As mentioned in my last blog piece I am currently reading nudge. Another example of how econs and humans is the purchasing of extended warranties. Like most consumers I have purchased extended warranties many of which I have used when the good stopped working. However, insurance companies couldn't make a profit and pay commissions if most of the time the warranty was paid out. Another way of putting this is the insurance company is betting you will never make a claim.
Why then do we purchase these policies at considerable expense if we know there is a high likelihood we will never use them. An econ would weigh the odds and figure they are better taking their chances. Humans however feel loses far greater than gains. The loss of an item not working is far greater than the expense of paying extra for an item.
For example I have taken out a warranty on my android tablet. For a cost of $80 I know I don't have to replace my for the next three years. Inspite of the obvious fact many extended warranties are never used, I have taken the beat that in the next three years something will go wrong with my tablet. On a previous occasion I purchased a LG digital video recorder the item, I went home and read reviews on the internet where alot of people who had previously purchased the device experienced technical problems. I rang up WOW and asked if I could still purchase a warranty, in this situation I was able to gain superior information to the insurance company and bet against them. Fourteen months later I won the bet.
However, on three previous occasions I have purchased used car waranties for about a cost of $800. On one occassion I have been able to make a claim on those warranties and "saved" about $450. Clearly, in this situation the purchase of used car warranties makes no economic sense. The only benefit is a human benefit of know that one is protected from unexpected repair costs to the vehicle. However, even in this case the warranty is extremely limited, anything that could be deemed routine maintenance is exempt.
So questions remains are extended warranties a good investment? The answer depends on whether you're an econ or a human and your ability to gather superior information to the insurance company.
Sunday, January 29, 2012
Thursday, January 26, 2012
Do we need to be nudged into income protection insurance?
I'm currently reading the behavioral economics book 'Nudge". In behavioral economics a distinction is made between econs and humans. Econs are perfectly rational being beings that make decisions that maximize their utility in the long run. Humans on the other hand are inclined to make decisions that are not perfectly rational. The introduction of compulsory superannuation was an example of government policy acknowledging that people tend toward the human rather than the econ end the behavioral spectrum. Even now with compulsory superannuation, most people do not put more than the required 9% into superannuation despite knowing 9% will not provide for a comfortable retirement.
Another possible human flaw is the failure to plan for periods of unemployment. The social welfare system is primarily geared for the long term unemployed, single parents, aged pensioners and the disabled. Homeowners do not get the equivalence of rent assistance and $450 a fortnight will not prevent the average middle class person from defaulting on their mortgage or failing to pay their rent. The social welfare system is a system paid for by the taxpayer for the non taxpayer. Despite knowing this very few people access income protection insurance in the marketplace.
Having checked the extra insurance I can take up with my superannuation I can take insurance 75% of my income for 2 years for $3.50 a week in the event I become seriously sick. If the government wanted to reduce the likelihood of sick people claiming welfare and defaulting on their obligations they could make this option automatic with an opt out option. This would nudge the working into insuring themselves through the private sector.
Unemployment insurance for job loses is significantly more expensive but also far more likely. I looked into this option when I first got my mortgage and decided against it. I believe the cost was around $100 a month. Another human characteristic is that humans feel loses far more than gains. Compulsory superannuation was introduced as apart of the Accord and was paid in place of wage increases. This helped reduce inflation and has resulted in Australian's having the highest proportion of share ownership in the world. In this case the government choose to do more than nudge people making the program compulsory but how many people would have kept their superannuation if they could have opt out but it was set up by default. How many people would have really chosen to opt out of superannuation knowing that they wouldn't have enough money to retire in the future?
Prior to the global financial crisis inflation was starting to increase significantly in Australia. When those conditions return perhaps a similar arrangement could be developed to phase in income protection for the middle class helping maintain consumer spending and reducing mortgage defaults in poor economic times. It would also reduce the cost of automatic stabilizers to the Government resulting in smaller deficits, reducing the need/demand for stimulus and lowering the risk of sovereign debt issues.
