A case for biofuels

Guest post by Sir Henry Casingbroke

The Howard government's winner-picking is clearly bad for the environment, dishonest, smacks of crony capitalism and in the case I am about to quote, inimical to the long-term aim of turning down the flow of petrodollars to islamofascists of the Wahhabi kind.

A budding biodiesel industry is being nipped in the bud in Australia because the Howard government has decided not to extend the diesel subsidy to biodiesel.

Why?

Yet, biodiesel is a brilliant interim tech and makes sense in Australia for the following reasons:

1. It requires very little energy to process it, unlike petroleum-based fuels

2. Diesel engines run on it without any modificationso we could in theory start using an alternative fuel in current technology cars and trucks, and trains and power stations.

3. It is comparatively easy to make, indeed you could make it at home, see link

4. It has relatively low carbon emissions, not as low as burning natural gas or LPG but lower than petro-diesel, petrol and of course coal, which is a real nightmare in this respect

5. Exhaust is clean: it is particulate (soot) free eliminating the black smoke of worn diesel engines

6. The oil for making biodiesel can be grown from plants. Australia's climate is ideal for such large-scale agronomy. Oil plants are many and various, and yields vary too. Candlenut and coconut are among the highest but have a long lead time. But best of all are oil-producing algae, which can reach a yield of around 95,000 L/ha (Compared to flax/linseed of 478L/ha!). See wiki article with a table link

7. Algae will grow very well on salinised land, or better still, brackish water. Especially genetically modified algae - hey wouldn't that put the tree huggers in a spin! This could be a great boost to the farmers in the WA eastern wheatbelts who have lost much of their acreage to salt. (For more on extent of the salinity problem see my article in Australian Geographic issue 72).

8. To grow, algae needs, yes! carbon dioxide, lots of it. Geosequestration is useless, diverting carbon dioxide to algal fields situated on land around coal fired power stations would make sense and allow the coal users to obtain carbon-tax credits and then use the resultant biodiesel in adjunct diesel generators running them into the grid without any need to create new infrastructure.

9. It would improve Australia's balance of payments situation by lessening the need for imported petroleum products.

10. Finally, the main criticism levelled against biodiesel is that it would require too much real estate and would thus "eat" into the land available for food production. This of course is total self-serving bullshit. Apart from the fact that oil can be grown on land too damaged even for crudest fodder for sheep (saltbush), there has been some good, serious work done on this, see link and link

In the wake of Australia Day

I had a quiet Saturday making yet another attempt to grow Kangaroo Paws from seed. A few years ago I did the whole thing carefully - first soaking the pots in bleach and cooking the seeding mix for 30 minutes at 180 degrees C to kill bugs - and had brilliant success with dozens of healthy plants germinating.

So this year I meticulously did everything according to the book. I planted some mixed colour Anigozanthos flavidus and some of the short-lived, red and green Anigozanthos manglesii seed.

Of course KPs are West Australian plants so this exercise fails to reach my intent of planting only local native species. But the KPs that I have grown in the past were not so good this year because of Ink Disease that blackens the leaves, and because some of the species I grew only last for a few years anyway.

I’ve just learned that KPs regenerate from points below ground level so that the best way to get healthy plants is to cut them right back to this level once they have flowered.

Another thrilling Saturday in suburbia!

Savvy investors don’t like polluting firms

I put up a rather dull post a few days ago showing how water restrictions were having some obvious market effects that would enhance water conservation. For example, households have incentives to invest using use grey water for their gardens or covers to prevent evaporation from their swimming pools.

More importantly concerns over high fuel prices and climate change are having intriguing effects on equity markets. The Bulletin (subscription only, 30/1/07) has a piece by Giles Parkinson ‘Emission Impossible’ (I’ll attach a link if one becomes available) arguing that savvy investors are avoiding companies that pollute.

For example Citygroup have slashed their valuation on BMW even though the firm has forecast a 20% increase in sales. The reason? BMW is heavily exposed to likely new carbon emission regulations. On the other hand firms like Peugeot Citroen, the ‘small car kings’ and firms like Toyota and Honda are being heavily backed because of their heavy investment in fuel-efficient technologies.

Concern for the environment is not only a moral issue – the big polluters are just high risk firms that are a bad bet for savvy investors..

Citigroup have just compiled a study on ‘Climate Change and the ASX’ which studies the implications of global heating for the 100 top ASX companies in Australia. The presumption is that 2007 will see a major turnaround in thinking on climate change – the IPCC release their 4th assessment report on February 2 – and markets will adjust accordingly.

The Australian Investor Group on Climate Change, which manage $200 billion, surveyed 150 local companies (report here) and got responses from 57%:

• 94% recognise the potential for climate change related issues to impact future earnings, liabilities or firm risk profiles.
• 83% recognise the physical risks associated with climate change (eg. drought, extreme weather events) that impact upon their businesses.
• 31% have established clear internal accountabilities for climate change.
• 9% fully disclosed their emissions profile from owned and controlled entities (including 3rd party verification).
• 9% have established formal GHG emission reduction targets with clear timelines.
• 9% provided total energy costs and demonstrated a clear understanding of potential impact on profitability of changes in energy pricing.
  

So what are the good and bad equity buys? Well of course you want to avoid stocks with heavy carbon imprints such as traditional energy stocks and choose those without. Citicorp’s rankings were:

• Possible winners: Investa Property, Origin Energy, Sims Group, Lend Lease, AGL, GPT Group, DB Reef, Macquarie Office, Stockland, AMP.
• 'At risk' stocks: Rio Tinto, OneSteel, Iluka, Bluescope Steel, BHP, Woodside, Transurban, Toll Holdings, Santos, QBE, Centro Properties.

I’ll leave you to ponder these using Google since my interest here is to show that this investment advice is being given rather than to help you make money.

Finally, Goldman Sachs has launched a mutual fund KLD Global Climate 100 index which selects firms which show leadership in handling climate risk and the ability to prosper in a carbon-constrained environment.

These are interesting developments. Consumers have incentives to avoid goods that they expect to be subject to hefty restrictions on use or carbon taxes. Investors with foresight have incentives to place low valuations on firms that produce such products and these low valuations restrict the ability to grow and expand.

Pursuit of the almighty buck helps to drive yet another socially worthwhile outcome.

Tim Flannery

Well I missed out on a best blog posts award last year and was omitted from the Australia Day honours list today. All those wasted emails and postage on nominations and letters of support!

But I was delighted that Tim Flannery was given the Australia Day, Australian of the Year award. I’ve read several of Tim’s books (The Future Eaters, Throwin Way Leg, The Weather Makers) and enjoyed, as well as learnt from them all. I set some as reading for my environmental economics classes. He is a passionate, though relatively moderate, environmentalist and a skilled writer.

He has gone straight to the point today on the Government’s inaction on the climate change issue. He has also attacked the rushed proposal to develop northern Australia as an agricultural zone. Tim has the skills to argue a case well and the position to help make 2007 the year that Australians take climate change, as well as water resource, problems seriously.

Climate change & climatic extremes: forecasts

One prediction is that with global heating (James Lovelock’s term that emphasizes that humans are cooking the planet) we will be hotter and there will be more climatic disasters. More droughts, floods, cyclones, extremely hot days and so on.

Australia’s climate is dominated by El Nino, and hence those ‘droughts and flooding rains’ that Dorothy Mackellar wrote about are already an integral part of our climate. Hence I thought we might really cope it in terms of increased climatic extremes when things get globally hotter. I also believed that Australia would cop it bad simply through above-average, average temperature elevation effects.

According to recent forecasts provided in the current New Scientist Australia is likely to get 6-7o C hotter – indeed the whole globe gets hotter - but the climatic extremes experienced and the extent of warming will be more moderate than those experienced in many other parts of the world. An exception is the area around Perth which will have a more extreme climate – Perth already faces a looming water supply crisis and is destined to be a climate change 'hotspot' (see R. Hensen, The Rough Guide to Climate Change. Roughguides 2006). Maybe that will finally deflate the booming Perth property market.

Globally the areas that are really hammered in terms of extreme climatic variability are the Amazon rainforest, the Congo Basin and a fair bit of China. These areas are also hammered in terms of the sheer extent of temperature gain - temperature increases will range up to 11 degrees C. The result for China is of particular interest since, although its per capita energy consumptions are low, it already emits 15% of the world's Greenhouse gas emissions. It has a stake in cutting carbon emissions to secure its own future viability!

