Economic Logic

Net neutrality, the fact tat no one has priority over the use of the Internet, may sound very democratic, but it is also potentially inefficient. A Skype communication, which cannot afford much latency, has the same priority as an email, which can definitely afford to wait a few seconds. The obvious solution is market based: let people pay if they want less latency. This should also make the broadband hogs who need to watch videos absolutely everywhere realize how they are affecting the Internet use of others. But that would give up the ideal that the Internet is free for all and whichever way you use it.

Nicolas Curien points out that net neutrality does not imply that Internet use should remain free, both for end users and content providers. It only implies that the price does not discriminate in any way. Curien goes on to formalize in a rather convoluted way neutrality and efficiency, showing that the most efficient outcome in many situations implies some imperfection in neutrality. This is hardly surprising. Maybe more interesting is the discussion in the conclusion, unfortunately not backed up by formal analytics, that competition makes neutrality easier to enforce, and thus Europe is in a better position in this respect than the United States. I am curious whether is true.

The current talk in Republican circles is that one can achieve significant job growth by deregulating. One may want to question this idea on two fronts. First, regulation has been initially imposed not for the fun of killing jobs, but because it improves the well-being of people. There is a trade-off, and sometimes it is worth having a little fewer jobs if it means improving the life of a lot of people. Second, the job loss numbers from regulation are often more fantasy than reality.

This is not a new question. Take the case of Australia, as discussed by Bruce Chapman. He looks at estimate of job loss in Australian mining from the implementation of an emission trading scheme. These 23,510 lost jobs are not as large as they appear. First, there would be job gains elsewhere, in particular in alternative energies. Second, when compared to normal job flows in the mining sectors, this number is quite negligible. Third, once you look at a somewhat longer horizon, say, ten years, a job loss is virtually undetectable. I would add finally, measurement of jobs losses has high uncertainty, and any result commissioned by one party in the debate needs to be taken as an extreme value.

So, do not have too high hopes that a sudden deregulation will create a job boom, especially in a country that has remarkably little regulation to start with.

The insurance market is thought to be rather competitive, at least for the most common risks. That is in part because insurance companies are willing to take risks thanks to re-insurance, where they can insure large event risks and to some degree over-exposure. But there are rather few actors on the re-insurance market. Is this bad, and does it have an impact on the insurance market?

Sabine Lemoyne de Forges, Ruben Bibas and Stéphane Hallegatte play with a model of re-insurance and find that there is a trade-off. The lack of competition leads to sub-optimal re-insurance provision, obviously. But is also allows the few players to take on larger risks, some of which may not have been insured otherwise. And, the larger the re-insurers, the more resilient the market can be. As a regulator, this means that means that you may to let the re-insurance companies grow larger than want is optimal in terms of competition.

Pollution regulation is typically cast as a game between citizens and firms, the first suffering the consequences of pollution while the second are the origin of the pollution. In such a case, there is no incentive for firms to abate pollution, and the government has to mediate. But could a case be made that firms should be willing, individually or collectively, to reduce pollution. One way can be green labeling, which could increase the demand for their products. Another would be if firms realize pollution has an impact on their on productivity or on the labor supply.

Joshua Graff Zivin and Matthew Neidell take the worker productivity angle by using a dataset of dairy farm workers from a large farm in the Central Valley of California. In particular, they look how ozone levels impact the output of piece rate workers. At it is substantial. For example, a 10 ppb reduction of ozone increases productivity by 4.2%, noting that the standard deviation of ozone levels is 13 ppb. And if you object that some of the workers fall under minimum wage law and may not exert the right effort, be reassured, the authors took that into account. In addition, this impact happens even when the ozone level is well below the current national standards. Realizing this, industry should be more willing to accept the suggested tightening of pollution standards for ozone, and for nitrogen oxides and volatile organic chemicals that are the source of ground-level ozone.

A classic example of the law of unintended consequences is how seat belt laws gave reasons to drive more dangerously, as car drivers feel more secure. This idea has been popularized by Sam Peltzman and several follow-up studies.