Another possible human flaw is the failure to plan for periods of unemployment. The social welfare system is primarily geared for the long term unemployed, single parents, aged pensioners and the disabled. Homeowners do not get the equivalence of rent assistance and $450 a fortnight will not prevent the average middle class person from defaulting on their mortgage or failing to pay their rent. The social welfare system is a system paid for by the taxpayer for the non taxpayer. Despite knowing this very few people access income protection insurance in the marketplace.
Having checked the extra insurance I can take up with my superannuation I can take insurance 75% of my income for 2 years for $3.50 a week in the event I become seriously sick. If the government wanted to reduce the likelihood of sick people claiming welfare and defaulting on their obligations they could make this option automatic with an opt out option. This would nudge the working into insuring themselves through the private sector.
Unemployment insurance for job loses is significantly more expensive but also far more likely. I looked into this option when I first got my mortgage and decided against it. I believe the cost was around $100 a month. Another human characteristic is that humans feel loses far more than gains. Compulsory superannuation was introduced as apart of the Accord and was paid in place of wage increases. This helped reduce inflation and has resulted in Australian's having the highest proportion of share ownership in the world. In this case the government choose to do more than nudge people making the program compulsory but how many people would have kept their superannuation if they could have opt out but it was set up by default. How many people would have really chosen to opt out of superannuation knowing that they wouldn't have enough money to retire in the future?
Prior to the global financial crisis inflation was starting to increase significantly in Australia. When those conditions return perhaps a similar arrangement could be developed to phase in income protection for the middle class helping maintain consumer spending and reducing mortgage defaults in poor economic times. It would also reduce the cost of automatic stabilizers to the Government resulting in smaller deficits, reducing the need/demand for stimulus and lowering the risk of sovereign debt issues.
Saturday, January 21, 2012
Foreign Panel Beaters Steal Aussie Jobs!
I was listening to the radio yesterday afternoon and heard a story on the ABC's PM program about foreign panel beaters illegally working in Australia. http://www.abc.net.au/pm/content/2012/s3412633.htm The story explained that on Christmas day tens of thousands of cars were damaged in a hailstorm in Melbourne. Out of work panel beaters have come from the United States and other nations on tourist visas and have been illegally working in local workshops.
This is a perfect example of the market delivering an efficient outcome in spite of laws and regulations limiting their trade. In this situation a sudden event has caused a surge in demand for panel beaters. Due to insufficient capacity to meet demand the price of panel beating services would rise and shortages would occur. Responding to market signals panel beaters have relocated to Melbourne meeting this demand and putting downward pressure on prices.
The industry has responded either by hiring this illegal labour increasing their capacity to service the increased demand or by complaining to the immigration department. So lets consider who these workers are hurting. Local consumers benefit by getting their cars repaired earlier. Insurance holders benefit through lower repair costs and in the long run lower premiums. The foreign workers benefit from the work. The only losers are local panel beaters who lose the ability to profiteer from natural disasters.
This new story provides an excellent example of how policies are that are suppose to protect Australians actually protect a narrow group of rent seekers while causing dead weight loses to broader society. When asked, local panel beaters said the 457 visa process was too difficult and took to long. When the global economy recovers and Australia starts to experience capacity constraints in its labour market, having more flexible regulation will be significant in controlling inflation.
This is a perfect example of the market delivering an efficient outcome in spite of laws and regulations limiting their trade. In this situation a sudden event has caused a surge in demand for panel beaters. Due to insufficient capacity to meet demand the price of panel beating services would rise and shortages would occur. Responding to market signals panel beaters have relocated to Melbourne meeting this demand and putting downward pressure on prices.
The industry has responded either by hiring this illegal labour increasing their capacity to service the increased demand or by complaining to the immigration department. So lets consider who these workers are hurting. Local consumers benefit by getting their cars repaired earlier. Insurance holders benefit through lower repair costs and in the long run lower premiums. The foreign workers benefit from the work. The only losers are local panel beaters who lose the ability to profiteer from natural disasters.
This new story provides an excellent example of how policies are that are suppose to protect Australians actually protect a narrow group of rent seekers while causing dead weight loses to broader society. When asked, local panel beaters said the 457 visa process was too difficult and took to long. When the global economy recovers and Australia starts to experience capacity constraints in its labour market, having more flexible regulation will be significant in controlling inflation.
