The Economics of Soccer: Euro 2008

Perhaps it is a stretch to try and justify the amount of time I have spent (late at night with my DVR after shielding myself from news reports all day) watching Euro 2008 matches by trying to do an economic analysis. But here goes.

It has been a great tournament, and I think what it has represented is a pretty dramatic change for the usually stultifying international tournament fare. Why this is, in my opinion is the lack of risk-aversion that usually dominates strategies in such tournaments. There is obviously a reason for this - it is usually quites successful. But many teams at Euro 2008 were relatively young and inexperienced either due to the overall pool of players or due to some untimely injuries. I think the fact that inexperience means you can't play the strict, organized defense necessary to pull off the risk-averse strategy, liberated the tournament from such teams. In any event, young attacking teams like the Netherlands, Turkey, Russia were a delight to watch. Even the Germans, who are usually masters of such a strategy, realized a couple of years ago that they could no longer rely on defense and have opened up. Italy still got very far employing such a strategy, but ultimately fell to a superior Spanish side.

The surprise of the tournament, and until yesterday the Cinderella story, was the young Russian team who (after a terrible opening performance against Spain) seemed to throw caution to the wind, play open, inventive attacking soccer and were rewarded by some marvelous results. None more so than the brilliant display against the Dutch who were deservedly beaten. They were a revelation and a delight - and given their age should be a force at the next World Cup.

The Dutch themselves were open, inventive, shockingly fast and beautiful to watch in the group stage (where the pressure is diminished), but seemed to wilt under the pressure of the knock-out stages and seemed lost and rudderless against the Russians who ran circles around them.

The aforementioned German team have been over-achievers in my opinion. Typically well-organized (insert your own Teutonic quip here), the German team have been able to be attacking without throwing caution to the wind. The semi-final game against Turkey, where three goals were scored in the dying moments of the game to thrice alter the fortunes of the two teams, was the game of the tournament. [Unfortunately, most of the world could not watch the events live as lightening knocked out the international feed] Philipp Lahm's final seconds goal (a beauty - above) , atoned for a Turkish goal, minutes earlier that was the result of a Lahm blunder. This is why this is the beautiful game!

I am feeling pretty smug now, as my Spain prediction is looking very good at the moment. Thanks mostly, in my unbiased opinion, to ARSENAL midfield magician Cesc Fabregas who came in for an injured David Villa and changed the entire game. Will he get a well-deserved start in the final game? He should.



So what we have on tap Sunday's final is a neutral's delight: a young German team playing more open and attacking football, but still keeping amazingly well-organized versus a Spanish team that in renowned for folding under pressure yet who delight in picking teams apart with intricate and inventive passing - in the highest pressure situation of most of these player's lives. Should be a great game. I am sticking with my prediction: Spain 2 - Germany 1.

Field Research: The Oregon Housing Market

I have now written many blog posts about the Oregon housing market. In them, I inevitably talk about some new data that have been released and what they mean. But out of loyalty and devotion to you, dear readers, I have decided to go one step further - I have conducted my own field experiment. Well, okay, it is not exactly an experiment.

I am moving to Portland so that my wife can continue her career as a non-profit fundraiser. This means that I had to sell a house in Corvallis, find a rental in Portland and will soon begin the search for a house to purchase. The Corvallis end went shockingly fast - we had an offer accepted the very day it was listed - no sign of a housing slump from my experience. Talking to the realtor I think our experience, while exceptional, is evidence of a real estate market that is fairly solid in Corvallis. The supply of new houses slowed quickly as the market softened and now the market for the stock of existing houses is fairly strong.

The Portland side also looks pretty strong in relative terms, but nothing like two years ago when we were deciding between Portland and Corvallis as a place to live. As we are focused on a close-in neighborhood (Sellwood), the softness of the suburban developments is not very apparent.

What was striking was the trouble we had finding a decent rental. I have a theory: because the credit crunch is national many would-be buyers, even in Portland, are being pushed onto the rental market. However, as the market, especially in near-in neighborhoods, is still pretty robust, there have not been many houses pushed into converting to a rental. So tight supply versus strong demand make for a tough rental market.

