Do You Trust Markets?

Greg Mankiw has a nice post on trust in response to Paul Krugman's views on the government's role in health care. An excerpt:

I tend to distrust power unchecked by competition. This makes me particularly suspicious of federal policies that take a strong role in directing private decisions. I am much more willing to have state and local governments exercise power in a variety of ways than for the federal government to undertake similar actions. I can more easily move to another state or town than to another nation. (I am not good with languages.)

Most private organizations have some competitors, and this fact makes me more comfortable interacting with them. If Harvard is a bad employer, I can move to Princeton or Yale, and this knowledge keeps Harvard in line. To be sure, we need a government-run court system to enforce contracts, prevent fraud, and preserve honest competition. But it is fundamentally competition among private organizations that I trust.

This philosophical inclination most likely influences my views of the healthcare
debate. The more power a centralized government authority asserts, the more worried I am that the power will be misused either purposefully or, more likely, because of some well-intentioned but mistaken social theory. I prefer reforms that set up rules of the game but end up with power over key decisions as decentralized as possible.

What puzzles me is that Paul seems so ready to trust solutions that give a large role to the federal government. (In the past, for instance, he has advocated a single payer for healthcare.) I understand that trust of centralized authority is common among liberals. But here is the part that puzzles me: Over the past eight years, Paul has tried to convince his readers that Republicans are stupid and venal. History suggests that Republicans will run the government about half the time. Does he really want to turn control of healthcare half the time over to a group that he considers stupid and
venal?

These thoughts, I appreciate, are broad generalizations. They don't immediately lead to a specific set of reform proposals. But I wanted to give Paul credit for a key insight: A central question in this and perhaps other debates is, Whom do you trust?

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...

What is a Blog? Economics and the Marketplace of Ideas

Astute readers of this blog will have long ago noticed a connection with the BlueOregon blog edited by Kari Chisholm, Jeff Alworth and Charlie Burr. This connection is personal, not political, and is due to the fact that Jeff is a very close friend and has been for two decades. Jeff and Kari, from time to time, mention my blog on BlueOregon and have increased my traffic considerably. However, I try not to engage in politics (as opposed to policy) in my blog and have just as often rankled BlueOregon readers as have pleased them with my analyses of policy proposals. In my blog roll, I link to BlueOregon and its closest right-wing counterpart, Oregon Catalyst, because I have the arrogance to believe that people of all political persuasions can benefit from some well thought out economic reason.

With that said, BlueOregon has become the target of a little yellow journalism hatchet job from Willamette Week which attacks the blog and suggests bias and conflict of interest. This amuses me for just what does WW think a blog is? It appears it thinks blogs are a form of journalism and thus should be subject to the rules of journalistic ethics. But this is patently absurd. While a few blogs explicitly aspire to a form of journalism, most notably Talking Points Memo and especially its related projects, the vast majority are simply opinion. Even at TPM the bias is up front: "Commentary on political events from a politically left perspective."

I have no illusions about what a blog is; it took me about 3 minutes on Blogger to set up this blog and get it up on the world wide web. This blog is a representation of my opinions, biases, peccadilloes, etc. What I love about the web and the blog-o-sphere is the very embodiment of the "marketplace of ideas." But in this market, as in any market, the burden is on the consumer: "caveat emptor." This does also suggest a burden on producers to truthfully reveal relevant information about the product. I have disclosed that I am a economist and professor and, in fact you can visit my web site and CV to decide if you think anything I say should be taken seriously or not. You can easily satisfy yourself with an echo chamber of like minded bloggers, or you can (as I do) look to find a spectrum of opinions that will challenge your views on an issue and make you a better and more nuanced thinker. It is entirely up to you.

But this is a marketplace and the consumer has only to click a mouse button to quickly express their preferences. Which gets me back to the WW article. The logic of the article seems to go like this, because BlueOregon is so popular it should be held to journalistic standards of ethics, and conflicts of interest on the part of its editors should not be allowed. Then, through strong innuendo they imply terrible bias on the pert of BlueOregon itself (talk about journalistic ethics). There are two things wrong with this argument. First, as I said above, a blog is not journalism, and second, WW does not seem to believe in markets.

If the blog is biased and there are a lot of dissenting voices that are being suppressed, then other outlets could and should emerge. BlueOregon is in a hyper-competitive market: new entrants can start up at zero cost - there are no barriers to entry. This is very different than print journalism in which there are extremely high start-up costs. So the very fact that BlueOregon is so popular does not suggest that they are some kind of gate-keeper for Oregon progressives on the web, it suggests the opposite - that BlueOregon is extremely good at doing what it aspires to do, provide a forum for these progressive minded Oregonians to express themselves. Its success in the marketplace of ideas in other words, is not due to some market power, come corner on the market, but is due rather to the fact that it offers a product many want to consume. There is one requirement for the market outcome to be efficient and that is full information. Thus it is important for the editors of the blog to be up front about conflicts of interest they may have, and the editors of BlueOregon are.

