Is the race-to-the-bottom over for Ireland?

In ECON110 this week, we talked about the debate over globalisation. One aspect we discussed (albeit briefly as I was running out of time) was the 'race to the bottom'. This is a form of Tiebout competition (though Tiebout was writing about local governments rather than national governments). National governments want to attract multinational corporations to locate their production (or other) activities in their country rather than other countries. This creates jobs and keeps the population happy, and increases the chances that the government gets re-elected (if the country is democratic). Alternatively, it offers the chance for corrupt politicians to enjoy kickbacks and place their cronies in positions of power in the local subsidiary firm. Either way, there are incentives for the government to attract multinationals to locate in their country.

But, lots of countries have the same incentives here. They need to compete for the attention of the multinational. In order to ensure that the factory (for example) is built in their country, the government will need to offer a more attractive package than other countries. This package might include tax breaks, priority access to land, generous subsidies, and so on. Once one country starts to offer these inducements, other countries will need to do so to have any chance of attracting the factory to locate in their jurisdiction. This is the 'race to the bottom' - essentially a race towards zero corporate taxes (or even negative corporate taxes, if subsidies are eventually included in the offers).

And so, we end up with the situation where Apple apparently pays a 0.0005 per cent tax rate in Ireland. As reported in Stuff yesterday (and widely reported elsewhere):

The European Union says Ireland has given illegal tax benefits worth up to 13 billion euros (NZ$20.08bn) to Apple and must now recover the unpaid back taxes from the US technology company, plus interest.

EU Competition Commissioner Margrethe Vestager said: "Member states cannot give tax benefits to selected companies - this is illegal under EU state aid rules."

The announcement was made on Tuesday night, NZ time.

She said a three-year investigation found Ireland granted such lavish tax breaks to Apple over many years that the multinational's effective corporate tax rate on its European profits dropped from one per cent in 2003 to a mere 0.0005 per cent in 2014.

The race-to-the-bottom may have reached its limits. The big question for me is now: will the EU also take a closer look at the tax arrangements in Luxembourg as well? Watch this space.

[HT: David in the Waikato EDG Facebook group]

Why restricting natural gas exports is not a good idea

This week in ECON110 we are covering international trade (and globalisation). The arguments against free trade often focus on the harms to workers (and firms) in import-competing industries - that is, those firms where jobs would be lost by having to compete with lower-cost foreign producers. The counter-argument is that consumers are made better off in these markets by being able to buy the imported products at much lower prices (increasing their consumer surplus).

Much less attention is focused on the impacts of trade restrictions on exporting industries. Consider for example, this 2013 New York Times story about the exporting of natural gas in the U.S.:

As Dow Chemical’s chief executive, Andrew N. Liveris has made himself into something of an outcast among his fellow business leaders.

The reason? He is spearheading a public campaign against increased exports of natural gas, which he sees as a threat to a manufacturing renaissance in the United States, not to mention his own company’s bottom line. But many others say such exports would provide far more benefits to the country than drawbacks, all part of a transformation that promises to increase the nation’s weight in the global economy...

By 2020, new oil and gas production could increase the country’s economic output by 2 to 4 percent beyond what it otherwise would be, add as many as 1.7 million jobs and perhaps reduce the bill for energy imports to zero, according to a report by the McKinsey Global Institute.

“This is a giant turnaround,” said Daniel Yergin, a longtime energy expert and author of a recent book, “The Quest: Energy, Security and the Remaking of the Modern World.” “This is fundamentally improving the competitive position of the United States in the world economy.”

But that windfall is at risk if the government permits natural gas exports to increase quickly, Mr. Liveris warns.

Natural gas is valuable, and on the surface the argument to restrict exports of natural gas in order to keep the value in the U.S. economy makes some intuitive sense. But it would also be quite wrong, and actually make the U.S. worse off.

To see why, let's take a step back and compare an exporting country with trade and without trade. Consider the diagram below, and we'll assume that the U.S. has a comparative advantage in producing natural gas - that means that the domestic price of natural gas (PD) would be below the price of natural gas on the world market (PW). This indicates that U.S. natural gas producers can produce and sell natural gas at a lower cost than foreign producers. Because the domestic price is lower than the world price, if the country is open to trade there are opportunities for traders to buy natural gas in the domestic market (at the price PD), and sell it on the world market (at the price PW) and make a profit (or maybe the suppliers themselves sell directly to the world market for the price PW). In other words, there are incentives to export natural gas. The domestic consumers would end up having to pay the price PW for natural gas as well, since they would be competing with the world price (and who would sell at the lower price PD when they could sell on the world market for PW instead?). At this higher price, the domestic consumers choose to purchase Qd0 natural gas, while the domestic suppliers sell Qs0 natural gas (assuming that the world market could absorb any quantity of natural gas that was produced). The difference (Qs0 - Qd0) is the quantity of natural gas that is exported. Essentially the demand curve with exports follows the red line in the diagram.