By the way, I am still keeping my position at Oregon State, so thank goodness I have a very fuel-efficient car. Our families carbon footprint is going to be slammed by my energy profligacy. But we should come out ahead, I reckon, because we can walk everywhere in Sellwood to get what we need, and my wife, who will work in Old Town, plans on commuting mainly by bike and bus.

[By the way, this explains recent and near-future spotty blogging - my apologies]

Energy Policy: Fred Thompson, Guest Blogger

Once again, The Oregon Economics Blog welcomes Fred Thompson writing about something I have been thinking of writing about for a while - energy policy.  Hopefully, if I can find the time, I will share some thoughts as well.  Here's Fred:

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A friend and former boss, who is also now a serious mover and shaker
the energy biz, recently privately opined:

"This country has had no energy policy for almost three decades.
Both parties are equally culpable for a situation that places our
economy in peril for many years to come. My answer for a
comprehensive energy policy:

1. Incentives and requirements for bio-fuels and alternative energy
sources now.

2. Revitalizing our nuclear energy program, ala France.

3. Opening up off-shore and ANWR drilling. (I am not convinced that
the shale program is feasible.)

4. Immediate construction of refinery capacity.

5. Immediate regulation of hedge fund investing in commodities that
have driven prices up for all commodities with no economically
productive purpose. (I don't completely buy into the argument that
these markets provide stability required by the refiners.)

There is no silver bullet, no single answer. Also, no short-term
solution. We are going to be in the energy soup for several years.
But we can find a way out of this mess with boldness and patience."

I have been hesitant to weigh in on this topic. I don’t have any
professional competence in the area of energy policy. However, these
are my thoughts.

It is true that last time (perhaps the only time) we had an energy
policy was during the Carter administration – remember the moral
equivalent of war? Those of you who are old enough will. The results
were not pretty.

The reason for current high energy prices mostly goes to supply and
demand for oil – energy prices are up because of booming demand for
oil from China, India and the Middle East and supply shortfalls in
the US, Mexico, Venezuela, Nigeria, Iran and Russia, not to say
Iraq. Moreover, while there are many substitutes for oil and gas,
few if any are cheaper, instead high oil and gas prices have merely
raised the prices of those alternatives. As my friend correctly
opines: “There is no silver bullet, no single answer. Also, no
short term solution.”

So, what about his proposals:

1. Incentives and requirements for bio-fuels and alternative energy
sources now.

I agree, we don’t do enough to promote energy conservation.
Moreover, what we do – direct regulation, for the most part, e.g.
the CAFE standards – is pretty inefficient. Most of our conservation
promotion programs seem ill designed from a behavioral standpoint.
On the other hand, we probably have sufficient incentives for the
production of wind and solar power right now, although only recently
have folks started to engage in serious genetic engineering to
reconfigure biological processes to generate increased energy from
solar power. Those programs should be accelerated, but it is
unlikely they will have a substantial payoff any time soon. In the
short run, it looks like Brazil has the capacity to increase sugar
cane ethanol production. Most developed countries won’t import it,
the US included. That is simply foolish. But I see no sense in the
multibillion-dollar government subsidies for domestic ethanol. Why
are higher food prices better than higher energy prices?

2. Revitalizing our nuclear energy program, ala France.

Absolutely. The French use half the oil per-capita we do. Nuclear
technology has advanced considerably in the last 30 years. It is
safer and cheaper. The lack of trained nuclear engineers is a
serious bottleneck, however.

3. Opening up off-shore and ANWR drilling. (I am less convinced
that the shale program is feasible.)

Makes sense to me. Again we know a lot more about off-shore drilling
now than we did when the Santa Barbara spill occurred. Listening to
the folks who are opposed, their main objection is to the
consumption of oil, not the danger to the environment from drilling.
I doubt that that argument has political legs. In the short run, I
agree with Nick about the shale program. One reason the tar sands in
Alberta work now and oil shale doesn’t is that the Canadians have
plenty of water in the right places. However, I have heard some
ideas about nuclear power/oil shale cogeneration that might solve
some of these problems, although this is certainly not a quick fix.