Wednesday, January 18, 2012
Micoeconomic barriers that increase inequity
Since the global financial crisis there has been a growing focus on increasing inequity in all developed nations but especially the United States. One of the few things experts can agree upon on this issue is that there is a strong relationship between education and income. The difference in weekly wages paid to college graduates compared to those with a high school diploma (Junior and Senior Certificate in Australia) is know as a the college premium. This premium has increased overtime. http://gregmankiw.blogspot.com/2007/04/college-premium.html
The college premium makes sense when one considers the way western economies have changed in the last 30 years. In the mid 20th century the West was the workshop of the world, there were many unionised well paid positions for those people with a high school education. As manufacturing has moved to Asia many of those well paid positions have disappeared. As the West has moved to knowledge industries education has become more important than every.
However, are there artificial microeconomic barriers preventing people from working in a more productive way and earning higher wages? In a recent blog post Paul Krugman provided a table of the occupations in the top 0.1. http://krugman.blogs.nytimes.com/2012/01/15/but-the-top-0-1-percent-isnt-diverse/While the usual suspects (executives) are heavily represented in this group at 40.8%, other occupations represented are law and medicine. One common quality amongst these occupations is that they can all be defined by either market failure or government failure. Executives of large firms are able to exploit the principal/agent problem through their control of their the governance procedures that control their salaries. Professions such as medicine and law strongly influence government policy creating regulations that protect their members profits. The legal profession has succeeded in preventing of professions or para professionals from offering basic legal services at lower prices. For example, there are many basic legal services that accountants could offer or could be provided by people with a diploma level education but are currently only allowed to be performed by a registered solicitor. Equally the medical profession has prevented other health professionals from providing medical services such as requiring a doctors scripts for common medications.
Both medicine and law have also raised significant barriers to entry to their industry. An example of this is how the Australian Medical Association has successfully played on fears in the community about foreign doctors. There have been several instances where country towns have lost their local general practitioner because the foreign trained doctor was unable to pass the extremely hard tests required by the regulator. Such regulation does not protect the community, it merely denies communities the medical care they require. Such policies does benefit locally trained doctors who can demand exorbitant rents for their skill on a fly in fly out basis without fear of being undercut by foreign trained doctors.
Many commentators on the inequity problem advocate a return to high marginal income tax rates and significant redistribution of income. I'm inclined to think that a better strategy is to improve educational attainment in the general population and to remove many of protections enjoyed by some professions allowing greater competition in those fields. The result would be lower prices for consumers and greater employment opportunities for the broader population. Equally, corporate governance procedures need to be strengthen to prevent executive from grossly over paying themselves. Fortunately, there have been some recent developments in this areas with shareholders at the annual general meetings of publicly listed companies refusing to approve increase to executive salaries.
The college premium makes sense when one considers the way western economies have changed in the last 30 years. In the mid 20th century the West was the workshop of the world, there were many unionised well paid positions for those people with a high school education. As manufacturing has moved to Asia many of those well paid positions have disappeared. As the West has moved to knowledge industries education has become more important than every.
However, are there artificial microeconomic barriers preventing people from working in a more productive way and earning higher wages? In a recent blog post Paul Krugman provided a table of the occupations in the top 0.1. http://krugman.blogs.nytimes.com/2012/01/15/but-the-top-0-1-percent-isnt-diverse/While the usual suspects (executives) are heavily represented in this group at 40.8%, other occupations represented are law and medicine. One common quality amongst these occupations is that they can all be defined by either market failure or government failure. Executives of large firms are able to exploit the principal/agent problem through their control of their the governance procedures that control their salaries. Professions such as medicine and law strongly influence government policy creating regulations that protect their members profits. The legal profession has succeeded in preventing of professions or para professionals from offering basic legal services at lower prices. For example, there are many basic legal services that accountants could offer or could be provided by people with a diploma level education but are currently only allowed to be performed by a registered solicitor. Equally the medical profession has prevented other health professionals from providing medical services such as requiring a doctors scripts for common medications.