Michele Battig provides a nice visual graphic of where things get much hotter here. She published her co-authored research in Geophysical Research Letters.

Howard's bold move on water

The Howard Government's proposal to give the Commonwealth control of the Murray-Darling River system is welcome news. The government will spend $1.5 million paying farmers to reduce their water usage - $500 million to reduce evaporation and seepage, about $500 million on improving river flows and $500 million will be given to the Bureau of Meteorology to do a national water audit.

The Murray-Darling system crosses four Australian states, including the three most densely populated states. State government control of these major rivers is inefficient because it has primarily reflected state interests and ignored the effects of individual state water comnsumption decisions on other states. A review of the issues is here.

The South Australian and Victorian Governments have already protested the moves. The Victorian dills want ‘co-operation’not a takeover while the South Australians are worried that the Howard Government is the pocket of industry interests. South Australia has the most to gain from this reform so Mike Rann’s comments are particularly foolish, if predictable. I have not yet seen a response from the other states but can take a good guess what the brainless, grinning, toothy, media-tart Beattie will have to say. My guess is populist fluff that appeals to a parochial interests but which leaves us all worse-off. The States are governed by Labor and will put party-political interests ahead of the national interest.

While the states have constitutional control over water the Howard Government is confident it can achieve a takeover. I hope so. It is a bold move and good news.

Update: (26/1/07). Things move a long way in a day. The bill for the projected water reforms has gone up to $10 billion over 10 years and the political response of the states has been muted and in the case of NSW positive. Kevin Rudd has endorsed the plan. This is a surprising but very welcome outcome. Only rightist ideologues could criticize this plan as overly centralist – how can any solution to the Murray-Darling problem not be centralist given that 4 state governments are involved?

There is some criticism of the ‘handout’ component to the scheme because water rights to farmers will be purchased. It is important to understand that current water usage in the Murray Darling is inefficient. This means that the total money value of the water benefits from the MD are less than they could be. Buying out water rights involve transfers that, ignoring deadweight losses of taxes used to fund them, are not losses to society as a whole. If the final water allocations drive water into higher-valued uses we benefit from these transfers.

Assisted migration for biodiversity

This article in the NYT deals with one of the biodiversity conservation options I have been thinking about as an adaptation policy for dealing with the effects of climate change. The radical strategy is assisted migration - moving species to climatic zones where they have a better chance of survival.

This triggers strong, mixed feelings from conservation biologists because the procedure is plagued by risk. Yet not undertaking the strategy may condemn species to inevitable extinction.
The average temperature of the planet is 1.6 degrees F higher than in 1880. Dr. Camille Parmesan, reviewed hundreds of studies on the ecological effects of climate change in this month's Annual Review of Ecology, Evolution, and Systematics. Many plant species are now budding earlier in the spring. Animals migrate earlier as well. And the ranges of many species are shifting to higher latitudes, as they track the climate that suits them.

These adjustments have occurred over the past 2 million years as the planet has swung between ice ages and warm periods. But the current bout of warming may be different as the earth was already relatively warm when it began. It’s also going to be more difficult for some species to move since when the planet warmed at the end of past ice ages, retreating glaciers left behind empty landscapes. Today’s species will face an obstacle course of cities, farms and other human settlements. Animals and plants will also have to move quickly if they are to keep up with relatively quick climatic changes.

Many conservation biologists believe that conventional strategies may help combat extinctions from global warming. Bigger reserves and corridors connecting them, could give species more room to move.

McLachlan, Schwartz and Hellmann lay out the debate in a paper to be published in Conservation Biology. Assisted migration may be the only way to save some species but biologists need to answer many questions before they can do it safely and effectively. Some questions:

Which species to move? If thousands are facing extinction, it will probably be impossible to save them all. Conservation biologists will have to make decisions about which species to try to save. Some species threatened by climate change, including polar bears and other animals adapted to very cold climates, may have nowhere to go.

Where to take them? Conservation biologists will have to identify regions where species can survive in a warmer climate. But to make that prediction, scientists need to know how climate controls the range of species today. That information is lacking. Simply moving a species is no guarantee it will be saved since many species depend on other species for their survival. In addition, a transplanted species would be an invasive one which might thrive so well that it would start to harm other species.

Perhaps assisted migration should be a measure of last resort that is used sparingly. But species migrations will occur anyway and, as species shift their ranges, some will push into preserves that are refuges for endangered species. Will some new migrants need to be eradicated?

None of these questions are simple and all are relevant.

Greenhouse policies in a complex world – some analytics

How do you design an appropriate response to anthropogenic climatic change when the costs and benefits of dealing with the problem are uncertain? The physical and environmental effects of climate change are uncertain, there is controversy over the discount rate to be used and damage functions are highly nonlinear, involve important irreversibilities and policy makers must address very long time horizons.

Robert Pindyck’s ‘Uncertainty in Environmental Economics’ discusses these issues for environmental problems with emphasis on climate change issues. I specialise his discussion to the design of adaptation policies for preventing species extinctions in the face of global warming – a topic that holds my current interest.

Meteorological science shows that the relation between greenhouse gas emissions (GHGs), temperatures and climate patterns is highly uncertain. We don’t know the exact effects on climate of measures to control emissions. Nor do we know the effects of climate changes on ecosystems or of the effects of policy measures that seek to improve the survival of species. We are therefore uncertain about the adaptability and resilience of different species both now, and in the longer-term, in the face of climate change and an adaptation policy response.

These uncertainties have implications for the design of adaptive policies. Hybrid policies make more sense than dedicated uniform policies in settings where policy makers choose between ‘price’ and ‘quantity’ instruments and the same will probably be true if the policy task is to select among various ways of helping biodiversity to adapt to climate change. Strengthening existing conservation programs might make sense as might providing translocation sites and, perhaps, captive breeding programs. The optimal policy hybrid will depend on the extent of the uncertainties.

The effects of uncertainty on the intensity of policy response are complex. Without irreversibilities uncertainty often leads to lower policy intensities – here less conservation effort. This would be the case if conservation benefits are an increasing concave function of investment in reserves and so on and if conservation costs are convex in the extent of conservation. But irreversibilities are fundamental so this special case is not robust or particularly useful.

Pindyck also suggests there is substantial discount rate uncertainty in GHG problems. In my view this can be exaggerated since, if discount rates are anything other than very low, the policy answer is simple – do nothing – the discounted benefits then won’t justify the costs. Moreover, intergenerational arguments suggest we should discount at a low rate. Pindyck’s response would be that being uncertain about the discount rate means itself that the rate that is used should be set at less than the expected future discount rate with the difference here increasing as the time-horizon for planning increases. Indeed, for long-term planning, a rate close to zero is not implausible.

Climate change issues do indeed involve very long time horizons. This exacerbates the uncertainties associated with estimating future costs and benefits particularly if a low discount rate is used.

It is also plausible to suppose damage functions defined on adaptation conservation effort are highly non-linear with highly uncertain ‘tipping’ or ‘threshold’ points. An insufficiently large effort might tip the environment towards a catastrophic state where many species become extinct.

In addition, there are significant irreversibilities that pull in two opposite directions. These substantially complicate policy planning.

(i) Species loss effects – in particular species extinctions - are irreversible. This creates incentives to adopt active management policies early even if benefits from doing so fall short of costs. The existence of the possibility of a future benefit from not allowing a species to go extinct provides an ‘option value’ rationale for species protection that reflects the irreversible loss of options those extinctions imply. This provides a bias towards early adoption of policy.

(ii) Sunk cost effects however also arise because policies to deal with GHG problems impose sunk costs for society. For example, investing in captive-breeding programs or in translocating species are discrete investments that might prove unwise should uncertain policy costs and benefits turn against such provisions. For example if long-term conservation costs should turn out to be high and long term benefits low. This provides a motivation to wait for better information before investment in species protection is undertaken. Cost benefit analysis which accounts for the value of waiting for better information, will be biased toward postponing adoption of such policies.

Thus irreversibilities combined with uncertainty can sometimes increase and sometimes decrease desired conservation effort. What a pity! There is no neat analytical result! Without good empirical evidence – and this seems lacking to this point – there is no way of making a simple qualitative judgement. One needs to assess the relative scale of species loss and sunk cost effects.