4. Immediate construction of refinery capacity.

Duh. Same goes for oil and gas pipelines and LNG terminals – some
environmentalists may not to see it, but these are primarily
conservation measures. Unfortunately, immediate construction in this
instance is something of an oxy-moron.

5. Immediate regulation of hedge fund investing in commodities that
have driven prices up for all commodities with no economically
productive purpose. (I don't completely buy into the argument that
these markets provide stability.)

I disagree. Hedging produces significant benefits for the risk
averse. Moreover, I don’t see how that options and futures trading
can distort spot prices without physical hoarding. Show me the
inventories and I'll reconsider the point. I would also note that
futures markets are different from carry-trade speculation
(borrowing at low interest rates to invest at higher rates).
Carry-trade speculation is dangerous, because you are betting
against the law of one price (uncovered interest-rate parity), in
other words, betting on your ability to time the market – when the
market turns, the herd stampedes. Moreover, in commodity trading
there is a counter position for every long position and, while you
can buy on the margin, you must mark to margin every day.

My big disagreement is with a point that is only implicit in my
friend’s comments. I want energy to carry a high price. That is the
best way I know to promote energy conservation and abate greenhouse
gases. Moreover, people will make the necessary investments in
plant, equipment, and lifestyle changes required to reduce energy
consumption substantially only if they expect energy prices to
remain high. Since there is but one thing more certain than taxes, I
think a high carbon tax is a great idea. Besides I’d rather the IRS
collected the rent than the Saudis, Russians, Nigerians,
Venezuelans, or even the Canadians. One could use the revenues to
offset social security and medi-care taxes on say the first $50k
(real $) of earned income as suggested by Irwin Seltzer, for
example. Actually, I think that is a marvelous idea for all sorts of
reasons. But that is a different story.

Portland Housing Market: Case-Shiller April 08 Numbers

The latest Case-Shiller numbers are out for April 08, I have posted the numbers for Portland, Seattle and the 20 city composite above. The Oregonian is emphasizing the big drop from the year to year number (April 07 was about 184 and April 08 is about 175), but the interesting thing for me is that the seasonal uptick (albeit small) is finally showing up. This is not true of the 20 city composite. Whether this is an anomaly or a signal that the market is not going to crash further is anyone's guess at this point, but I would suspect that ceteris paribus the downturn is bottoming out.  However the worsening overall economic conditions might cause this to start its downward march again.

Here is the graph of the numbers themselves.



By the way, the much improved graphics come thanks to my new Mac upon which this blog post was created.

Portland's New Bridges: Do Economists Care About Uplifting the Soul?

Last weekend, I attended the graduation of my (much younger) sister from the University of Washington's College of Architecture and Urban Planning. The commencement speaker spoke of Architecture and Planning's ability to improve the human condition and uplift the soul. That got me thinking about the planning process for the new I-5 and Sellwood bridges and the question of whether the bridge should be striking and beautiful or just functional. In particular, it got me thinking about what economics has to say about such a question.

Contrary to what most people expect, economics does not just deal with dollars and cents. Economics starts with individual utility maximization. People buy art, commission architects and purchase beautiful things because it returns some utility - it makes them happy - and that happiness is worth some monetary payment. But what does this mean for a public works project like a bridge? Well, we run into the familiar problems of externalities, public goods and free-riders - problems that affect the building of the bridge regardless of the design.

If a beautiful design confers a benefit to users and residents then it has a real value and that values should be taken into account in any cost-benefit calculation dealing with bridge construction. But how do you measure such a benefit?

One way that economists have tried is through something called 'contingent valuation' - a survey of individuals willingness to pay for generally some non-market resource (like clean air). This allows economists to try and come up with a number that assesses the worth of such a resource. The problem is, of course, it is all hypothetical and the valuations, it turns out, can be highly influenced by how the question is asked. [One example: while I was in grad school, an Ag. Econ professor compared the results of a hypothetical 'how much would' you pay to save a tree' to a real tree he brought into the room and would threaten to kill if not enough money were raised - the real tree raised valuations a lot]

Another way is through some sort of democratic process, but as I have talked about previously, voting induces some selfish behavior, most notably free-riding: "I would love to have a nice bridge, and would even pay for it, but if I can get everyone else to pay for it and not have to myself, even better!"