We can also use the diagram to demonstrate the gains from trade for an exporting country. Without trade, the market would operate at the domestic equilibrium, with price PD and quantity Q0. Consumer surplus (the gains to domestic natural gas consumers) would be the area AEPD, the producer surplus (the gains to domestic natural gas producers) would be the area PDEF, and total welfare (the sum of consumer surplus and producer surplus, or the gains to society overall) would be the area AEF. With trade, the consumer surplus decreases to ABPW, the producer surplus increases to PWCF, and total welfare increases to ABCF. Since total welfare is larger (by the area BCE), this represents the gains from trade. So, the U.S. is better off with trade, because the total welfare is larger than it is without trade.

Now consider an intermediate case. Instead of having no trade, or having unlimited trade, what would happen if the government allows trade up to some limit? In other words, what happens when there is an export quota? This is demonstrated in the diagram below. Whereas previously, we assumed that the world market could absorb any quantity of exports of natural gas, now the quantity of exports is limited to the agreed quota amount. Let's say that the export quota is limited to the amount between B and G (about half the amount of unrestricted exports). Importantly, the export quota is implemented using licenses - only holders of export licenses are allowed to export natural gas.

Now that there is a quota on exports, consider what happens to the demand curve (including exports). The upper part represents the domestic consumers with high willingness-to-pay for natural gas. Then there is a limited quantity of export demand, at the world price PW. After that, there are still profit opportunities for domestic suppliers (that is, there are still some domestic consumers who are willing to pay more than what it costs the suppliers to produce natural gas). So, the demand curve (including the export quota) pivots at the point G, and follows a parallel path to the original demand curve (i.e. the demand curve including exports follows the red line in the diagram). The domestic price is the price where supply is equal to demand (P1). Export license holders can purchase natural gas at this price, and then sell it on the world market and receive the higher world price (PW), and pocket a profit. The domestic consumers choose to purchase Qd1 natural gas at the price P1, while the domestic suppliers sell Qs1 natural gas at that price. The difference (Qs1 - Qd1) is the quantity of exports (which is also the quantity of the quota).

Now the consumer surplus is larger than it was without the export quota (it is now the area AJP1), the producer surplus is smaller than it was without the export quota (it is now the area P1HF). The export license holders now receive a surplus (profit), equal to the area KLHJ. Total welfare (which is now made up of the consumer surplus, producer surplus, and license holder surplus) is smaller than without the export quota (it is now the area AJHF+KLHJ). There is a deadweight loss (a loss of total welfare arising from the export quota) equal to the area [BKJ + LCH] - these areas were part of total welfare with trade and no export quota, but have now been lost.

Importantly though, note that the total welfare area is larger with the export quota (AJHF+KLHJ) than with no trade at all (AEF). So, the argument that restricting exports of natural gas makes the U.S. better off and will "fundamentally improve the competitive position of the U.S. economy" is simply untrue. Up to the point where the market-determined quantity of natural gas is exported, there are gains to be had from additional exports. That doesn't mean that more exports are always better. For instance, export subsidies that increase exports beyond the quantity shown in the first diagram above are also bad. And, you might want to restrict natural gas production for environmental reasons (which haven't been accounted for in the diagrams above). But those are stories for another day.

Read more:

• Why export quotas probably failed to help coffee farmers

Sustainable kereru harvesting

Protecting threatened and endangered species is hard. That's because they are common resources - resources that are rival and non-excludable. Rival resources are those where one person's use of the good reduces the amount available to everyone else, i.e. in this case one hunter killing a threatened animal reduces the number of those animals available to everyone. Non-excludable resources are those where you cannot easily prevent a person from obtaining the benefit from them, i.e. in this case it is difficult to stop the hunters from hunting.

There are many proposed solutions to solving the common resources problem (see some of my previous posts on common resources for some examples). However, the most sustainable solution is likely to be making the species excludable, rather than non-excludable. If you can prevent the hunters from hunting, then sustainability of animal populations will be much easier to attain. But how do you achieve excludability?

