even induce consumers to switch to lower quality drinks, as Eric Crampton has argued (see here and here, for example). So, if the anti-sugar brigade want to reduce sugar consumption, wouldn't it be better for them to argue for a minimum sugar price instead?

Read more:

• Alcohol minimum pricing, elasticity and profits

Is Trump vs. Xi a game of chicken, or a prisoners' dilemma?

There are several famous games that we use to teach game theory, one of which is the prisoners' dilemma (which I blogged on earlier in the week). Another is the game of chicken.

In the classic chicken game, two rivals line their cars up at opposite ends of the street. They then race directly towards each other. Each rival then has two options: (1) to swerve out of the way; or (2) to speed on. If one rival swerves and the other speeds on, the rival that sped on wins and the other driver looks foolish and loses some street cred. If both swerve, they both look a bit foolish. If both speed on, then there is a horrific accident and both may be severely injured or die. The game is presented in the payoff table below, for two drivers (Driver A and Driver B).

To find the Nash equilibrium in this game, we 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). In this game, the best responses are:

1. If Driver A speeds ahead, Driver B's best response is to swerve (since a loss of face is better than dying in a fiery crash - maybe not immediately, but certainly in the long term) [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 Driver A swerves, Driver B's best response is to speed ahead (since winning is better than looking a little foolish);
3. If Driver B speeds ahead, Driver A's best response is to swerve (since, again, a loss of face is better than dying in a fiery crash);
4. If Driver B swerves, Driver A's best response is to speed ahead (since winning is better than looking a little foolish).

Notice that there are two Nash equilibriums in this game - where one driver swerves and the other speeds ahead. Both drivers prefer the outcome where they are the one speeding ahead though, so if both try to get that outcome, we end up with both drivers dying in a fiery crash. The chicken game suggests that both players, acting in their own selfish best interest (or not considering the response of the other driver), leads to the worst possible outcome.

Which brings me to this article by Ambrose Evans-Pritchard in the Telegraph UK (gated, but there is an ungated version here):

The US and China are on a combustible escalation path that can end only when there is economic blood on the floor and the political pain threshold of one side or the other has been hit.

Both think they can withstand the longer siege. Neither can retreat easily...

China has in any case stated already that it will match each round of US tariffs with a riposte in kind.

Beijing must carry out this threat or lose face, and Trump has already vowed to escalate further when it does.

It is very hard to see how asset markets priced for perfection can ignore this deranged game of chicken for much longer. The mystery is that they have not crumbled yet.

Is this really a game of chicken? It turns out that it depends on how you define the payoffs. There are two players in the game (the U.S. and China), and two strategies (enact tariffs or hold off - the equivalents of speeding ahead or swerving). So, we can represent the game easily in a payoff table.

First, let's consider the payoffs to each country. If one country enacts tariffs and the other holds off, both countries are worse off than the status quo (they both lose some gains from trade), but the country that holds off probably loses less (their exporters are a bit worse off) [*]. We'll say that the payoff to the country enacting the tariffs is "bad", but for the other country the payoff is just "not so bad". If both countries enact tariffs then all of the bad stuff happens (exporters are a bit worse off, and there are lost gains from trade). We'll say that payoff is "very bad" for both countries. If both countries hold off, then the status quo prevails - the payoff is "OK" for both countries. The game is presented in the payoff table below.

Again solving for Nash equilibrium, the best responses are:

1. If China enacts tariffs, the U.S.'s best response is to hold off (since "not so bad" is better than "very bad");
2. If China holds off, the U.S.'s best response is to hold off (since "OK" is better than "bad");
3. If the U.S. enacts tariffs, China's best response is to hold off (since "not so bad" is better than "very bad");
4. If the U.S. holds off, China's best response is to hold off (since "OK" is better than "bad").

Notice that the best response for both countries is to hold off, regardless of what the other country does. Holding off is a dominant strategy. There is one Nash equilibrium here, which is for both countries to hold off (the status quo). It is also a dominant strategy equilibrium (because both countries have a dominant strategy). The equilibrium outcome of this game is the best outcome overall.

Clearly, that isn't the game that is playing out at the moment though, so how are things different? The current game is not a game about trade, it is a game about political posturing. The players are not the U.S. and China, but Donald Trump and Xi Jinping. They want to look strong, and not appear weak (to each other, or to their respective peoples). So, the payoffs and the players are different. The game that is actually being played looks more like the payoff table below. If both hold off, the status quo prevails (the payoff is "OK" for both. If one of them enacts tariffs and the other holds off, whichever of them enacted tariffs appears strong, and the other appears weak. If both enact tariffs, the payoff is costly to the economy.