Both medicine and law have also raised significant barriers to entry to their industry. An example of this is how the Australian Medical Association has successfully played on fears in the community about foreign doctors. There have been several instances where country towns have lost their local general practitioner because the foreign trained doctor was unable to pass the extremely hard tests required by the regulator. Such regulation does not protect the community, it merely denies communities the medical care they require. Such policies does benefit locally trained doctors who can demand exorbitant rents for their skill on a fly in fly out basis without fear of being undercut by foreign trained doctors.
Many commentators on the inequity problem advocate a return to high marginal income tax rates and significant redistribution of income. I'm inclined to think that a better strategy is to improve educational attainment in the general population and to remove many of protections enjoyed by some professions allowing greater competition in those fields. The result would be lower prices for consumers and greater employment opportunities for the broader population. Equally, corporate governance procedures need to be strengthen to prevent executive from grossly over paying themselves. Fortunately, there have been some recent developments in this areas with shareholders at the annual general meetings of publicly listed companies refusing to approve increase to executive salaries.
Sunday, January 15, 2012
Fault Lines: Book Review
Let them eat credit, is the first chapter of Raghuram G Rajan book 'Fault Lines'. Rajan explores further a hypothesis that the great recession was caused by failure of median incomes in the United States to grow. While at the same time the incomes of the top 10% have grown considerably. A range of factors have contributed to the stagnation of median incomes including technological change, the increasing importance of having a college education and the decline of manufacturing. The political class feeling pressure from their constituents. Applied pressure on both Fannie Mae and Fannie Mac to make cheap credit more readily available. This cheap credit fuel a housing boom and led to growth in construction. As long as house prices continued to go up the middle class continued to believe their wealth was growing.
Rajan also explores the impact much of the developing world's export led growth strategies have impacted upon the West. Countries such as Japan, China and even Germany have grown in the post war period on the back of exports with their consumer spending suppressed by the government's control of the banking sector. Instead of using the US dollars earned through exporting to purchase goods or services from the United States the exporting nations lent them back to the debtors nations allowing those nations to continue purchasing their goods. The book details the incompatibility between the West's arms length financial system and the developing world's more controlled system. The limitations of the efficient market hypothesis are discussed in this context.
The now familiar failures of the American financial system are also discussed and notion of whether returning to "boring banking" is either feasible or desirable. The book provides an interesting discussion of the pros and cons of returning to a more regulated financial system.
Overall this book is an interesting read for anyone interested in the global financial crisis and provides a far deeper analysis than the superficial analysis provided by other material on this topic such as, Inside Job. The main message of this book is that the sub-prime crisis though a failure of both markets and government was simply the outlet for a economic situation caused by the meeting of faultlines in the global economy. The message I have taken away from this book is that we can't simply re-regulate to prevent this crisis from happening again we need to deal with the underlying cause of the current crisis.
Rajan also explores the impact much of the developing world's export led growth strategies have impacted upon the West. Countries such as Japan, China and even Germany have grown in the post war period on the back of exports with their consumer spending suppressed by the government's control of the banking sector. Instead of using the US dollars earned through exporting to purchase goods or services from the United States the exporting nations lent them back to the debtors nations allowing those nations to continue purchasing their goods. The book details the incompatibility between the West's arms length financial system and the developing world's more controlled system. The limitations of the efficient market hypothesis are discussed in this context.
The now familiar failures of the American financial system are also discussed and notion of whether returning to "boring banking" is either feasible or desirable. The book provides an interesting discussion of the pros and cons of returning to a more regulated financial system.
Overall this book is an interesting read for anyone interested in the global financial crisis and provides a far deeper analysis than the superficial analysis provided by other material on this topic such as, Inside Job. The main message of this book is that the sub-prime crisis though a failure of both markets and government was simply the outlet for a economic situation caused by the meeting of faultlines in the global economy. The message I have taken away from this book is that we can't simply re-regulate to prevent this crisis from happening again we need to deal with the underlying cause of the current crisis.
Wednesday, January 11, 2012
One under 30's accident prone male owner, poor maintenance history. - The used car market.