On this issue some of the literature suggests a reduced level of control and waiting as opposed to early action: see Pindyck (2000), (2002). One can ask if this story is changed when allowance is made for the prospect of a catastrophic risk of widespread species extinctions. In a paper I wrote with William Reed in 1994 we show that if the degree of risk of catastrophic collapse is strongly related to the extent of policy intervention – so for example a critical level of lack of conservation effort will bring about a wave of very costly extinctions - that greater stringency in control is sought.

My intuition too is that the case for early action is motivated by standard arguments that emphasise the increasing value of natural capital relative to person-made capital as society advances. With increasing wealth person-made capital can be replaced but natural capital cannot be. Also with increasing wealth and supposing that demands for biodiversity conservation are a luxury good – more is demanded with increased affluence – there is again a ‘preference’ argument favouring early adoption of adaptation policies for improving the resilience of biodiversity.

The AEI-Brookings Joint Centre for Regulatory Studies has a range of readable economic papers at its website – including this excellent paper by Robert Pindyck. I’ve attached the site to my blogroll.

Reference: Harry Clarke & William Reed, ‘Long-Run Consumption Pollution Tradeoffs in An Environment Subject to the Possibility of Pollution-Related Catastrophic Collapse’, Journal of Economic Dynamics and Control, 18, 1994, 991-1010.

State public sector wages bills gallop away

We have Labor governments in each of our states and territories. According to the AFR editorial this morning (subscription only) the expenses of these governments in recent years have risen by an average of 7.5% per annum.

Most of this has gone on extra wages for public employees. In 2006-07 wages growth in Queensland will be 12.4% while in NSW and Victoria it will be 5.5% and 4.4% respectively. Teachers, nurses and police account for a fair portion of this increase but burgeoning bureaucracies add their share.

These trends reflect ties between the Labor Party and the union movement. You can see this in NSW where an election is due in March and where the police association are demanding another 3000 members. Against Treasury advice the NSW Government will provide an extra 750 police at an annual cost of $69 million. The nurses and teachers are always after more members and higher wages divorced from productivity gains. Indeed the ratbag Victorian teachers union has demanded a 30% increase in wages over 3 years without - of course - performance testing.

Of course governments should award such hefty gains only when unions agree to substantial workforce reform. But to quote the AFR this is not happening:

'State governments also cause themselves problems by resisting the concepts behind the federal government's WorkChoices policies and legislation. While the commonwealth wants to emphasise the contribution that individuals make to the workplace, state ministers - under the influence of unions - prefer to treat all workers equally, even though the value added by individual employees differs markedly.'

The states and territories have the capacity to squander the benefits of the current resources boom just as the commonwealth can. The Labor Party dinosaurs running state and territory governments are currently held in check by the commonwealth. What a disaster it will be if a Labor victory federally meant Rudd-style support, for an antiquated industrial relations system, was to give additional licence to the spendthrift states.

Sound economic analysis made me a tree-hugger

Over a decade ago I wrote a paper (‘Forest Rotation and Streamflow Benefits’, Australian Journal of Forestry, 1994) that looked at optimizing the total water supply plus timber benefits from logging in a water catchment – specifically the Thomson River catchment.

When trees are of intermediate size and growing fast they cut into water yields simply because they drink a lot. When they are small their small absolute size means that their drinking has little effect while when they are old they don’t drink much because they are not growing quickly.
Thus if you are thinking about harvesting trees you want to avoid having forest stands that lie in an intermediate age group. Either cut them very young or leave them alone and don’t cut them at all to gain sustained water supply benefits. (I always enjoyed obtaining this result just by drawing a few graphs using Excel and tree growth-water yield data – the optimization task itself is a complicated, non-concave problem so drawing graphs turns out to be the simplest and best approach). Generally I favored not logging at all in the Thomson.

According to The Sunday Age this morning the solution I suggested seems right.

‘MELBOURNE is losing out on a million litres of drinking water every year [as reader ChrisL points out this is a ludicrously low, presumably a typo] from continued logging in the city's main catchment area. And it comes at a cost to the taxpayer of at least $147 million — the difference between the royalties paid by the logging industry to the State Government and the value of the lost water, according to economic consultants commissioned by Melbourne Water.
As the city heads towards stringent stage 4 restrictions, a host of scientific studies indicate the Thomson Dam, which supplies about 60 % of Melbourne's water, is losing up to half the potential run-off in the highest rainfall area owing to effects of logging……
It is estimated that if logging was stopped, water yields in the catchment would increase by 20,000 megalitres within two decades.
Despite the existence of studies dating to the 1950s, in 2004 the Bracks Government decided to conduct more research into the reduced water yields
caused by logging. It is scheduled to be completed in May 2008.
All the scientists spoken to by The Sunday Age questioned the need for further studies, saying the numerous existing reports, many of which were commissioned by the Kennett and Bracks governments and on which this article is based, were sufficient’.

Of course the Bracks Government seeks further studies because it is fearful of the electoral implications of giving the forest industry a well-deserved kick in the rear-end. In the meantime we continue to face costly water restrictions, lose beautiful forests of mountain ash and other species and pay a huge implied subsidy to the forestry industry.

Neuroeconomics of being a spendthrift or tightwad

Why do people run up excessive debt? Why are many in the population tightwads? The Economist reviews an article in Neuron (by Brian Knutson, Scott Rick, G. Elliott Wimmer, Drazen Prelec and George Loewenstein) which provides a possible neuroeconomic explanation.

Economics assumes humans are rational beings so price is a signal that helps decide the combination of choices that suits best. But evidence suggests that decision-making draws on the emotions along with reason.

The role of emotions in traditional tasks such as obtaining food and mates, and in dealing with threats can be explained by neural mechanisms which weigh up pros and cons to produce an optimal outcome. Emotions help prod animals towards optimal outcomes. Then neuroeconomics and economic theory predict the same outcomes. But this may not apply to less traditional choices. Perhaps modern shopping subverts the decision-making machinery and encourages some people to run up debt.

The authors asked 26 volunteers to decide whether to buy various products that were flashed on a computer screen one after another. In each round the researchers first presented the product and then its price, with each step lasting four seconds. In the final stage, which also lasted four seconds, they asked the volunteers to select a product. To make the task realistic two randomly selected sales were real—paid for out of a $40 credit from which the volunteer got to keep the change.

The researchers scanned the brains of volunteers using functional magnetic resonance imaging (fMRI) which measures blood flow and oxygen consumption in the brain, as an indication of brain activity. Different parts of the brain were involved at different stages of the test.

1. Product virtues. The nucleus accumbens—known to be involved in processing rewarding stimuli such as food, recreational drugs and monetary gain, as well as the anticipation of those rewards—was the most active part when a product was being displayed. The level of activity correlated with the reported desirability of the product.

2. Immediate product costs. When the price appeared, however, fMRI reported more activity in other parts of the brain. Excessively high prices increased activity in the insular cortex, a region linked to expectations of likely immediate pain, monetary loss and viewing of upsetting pictures. There was greater activity in this region when the subject decided not to purchase an item.

3. Balancing virtues against costs. Price information also activated the medial prefrontal cortex which is involved in rational calculation and in balancing expected and actual outcomes of monetary decisions. In this experiment its activity correlated with a volunteer's reaction to both product and price, rather than to price alone. The sense of a good bargain evoked higher activity levels here and often preceded a decision to buy.

What is interesting is the separation of a product’s assessment (by the nucleus accumbens) from the assessment of its price (by the insular cortex) though the two are then synthesised in the prefrontal cortex. Rather than weighing the present good against future alternatives, as economics suggests, people balance the immediate pleasure of the prospective product with the immediate pain of paying for it.

That makes sense as an evolved mechanism for trading. If one useful object is being traded for another or for cash, the future utility of what is being given up is embedded in the object being traded. Emotion is then as capable of assigning value as reason.

But buying on credit might be different. The abstract nature of credit cards, coupled with the deferment of payment that they promise, may modulate the ‘con’ in the insular cortex side of the calculation in favour of the ‘pro’. This will be particularly true among spendthrifts who may have lazy insular cortexes!

Further work might test whether people with different spending behaviour, such as miserliness and extravagance, experience different amounts of pain (or show different patterns of brain activity) in response to prices. They will also assess whether, in the same individuals, buying with credit cards eases the pain compared with paying by cash. If it does, then credit cards may have to join the list of things such as fatty and sugary foods, and recreational drugs, that subvert human instincts in ways that are pleasurable at the time but have an adverse aftertaste.