Again solving for Nash equilibrium, the best responses are:

1. If Xi enacts tariffs, Trump's best response is to enact tariffs (since "costly" is better than "weak");
2. If Xi holds off, Trump's best response is to enact tariffs (since "strong" is better than "OK");
3. If Trump enacts tariffs, Xi's best response is to enact tariffs (since "costly" is better than "weak");
4. If Trump holds off, Xi's best response is to enact tariffs (since "strong" is better than "OK").

Notice that the best response for both leaders is to enact tariffs, regardless of what the other leader does! Enacting tariffs is a dominant strategy, and both leaders enacting tariffs is both the only Nash equilibrium and a dominant strategy equilibrium. The single equilibrium is also unambiguously worse than one of the other outcomes - this is an example of the prisoners' dilemma. Notice that it is not a chicken game.

How could this become a chicken game? If costing the economy was worse than appearing weak, then that would change things around. In that case, the best response to the other leader enacting tariffs would be to hold off. There would be two Nash equilibriums - where one leader enacts tariffs and the other holds off. However, both would prefer to be the leader enacting the tariffs rather than the one holding off.

So, whether this game is a chicken game or a prisoners' dilemma depends on how you think each leader feels about appearing weak. It seems to me that both want to avoid that at all costs. In my mind, this is a prisoners' dilemma, not a chicken game.

The repeated prisoners' dilemma can be solved for the optimal outcome (both holding off), but this requires cooperation between the two leaders. In order for this cooperation to arise, each leader must trust the other (because enacting tariffs is still a dominant strategy). If we want global trade to survive this showdown, somehow we need these leaders to develop a trusting relationship. It's a pity that Trump will not be at the APEC leaders meeting - it seems like a group hug is in order!

*****

[*] This might sound surprising. For the country imposing tariffs, tariffs lead to a deadweight loss (lost wellbeing). They make domestic sellers better off, but make domestic consumers worse off by more than the gain to domestic sellers. In contrast, the market in the country that holds off has no deadweight loss. The exporting firms in that country will be able to export a bit less, but that probably doesn't have as big of a negative impact as the tariffs do on the country that imposed them.

Safety concerns and strawberry markets

The economic model of demand and supply is remarkably robust in terms of explaining changes in prices, and as I show in my ECONS101 class, it even works (qualitatively) when the market is not perfectly competitive. Given that my ECONS101 class has a test coming up in a week and a half, I thought it might be timely to look at an example. Let's take the recent safety scares in Australia, as reported by the New Zealand Herald:

Fruit growers across Australia are reeling from 20 reports of needles found in punnets of berries, with isolated cases of banana and apple sabotage...

Mass harvests of fruit have been dumped as prices plunge, consumer demand evaporates and products are ripped from shelves.

A police operation involving 100 officers across multiple states is now under way to hunt down those responsible...

Up to 120 growers in Queensland alone — where the scare originated — have been hit by a slump in demand and a wholesale price collapse of more than 50 per cent.

Consider the market for strawberries, as shown in the diagram below. Before the sabotage, the market was operating in equilibrium with price P0, and Q0 strawberries were being traded. Following reports of needles in strawberries, consumers have product safety concerns (who wants to buy strawberries when there's a chance of a needle strike?), so demand decreases from D0 to D1. The equilibrium price falls from P0 to P1 (a "price collapse of more than 50 per cent"), and the quantity of strawberries traded falls from Q0 to Q1.

So far, so bad. But, if you're strawberry growers, what do you do with all those strawberries that aren't being demanded by consumers? You could dump them (and some have), so maybe you find someone else willing to take them. Consider the market for strawberry jam, as shown in the second diagram below. The market was initially operating in equilibrium with price PA, and QA units of strawberry jam were being traded. Then, sabotage hits the strawberry market. The price falls. Strawberries are now much cheaper to buy (not just for consumers, but for strawberry jam producers as well). The supply curve for strawberry jam shifts down and to the right (an increase in supply), from SA to SB. The equilibrium price of strawberry jam falls from PA to PB, and the quantity of strawberry jam traded increases from QA to QB.

That last implication is testable. Check the supermarket shelves in coming months, and expect to see cheaper strawberry jam.