So, in the end, I think policy makers will simply have to understand that design does matter, and that a beautiful bridge (like the Golden Gate and St. Johns above) is worth a lot.

The Glenn Jackson (to the left) is a inoffensive and very functional bridge, but forgettable. Below is Boston's new Zakim bridge. Which would you rather have? Oh yea, how much is it worth to you...?

Land Grant Universities and the Liberal Arts and Sciences

I have spent all of my graduate school at three land grant institutions: University of Cal – Davis, University of Wisconsin – Madison and Cornell University. Never had I encountered the opinion that because the university is a land grant, not only should we accept mediocrity in the core liberal arts and sciences, but in fact, we should actively seek it lest we sacrifice the strengths of the other units, such as agriculture, until I came to Oregon State. There is some sense to this logic – the core arts and sciences are expensive in that they tend not to bring in as much grant funding as the more applied areas, but the problem with this logic is that it is the core arts and sciences that make up the heart of the undergraduate education. In fact the quality of the core arts and sciences are in large part what determine the reputation and the overall quality of the university. Is it any wonder then, that the three universities I mention above are considered exceptional while Oregon State is ranked in the third tier of the US News university rankings? In fact, it is the only Pac 10 school in the third tier.

Though it may seem a good strategy in response to a resource poor environment, this subjugation of the core arts and sciences at OSU is not a good long term strategy. OSU has a shockingly low undergraduate retention rate, a poor academic reputation, low undergraduate morale and a very big need for quality in-state as well as the high price paying out-of-state students. It is not going to attract these students with big grants to the forestry college. In fact the course that OSU is on will lead it right back to where it started – a four year vocational college. It is also not a zero-sum game. Strength in the core arts and sciences would help other units and especially the interdisciplinary programs OSU's administration is so hot on. I don't think you build strong interdisciplinary programs on top of poor discipline specific programs. Strong interdisciplinary programs come from strong discipline specific programs.

I am constantly dumbfounded and wonder where this attitude that a Land Grant university has no business being strong in the core arts and sciences comes from. Let’s look at the College of Liberal Arts and compare the departments at OSU with key departments at the three universities I mention. Here are the US News rankings of departments at Cornell, Wisconsin and Davis (in that order) in Economics: 12, 38, 42; English: 17, 11, 28; History: 11, 11, 26; Political Science: 18, 16, 29; Psychology: 16, 9, 47; and Sociology: 14, 1, 29. Where is OSU in all of this? In most of these disciplines, OSU doesn’t even have PhD programs, so they don’t qualify to be ranked, the couple that do (Econ and History – sort of, History's program is in the history of science and is mostly moribund) are too low to rank. The point is this good universities, land grant or not, excel in the core arts and sciences. So this idea that OSU has no business trying to be strong in those areas is completely baseless. By neglecting the core arts and sciences, OSU is not just a poor university, but it is getting worse.

I think that part of this attitude springs from a shockingly (to this outsider at least) insular culture at OSU. Much of the administration has started out as students here, spent their entire careers here, and have very little perspective. I often hear expressed the attitude that OSU is ‘different’ as if this is a point of pride. Well I have news for the OSU cognoscenti: OSU is competing in an increasingly international market for talent, it needs to stop being ‘different’ and start being ‘competitive.’

So why this lengthy diatribe? Well in addition to the cutting of language arts, which has received a little attention, starting this year, if you wish to pursue a graduate degree in economics, don’t bother applying to OSU - the administration has shut us down. This leaves the College of Liberal Arts with exactly zero legitimate PhD programs. Good luck trying to get good faculty in economics now - I, for one, would not have come here without a PhD program. This is an interesting decision at a time when Economics is one of the most popular undergraduate majors across the country and is the most popular major at schools such as Harvard, Duke and NYU. To abolish econ when it was the only legitimate PhD program in the entire College of Liberal Arts is truly dumbfounding and sends a very bad signal about the future of the University.