Today I put my car in for a service and found out that I need to invest $3000 in the car to keep it in full working order. My timing belt, shock absorbers, suspension need replacing. I also need to replace two tyres and my brake pads soon need replacing. Also my handbrake cable broke and needs to be replaced. My car is a 2002 model Hyundai Elantra and this year will be 10 years old. The car has already had a new radiator and after my investment my car should last me another five years. A cheap new car would cost me at least $14,000. The market value of my car is around $6,000-$7,000. Assuming that most cars in the price range have similar maintenance issues as my Elantra why won't my investment increase the value of the car?
If markets functioned perfectly, my car after such a significant investment would probably be worth more like $10,000-$15,000. A similar new car would be worth $25,000 yet after 10 years that car will only be worth one third of it's current value. If you reduce its value for the fact it will have some paint damage, is an older model, probably less fuel efficient than new models and there will also still be some parts that will probably need replacing in the near future it would be reasonable for the car to be worth less than it's current value . You would assume a car would be worth $10,000-$15,000 less due to the general preference of having a new vehicle and the issues mentioned previously. However, a car in good mechanical order should still maintain much of its original value reflecting the on going investment in it. Other assets such as houses, capital goods still retain a significant percentage of their original value. Why is it then that a used car of high quality is worth so little?
The reason for the low market price for well maintained cars is quality uncertainty. A consumer in the used car market will have a difficult time distinguishing my recently maintained car from a car of the same model and age. The consumer will assume that all cars around the age of my car will have similar mechanical problems. I could provide evidence of the repairs which may help increase the car's value however the consumer still has less information about the car then I do and will assume there is information that he or she is not being told.
This market for lemons problem is a self for filling prophecy because consumers are assuming all cars are of medium to low quality, they will not pay for a high quality (well maintained) car. Therefore the only determinate of price is the age of the vehicle, the model and to some extent millage. Since consumers will not pay for high quality cars the suppliers of those cars have little incentive to sell them. In my case I intend to own my car for another 5 years reasonably safe in the knowledge that expensive jobs like the timing belt won't be due for another 150,000km.
The fact that an investment in car maintenance cannot be returned in the sale value of the vehicle reduces the incentive for people to properly maintain their vehicles and also reduces the likelihood that well maintained vehicles will be sold through the used car market. The used car market is clear example of how imperfect information can lead to market failure in the real world.
If markets functioned perfectly, my car after such a significant investment would probably be worth more like $10,000-$15,000. A similar new car would be worth $25,000 yet after 10 years that car will only be worth one third of it's current value. If you reduce its value for the fact it will have some paint damage, is an older model, probably less fuel efficient than new models and there will also still be some parts that will probably need replacing in the near future it would be reasonable for the car to be worth less than it's current value . You would assume a car would be worth $10,000-$15,000 less due to the general preference of having a new vehicle and the issues mentioned previously. However, a car in good mechanical order should still maintain much of its original value reflecting the on going investment in it. Other assets such as houses, capital goods still retain a significant percentage of their original value. Why is it then that a used car of high quality is worth so little?
The reason for the low market price for well maintained cars is quality uncertainty. A consumer in the used car market will have a difficult time distinguishing my recently maintained car from a car of the same model and age. The consumer will assume that all cars around the age of my car will have similar mechanical problems. I could provide evidence of the repairs which may help increase the car's value however the consumer still has less information about the car then I do and will assume there is information that he or she is not being told.
This market for lemons problem is a self for filling prophecy because consumers are assuming all cars are of medium to low quality, they will not pay for a high quality (well maintained) car. Therefore the only determinate of price is the age of the vehicle, the model and to some extent millage. Since consumers will not pay for high quality cars the suppliers of those cars have little incentive to sell them. In my case I intend to own my car for another 5 years reasonably safe in the knowledge that expensive jobs like the timing belt won't be due for another 150,000km.
The fact that an investment in car maintenance cannot be returned in the sale value of the vehicle reduces the incentive for people to properly maintain their vehicles and also reduces the likelihood that well maintained vehicles will be sold through the used car market. The used car market is clear example of how imperfect information can lead to market failure in the real world.
Saturday, January 7, 2012
Open Courseware Universities - Social Good or Free rider's paradise
Open Courseware has been around for over 10 years with its popularity dramatically increasing when MIT started there program http://ocw.mit.edu. Their economics page is here
http://ocw.mit.edu/courses/economics/. The idea behind Open Courseware is that lifetime learners and people who do not have the time or money to attend university in a traditional way can for free gain access to the learning materials, reading material, podcasts for courses and self teach.