Yong-Kyun Bae puts some serious doubts in this results by pointing out that all these studies were based on aggregate data. Using individual data, which allows to exploit individual characteristics, as well as the circumstances of accidents. And once you control for these factors and exploit cross-state variations of how seat-belt laws became more or less stringent in the last decade, it appears more stringent laws make people drive more carefully. Indeed, pedestrians are getting safer. If this result stands, the challenge is to explain it: do tougher seat-belt laws signal stronger enforcement of other traffic laws? In particular, as Bae suggests, these laws may come in tandem with cell-phone and texting-while-driving laws.

Europe and the United States have a different attitude towards many things, and one in particular is regulation. Think, for example, how Europe is adverse to genetically modified agricultural goods, while nobody really cares about that in the United States. Other examples abound, like the little checks there are in the American meat industry or the fact that helmets are not required for motorcycles in most US states. How can such drastic differences arise in countries that after all have a similar standard of living?

Johan F.M. Swinnen and Thijs Vandemoortele show that tiny differences in preferences can lead to large differences in regulation. To prove this, they develop a dynamic model with households, producers and political decisions on whether to allow a potentially objectionable technology. It implies that no regulation is imposed below some threshold level of preferences, and the technology is not allowed above that. This results is, I believe, mostly the consequence of the discrete nature of regulation here: either you allow or you do not. With intermediate levels of regulation, the story may be different. More interesting is the result that there is substantial hysteresis: once a decision is taken one way, it is very difficult to revert it even if preferences or the negative consequences of the technology change. This result is reinforced by the discreteness of regulation, but would most likely be present even without it. In other words, it is possible that tiny initial differences in preferences between countries can lead to large regulatory differences that cannot be overturned.

PS: As in much of this kind of literature, quadratic costs are imposed. I always wonder whether this functional form has implications on results, but nobody seems to care.

There has been and there still is much outrage about the large bonus payments bankers get. What the public does not understand is that bonus pay is a very large part of total pay, and it is so to encourage bankers to perform really well. And they certainly put in the hours. For example, bonus pay has been criticized because there is most often no "malus," but given that base pay is relatively low, this should capture it. The main criticism is aimed at the disparity of these bonus payments with respect to the average pay of a worker. This is, however, not something that should be regulated at the level of bonus pay, but through redistribution with income taxes. In this regard, whether it is regular pay or bonus pay makes no difference. So, should then bonus pay in banking be left unregulated?

John Thanassoulis does not think so. He argues that as bank compete for top bankers and try to shift the risk on them, they end up paying them too much and all in bonuses. This is optimal for the bank as it lowers its costs right when things get critical. But as a consequence, the bank gets too much into risky activities, as competition for bankers drives bonuses up higher than socially optimal, especially if there is a contagion risk of default for other banks. So you want a regulator to limit bonuses, but in a flexible way, or the benefit of having bonuses in the first place gets eroded. Indeed, it is the top brass that sets the bank level risk, whereas other employees all the way down to secretaries (who also get bonuses) are less influential, even collectively, on the aggregate risk. Thus the idea is not to cap bonuses individually, but at the bank level as a proportion of the balance sheet (which is what matters in terms of default). The pay structure would then presumably be readjusted by the bank, relying more on bonuses where it matters the most. Taxing bonuses has no risk impact, though, except for reducing bankers' pay.

Another possibility could be the dynamic incentive accounts I mentioned before.

The past two decades have seen an impressive wave of privatizations all around the world, especially in utilities and resources. This trend has recently been reversed though, with several large nationalization waves, in particular Latin America. This kind of cycle is not new, as especially the gas industry has gone through several waves each way during the last century. Why all this back and forth?