One option is farming. Have you ever considered why many bird species are threatened or endangered, but chickens are not? It's because most bird species are non-excludable (it's difficult to stop someone shooting or trapping a bird in the forest), but chickens are excludable because people own them (and presumably, chicken farmers watch their chickens at least closely enough that hunters wouldn't try to hunt them). Farmers also have large incentives to ensure that they keep their flocks sustainable (by taking out only the number of chickens that leaves a reasonably stable, or even growing, population).

However, for most birds farming is not an option. Some don't do well in captivity, and most of us would probably prefer that wild populations are kept sustainable, rather than developing increasingly in-bred farmed populations. So, we need an alternative option.

Fisheries in many countries are managed through transferable quota systems. Quotas regulate the number of fish that are allowed to be removed from the sea in a given period of time. The total quota is set by determining a total allowable catch for a year (in theory at least this is roughly equal to the growth in the fishery stock), with some allowance made for recreational fishing. Quotas work well because they make fish excludable (no quota means no fishing) and are backed up by monitoring and enforcement.

So I found this article from last week by Len Gillman (head of science at AUT) interesting. Gillman notes:

The kereru is a native New Zealand species protected under legislation, but despite this protection it has continued to decline in abundance since European colonisation. As an iconic native species, it is treasured by many Maori and Pakeha as something that must be preserved at all costs...

The main cause of kereru decline is predation and competition from mammalian pests, not hunting, and controlling these pests with natural poisons such as 1080 has been shown to promote their recovery. With ongoing predator control, populations increase until they reach a point where, limited by resources, surviving fledglings entering the local population roughly equal those leaving the population due to emigration and mortality.

When a population reaches stability, small harvests can be made without affecting the total number of birds, because those removed by harvest allow more fledglings to survive. This concept is known as a sustainable harvest - it allows a small ongoing harvest without affecting the size of the population. Harvesting quotas would need to be based on kereru numbers and age distributions, considering young birds learn survival skills from older birds, but sustainable harvesting holds great promise.

There are a couple of points to add to this. First, once the sustainable harvest number of kereru have been determined, how would the harvest be allocated? In other words, who would determine who has the rights to harvest kereru, and for how many birds? This sort of allocation problem is key (see here for a similar example relating to water).

Second, to ensure efficiency the rights should be transferable between parties in a voluntary exchange. Assuming that the rights to harvest kereru are only provided to iwi, and can only be transferred between iwi, this would still ensure that iwi who have the most to gain from harvesting kereru would be those that did the harvesting (since they would be willing to buy the rights off other iwi who valued the harvest less). This would ensure the maximum net gain for society (as a whole) from the limited (and sustainable) kereru harvest.

Wage segregation, asymmetric information and inequality

Samuel Hammond wrote a post for the Niskanen Center blog that might be one of the clearest and most insightful blog posts I've ever read. Hammond writes about increasing wage segregation in the U.S. labour market, but the insightful bit is to link it to reductions in information asymmetry between employers and workers. I'll refrain from wholesale copying-and-pasting most of the post, which you should read! Here is the most important bit:

How does this apply to technological change, wages, and inequality?

Think back to the naive insurer attempting to “pool” high and low risk types under one premium. Now substitute insurer with employer, and high and low risk types with low and high productivity workers, and the flat premium with a relatively flat wage structure.

Our nostalgic vision of the mid-20th century’s strong middle class is a memory of a wage pooling equilibrium that eventually unraveled. Behemoth corporate employers priced labor in a relatively naive way, given an inability to observe the heterogeneity of individual productivity moment by moment, and the role of labor unions in negotiating wages as a collective. While there was still a premium on things like seniority and higher education, wages were nevertheless fairly compressed.

For workers who contributed substantially more value to the company than they were being paid for, this was a raw deal. Conversely, it was great deal for workers whose productivity lagged. In other words, high productivity workers bore a negative externality by having to partially subsidize low productivity workers due to the inherent opacity of who-contributes-what within team production.

That has changed with information technology that makes it easier than ever to observe and measure individual worker productivity and screen for it accordingly (which may be why the premium from working at larger firms has also diminished).

Wage segregation is of course important because it is one of the causes of the recent increase in inequality observed in the U.S. The previous pooling equilibrium led both high and low productivity workers to have roughly the same wages, because it was difficult for employers to tell them apart. With the (technological) ability to more closely monitor and measure worker performance, the high and low productivity workers can be separated, allowing firms to reward the high productivity workers with higher wages (and not reward low productivity workers).

Now, having said all that it makes me wonder - why isn't inequality increasing in New Zealand for the same reason? As Eric Crampton has noted many times, inequality has barely changed in New Zealand since the mid-1990s. Surely we must have wage segregation here as well? What gives?