A related nice read from the NYT is here. Spendthrifts have a lazy insula cortex while in tightwads have an overactive one. But tightwads behave irrationally too by uncoupling the comparison of current benefits and financial pain from their rational thinking.

No sour grapes ex this buttercup

So the best blog posts of 2006 have been selected by Ken Parish at Troppo with assistance from a committee including Ken Parish, Nicholas Gruen and Helen Dale. Having co-operated in producing a shortlist, Ken then chose the best blogs with Nicholas acting as a ‘sounding board’.

I didn’t get a prize – indeed I didn’t get a nomination - so I’ll try again this year. I’ve already run off copies of the winning posts and I’ll try to imitate their style, humour, depth and lack of snarkiness.

The committee gave awards to, well, themselves (Ken Parish 1, Nicholas Gruen 1, Helen Dale 1). Others from Troppo such as Rex Ringschott and Don Arthur also got prizes. There were no prizes to anyone on the conservative side of politics except for Helen Dale – and yeah, she too was on the committee!

At the ANU in 1975 I recall a mathematician who described one of his earlier papers in a later paper as a ‘seminal contribution’. I always wondered whether this is the type of complimentary remark you best hope others will make of your work.

But blogging is a bit more free-for-all so I assume that the Troppo moves are proper – if you are a good blog poster you just got to be a good judge of what else is good out there, otherwise you would not have the power of judgment. Or something like that.

Indeed, I’ll try to mimic this process myself during 2007. If others would like to join me on a ‘best blog post’ selection committee I promise that they’ll get at least one award. But they do have to satisfy my strict selection criteria and agree to vote for at least a few of my posts. Maybe, 2007, I should also circulate a best blog posts of the week feature just so you all know what you must read in the lead-up.

By the way I did glance through the Troppo award winners and a few were worth the megapixels. Apart from one by Robert Merkel however they did not overflow with specificity and content. They were (if anything) artistic rather than informative with one really bitchy feminist rant about how awful it is to get up the duff.

The debate rages on in an anarchic way at Catallaxy.

Puff harder, the price went up

An attractive paper by Jérôme Adda & Francesca Cornaglia in the September 2006 American Economic Review (a preprint here) re-examines popular accounts of the price-sensitivity of the demand for cigarettes.

Smoking can be defined as a process by which agents give their brains a nicotine hit. Nicotine is a psychoactive stimulant and one of the most addictive drugs around. Cigarettes are an efficient nicotine delivery device – once inhaled nicotine can reach the brain’s pleasure centres in less than 10 seconds where it increases the release and delays the metabolism of dopamine. It is this dopamine release that smokers seek.

This suggests that if the price of cigarettes rises because of a tax increase that consumers might endeavour to increase the nicotine they gain per cigarette by smoking each cigarette more intensively. This might occur by puffing harder, increasing the number of puffs, inhaling for longer periods and blocking ventilation holes on the cigarette filter. If this is true then the conventional findings that the demand for cigarettes is reasonably responsive to price (elasticities of the order of -0.4) in the short-run and a higher elasticity in the long-run (perhaps -0.7) might overstate the health benefits from smoking.

Adda and Coraglia build on work by William Evans and Matthew Farrelly (1998) and Jeffrey Harris (1980) in confirming such compensatory behaviour particularly among heavy smokers. They find that a 1% increase in taxes causes a 0.4% increase in smoking intensity. Smokers not only cut their smoking with a tax increase but compensate by smoking more intensively.

Smoking more intensively has the additional health cost of causing cancer deeper in the lung – see Michael Thun et al. (1997) – an adverse effect from a health perspective. This suggests that the value of excise taxes on cigarettes as a means of improving health has, in the past, been overstated.

The US engagement in Iraq as a behavioural quirk

I have no dispute with the idea that agents have optimism biases and an aversion to cutting one’s losses and that these insights may have application to military conflicts and the proclivity to be a hawk as Daniel Kahneman and Daniel Renshon have recently argued.

Optimism biases make sense in optimistic positive-thinking societies where ‘having a go’ is important. Also ‘not admitting mistakes’ is important in organisations where you are punished for making them. Optimism biases can also arise because those prosecuting wards ignore the opportunity costs of staging a war as William Nordhaus and others (most recently David Leonardt) have pointed out.

But applying this analysis to the specifics of the war in Iraq, as John Quiggin and Kahneman-Renshon have done can amount to dressing up your own political views with a bit of jazzy behavioural economics. Maybe the US went into Iraq because it believed in the existence of potentially enormously dangerous WMDs and because it sought to get rid of Saddam. Maybe it believed this would be a straightforward process that would involve few casualties. That these beliefs tuned out to be in part false has little to do with the strength of ex ante convictions at that time. Even the Nordhaus paper approvingly intriguingly quote on the possible enormous costs of nuclear and biological weapons by Iraq:

‘In spite of some defector claims, it seems doubtful that Saddam has even one nuclear weapon. The same, however, is probably not true of biological and chemical weapons and a radiological weapon is possible. Iraq may also have enough components to assemble as many as 25 Scuds, has shorter range missiles, can modify drones and combat aircraft to act as “cruise missiles,” and has significant capability to smuggle weapons of mass destruction out of Iraq and deliver’. (Anthony H. Cordesman, Iraq’s Military Capabilities: Fighting A Wounded, But Dangerous, Poisonous Snake (Washington, D.C.: Center for Strategic and International Studies, 3 December 2001), 8).

While one can assume the worst about George Bush’s intentions in sending in an additional 21,500 troops it is not clear that this amounts to a ‘double-or-nothing’ bias. It may be that the actual loss of US prestige in accepting defeat in Iraq would be a serious cost to the international fight against terrorism – what signal would it send?- and Iraq would descend into a violent bloodbath even more serious than the current dire situation.

It’s a cunning way of advancing your political agenda of opposition to the war but logically invalid to argue that the Iraq intervention derived from some quirk in making decisions in a risky situation.

Markets resolve a hi definition DVD standards war

Have you been waiting to choose one of the new generation of high-definition DVDs and disc players? I have because there are two rival formats (Blu-ray and HD DVD) and because I don’t want to be left with a format that eventually is rejected by the market as was the Betamax videocassette. Consumers generally are unwilling to open their wallets while there are two incompatible formats if they assume one might dominate eventually but don't know which one.

A decade ago, I bought a laserdisc player plus a collection of $80 laserdisks only to find they were essentially made redundant by the DVD – I am not going to get burned again!

The choice of a format is referred to in economics as a ‘standard’ choice. There are ‘standards wars’ as firms compete to be the dominant technology format.

A famous example of a war was fought by Adobe Systems which invested heavily in developing a ‘page description language’ called PostScript for desktop publishing. Adobe realized that no one would invest the time necessary to learn PostScript unless it was the clear ‘standard’. So the firm deliberately allowed competitors to clone its language to create a competitive market in PostScript interpreters.

Adobe’s strategy paid off: several competitors emerged (including one that gave its product away) and PostScript became a widely-used standard for desktop publishing. Adobe kept a few things proprietary – for instance techniques for displaying fonts at low resolution – and managed to dominate the high end of the market. Ironically, Adobes’s market success was due to its ability to encourage entry by its competitors!

With respect to the high definition DVD format issue, 2 business responses to the ‘standards’ problem have been developed and were announced at the recent Las Vegas Consumer Electronics Show.

1. South Korea’s LG offered a DVD player which will, at modest additional cost, accommodates both high definition formats. It sells for about $1200US. Consumers then can buy a player and be confident that it will be useful if only one of the two formats endures. It also boosts the demand for complementor disk products.

2. Warner Bros plans to release a disk that will compete in either type of recorder with a Blu-ray movie on one side and a HD DVD format version on the other. This can be demanded by users of either type of player thus expanding its market. Moreover such disks will remain useful longer-term even if one of the formats fails to be a standard. It boosts demand for complementor DVD player products even those that deliver in only one of the two formats.

Each of these moves are interesting attempts to cash in on the standard war dilemma and each provides benefits to different complementor products. Of course the development does not ensure an unending lifespan for any of the products since it is very likely new ways of delivering high definition content are about to appear. Amir Majidimehr, corporate vice president of consumer technology at Microsoft has said that:
‘…the lifespan of both formats would also be less than the current DVD format. It has lasted 10 years with great success but …the technology would be superseded by developments in online delivery of hi-def content’.