Econ 101: Network Externalities and Switching Costs - or - How I Learned to Stop Worrying and Love the Mac

It all began with an Apple IIe upon which I programed a stupid animation of a duck kicking an egg. Then, in college, my brand new typewriter was immediately mothballed once I was shown the Mac labs in the basement of the dorms. Soon I owned one, then a PowerBook and finally a PowerMac that I bought upon starting my PhD. But it was soon over as economics was entirely PC and switching platforms got to become too burdensome. I was consumed by the evil Microsoft empire and have been a slave to PC ever since even after Macs got better and platform switching become a snap.

Economists call the two things that kept me enslaved network externalities and switching costs. Network externalities are when the value you get from using a product goes up the more that other people use it (and vice versa). So, since I was in economics and everyone used PCs, the value I got from PC usage went up and Mac usage went down. Thus I went to PC. Switching costs are just that, the costs you incur when you switch from one product to another. In my case, some software adjustments will have to be made and, more importantly, I have to retrain myself to do some things that I now do without thinking.

So what happened? Well with increased ease of moving across platforms and with the increased popularity of the Mac (including some of my colleagues) the network externality angle has lessened a lot. Switching costs have diminished as well thanks to USB ports, flash drives and Macs ability to link with Mac or PC networks (like I have at home).

And so it is that I have finally come back home to Mac. I am as giddy as the day I brought my first Mac home (a Mac SE - the IIe was a childhood friend's). Here is a picture of the beautiful little guy. A computer on which I wrote my first e-mail. Ah nostalgia. Anyway, I am now fully committed to making the complete transition over time and you know what? It feels fantastic!

So this, my dear readers, is the first blog post from the new MacBook Pro. Enjoy.

UPDATE: I do have one disappointment: in the old days when I used to start up my Mac, it would smile at me. It doesn't do that anymore...

The Beautiful Game

Boy am I tired these days - must have something to do with the fact that Euro 2008, the European soccer championship (think World Cup but with only European teams) is currently being contested, and the fact that I have a DVR - making it possible to record the games and watch them well into the night. Here is clearly the class of the teams so far, the Netherlands, scoring the goal of the tournament so far against World Cup champs Italy (whom they demolished). [Though it could be that Italy are simply past their sell-by date] The Dutch are famous imploders so we shall see how they fare as the tournament rolls on and please, please do something about those socks! Spain look pretty darn great as well, but they are also famous under-achievers. Will this be the year for one of them?

Right now, I would guess Spain.

Econ 101: Inflation, Exchange Rates and Commodities

Though I try and stick more to the local and the personal in this blog, I thought it might be a good time to try a little primer on international finance, as I just taught it in my international economics class. Call it the "what the heck is going on?" post.

I am going to borrow a pedagogical device right out of Krugman and Obstfeld's outstanding text and start with an asset either in Europe or the US. What determines the performance of this asset? Well, interest rates and inflation if you are investing domestically. If you are investing from abroad, however, exchange rates matter as well. But it is not what the state of the world today that matters most for the performance of an asset, it is what the state of the world will be in the future - when the asset matures - that matters most. Thus expectations about inflation and exchange rate movements matter a lot. This is why central banks have become more and more transparent: they are trying to manage expectations. This is also why central banks have become, first and foremost, inflation hawks: they want to guarantee low inflation lest investors get jittery.

So let's get back to that asset. Suppose you are in Europe and you have money to invest and you are thinking of investing in either a euro denominated asset or a US dollar denominated asset. If interest rates in the US are high, you might be tempted to invest in the dollar asset, to do so you want to sell euros and buy dollars so you can purchase the asset. Since many investors are making the same calculation the demand for dollars will be driven up and demand for euros will be driven down. This will lead to an appreciation of the dollar. Higher interest rates in Europe, all else equal, will have a similar effect: the euro should appreciate against the dollar (or dollar depreciation). Inflation in either zone will lower the real return on the asset and thus will have the same effect as lowering the nominal interest rate and thus high inflation in the US should lower the demand for dollar assets and lead to a depreciation of the dollar. Finally, expectations about exchange rates can lead to them being self-fulfilled: if you expect the dollar to depreciate this leads to a lower demand for dollar assets (because when it matures the dollars you get out are now worth less) and thus a lower demand for dollars and - hey presto! - a dollar depreciation.

