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Wednesday, June 25, 2014

Conflict and Growth

There is more out there on the subject of war. Economics blogger and libertarian Tyler Cowen seems to think that war (or at least the threat of it) is good for growth. There are two problems with this. First of all, across the post-WWII era, much of the evidence seems to support the opposite hypothesis: countries that are less prone to conflict grow faster. Second, growth is likely not the only variable worth exploring.
On the first issue, one might argue that countries that have been prone to conflict over the last 70 years have mostly been those countries that are also prone to slow growth, for institutional reasons, and that would be fair. So, let's not call in the jury yet on that, although the likes of Dani Rodrik would likely share my skepticism.
On the second issue, even if we found there to be spurts of growth following conflict, we would be hard pressed to show that those spurts would really leave us better off than the alternative scenario in which countries like those in the OECD had done everything else the same, except that they had fought more. Many countries are bound to have growth spurts after conflict simply because of the destruction of capital wrought by conflict. In other words, sometimes growth speeds up precisely because things have exogenously been made worse. This is merely an application of neoclassical growth theory.
Digging deeper into Dr. Cowen's argument, there is a hint that the threat of war might, historically, provided an incentive for investment in public goods, including infrastructure and technology. The mechanism through which this operates in Cowen's model, it seems, is by increasing competition between the incumbent regime and external and internal contestants. To his credit, this is indeed a hypothesis of that is well-established in the literature on institutions, for example by Mancur Olson (1993), but also North, Wallis, and Weingast (2006).
The problem is that in these institutional models, the threat of war as a constraint on power is mostly used in primitive nation-states that rely on fairly closed and autocratic forms of government that are more apt to be extractive. Also, in these models, the main priority of the dictator is to provide security so he can remain in power. This is done in three ways: (1) by buying off former warlords and elites; (2) by eliminating elites those who can't or won't be bought; and (3) by providing public goods.
More open, inclusive, and democratic forms of government can usually achieve the constraints on power necessary to provide public goods effectively through the electoral process, to the extent that the process is not too tainted by asymmetric information and special interest politics. Note that this does not mean that taxes will be lower in a democracy, nor that redistribution will be less. It just means that policies will better reflect the preferences of society at large, and in particular those of the average (median) voter. In fact, a democratic government may have a greater capacity to tax precisely because it uses public funds to provide public goods like infrastructure and technology.
So, it seems myopic at best to think that conflict (or the threat of conflict) should be considered a "good thing." At worst, it is dead wrong and a destructive way of thinking.

Monday, June 23, 2014

Conflict and Capitalism

This week, Pope Francis was quoted by the Economist to have said this in an interview with the Spanish newspaper La Vanguardia (translation in the National Catholic Register):
We are discarding an entire generation to maintain an economic system that can't hold up any more, a system that to survive, must make war, as all great empires have done. But as a third world war can't be waged, they make regional wars...they produce and sell weapons, and with this, the balance sheets of the idolatrous economies, the great world economies that sacrifice man at the feet of the idol of money, are resolved...
The Economist takes an philosophical approach in expressing its doubt towards the Pope's assertion of a link between capitalism and conflict, citing Shumpeter and Popper as having argued that capitalism can "consolidate peace, by offering non-violent ways to satisfy human needs."

On the one hand, there is a theoretical basis for the Pope's argument. Early studies of conflict posited that the rapid transition from traditional economic and social institutions to more modern (capitalistic) ones would alienate those who could not assimilate quickly, and thus foment conflict. These reasons include the unequal distribution of benefits, both between elites and non-elites of the same ethnic group, and among different ethnic groups.

On the other hand, empirical support for such an argument is weak. In particular, Collier and Hoeffler (2004) find little support for the hypothesis that either income or wealth inequality does in fact increase a society's propensity for conflict. These results are affirmed by Fearon and Laitin (2003). Moreover, a my own working paper with Atin Basu and William Shughart suggests that more open, more prosperous, and more capital-abundant societies are less likely to devolve into civil war. In fact, the positive impact of openness and wealth seem to be the greatest for countries with institutional arrangements that otherwise put them at risk of tipping into the abyss of state failure.