Libertarian paternalism & drug policy issues

I got a buzz from reading the Becker-Posner blog on libertarian-paternalism. Their argument is in part a criticism of C. Sunstein & R. Thaler’s ‘Libertarian Paternalism is Not an Oxymoron’ .

Sunstein & Thaler claim it is both possible and legitimate for private and public institutions to affect behaviour while respecting freedom of choice because people's preferences are ill-formed and their choices are influenced by behavioural quirks such as default rules, framing effects, and starting points. Equipped with an understanding of behavioral findings of bounded rationality and bounded self-control, libertarian paternalists seek to steer choices in welfare-promoting directions without eliminating freedom of choice. This view, in turn, was responded to by Daniel Klein’s ‘Status Quo Bias’. This debate has impacts on the sorts of arguments posed for restricting smoking or the intake of obesity-causing foods.

Libertarians believe individuals should be allowed to pursue their own interests unless their behaviour negatively impacts on others. So individuals should be allowed to buy the food they want but drunk drivers should be constrained because they harm others. But modern research shows that individuals may not have enough information to effectively pursue their interests so, it is argued, government regulations and rules might help guide them to the better pursuit of interests they would have if they had additional information. A libertarian paternalist accepts these information arguments for government regulation but also stresses considerations such as bounded rationality and self-control.

Consider a person who smokes, but has an internal conflict between his stronger ‘self’ who wants to quit, and his weaker ‘self’ who continues to smoke when he feels under pressure or in social situations. The weaker self does not stop smoking because of limited self-control. Paternalism here seeks to help the more dispassionate self gain control over the choices made by the conflicted individual because of his dual selves. Such paternalism might take the form of high cigarette taxes, so that weak selves would not want to smoke so much or of ordinances to limit smoking in restaurants, bars, and other social situations to protect weak selves from temptation. The argument is that individuals are ‘happier’ if given a helping hand to exercise self-control. They might even be happier with high cigarette taxes though Posner notes smokers never lobby for higher taxes!

But Posner notes that libertarianism does not assume adults always know their interests or even are always able to act on their interests when they know them. It does assume that adults know their own interests better than government officials or professors. In addition being able to make mistakes through having the right to make one's own choices leads to more self-reliant, competent, and independent individuals. For example prisoners often lose the ability to make choices for themselves after spending many years in prison where life is rigidly regulated. Thus libertarians claim is that the ‘process’ of making choices leads to individuals more capable of making good choices.

Also it is difficult to distinguish libertarian paternalism from unadulterated paternalism because it is difficult to decide with objective criteria where ‘bounded rationality and bounded self-control’ are important and where they are not? Posner claims that models of rational addiction do as well if not better than models of bounded self-control when applied empirically to smoking behaviour. Why adopt models of bounded self-control in this case?

Take another illustration: Is the obesity problem due to bounds on rationality and control? If so, why did it not happen earlier, or why is the gain in weight so much greater in certain countries? If it cannot answer these questions is not libertarian paternalism simply substituting an intellectual's (or bureaucrat's, politician’s) beliefs about should be done for the judgment of others. Libertarians recognize the temptation in us to control choices made by others and so are in favour of allowing people to make their own choices unless there are external effects. Moreover, even well-intentioned government officials are subject to the cognitive defects that are supposed to affect choices by others. Can one have confidence that they will promote individual interests better than these individuals do themselves?

Posner therefore believes that the case for classical libertarianism is not weakened by the literature motivating libertarian paternalism. Indeed, when similar considerations are applied to government officials and intellectuals the case for classical libertarianism is strengthened!

Posner’s arguments go to the heart of the case for government intervention in certain markets to restore self-control. The key issues are:

1. Are individuals better placed to make sound consumption decisions than others can for them? 2. Does assigning people freedom of choice lead to better decision-making?
3. Do models of rational choice account for behaviour better than models of self-control?
4. Are those making policy judgements subject to the same behavioural defects as citizens subject to self-control problems?

My answer to 1. is certainly ‘no’ for young individuals whose brains are still developing. Most decisions to initiate smoking arte taken when smokers are young but most smokers wish they had never initiated the habit. My response to 2. is ‘not necessarily’. Addictive consumption choices need not lead to better longer-term decision-making. Certainly though, making individuals responsible for their choices, will overcome the ‘moral hazard’ implications of offering ‘treatment’ and ‘care’ to those who make poor consumption choices. To be clear here I favour such care and treatment options because of their moral hazard costs.

I think point 3. is incorrect. The existence of substantial self-control problems is evident throughout the addictive consumption and obesity literature. To take Thomas Schelling’s famous example – rational choice theory cannot explain why a cocaine addict will agree to sign a document admitting use of illegal drugs and give this document to the manager of a drug treatment clinic with the instruction that if cocaine is detected in his urine the document is to be forwarded to the police. Closer to home – as an ex-smoker - I find it fantastic for anyone to claim that individuals do not struggle to quit smoking even though they seriously want to.

Point 4. has value. Some anti-drugs crusaders do suffer from cognitive defects but many are scientists and doctors who do have good knowledge. The case against smoking is motivated by abundant medical evidence and the self-control issues that smokers face are documented in a vast body of neurobiological evidence. Its playing a silly game to claim it is wrong to believe that ‘experts’ are always right. Of course they are not always right – nor are they inevitably wrong or less well-informed than others.

Water restrictions in Melbourne

The Stage 3 water restrictions that are being used to restrict household water consumption in Melbourne arise because water is under-priced so that an excess demand for it must be dealt with by means of restrictions.

The main implication for households is that gardens in Melbourne can only be hosed twice a week for 2 hours in the evening. In addition, if you wish to top up your swimming pool, you must use a bucket and a tap – not a hose.

These restrictions are asinine given that the water shortages are a longer-term not a short-term issue. The best way of rationing something like water in the longer-term is to charge a price that clears the market for it. Then the water that is used goes to its highest-valued uses. If one does insist that pricing must reflect distributional concerns, so poor people need access to water at low prices, then a two-block scheme can be used. Water is given at low or zero price up to a fixed number of liters per month and is then charged at a sufficiently high rate to clear the market. This two-block scheme is better than the current three-block scheme but inferior to a scheme where every consumer is charged the same price (the scarcity value of water at the margin) with poor consumers rebated all or part of the implied costs that would have been incurred in providing the subsidized water at the initial low rate. They cannot be worse-off since they can use the subsidy to pay for the efficiently priced water or for anything else they might want.

The restrictions are being policed by ‘water police’ and dobbing-in your neighbor is widespread and encouraged. Quote: ‘To report a breach, call 13WATER (139 2837)’. Dobbing-in is something I intrinsically dislike, particularly at the neighborhood level, but some I know self-righteously see it as their moral duty. I always find it interesting that such measures are introduced by our Labor government comrades.

The restrictions though are having some good economic effects as would just charging higher prices. Swimming pool covers are being sold which reduce evaporation from pools and hence the need to top up. New pools can be filled with salty aquifer water which will be delivered onsite for about $2000 for an average pool.

With respect to gardens the water shortage is encouraging more sensible watering practices such as the use of grey water and rainwater tanks. It is also encouraging people to pave yards rather than to pursue high maintenance lawns – the paving moreover, in some cases, is porous and allows water to soak into the ground supporting adjacent gardens – rather than becoming runoff. Finally, the restrictions are driving people to reconsider the case for native gardens which, as I have long argued, make sense on the basis both of aesthetics, environmental benefits and particularly, in the present context, of being water-friendly.

These moves to rationalize water use have reduced demand but would work more effectively with rational water pricing. This would also send out the correct signals for firms to augment private water supplies and for both firms and households to recycle.

Finally, rational pricing would also allow gardening fanatics and swimming enthusiasts to enjoy their pleasures and to pay for such pleasures by funding the cost of these indulgences.

Noble Park riots

Noble Park is 30 km south east of Melbourne’s CBD. It’s a rapidly urbanizing part of Melbourne with fairly cheap land and a high migrant population. During the 1980s it had one of the most notorious street gangs in Melbourne. Last Friday night it had a fully-fledged riot with a clearly criminal element supported by a mindless mob.

1500 drag racing morons and their brainless supporters (some with kids in prams) rioted, threw flares and rocks, at a hopelessly inadequate police response, and smashed up property including a video store. The rioters were proud of their achievements and put video clips of their rioting on YouTube – see here and particularly here.

Police, of course, were quick to use these clips to identify these bright sparks. 5 offenders were arrested at the site but hopefully a lot more arrests will come.