With this basic framework in hand, it is not surprising that the US dollar has depreciated so remarkably over the last few years - the fed kept interest rates low which both lowered the return on dollar assets and caused a bit of concern about inflation. Here is a picture of the dollar-euro exchange rate for the last five years:



Commodities play in interesting role here, especially if they are dollar denominated (which most are). Generally when the US dollar depreciates it makes US products sold abroad cheaper to the residents of those foreign countries. It also makes foreign products more expensive in the US. This generally leads to more exports being sold and fewer imports being bought which - in the US - would generally lower the trade deficit. However oil is a dollar denominated commodity, and since we import a lot of it, our trade deficit is actually going up (see graph from NY Times). Since oil prices are set in a futures market they are a function of expectations of future supply and demand and exchange rates. So questions about future supply and a weak dollar have pushed up oil prices dramatically, something we are seeing filter down to the gas pump. There could also be quite a bit of speculation as well, but it is not yet clear that this is the main culprit. Add to this the fact that food prices are climbing ever higher and that the crop year does not look to be particularly bountiful and you have even more pressure on inflation.

So where does this leave us today? Well, the US is in the midst of a major economic slow-down sparked by the credit crisis. The credit crisis, while still needing a long time to shake out, looks to have been largely tamed by some bold action by the Fed. Now we are faced with some unpleasant realities for the near future. The price of oil is starting to seep into core (non-energy and food) inflation. If wages start to respond (which as of yet they haven't), we could be in for a major inflationary episode. This will cause the dollar to further decline which will mean even higher oil prices. Yikes. So regardless of how the credit market is currently faring, the Fed will almost certainly have to start to raise interest rates. Doing so will quell inflation expectations and drive up demand for dollars which should start leading to an appreciation of the dollar. But it will also cause a slow down in domestic investment at the very time we want more of that to happen. Still the risks are much worse: once wages start adjusting to inflation, the Fed will have to respond much more drastically to keep inflation under control.

So, over the next 12 to 24 months I think we are in for a very tough time. The Fed will almost definitely start to raise interest rates, appreciating the dollar and taking some pressure off commodities prices. This will, unfortunately, curtail credit at the very time we are trying to get credit flowing again which will lengthen the malaise in the housing market. So right now the Fed knows it needs to stay on top of inflation but definitely does not want to jump the gun as the longer they with the more the credit markets can recover before increasing rates. I think we are likely in for a long and painfully slow recovery.

Hold on to your hats...

Beeronomics: Mergers and Distribution

Now that finals have started, all the work shifts to the students and I can now start to catch up on blogging. From last week: John Foyston of The Oregonian reported on a merger of some major Oregon beer distributors.

What should we think about this merger in economic terms? Well it depends on the relative economies of scale versus the market concentration trade off. Based on Foyston's article (and I believe it) there are considerable economies of scale - fewer half-full trucks delivering to the same stores (good environmentally as well) mean average costs should fall. And, in answer to Jeff, yes, smaller distributors could suffer disproportionately from high fuel costs if they are not as able as the bigger guys to make their trucks efficient. [Think one truck visiting 10 stores in a day of the little guy versus one truck visiting 5 for the bigs] So bigger may mean cheaper. However, with market concentration comes the ability to price above marginal cost which could easily wipe out the cost savings and be captured as rents. Clearly some of this is anticipated by the firms or they would not have merged in the first place. I have no way of knowing where the balance will fall, but I do worry about concentration as there is low contestability in this market due to government regulation. [Contestablilty is how easy it is for another firm to start competing in the same market]

Here is another twist. We know from the economics of product variety that the free market tends to offer too much variety relative to what is socially optimal. But serious beer connoisseurs benefit from this tremendous variety (and casual drinkers suffer as prices are higher than with less variety - thus the sub-optimality). If only one firm controls product variety, the competitive forces that cause this excess variety will be diminished and there is every reason to believe that the variety being distributed will be diminished. This is what I think really worries the beer-heads, and right they should. It IS quite possible that the smallest brewers will be pushed out - they are more expensive to deal with and the extra variety may no longer be desired.