At present Courseware from UNE is not available even to current students (not taking a particular course) and alumni. So this started me thinking, should it? I am nearly complete the coursework component of my Masters, however there are many more subjects I would like to take. However, my HELP debt will be around $50,000 once I have completed my masters and at present it will probably take 15 years to pay it off. This is fine assuming my degree increases my earning. If I go from making an income in the mid 40s to 60-70k in the next 5 years this will be an annual increase of 15-25k with an increase of tax of 2-4k until my debt is repaid. For those outside of Australia, student debts are indexed at CPI, meaning effectively no real interest is ever paid. So the question remains should people be able to free ride off of my investment of 20k in a masters course at UNE?
One argument is yes, because ultimately I'm not buying education I'm buying credentials. In other words teaching yourself does not provide a signal to potential employers that you have knowledge justifying higher wages. The sad reality is this is true, most students have little interest in education they are mainly interested in higher wages. (By students I mean people doing professional degrees there is another class of students who are interested in education and not employment outcomes. They are doing bachelors of arts.)
Another argument is that I may wish to continue learning after I have earned my qualification but by doing it in a less formal way. There are many subjects I simply don't have the time or electives for, which I would be interested in learning that are offered through UNE or other universities. I intend on learning more about mathematical economics and behavioral economics once I've earned my qualification.
A benefit to the university itself it may be a cheap form of advertising. At present students make their decision about what university to attend based on the reputation of the university and by the very limited information provided about courses. By being more transparent about what the university actually offers it will allow students to make a more informed decision. This maybe particularly beneficial to smaller universities who aren't as prestigious as larger institutions based in capital cities.
As discussed previously in my E-Learning blog piece. By providing high quality online course materials universities can reduced the need to "reinvent the wheel" every semester and focus on value adding on top of core material. Universities can also consider offering means of self teachers to gain credentials in the material for a fee, as MIT has done. This could provide a source of revenue and reduce the free-rider effect. The university would have to develop a system that giving someone a credential for passing an exam is distinguishable from formally completing a course through the university. For example, with MIT getting a a course graded is not the same as having an MIT degree.
Ultimately, Open Courseware has the potential to be a good thing for education as a whole and for universities provided the university takes measures to reduce the free rider effect and also ensure their paying students get value for money.
Wednesday, January 4, 2012
Tirade of the thin skinned economists
Since I first started studying economics in grade 11 I was hooked. I however, for a longtime envisioned my future in federal parliament rather than being a professional economist. I was a member of the Australian Democrats and ran in the Brisbane City Council Election. When the Democrats were in the process of formally de-registering I joined the Australian Labor Party. Although, I considered myself economically liberal and disagreed with elements of the Labor Party platform, I believed in progressive politics and the track record of the Hawke-Keating years made me feel that I could have my cake and eat it to. After a while I decided politics wasn't for me, possessing both a spin and a conscience I started to wonder if I had what it took to climb the greasy pole of major party politics.
It was at this point I made the decision to pursue a career in economics, it was a career that allowed me to focus on the thing I cared about most good policy. I imagined a career in which I could be intellectually free to pursue ideas and they would get a fair hearing. I imagined that good policy is what would matter and economists would work together to deliver it.
It has been with great disappointment that I have to come realise that economics is just as spiteful and divided as a politics. Recent blogs posted between Paul Krugman and his detractors have become particularly nasty and unbecoming of professors of their stature. Link Equally, the recent harsh review of Prof. John Quiggin's book Zombie Economics by Stephen Williams seemed to take an unnecessarily negative bent. (Having read the book myself and despite not being particularly sympathetic to Quiggin's views, I found the book interesting, raising many valid points. My Review) Unfortunately, acknowledging the validity of some aspects of alternative views seems out of fashion.
Petty disputes are not new, when Keynes released 'The general theory' and the 'treatise on money', Hayek and other economists of the day resorted to questioning Keynes understanding of key concepts in economics such as investment. Keynes himself in possession of a sharp tongue didn't mind attacking many of the great economists of his day. Sadly, it seems where there are significant disagreements on core issues the profession resorts to nitpicking methodology and questioning the validity of works in their entirety.