Finally, though it is in one's nature to defend oneself against unfounded and unreasonable attacks, BlueOregon really has no need to do so. The product and its success speaks for itself.

By the way in the further interest of disclosure, I do not define myself by political party but I did once take a (slightly silly) test on Political Compass to assess my economic and social leanings - here is my result:
So there. Apparently I am in good company with the Dalai Lama...

Payday Loans Redux

A new staff report by the Federal Reserve Bank of New York seems to confirm my fears about the regulation of payday lenders. As an economist, I believe that things like payday loan businesses arise due to some missing market, and to simply shut down that market does not address the original lacuna that caused it to arise. As payday borrowers are mostly lower income individuals, eliminating payday loans could end up making them worse off. Payday loans, as much as they seem usurious to us, seemed to be providing essential liquidity to a population that has a limited access to credit. Preliminary results are that credit troubles have worsened in areas where payday lenders were prohibited.

Economist's Notebook: Markets and Policy

I have already talked a lot about markets using specific policies and events to highlight aspects that I think are relevant. But I thought, thanks to a suggestion, that it might be worth talking briefly about the good and the bad of markets and the way that I, in general, assess a particular market and think about the potential for policy to do some good.

Here are the basics. As a mechanism for distributing scarce resources, complete free markets are exceptional. By exceptional I mean precisely that they extract every available amount of surplus possible and are, therefore, efficient. For example, if there are a number of people out there with tickets to a Kenny G concert and a number of people who wish to see Kenny G, allowing these individuals to interact in a free market will mean that the exchange of these tickets will ensure that the people who want to see Kenny G the most will get the tickets, and that every seller that wishes to sell for a given price (and for whom there exists a buyers willing to by at or above that price) will be able to sell. In other words, all mutually beneficial transactions will occur. To see this another way, a complete free market will prevent instances where there is a buyer of a Kenny G willing to pay up to, say, $100 for a ticket and a seller willing to accept anything above, say, $50 but a transaction between these two does not occur. This is what is meant by efficient: that last transaction should occur, if it did not occur, $50 worth of surplus (the difference between the $100 and the $50) would not have been created. This is the “miracle,” if you will, of the invisible hand: everyone in this market acts in their own self interest, but socially that create maximum surplus and the most efficient distribution of the tickets (only the people who values them the most will end up with them) and it is the price system that makes this all happen. Markets really are remarkable and this result is what fuels almost all free-market based arguments (individual liberty as a political philosophy is another).

NB: It is worth pausing for a moment to give the important disclaimer that efficiency has nothing to do with equity. Equity may be an important social goal, but does not mean we have to sacrifice efficiency. Extra-market redistributions can accomplish the equity goal, but without efficiency, there is less to redistribute to everyone.

Another note: careful reader may object by saying that the people who value the Kenny G tickets the most are almost surely the richest – and that allocating tickets to them is unfair. But consider this thought experiment. What if seeing Kenny G was worth only $25 to me (yes, perhaps because I have such low income). If I were given a chance to buy a ticket for $25, what would I do? I could go to Kenny G and basically come out even, or I could turn around and find the person who would pay $75 for it and sell it. Then I would come out $50 ahead. Remember everything is scarce and we are all trying to do the best we can with what we have. Creating the most surplus is best for everyone. So preventing this last transaction is what is unfair in this point of view.

So I have shown the basics of why complete free markets are so great, have so much traction in political consciousnesses and are often the lesson undergraduates take away from the little exposure they get to economics. This is partly due to how incredible we economists think they are and how important we think it is for people to understand and appreciate them. But the whole thing, it turns out, rests on a set of assumptions that really never hold in the real world. The four biggies are externalities, public goods, information asymmetries and perfect competition. I have talked about these and will continue to do so in my posts, because understanding these (and their implications for markets) is key, in my view, to evaluating policy. Briefly externalities are the costs and benefits of an economic activity that do not accrue to the person engaged in the activity. They can be positive (maintaining a nice garden in front of my house) or negative (the particulate pollution from my wood-burning fireplace). Either way the free market result is inefficient: I do too little than is socially optimal if the externality is positive and too much if the externality is negative. Public goods are goods in which there are aspects of non-excludability (can’t prevent non-payers from consuming) and non-diminishability (use by one person does not leave less for the next). The classic example of both is radio transmissions. It turns out that for these types of goods (roads, parks, fire protection, etc.) the free market will not allocate a socially efficient amount. Asymmetric information is where, for example, sellers know more about the quality of a good than do buyers. Efficient free markets rely on complete information – everyone (buyers and sellers) knows everything (prices, quality, availability) about everything (all products and their complements and substitutes). Finally, too much market power can be inefficient, so there often has to be perfect competition on the part of buyers and sellers for markets to operate efficiently. (We also know that inefficiencies can arise on the supply side from trying to prevent competition, offering too much variety and engaging in investments that are too risky, to give a few examples).