Yet, there is one last caveat in favor of the Pope's position: Greed does lead to conflict. The same studies cited above that discount the role of inequality and capital accumulation in stoking conflict almost unanimously find some role for competition over resources as a significant determinant of conflict. However, in most societies where greed and competition for resources significantly contribute to conflict it is the state that controls access to such resources, not the market. It is precisely this state control over resource rents that makes violence attractive (or necessary) for insurgent groups.

Friday, June 20, 2014

Maybe there is such a thing as a free appetizer

This week, Freakonomics Radio broadcast their take on so-called "free appetizers" - bread, chips, etc. that many restaurants supposedly give out for "free" with their meals.
Other supposed freebies include free soft drink refills, free unlimited salad bar with your meal, and even free french fries (and other sides!) at some casual restaurants. A listener contacted Dubner and asked, "Why do restaurants do this?" The program puts forth 6 hypotheses of varying plausibility:

  1. Increase turnover - people who fill up on bread eat their meal and leave, allowing the owner to clear the table and turn it over. People who stay for dessert linger too long. The experts in the podcast don't buy this one, and neither do I. Desserts may be low in menu price, but they typically have higher profit margins than entrees. People who stay longer are often also getting other high-margin items like coffee or alcohol. 
  2. Reduce complaints - Hungry people waiting for their order get cranky and may complain or leave. The broadcast also suggests that, for behavioral reasons, "free" is much more effective at this than just "cheap." This probably doesn't explain a lot of it, and I don't really buy the "behavioral" angle on this explanation, but it's a plausible contributor.
  3. Exploit complentarities with higher-margin items - A basket of salty chips or bread makes people buy other things that "go with" that item. The usual suspect here is drinks, which fits with the "loss leader" strategy. I would also point out that at many Mexican restaurants, about half of the available appetizers are direct complements to chips: cheese or bean dip, fundito, and guacamole. 
  4. Expectations and history - At some point a firm saw it in its strategic advantage to give stuff out for free, or to charge a fixed-price. Other firms followed suit, consumers developed expectations around receiving free stuff to snack on, and the rest is history. 

Finally, they propose that the "free" apps are not free at all, but rather that their cost is included in the price. This leads them to the question, "why not let consumers choose (or not choose) the appetizer they want, and price them separately?" This is really the key question, and the one that institutional analysis has a good answer for. Bottom line: Transactions costs matter.
To answer the first part of the question, then from the firm's perspective there is a value in knowing that all consumers that place an order will be ordering the same thing. If economies of scale matter, then making the same thing 400 times at predictable intervals each night will be cheaper than making 8 different things an average of 50 times each at unpredictable intervals. Consumers also then have to make their choice, which itself takes time, energy, and as Yoram Bauman comically points out, "choices are bad - really bad." In some contexts, and as Dan Ariely points out they can be dangerous.
But economies of scale alone don't quite answer the question, because we could always counter that by asking why "bread" or "chips" aren't listed on the menu for a nominal charge, even if they're unlimited. The broadcast hints at the answer by implying that people don't like to be "nickeled and dimed" which is part of it - but believe it or not, restaurants don't benefit from nickeling and diming either!
Market transactions create costs that aren't present when we leave them unpriced, kind of like friction. A common example (which is sometimes also applied to the related topic of property rights) is how to price fresh produce. In this case, it's quite possible that the restaurant and consumers both benefit from leaving bread or chips unpriced, since pricing them would involve greater mental cost, monitoring, and in the long run make the combined bill somewhat more expensive.
So, if the cost of producing a good is small relative to the transactions costs, then a price of zero is quite efficient. Further, if the side-benefits of supplying the good at a price of zero exceed the production costs, it will be in the firm's private self interest to supply that good at the efficient price of zero, and without such side-benefits (even if they do arise out of a "prisoner's dilemma"), the good may not be supplied at all! In fact, if the transactions costs of exchange exceed the production costs, it's possible that by economizing on transactions costs, free bread really is free.