While in the world of public policy it is not possible to follow the old rule, "if you have nothing nice to say, say nothing at all." Basic rules of courtesy and respect for the accomplishments of others should be a minimum. In Dale Carnegie's classic 'How to win friends and influence people', he advice's the following, let the other person save face, give a dog a good name and make the fault seem easy to correct. Something to think about.
Monday, January 2, 2012
Why classical liberals should support carbon taxes:
If one accepts the science of global climate change then it is clear that overall carbon emissions must be reduced. The preferred method of reducing carbon emissions or more broadly reducing pollution has been either the use of pigouvian taxes (pollution/carbon tax) or an emissions trading scheme. I have explained the basics of both these measures in my environmental economics mini-lectures http://www.youtube.com/watch?v=8ID6IP2-gHc&feature=youtu.be and http://youtu.be/Z6xB5b-4MRI.
In both cases the cost of the pollution is internalised and becomes part of the cost of producing the good or service in a marketplace. This moves the supply curve for the good and this results in a new market equilibrium that accounts for the social cost of the pollution. What this means is the people gaining the benefit from the carbon emitting activity have to compensate society for the impact of the carbon. This gives firms an incentive to find less carbon intensive methods of producing their goods and raises the prices of carbon inefficient activities compared to carbon efficient activities.
Unfortunately, many classical liberals have seen the introduction of carbon taxes or less directly emissions trading schemes as a further grab of economic liberty by the State thus reducing individual liberties. Based on past form this is not an unrealistic view. Since the second world war the percentage of GDP occupied by Government in all industrialised countries has increased in-spite of the fact the overall size of the their economies have grown. Much of this growth has been in the form of income redistribution with the government taxing the income from individuals work to redistribute to those group the government chooses.
However, I would argue if the tax revenues raised through pollution taxes are offset by reductions on income tax then this is moving from taxing positive externalities to taxing negative externalities. If you view labour as a good being sold in the marketplace the purchaser of that good is gaining a consumer surplus and the worker does not receive the full benefit of their work, there is infact a broader benefit to a company hiring the labour and to society as a whole. I would argue that taxing individual income is perverse when there are alternative means of raising taxation that discourage negative externalities rather than discourage positive externalities.
The argument can be made that the atmosphere belongs to society as a whole and there is a limit to how much pollution can be emitted into it before serious harm is caused. The limited amount of pollution that is sustainable is therefore a scarce resource owned by society and by it is fair to charge those who use that resource. I would argue that for society to get a compensation for the use of its property is not in contrast with classical liberal beliefs.
I believe that it is unfortunate that the environmental movement is so closely linked to groups who have economically left-wing views and those groups that would seek an expansion on the role of government. Carbon will be one of many common-resources society must develop mechanisms to achieve a socially optimal level of demand. We have the opportunity to develop a system that pays for public goods through the taxation of negative externalities, increasing personal responsibility and reducing many of the perverse disincentives of the current taxation system.
In both cases the cost of the pollution is internalised and becomes part of the cost of producing the good or service in a marketplace. This moves the supply curve for the good and this results in a new market equilibrium that accounts for the social cost of the pollution. What this means is the people gaining the benefit from the carbon emitting activity have to compensate society for the impact of the carbon. This gives firms an incentive to find less carbon intensive methods of producing their goods and raises the prices of carbon inefficient activities compared to carbon efficient activities.
Unfortunately, many classical liberals have seen the introduction of carbon taxes or less directly emissions trading schemes as a further grab of economic liberty by the State thus reducing individual liberties. Based on past form this is not an unrealistic view. Since the second world war the percentage of GDP occupied by Government in all industrialised countries has increased in-spite of the fact the overall size of the their economies have grown. Much of this growth has been in the form of income redistribution with the government taxing the income from individuals work to redistribute to those group the government chooses.