Almost every market you can imagine has some sort of market failure of the types mentioned above. The key to assessing interventions in free markets is in understanding the nature of the market failure, estimating the impact of the failure (is it important?, if so how important is it?), and then thinking of ways the government can correct the failure. Are the remedies going to be effective? Are they going to create new problems? Are they expensive relative to the cost of the inefficiency? These are all questions I ask every time I start to think about a policy and you will see them and references to the market failures ever time I post about policy.

As an economist I appreciate that free markets are great. But I also understand that most free markets are subject to some sort of failure. Sometimes this is small and interventions are bad, sometimes this is big and interventions are necessary. But I am a typical economist in that I view free markets as the first best when we can make them happen. I am also typical in that I understand that market interventions are often necessary, but that I tend to prefer as small an intervention as possible. Where most of the debate happens among economists is in this last bit – assessing the impact of the failure and the worthiness of the intervention. What I cannot tolerate are self-styled 'economists' who think that free markets are the answer to everything and who show no knowledge or appreciation of market failures - and we see these types far to often in public policy debates (hence this blog).

It is really not that hard to be a good economist, but it appears to be far too easy to be a bad one.

Payday Loans

Here is a topic which is a good example of the occasional enormous chasm that divides economists from non-economists and makes 'normal' people think that we just don't 'get it.' The argument for the regulation of the payday loan industry in Oregon (which, among other things, limits the amount of interest that can be charged at 36%) seems overwhelming: these businesses are praying on the poor and vulnerable and indenturing them into debt servitude, furthering their misery and contributing to their poverty. Yet, I don't buy it and I worry that the poor and vulnerable will be made worse off with such regulation, not better.

Let's begin the analysis with the root problem: access to credit for the poor and/or those with poor or no credit histories. This is a considerable hardship because credit provides flexibility when dealing with limited and often transitory income. Access to credit can also be a key to escaping poverty by allowing investments in productive assets (like education) that can increase future incomes. This is what I would call the disease.

Here is a symptom: Because credit at (for lack of a better term) mainstream financial institutions is inaccessible, a host of businesses have cropped up to provide credit to this population. They have been criticised for having exorbitantly high interest rates and short repayment periods. The subtext to this critique is that they are abnormally profiting from other's misfortune. Given as evidence of the scale of the problem are the vast numbers of payday loan shops. But these critiques strike me as completely misguided. The fact that there are many payday loan shops suggests to me that the industry is highly competitive, and therefore that the interest rates they charge are reflective mostly of the costs of doing business in small-scale loans and high delinquency rates. So the proposed cure will cause firms to exit the industry - worsening the disease by further limiting access to credit to the poor. For those that remain and are limited to 36% interest, they will impose more stringent requirements to limit their credit to only the least risky of their clients - again limiting access to credit for the poor.

So I find this a totally misguided policy. I think that payday loans are a problem, but that the problem is with access to credit for this population. What government could do that would be more appropriate perhaps is to mandate that banks, credit unions and thrifts extend credit to this population. To do so these institutions would end up charging more for credit for all and thus this would be a type of transfer from the relatively well to do to the relatively less fortunate. But it would be aimed at the disease and not the symptom.

Finally, one argument that really bothers me (and I am perhaps typical of economists) is that these payday lenders are predatory because borrowers are naive and don't understand what they are getting into when they borrow money. I find this incredibly patronizing - basically "the poor are dumb." While it is true that education and socio-economic status are highly correlated, intelligence is not. And even if people (in general) are not too savvy about understanding the implications of these loans, they tend to be very small and short and one experience is likely enough for borrowers to learn (unlike, say, sub-prime mortgages). It would be one thing if these lenders were accused of fraud (like, say, some sub-prime lenders) and I would be in favor of any sanction against such practices, but the argument is not fraud, but the failure to comprehend. But you don't have to just take my word for it, the issue of whether payday loans are really predatory has been studied very carefully by economists at the fed who find that, in fact, the population of payday loan customers looks very similar to customers of mainstream financial institutions in their delinquency rates and that the payday loan industry appears to be quite competitive.

So, in my view, here is a policy that just gets it wrong - it attacks a symptom, not a disease and is likely to hurt the very people it intends to help.