Some of the YouTube clips have been taken down by those who had posted them – but the police already have them. In addition the TV stations have their own video footage and the Herald Sun has run photos of the louts trashing the video store on their web page. This might help to catch them.

You can wail on about disadvantaged youth and so on but zero tolerance is called for here. The drag racers could kill themselves or – more significantly – innocent parties. And rioters who smash up shops and attack police are an aberration in Australia that is intolerable. Take back the streets.

Iraq war escalation

I thought George Bush made a good speech on the Iraq situation. He admitted strategic mistakes and addressed the problems caused by support for terrorist factions in Iraq by Syria and Iran – the Arab press see these comments as an indication that war against Iran is imminent and they might be right. The Iranians cannot be allowed to possess nuclear weapons and dominate the region. Bush resolved to put more effort into dealing with civilian security, particularly in Baghdad, and to put pressure on Prime Minister al-Maliki to restrain the Mahdi Army sponsored by his patron Moqtada al-Sadr and by Iran.

In the end I think Bush’s current judgment – and that of John Howard – is correct. Allowing barbarous thugs, with avowedly anti-western aims, to win in Iraq and to impose their particular brand of sectarian tyranny on Iraq is too costly an outcome - too costly for Iraqis and for the West.

On the other hand with only an additional 21,000 troops the obvious question is, as The Australian editorializes, whether a substantive change in outcomes is likely. The increased troop commitments are anything but a ‘troop surge’ – they are an escalation and one that might be part of a broader strategy in the region to deal with Iran. The cost of the conflict has already been massive for all concerned and the power of the murderous militias is unrelenting. If the terrorist factions in Iraq make the judgment that the increase in troop numbers is only a temporary palliative, until the next US President is elected and withdraws US forces, expectations will drive a self-fulfilling US defeat.

US policy on Iraq must be all-or-nothing. Either withdraw completely or provide enough troops to maintain civil order.

I thought the Aussie blogs would say something about Bush’s speech so I had a quick look around. Most said very little – a survey of the standard leftwing blogs is here. It’s for the most part a routine dismissal of Bush’s arguments - none of it addresses the issues at hand. The situation in Iraq is dire but this is not the time to whistle to the propaganda tune of Iran and the terrorists. I was similarly unimpressed by the points scoring of the Democrats in the US who similarly failed to address the issues raised by Bush.

Aside: By the way William Shawcross writes an interesting piece in The Australian suggesting current signs of improvement in Iraq’s economy.

Inquiry on open skies for Australia - one to watch

I have blogged on the case for an ‘open skies’ aviation policy for Australia. It seems that the case for one will be tesated by an inquiry launched by Tourism Minister, Fran Bailey, though details are scant. Qantas has predictably rejected the case for it and I wonder if the falling Qantas share price is an indication that the Macquarie debt-junkies looking for a quick buck from their planned private equity move on Qantas are being anticipated by the market not to appreciate the implied extra competition.

Efficiency in international and domestic aviation is a major concern to Australia given the distribution of our population over a large area, the distance of Australia to its major markets and the crucial role of internal and external tourism as economic drivers. The low travel flows within Australia on all routes other than the Melbourne-Sydney (M-S) route means internally the sorts of competition gains the US has enjoyed on its domestic routes won't be realized.

I looked at domestic fares on internal US flights during my recent trip to the US. For example, the 4 hour flight from Chicago to Los Angeles for less than $200US return can be compared to discount return tickets on the 1 hour flight from M-S of about double that. And the M-S route is a major link with huge traffic volumes.

I’ll add to this post as further information about the inquiry comes to hand.

Dating services & getting a job

One of the more onerous tasks faced by younger participants at the American Economic Association (AEA) meetings is to try to get a job.

The meetings provide the largest organized job market in economics. Each year around 1000 soon-to-be doctoral graduates attempt to get jobs in universities and public agencies around the world that send representatives to the meetings and interview. Most of the larger, and some of the smaller, Australian universities send representatives and there are now typically quite a few Australian-based job applicants at the meeting as well.

The task of getting a job is onerous for all concerned because of the sheer volume of interviews – talented students might secure up to 30 interviews over the 3 days. For the interviewing institution the cost of hiring a young Assistant Professor can range between $10,000-$15,000. It’s a lot and my guess is that it would cost Australian universities more than this.

Harvard’s Alvin Roth has sought to simplify the procedure and reduce everyone’s costs. To do this he borrowed a technique from online dating – each applicant is allowed to send to electronic pings to potential employers to ‘signal’ a serious desire to secure employment at a school and to reduce frivolous applications. This is a market design procedure that reduces the costs of both applicant and interviewing institution.

Candidates are advised not to waste a ping on a school who already knows they are interested and not to waste a ping on a school that is well away from their plausible range. Schools in turn are told not to take a failure to ping as a brush-off.

The approach follows the 2005 suggestion of Stanford’s Muriel Niederle and MIT economist Dan Ariely to the dating service Cupid.com. The difficulty in online dating services is that women get lots of approaches from men but men only get a few. Thus this dating service allocates two electronic roses to its male members which they can use to contact two women. The men tend therefore to be much more selective and the signals they do send are much more serious. This reduces the search costs of both men and women by weeding out the non-serious interest.

Each of these examples illustrate the idea that getting more information in a market does not always promote efficiency given positive search costs. Measures can often be devised which restrict the amount of information provided and which thereby deliver efficiency gains to all.

Notes on the AEA meetings in Chicago

The main point of my US visit was to attend the American Economic Association (AEA) meetings. They have been pretty good although many of the sessions were (predictably) mainly oriented to the US. In all I attended 12 sessions over 2.5 days with 4 speakers per session. I saw several Aussies at social events during the meetings but most were recuiting new staff not attending the actual meetings. I took the following notes as the conference proceeded to force myself to begin to think about what I had learned.

Day 1

I went to a ‘social economics’ session on climate change where the speaker sought to apply behavioral economics ideas to global warming issues – I approve of the idea of attempting to encourage a change in US mass consumption ethics as a way of reducing greenhouse gas emissions but still wonder how you do it. Conventional carbon taxes coupled with tradable quotas seem to me to be the necessary proximate policy instruments although I am as happy as the next guy if ‘moral suasion’ to cut energy waste can work. Generally, I think we can sensibly cut our desires Buddhist-fashion to augment our welfare – substituting leisure for material consumption – but I would be very reluctant to cut out conventional policy approaches. I have long thought of writing a new version of the basic consumption model of economics where you allow the consumer to invest money and time in contracting desires!

A session on the economics of obesity was focused on things that interest me. Getting fat involves external health costs because (unlike smoking or drinking) the activity is untaxed and there are health costs generated that are paid for by risk-pooling insurance arrangements. But, for certain, the private costs you incur from being a fatty are much bigger than the public costs so perhaps obesity is not so much of a public health issue. Two of the three papers presented focused on this issue. In the US health insurance is generally provided by your employer and fatties are paid less than people of normal weight. Indeed the lower wage probably more than compensates for the extra health costs imposed by being fat. So I am unsure if this analysis applies much to Australia. If health care funds in Australia could charge higher premia to fatties effects would differ.

I then went to a session chaired by James Galbraith (son of John Kenneth) on the economics of exiting from Iraq. It was chilling from the perspective of the US. Nobel Laureate Thomas Schelling argued that the war had ended and the issue was how does the US get out of an occupation? He generally thought that an exit would not occur until the Presidency changed – then an ‘if you break it you must pay for it policy’ should be used. Lynda Bilmes (co-author last year of a celebrated study with Joe Stiglitz on the cost of the war in Iraq) estimated the huge costs the US would continue to experience from disability payouts even if it withdrew now. For each of the 3,040 US troops killed there are 16 with injuries that need treatment (50,508 injured disability claimants) creating ongoing health costs of a $700 billion dollars. Lynda ideas are summarized here. By the way she has increased her estimated total cost of US involvement in Iraq at $18,000 per US household!

The most astonishing paper in this session for me was by ex-1991 Iraq veteran Col. Douglas MacGregor who argued that the US had lost the war in Iraq and was an irrelevant force in the region. He argued that the US politicians who had organized the war as well as their generals were simply militarily incompetent. His classic line with respect to the idea of sticking around and ‘building institutions’ was ‘Iraqi Muslims would not accept a cancer cure from an invading white Christian military force’. He rejected ‘break it you must pay for it policy’ and argued for withdrawal now without any attempt to transfer military prowess to the local US-backed administration which he described as ‘doomed’. He believed the US had mistaken impressions of its invincibility because of flawed perceptions of its role in World War 2. There was an urgent need to think about how to stage moderate interventions that did not involve ‘shock and awe’ attempts to annihilate a country.