But it is important to realize that distributors are responders to markets just as are retail outlets. If craft beer is selling better than macro-brew, guess what they will want to stock their shelves with? So, in the end I think it is too soon to tell about the merger, but I am cautiously optimistic, after all it is the very distributors that were instrumental in creating the amazing craft beer industry in Oregon.

Beeronomics: Honest Pint Project in the Wall Street Journal

Over the weekend the Wall Street Journal reported on the Honest Pint Project. Unfortunately for all of humanity, the reporter, with whom I spoke, did not choose to discuss my erudite discussion of the economics of information but nonetheless she did manage to write a pretty interesting article about the economics of the craft beer industry and incorporate the Honest Pint into it.

The best part of the article, however, was this picture which shows the problem of asymmetric information. Oh yea, and it did do a good job of describing Jeff slinking off into the gents with a pint glass and measuring cup tucked under his shirt. If not for martyrs like Jeff, where would we be?

Also a note: I went to the Hopworks Urban Brewery (HUB) on SE Powell in Portland last week and had some very good beer and exceptional service (the very friendly server brought me a number of free tasters) . I admit to liking but not loving Brewmaster Christian Ettinger's beers - they have an astringent quality that I find displeasing, an antiseptic bite that lingers on the tongue - but my companion did have one truly transcendent beer, the Baltic Porter. The pub itself is fantastic, the service wonderful, the beer very good and the Baltic Porter is out of this world. But this is not what I wanted to say. What I wanted to say is that HUB uses a unique style of glassware that has on it, clearly marked, a 14oz line (well below the rim). HUB also prices its beer, very clearly, as 16.5oz. Good for them - an honest, well, pint and change. The point is that they are clear about what they are serving and charging for.

I have one quibble, however, and that is 16.5 ounces must be right to the rim of the glass. Meaning that with head, the beer will not really be 16.5 ounces. The 14oz line is clearly there for serving purposes, allowing for the head to rise above. Why not just use that?

Economist's Notebook: Americans, Europeans and Markets

It says a lot, I think, about the difference between how Americans and Europeans view the interaction of their governments and markets that the New York Times today reports on a truckers' strike in Spain to protest high fuel prices. [Here is a NYT picture of a blockade at a Spanish-French border crossing] Americans, trained from birth to respect the sanctity and power of markets, only complain when they feel that the outcomes they are seeing are the result of manipulation. Europeans, on the other hand, have an expectation that government will protect them from the harsh realities of supply and demand. A similar scene in the US would be unprecedented.

I remarked to a French friend once, as he was lamenting the vulgar display of the French flag by citizens celebrating the French victory at the European soccer tournament (the flag is the symbol of the state, you see and should only be displayed on government buildings, was his complaint) , that the relationship between the state and the citizens of France is quite different than in the US. In the US, I claimed, it is common for people to display the flag on private property because of the belief that the government is an extension of us. We send our representatives to Washington and they govern, but they are citizens just like us. In France, I felt, there was much more of an attitude that the government is a group of professionals whose task was to take care of the people. So the attitude is more paternalistic, if you will, and there is a higher expectation that the government will decide for the people and will protect the people.

I think this analysis, albeit a little crude, follows for markets as well. Both Europeans and Americans understand the basics of supply and demand, but Americans are much more willing to accept the outcomes of markets as they are. Europeans believe that the government should become active when the outcomes turn too unfavorable. Perhaps this is simply an artifact of a society founded on free market ideals versus societies that evolved slowly to markets occupying a central position. Perhaps it is a artifact of more homogeneous cultures. Who knows?

What is interesting is that the UK, which used to be the poster child for this type of protest and strike, is largely silent these days on such issues. An artifact of the Thatcher years followed by the "new labour" of Tony Blair who officially allowed free market acceptance as a part of the Labour platform.

Which is the better attitude or stance? I know not, but as fuel prices affect the less affluent much harder than the affluent (especially in America where affordable housing is often on the outskirts of big cities and public transport is scarce), I think it is an indication that we are reaching the limit of how much inequality society is willing to bear.

Scattered thoughts for a Monday morning...

Fred Thompson - Econ 101: Economic Growth

I was desperately trying to find time to post and, hooray, along comes Fred Thompson to save the day with a great post on economic growth theory. Thanks Fred.