Roberto Chang, Constantino Hevia and Norman Loayza observe that nationalizations typically happen when the price of the output of reference is high and inequality of wages is also high. The opposite is the case for privatizations. They can explain this with a model of a benevolent government that maximizes a social welfare function represented by the average utility of workers. Under nationalization, all workers are paid the same and exert little effort. Under privatization, firms can discriminate workers, who then put more heart at work, creating wage differentials. When prices for the commodity increase, this generates larger rents for the most productive, and inequality increases.

The story is then of a inequality-efficiency trade-off for the government. In the naturalized state, inequality is low, but so is efficiency. If prices are low, it is more important to increase efficiency, and the firm is privatized. But as it becomes more efficient and discriminates its workers, inequality becomes more important, and the firm is nationalized back. And the cycle continues, with an average of 12 years of privatization and 25 years for nationalization. While this is a very stylized story, after all the model assume an economy with a single sector that has no impact on world prices, it is still a compelling story.

Now that Lebanon and Israel are at it again, one can ask whether this can have an economic impact. The prime candidate (a part for the defense industry) is the tourism industry. Casual empiricism seems to indicate that tourist react very strongly to very small probabilities of danger and thus should be deserting those countries.

David Fielding and Anja Shortland look at the case of Egypt, which has suffered from Islamist fundamentalist violence for the last two decades, sometimes targeted at tourists. They find that tourists stay away when violence has occurred, but only when it was directed towards tourists. Violence among locals has no impact. And when the Egyptian government takes (usually heavy-handed) counter-terrorism measures, European tourists stay away, while US ones are not affected. Interestingly, there is substitution: Egypt's tourism industry benefits when things turn sours in Israel, at least if it does not mean local trouble.

Alcohol use has an impact on crime in many ways. Perpetrators maybe mentally impaired by alcohol abuse, may be motivated by an addiction, or venues were alcohol is consumed may give opportunities for crime. Also, being a consumer of alcohol may increase the likelihood of victimization. What economic policy means are available to reduce crime from alcohol use? Obviously, you want to reduce alcohol use and abuse, but let us for once leave the health consequences aside (assume they are already internalized by the consumer).

Christopher Carpenter and Carlos Dobkin perform a meta-analysis of the literature and find that taxing alcohol and putting age limits to its consumption are the best policies. Restricting when or where alcohol can be consumed has, however, little impact on alcohol-related crime.

Beyond what the literature says, I have always been puzzled how different cultures deal differently with alcohol. For example, Italians drink wine already as kids, yet you rarely find drunken Italians. In fact, the only drunks I have encountered in Italy where American students and British tourists. My anecdotal evidence is that the more regulated alcohol consumption is, the more people are drunk. But the causality may very well run the other way. For the current paper, though, what really matters is how alcohol consumption translates into criminal behavior. And the literature seems here counter-intuitive to me.

While people are now used to widespread smoking bans in the United States, European countries are right now going through the painful transitions, with the expected anxieties from restaurant and bar owners. They will do fine, but one can still ask whether simple taxation of tobacco would not be sufficient and especially more efficient in internalizing second hand smoke.

Charles de Bartolome and Ian Irvine note that taxation has a major problem here: the emergence of a thriving black market. Banning smoking in public areas also has a major disadvantage, namely that one can smoke more at home, potentially exposing more family members and especially children (see previous post in this regard). De Bartolome and Irvine give a counterargument: a ban interrupts to continues flow of nicotine, making it emotionally more expensive to the smoker, and possibly may also drive him to abandon smoking more than a tax could. We now need a paper that disentangles the quantitative effects of the polices to sort it out.

Imagine that the world is separated in two: a more developed North that cares about the environment, and a less developed South that does not. The North imposes restrictions on the consumption of goods that pollute. Conventional wisdom tells us the environment should be improving in the North and deteriorate in the South.

Jota Ishikawa and Toshihiro Okubo tell us the opposite could happen. The crucial aspect here is that firm can relocate. The producer of a polluting good could just stop serving the North and then relocate to the South. This is what all those against environmental regulation are afraid of. As long as the remaining goods are still polluting, and if there is going to be more production and consumption of those, one could get more pollution in the North. For this to happen, though, one needs some particular circumstances: pollution is only global, competition is monopolistic, compliance costs are low, and standards are lax. To make sure the environment is improved this calls for perfect competition (getting rid of protectionist measures), high compliance costs and rigorous standards. Easy.