Tuesday, May 27, 2014

I just bought a new car - a Honda Civic. I think I actually got a really good deal on it. I also think my background in economics helped me negotiate that deal.
A number of websites give tips - some good, some bad - on how to negotiate a car deal. Here's my take.
1. Before you step on a lot, get a lot of information on a lot of different cars. Information is extremely valuable to economic transactions. Know the price differences between different makes, trim levels, options, and other things. Here, I would say that adverse information about the cars you are considering (especially your first choice) is at least as valuable as the positive information.
2. Also before stepping on a lot, shop online. If you have access to a car buying service through a bank or credit union you have membership with, use it to get concrete quotes for dealers within an x-mile radius.
3. Get pre-approved for your loan so they can't get you to fill out a credit application before you have a price. This is mostly likely an attempt by the seller to increase the fixed cost of leaving.
4. Have an outside option and be flexible. A couple of fora on buying a car say to really zero in on what you really want before you start. I couldn't imagine worse advice. The only way to get a good deal is to induce competition. If you are too zeroed in on one model then you probably aren't recognizing the positive aspects of comparable cars, or the negative aspects of your first choice. Use these trade-offs in your negotiation, and be willing to walk away. One problem with walking away, though, is that there's a bit of a "secretary problem" here in the sense that if you negotiate hard, then decide to walk away, you may not be able to come back. This gives a dealer considerable monopoly power once negotiation starts: Advantage, seller.
5. Be respectful and honest.

Monday, April 14, 2014

5 Flaws of "Cosmos"

This post by Hank Campbell at "The Federalist" blog suggests 5 myths in the Neil Degrasse Tyson's remake of the Carl Sagan's "Cosmos". I admit that Mr. Campbell may know more about the scientific validity of the claims put forth in the series (or perhaps not - it does not appear Mr. Campbell has any specialized training in physics or astronomy), but in some ways he comes off a little to harshly in the opposite direction. Here are the flaws Campbell points out:
1. Venus Was Not Caused By Global Warming
Perhaps he is right here. There are probably several factors that make Venus' average temperature consistently around 860 degrees Fahrenheit, but Mr. Campbell doesn't explain what REALLY might make Venus that hot, and it's not simply proximity to the sun: Mercury is about the same temperature as Venus on its sun-facing side, but reaches extremes of about -300 degrees on its dark side. Probably it is a combination of factors, but something has to be at work keeping the dark side of Venus at a temperature as remarkably close to the sunny side as we have observed. Atmospheric gasses play an important role (if it weren't for the green house effect we'd all freeze by the way!).
2. The Multiverse Is Not Science
In a narrow definition of science, this is a true statement. Multiverse theory is not fully testable because seeing beyond the "horizon" of the observable universe (and yes, I know the universe doesn't have a "horizon" per se) is not possible.That doesn't make it non-science. Scientists who "believe" in a multiverse derive their models of the multiverse from models that must follow physical laws we have observed in tests of other hypotheses about the big bang. In fact, the recent discovery of gravitational waves near the universe's origins, which also supported "inflation theory", increased the likelihood that a multiverse is possible.
3. There Is No Sound In Space
Ok. Sure.
4. Giordano Bruno Was Not More Important To Science Than Kepler And Galileo
Yeah, I kinda hated that part, too.
5. The Universe Was Also Not Created In One Year
As Campbell admits, this is mostly a style issue. It's meant to be a device for understanding the vastness of time. Apparently it didn't work on the founder of Science 2.0. But here is my beef with this point. Campbell states:
Rather than seeking to take jabs at religion, science should be embracing it. From a science perspective, religious people are involved in the largest ongoing experiment of all time. The major religions all disagree with each other in ways large and small and yet people are turning knobs in their lives and making adjustments to try and solve a grand mystery. What, if anything, comes next?
Whoa. I don't really see religious or areligious people as being any more or less in the struggle to understand the meaning of existence, or what comes after the life we know than the other. Much of this depends more on the individual. An atheist who adamantly believes that death is the end is no less at struggle with that grand mystery than someone who adamantly believes we will all be swept up to heaven or hell depending on our deeds and on our faith. I'm agonstic, and believe you me, Mr. Campbell, I spend much of my time turning knobs trying to figure out what's in store for me when my body's strength is gone.