Patrick Emerson in an earlier blog post wrote:

“But children are also resources in and of themselves: they are the ones who will have to come up with the solutions to the resource issues and I have faith that they can and will do it. Within each child comes the potential for being a vital part of the world's human capital resource that will solve global warming, find new renewable energy technologies, will invent more efficient ways to produces goods and services that use fewer resources, and so on. They are the ones that will create the new resources with which humanity will thrive. In fact, during the recent explosion in human population, living standards have risen considerably.”

Patrick eloquently explains the conclusions of contemporary economic growth theory. I am going to ratchet this up a bit and try to explain the theory itself and how these conclusions were reached.

This story begins with the notion that capital and labor are combined to produce goods and services. The more goods and serves you can produce/consume the wealthier you are. We call the mathematical representation of this process a production function. Once upon a time, most economists believed that the rate of capital accumulation determined the productivity and wealth of an economy. That is, if you added more tools, plant, and equipment, you could make the labor force more productive. The faster you accumulate capital the faster economic output will grow.

Then, in the early 1950s, a guy named Robert Solow was playing around with production functions and discovered something very interesting about them. Beyond a certain point you cannot increase output per unit of labor input by adding more capital. The implication is that once the optimal labor capital combination has been reached an economy can grow no faster that the rate at which the labor force expands. Moreover, in the real world, where resources can and throughout history have been depleted, this implies that output per worker must fall, ultimately to below subsistence levels.

However, when Solow looked at the available data he found that output actually grew faster than could be explained by the growth in labor and capital. In mathematics a result that isn’t explained by a model’s variables is called a residual, in this case, unexplained growth. By definition a residual must be explained by a variable that is outside (or exogenous to) the model. Solow hypothesized that this particular residual was due to technological improvements that made capital and labor more productive. The implication is that, if technology complements labor and capital in a production function, as long as it grows faster than the rate of resource depletion, the economy can continue to grow in wealth and population.

So what determines the rate at which technology grows? In exogenous growth theory, once you have reached the limits of investment in human as well as physical capital, the rate of technological innovation ought to be about the same as the rate of population growth. Ultimately, however, this implies that, since the rate of resource depletion speeds up as the labor force grows, while technology is a linear function of population size, all technological innovation does is to put off the eventual crash to a later date. This is, of course, the kind of model that drove the Club of Rome’s doomsday results. Folks talk about these formulations in terms of limits to growth (in wealth and population). In fact, almost any kind sustainable human future is incompatible with this kind of model. Every conceivable set of choices eventually leads to declining wealth and eventually a population crash.

Unsatisfied with this approach, economists, including, most prominently Paul Romer, built mathematical models (or production functions) that included (or endogenized) technological advancement as an explanatory variable. In so doing they made a surprising discovery: the payoff to investment in technological advancement is different than the payoff to investment in capital. Because in theory, technological advancement can be freely shared with all users, it is characterized by increasing returns to scale. This means that even if the rate of technological innovation is a direct or linear function of the size of the population and, thereby, the workforce, its payoff increases at an increasing rate when you increase workforce size.

For example, if every unit of the workforce invents something that makes work ten percent more productive and you have one workforce unit, productivity is increased ten percent. If you have two units, you can produce 21 percent more stuff; ten units, 160 percent; and 100 units, 1,378,000 percent.

The implication of this theory is that population growth is not inimical to increased economic wealth. Moreover, there are almost an infinite number of sustainable growth paths both in terms wealth and population (although not all growth paths are sustainable). I think the best growth paths are those in which everyone is well educated and technologically innovative. Indeed, where being smart, technologically literate, and innovative are universally admired personal qualities. But the status quo will probably suffice.

I also like plenty of open spaces, clean rivers, blue skies, old-growth forests, and pristine beaches. I don’t like crowds and can barely tolerate cities. But these are aesthetic preferences, not matters of survival. We all have to make trade offs, individually and collectively. Generally, however, richer is better. And, because aesthetic preferences are normal goods, richer also means that they are more likely to be realized.

End of Term Blues

Sorry for the lack of posts, the term is ending here at OSU and I am swamped. I shall post again soon.