A luncheon address on the case for the US Federal Reserve to continue combine monetary policy with supervision of the banks – on the basis of economies of scope- was provided by Governor Ben Bernanke. It was boring – better suited for a straight banking audience though I was curious to see Bernanke. It was well argued using agency theory and ideas of economies of scope.

I finished my day with a session on the economic contributions of Milton Friedman by Thomas Sargent, Gary Becker and Robert Lucas. There were no eulogies but a lot of emotion. All three economists identified Friedman’s skills as a teacher along with his superb economic insight. Becker is not a young man but said that Friedman had been his friend - and teacher - for 50 years. Lucas was an ex-student of Friedman. All three say Friedman’s strength as his love of argument and his respect for opposing views even as he sought to demolish them as among his strongest assets.

I have long lost my copy of Friedman’s Capitalism and Freedom so bought a new copy after this talk. I have been flipping through it during dull presentations - it is still a good read!

Day 2

The opening session I made it to was on economics and biology chaired by Gary Becker. Economic motivations for biological phenomena such as the demographic transition, other-regarding utilities and perhaps most interestingly of all piece by Arthur Robson on ‘why we die?’ and (with Larry Samuelson) ‘why nature might want us to hyperbolically discount/’. Generally I found the discussion a bit space-cadet-ish and abstract. The paper by Robson is good but requires careful reading.

The luncheon involved a speech by David Kreps on the contributions to game theory of Thomas Schelling and Robert Aumann with a response by Schelling who told some nice intuitive stories about focal points in game theory. He discussed his delightful story about two separated friends in a city might find each other by thinking where the other person might focus.

Then excellent presentations on the US productivity acceleration after 1995 – they have finally agreed there was an acceleration! Standard stories dominated about the role of IT. An interesting piece by Barry Triplett argued that the main source of productivity growth was growth in the services sector backed by IT. It was a neat argument. Since the 1960s and a famous paper by William Baumol economists have regarded services as a sector that will not benefit greatly from technological advance – it was Baumol’s ‘unbalanced growth’ thesis. But in the US this is no longer true – services are the sector where most productivity gains are occurring. Indeed as I noticed on this trip there are now not only automatic check-in facilities for air travelers in the US but also automated check-in facilities in hotels. (The Hyatt Regency Chicago also has a device that checks on whether the bottles in your room bar fridge move – if they do you are charged for the drinks even if you don’t consume them – the idea is to stop you stacking your fridge with outside supplies – if you do the supplies are confiscated and you are charged $25). A final paper on Europe finds that it didn’t enjoy productivity acceleration after 1995 because its use of IT, particularly in the services sector, was so low. I found this interesting.

Finally I went to what I thought was the best paper at the meetings so far, an AEA Presidential address by George Akerloff on the use of norms in macroeconomics – ‘The Missing Motivation in Macroeconomics’. All the big consequences of neoclassical macroeconomics (Ricardian equivalence, independence of consumption from current income, the Modigliani-Miller theory, irrelevance of monetary policy etc) are a consequence of ignoring norms about how people believe they should behave. Incorporating these norms restores the commonsense conclusion that none of these neutralities need hold and, indeed, restores the valuable insights of Keynes. Highly recommended reading - the full paper is here. This might be a new topic I pursue. Many of the behavioral economics I understand through my work on economics and psychology for the study of illicit drugs.

Day 3

The first session was on urban economics and sprawl. We had what I think was a trite paper on the game-theoretic economics of building skyscrapers which modified conventional building models by defining a benefit from being biggest. It suggested developers wouldn’t earn big profits since they would overdevelop. But often they do earn very big profits. Very large buildings often reflect the lumpy nature of planned expansions in office and residential space rather than skyscraper wars. Another paper looked at persistence in urban structures by examining Los Angeles. The pattern of urban concentrations could be better explained by patterns of highway networks many decades ago than current networks. Interesting – you cannot ignore history. I also liked a paper by Jan Breuckner on urban sprawl externalities that focused on the issue of population densities and externalities from being social – the intriguing result was that sociable people choose to live in denser environments but that density itself is associated with low social capital. Thus sprawl delivers positive externalities in terms of allowing people to be sociable – on this grounds it should be subsidized not taxed! Of course agglomeration an d congestion externalities interact in complex ways so this is not a particularly robust finding.

A subsequent session looked at mega-stores such as WalMart. Although Mum & Pop single stores remain about constant in numbers in the US – they remain an important force - many of them are exiting just as many are entering. It is the big chains however which are growing much more rapidly and which don’t exit (close individual stores) so frequently – there are 500 US retailers which operate in more than 14 US states. Some of the papers used standard economies of scope arguments (demands for ‘one stop shopping’) to account for such trends possibly fostered by an increased role of women in the workforce. On the supply side WalMart now uses satellite technology, new barcode and GPS technologies and benefits from lower trade barriers. One stop shopping might be part of the explanation for the success of the chain but my guess is that cheaper prices are as important. Many of these efficiencies won’t be realized in smaller markets such as Australia – at least to the same extent. But still it is the large Australian chains such as Coles and Woolworths that should do best given the US experience. This seesion feed into ideas about the next session - the greater stability of US mega-stoire chains may have contributed to the greater macroeconomic stability of the US economy over the past decades.

The final session I attended was mainly on the great moderation (the perceived reduction in macroeconomic volatility) and financial markets. The main idea is that financial innovation and the removal of credit constraints better enables households to consumption smooth and thereby reduces the volatility of aggregate demand. This is a hypothesis not a claimed regularity since better access to debt might conceivably destabilize things. But household and cross-country OECD studies confirm that greater stability has been associated with financial market liberalization.

Recreation

Chicago is architecturally a beautiful city with both attractive older and more modern buildings. Its centre has broad footpaths that give it spaciousness. The Magnificent Mile portion of Michigan Avenue is a buzz for tourists, like me, with elegant buildings and shops. I have been here early January before and it was freezing cold but this year it is mild – cool, sunny spring weather in the middle of winter – the result of warmer air masses flowing in from the west and southwest and the effects of an El Nino year.

Is this weather trivia? Perhaps but it has caused a downturn in US oil demands and the largest drop in spot oil prices in 20 months. At $55-59US per barrel it’s the lowest priced oil since June 2005. It shows the market power of US energy consumers! And in turn a big collapse in gold prices and, surely not, base metal prices as well. I was interested to note that the warm winter in Chicago seemed to be having effects on the resource sector of the Australian economy which has dropped dramatically while I was here!

I was jetlagged throughout my visit and spent a lot of non-conference time reading and watching US TV. If anyone has good ways of dealing ewith jetlag I'd be interested to hear. I have tried melatonin and tryied adjusting immediately to the new time zone but after 6 days I was still very jet-lagged.

TV in the US describes a different world. Apart from the medical ads, the endless get-rich-quick schemes (Donald Trump was performing in Chicago while I was here), the body-beautiful schemes, the boring god-talk-shows and the expanded range of commercial trash shows available here, there was TV of great interest. I watched a PBS show on the withdrawn book Hit Man which describes how to kill people. It was defended by the press here on the grounds on freedom of speech. On the same theme while here I read the chilling (though poorly written) Phillip Carlo account of The Ice Man – a ghoulish account of a Mafia contract killer’s trade that has won high acclaim – he claims to have helped kill Jimmy Hoffa – gripping as it is it lacks credibility – save your money.

I did very much enjoyed a Frontline show on PBS that examined how the weapons of mass destruction lies in Iraq were concocted with the involvement of VP Dick Cheney. Astounding documentary television and well worth watching. By the way Cheney is still making money out of Halliburton!

Meanwhile I’ve had a carnivorous time in Chicago in the evenings eating my way through some great NY-cuts, prime rib and two excellent lobster tails over the past few days. While I may have made a bit of a pig of myself I have remained alcohol-free now for 6 days – the world looks different! I am a bit steaked-out so on my last evening here tonight I’ll try some Asian food.

The death of quality public libraries?

You hear the story from university executives and VCs all the time. Science, mathematics and economics are out – sports management, media studies and marketing are in. The reason, they say, is demand. Students, as consumers, prefer the latter to the former.