The reason for the counter-intuitive result is, not unexpectedly, rather twisted. Once the North introduces regulation, firms producing affected goods move South. There is less competition in the North, which attracts firms not affected by regulation from the South. But there is less good variety in the North, and the goods of the newcomers cost less than before because trade costs are dropped, thus consumers buy more. The opposite happens in the South. Kind of hard to believe, but I cannot see where the argument would go wrong.

Why are Japanese farms so small and so inefficient/ As usual under such circumstances, this is because they are protected through subsidies and zoning laws. But why? No matter what the country, agriculture enjoys protection. Some reasons, depending on the country, may include resistance to change, preservation of the landscape, preservation of traditions and securing wartime food for the country. All this can explain why the agricultural sector is subsidized and then inefficient, but that does not explain why Japanese farms are small. They could still merge.

Yoshihisa Godo finds an explanation from political economy. Japanese farmers can make more money from manipulating farmland regulation than from farming itself. In other words, they are extracting rents from holding a regulated asset. For example, as a land-owner, you get money if you preserve its agricultural purpose, and the more prone to conversion to other uses the location is, the more you get. That explains why you would find rice paddies in the middle of dense cities. But when an opportunity arises, farmers convince ("manipulate") authorities to convert the classification of the land to cash in on its market value.

Godo links this to a misunderstanding of democracy, in that people only care for themselves and do not see the consequences for the others. While it may be true that people in Japan a century ago may have been less selfish, the current problem is one of deficient institutions, not deficient people. That institutions cannot be changed may very well be an issue of lobbying and rent-seeking, but you cannot blame it on citizen having little regard on the duties in participatory democracy. Godo's main point is that people complain when a zoning change hurts them, and then exploit other zoning changes for their own gain. He also complains that those hurt ask for compensation. Yet, good economics would precisely ask for such compensation, a very Coasian argument. It would also ask for those who gain to pay for such privilege. This is where Japan is lacking, and once this is implemented, land would be used much more efficiently. Making this happen could very well be a political problem, but it has nothing to do with an implied lack of servitude of the average voter.

PS: I hate it when a paper starts on page 9.

With increasing frequency, it is proposed that restaurants should post on their menus nutritional information. The restaurants resist this because they think it may shoo customers away, or at least make them eat less (assuming they underestimated the calories, which may not be always true). But if they eat less, why not make portions smaller and thus reduce costs and possibly increase profits?

Bryan Bollinger, Phillip Leslie and Alan Sorensen observed Starbucks outlets in New York City as such a calorie posting policy was implemented. They got data about each transaction in a NYC outlet for a 14-month period, including 11 months with calorie postings, as well as in Boston and Philadelphia, which act as control groups. They finding that the posting reduced calories per transaction by 14 units, 10 coming from fewer purchases and 4 from switching to a lower calorie item. You may think this would be bad for Starbucks? Think again, there was no significant change in revenue, in fact there was even a 3% increase for Starbucks outlets close to Dunkin Donuts: the calorie posting attracted clients from competitors.

Charities need to raise funds, and it is costly doing so. As the number of charities increases, so do these costs. This raises the question whether there is an optimal number of charities and whether some sort of regulation can bring us closer to this optimal number.

Murat Mungan and Yoruk Barls should that free competition leads to a suboptimal number of charities, in particular because some donors are solicited by several charities. In this respect, is a regulated monopoly the solution? One would think this is not optimal because charities pursue very diverse goals. Mugan and Barls show that in a spatial model this charity "ideologies," some extent of competition is good for maximizing net charity revenues as long as the fixed costs is sufficiently low. That seems like a trivially simple result, but it one worth pointing out. The way charities are regulated is by restricting entry and then taxing or subsidizing them to get the "right" fix cost.