However, I would argue if the tax revenues raised through pollution taxes are offset by reductions on income tax then this is moving from taxing positive externalities to taxing negative externalities. If you view labour as a good being sold in the marketplace the purchaser of that good is gaining a consumer surplus and the worker does not receive the full benefit of their work, there is infact a broader benefit to a company hiring the labour and to society as a whole. I would argue that taxing individual income is perverse when there are alternative means of raising taxation that discourage negative externalities rather than discourage positive externalities.
The argument can be made that the atmosphere belongs to society as a whole and there is a limit to how much pollution can be emitted into it before serious harm is caused. The limited amount of pollution that is sustainable is therefore a scarce resource owned by society and by it is fair to charge those who use that resource. I would argue that for society to get a compensation for the use of its property is not in contrast with classical liberal beliefs.
I believe that it is unfortunate that the environmental movement is so closely linked to groups who have economically left-wing views and those groups that would seek an expansion on the role of government. Carbon will be one of many common-resources society must develop mechanisms to achieve a socially optimal level of demand. We have the opportunity to develop a system that pays for public goods through the taxation of negative externalities, increasing personal responsibility and reducing many of the perverse disincentives of the current taxation system.
Sunday, January 1, 2012
Keynes Hayek: The Clash that defined modern economics - Book Review
Keynes Hayek: The clash that defined modern economics tells the story of two rivals who have for the last century fought to define modern economics. This fight has continued long after both men's death and has taken on a renew vigor since the great recession. Most people will know that their is a divide in Macroeconomics between those who believe government can stimulate the economy into a recovery and those who believe such measures are harmful. However, the debate between Keynes and Hayek was far deeper than this. Their fight was ultimately over the legitimacy of macroeconomics.
Many of core concepts we take for granted such as Gross Domestic Product owe their existence to John Maynard Keynes. Prior to this economics was confined to what we today would call microeconomics. The book clearly outlines the fight between a new guard of economists lead by Keynes at Cambridge (The Circus) against the skeptical economists at the London School of Economics. Many economists well known to students make Cameo appearances in this book including, Alfred Marshall, Arthur Pigou, John Hicks, Nicholas Kaldor and latter Milton Friedman. Ultimately as Hayek acknowledged, Keynes won this fight with almost all economists accepting macroeconomics. Economists including the great Milton Friedman have used macoeconomics (a top down approach) to analyse the economy.
Where Keynes' methodology for analyzing the economy have been largely accepted and used by even those considered opponents of Keynesian economics. The measured argued for in the general theory have not received universal acceptance. To this day whether or not governments should borrow heavily to stimulate the economy remain controversial. This book gives the reader some interesting insight into the debates on both sides on this issue.
The book continues after Keyne's death and describes the 20 year of high growth and soft recessions that followed the post war history. While finance ministers were not willing to pursue Keynes' medicine in the great depression until the second world war but the end of the war many had been covered and the tools of stimulus were readily used. This period also saw Hayek leave the London School of Economics under a cloud of scandal moving to the United States were he took a position at the University of Chicago. Though not in the school of economics who resisted attempts by the university president to place him there.
Interestingly, despite being employed at the university of Chicago Hayek was not part of the counter revolution that lead the charge against Keynesian and the predicted the stagflation of the 1970s. Hayek eventually migrated back to Austria and only in his last years did he see his world view vindicated.
In the 1970s and 80s Margret Thatcher and Ronald Reagan came to power having been influence by Hayek's book the road to Serfdom. For the first time in the post war era there was significant reduction in the role of Government.
In Britain in particular Keynes work had been used to justify the mixed economy. Britain far more than America or Australia had nationalised it's industries and heavily regulated those it didn't directly controlled. Thatcher came to power during the winter of discontent a time made most famous by the accumulating rubbish in London caused by council workers striking. This change from the mixed economy to the market economy was adopted by the Labour Party whom abandoned it's goal of nationalising major industries.
Another interesting aspect to the debate covered in the book was how vicious the debates between Keynes supports and classical economists could be. People active in the blogisphere could see similarities between the debates they had then and the debates being had between Paul Krugman and Robert Lucas et. al.
Overall I would recommend the this book for anyone wanting to learn economic history and wants to put what they learnt in economics 101 into context. For my part until very recently I was unaware of how at odds micro and macro economics are and how far we still have to go in our understanding of the economy.
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