I have never accepted this view for an instant since the two parties transacting (teachers and students) have asymmetric information. Suppliers of student services have much better information than students have as consumers of these services. This potentially creates a ‘lemons problem’ with universities offering inexpensive less intellectually challenging courses to clients who are in a poor position to judge their worth. Moreover, in the Australian university scene, any queries about academic direction get the same response – everyone else is doing it, why not us? A bad eventual equilibrium from such shallow thinking is that the ‘bad’ courses drive out the ‘good’ and universities end up teaching only poor courses. It hasn’t happened yet everywhere but it can.

Indeed, I have never liked to think of students as ‘consumers’. University teachers are in much the same position as physicians receiving patients who seek medical advice. The responsibility of a physician is not to meet any perceived demand for services but to offer accurate medical advice. Ditto for universities – it’s a moral responsibility not to offer a second rate educational product.

In this week’s Wall Street Journal (I can’t find an electronic link but a briefer blogged version of the main idea is here) an analogous point is raised in relation to public libraries. John Miller notes that, while ‘For Whom the Bell Tolls’ is perhaps Ernest Hemingway’s best novel, nobody has borrowed it from the Fairfax Public Library in Washington for 2 years. And now the ‘bell may toll for Hemingway’ – the library director will get rid of the book on the basis of such evidently low demand. Books by Charlotte Bronte, William Faulkner, Thomas Hardy and Alexander Solzhenitsyn have already been pulled.

Libraries will accordingly come to accommodate mainly cheapskates with mass tastes. They will not be cultural storehouses that contain the best that has been written but simply operate to subsidize the reading habits of a mass audience too cheap to buy their own low-level reading – mass circulation books are, after all, cheap these days. You can even download audio books into MP3 players. And, from this perspective, why have public libraries at all? Are libraries outmoded? Do they now provide mainly welfare for middle-class readers who are too stingy to shell out a few dollars for the latest Stephen King trash that you can buy discounted at Target?

John Miller argues that:

‘Instead of embracing this doomed model, libraries might seek to differentiate themselves among the many options readers have, using a good dictionary as the model. …New words come and old ones come out, but a reliable lexicon becomes the foundation of linguistic stability and coherence. Likewise, libraries should seek to shore up the culture against the eroding force of trends’

Miller sees librarians as experts who are teachers, advisors and guardians of an intellectual inheritance - not as clerks who fill their shelves with whatever their ‘customers’ want.

I agree. Libertarians and ideologically-disposed free market economists take tastes as something immutable and god-given that production emerges to satisfy. Tastes are not exogenous in this sense – they are determined, in part, by commercial interests and capricious fashion as well as by ‘lemons problem’ market failures. Libraries (and universities) should exist to help preserve what are valuable beliefs and preferences. Neither libraries nor universities should be run purely on the basis of demand signals from poorly-informed customers.

There are links between the two 'lemons' issues here - books and universities. The next time you visit a large university bookshop compare the number of books for sale on tourism, marketing (or, even worse, feminism or Marxism) with the number of books on mathematics or science. Its an important index of university quality though one that I am certain the market-driven ideologues running mmodern universities would be embarrassed to embrace.

KKR on private equity

I was interested in the views of George Roberts (of Kohlberg Kravis and Roberts) on the rationale for the boom in private equity – equity not publicly-traded in a share market.

‘Managements want to take a long-term view, but they know they get clobbered in the short-term. A lot of companies want to start new projects but they can’t because they are afraid of the hit to quarterly earnings, even though it may be right in 3 to 5 years. When we say our average hold [before selling the company or taking it private] is 7 years they sit up’.

It’s a version of the ‘short-termism’ arguments often directed at private equity investors and bolsters arguments that private equity boosts the efficiency of capitalism by forcing investors under the cold discipline of unrelenting debt to rid companies of underperforming assets, ruthless cost-cutting, outsourcing of jobs and so on. It also means, of course, that we don’t need to be as concerned about possible excesses of such firms.

Indeed one argument for establishing corporations with many shareholders is that, by sharing risks it is possible to access the vast amounts of capital necessary to fund capital-intensive industries. Some of the earliest joint-stock companies were US railways which needed huge funding to be feasible and old-fashioned family-style businesses would not work. But this type of argument is increasingly irrelevant when firms such as KKR can mobilize investment war chests of over $100 billion US. Last year KKR bought 12 companies for a shade under $7 billion. Moreover, they can afford to lose $1 billion on a particular deal given their spread of interests.

Another argument for the rise of private equity that one can make is that equity premia mean that debt is cheap, at least for firms that don’t experience disastrous ‘long-tail’ events. I’ve put this argument before. It suggests that equity premia arise because debt holders ignore the prospect of severe ‘long-tail’ adverse circumstances. In this case it is important to be concerned about the rise of private equity since it all can ‘end-in-tears’ (particularly for the shareholders of banks and the stakeholders in pension schemes who fund such purchases) as the RBA and other groups warn.

Both views here may have some truth to them. Some deals will work out delivering great efficiency while others won’t, instead delivering much financial pain. In any even capital markets must be now modeling by supposing there is a mix of both public and private equity claims.

An inspirational story

An extremely brave man, Wesley Autry, a construction worker from Harlem, watched as a convulsing stranger toppled onto the rail tracks in New York’s subway system. A train was roaring towards the man and, without a moment’s thought, he leapt onto the line and pinned the stricken stranger to a groove between the tracks while the train passed over their heads with only centimeters to spare. At the end of it all Autry’s concern was for his young daughters who were waiting on the platform above – ‘let them know their dad’s OK’, he said.

Autry modestly denied hero status after the incident and says that what he did frightened him ex post. But his impulse was magnificent – a real hero.

Chicago and the AEA meetings

I am leaving for North America today. I’ll spend about a week in Chicago attending the American Economic Association meetings there.

Chicago is the third-largest city in the United States with population of 7 million and one of my favorite US cities – I first spent six months living in Illinois in 1982 while visiting the University of Illinois at Urbana-Champaign. I have revisited the ‘windy city’ several times since then and always find plenty to do. There’s a newspaper that comes out with a list of weekly events – the variety overwhelms me – there are 9000 restaurants and 4,000 clubs and bars. I’ll try to make it to 1 or 2 – the blues bars are unforgettable. It is freezing in Chicago at this time of year with mean maximum temperatures below zero. I’ll do some of the tourist bit while there and certainly visit the bookshop at the University of Chicago which is good. I’ll also enjoy the Chicago Tribune – a great newspaper.

The papers of the Conference are a nightmare to select between. It a vast meeting – the program is 191 pages and the number of concurrent sessions huge – in the first time slot, for example, there are 50 concurrent sessions. Many of the papers are on the web so one can preview which helps. But I will be busy and posts over the next week will be occasional.

85% support English language citizenship test

Despite widespread criticism of the proposed citizenship pledge and the test of knowledge of Australia to be posed in English The Australian newspaper reports that 85% of Australians support this test. My surprise is that the figure is so low.

The release of Cabinet Papers yesterday also shows that Liberal ex-Prime Minister, Malcolm Fraser, can be brought to account for what some euphemistically refer to as 'problems of multiculturalism' rampant among Lebanese Muslim communities in south-west Sydney. Fraser allowed into Australia, in the late 1970s, refugee migrants that then immigration authorities described as lacking requisite qualities for integration - many were illiterate, unskilled and had questionable characters (and even personal hygiene).

There were warnings at the time that terrorists and criminals could be seeking to enter Australia. The then Immigration Minister, Michael MacKellar, stated that the Lebanese refugee program was 'scraping the bottom of the barrel with regard to quality'. Even the local Lebanese community indicated they would not oppose more stringent requirements on Lebanese seeking entry.

The high-unemployment, high-crime communities established in Sydney’s south-west and the associated social problems are attributable to Fraser’s poor decisions. These migrants, and their progeny, are the same minority who cry out for jihad, participate in riots at Cronulla and generally hold in contempt Australia's democracy. As John Howard has stated, they have ‘attitudes utterly antagonistic to our kind of society’.

Fraser is a patrician hypocrite, loved by the left, who damns Howard for inducing divisiveness.

But Howard has increased the immigration intake and refocused it to include skilled migrants who add economically and culturally to Australia. It was Fraser’s inept policies, not John Howard, that has led to the fiasco in Sydney’s south-west.