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Economics Detective Radio Podcast by Garrett Petersen

Economics Detective Radio Podcast

by Garrett Petersen

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Economics Detective Radio is a podcast about markets, ideas, institutions, and all things related to the field of economics. Episodes consist of long-form interviews, and are generally released on Fridays. Topics include economic theory, economic history, the history of thought, money, banking, finance, macroeconomics, public choice, Austrian economics, business cycles, health care, education, international trade, and anything else of interest to economists, students, and serious amateurs interested in the science of human action. For additional content and links related to each episode, visit economicsdetective.com.

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Rentberry, Digital Markets, and Affordable Housing with Alex Lubinsky

Sat, Apr 15, 2017

My guest today is Alex Lubinsky, co-founder of the Silicon Valley startup Rentberry.

Rentberry is a platform that lets landlords post units for rent so that tenants can bid on them. Once a landlord posts a vacancy, different potential tenants can make offers and the landlord can select which one to rent to.

Importantly, the landlord doesn't have to select the highest bidder. Potential tenants on Rentberry put in their personal characteristics up on the site, so landlords can select for the type of tenants they want. Maybe they're willing to accept a lower rent from a quiet single woman than a family of five with four dogs and six cats.

There has been some controversy about the site, stemming from the fact that it leads tenants to bid against one another, potentially pushing up prices. One tenant advocate said, "I think it's incredibly arrogant and incredibly concerning in light of the fact that we have the highest number of homeless families since the Great Depression. For them to do something to increase the rents seems really callous." Vanity Fair said Rentberry would turn rental markets into a Hunger Games-like death match.

Alex and I address these criticisms in the episode. The critics are missing one simple element to the story, which is that Rentberry doesn't just cause more tenants to bid on any given listing, driving up the price, it also allows each tenant to bid on more listings, driving down prices by giving each tenant more options. The two forces cancel one another. By only charging a one-time fee of $25 when a lease is signed, Rentberry reduces the costs of applying for vacancies. In some markets, tenants can expect to pay hundreds of dollars in application fees while apartment hunting and Rentberry allows them to avoid those. What Rentberry is really doing is allowing the market to approach equilibrium more rapidly.

Preliminary evidence also suggests that Rentberry decreases vacancy rates, since these are lower for landlords using the site than for the country in general. This is equivalent to an increase in the housing supply, which is unambiguously good.

Listen to the episode for the full discussion.

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50th Episode Special with Garrett Petersen and Ash Navabi

Fri, Apr 07, 2017

Hello and welcome to the fiftieth episode special of Economics Detective Radio! Today we have Ash Navabi back on the program, but we’re flipping the script: Ash will be interviewing me about the show and about all the things I’ve learned while making it.

In this episode, I alienate the political right by discussing the importance of labour mobility and the desirability of open borders. I also alienate the political left by expressing a lukewarm position on climate change. I also discuss my own research plans relating to law and economics.

Finally, we discuss literature! Really, if you like Economics Detective Radio, you have to hear this episode.


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Anthropometric History, Quebec, and the Antebellum Height Puzzle with Vincent Geloso

Sat, Mar 25, 2017

Returning to the podcast is Vincent Geloso of Texas Tech University.

Our topic for this episode is anthropometric history, the study of history by means of measuring humans. Doing serious historical research into the distant past is difficult work, because the further you look back in time, the less information you can access. For the 20th century we have wonderful thing like chain-weighted real GDP. Going back further, we have some statistics, lots of surviving physical evidence, and loads of documents and writings. Going further than that, we're left with the odd scrap of thrice-copied surviving manuscripts and second-hand accounts from people who lived centuries after the events they describe. And going even further than that, we have just bones and dilapidated temples with the occasional inscription.

Anthropometric history allows us to look into the distant past at what economic historians like Vincent hope might be a good measure of different populations' health and standards of living: their heights. People who have healthy upbringings with lots of access to food tend to be taller than people who don't; that's why modern humans are much taller than they were a thousand or even a hundred years ago.

Vincent has contributed to this literature with his latest co-authored paper, The Heights of French-Canadian Convicts, 1780s to 1820s. The abstract reads as follows:

This paper uses a novel dataset of heights collected from the records of the Quebec City prison between 1813 and 1847 to survey the French-Canadian population of Quebec—which was then known either as Lower Canada or Canada East. Using a birth-cohort approach with 10 year birth cohorts from the 1780s to the 1820s, we find that French-Canadian prisoners grew shorter over the period. Through the whole sample period, they were short compared to Americans. However, French-Canadians were taller either than their cousins in France or the inhabitants of Latin America (except Argentinians). In addition to extending anthropometric data in Canada to the 1780s, we are able to extend comparisons between the Old and New Worlds as well as comparisons between North America and Latin America. We highlight the key structural economic changes and shocks and discuss their possible impact on the anthropometric data.

Listen to the full episode for our fascinating discussion of this branch of historical research, including the so-called "Antebellum puzzle," the anomalous observation that American heights decreased in the years prior to the Civil War even though the economy was apparently growing rapidly. We also discuss the heights of slaves in the American South, who were taller than their white counterparts despite being oppressed as slaves.


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Doughnut Economics, Inequality, and the Future of Economic Growth with Kate Raworth

Fri, Mar 17, 2017

Today's guest is Kate Raworth, she is a senior visiting research associate at Oxford University’s Environmental Change Institute, a Senior Associate at the Cambridge Institute for Sustainability Leadership, and the author of Doughnut Economics: Seven Ways to Think Like a 21st-Century Economist.

In this interesting and wide-ranging discussion, we discuss Kate's critiques of the standard models taught to economics undergraduates, as well as her views on development, economic growth, inequality, and the environment. You might think our viewpoints would be very different on these topics, but we find a surprising amount of common ground.

During our discussion of inequality and the patterns noticed in the 1950s by Simon Kuznets, I bring up Geloso and Magness' work on inequality in the early 20th century. You can hear my conversation with Vincent Geloso about that research here, as well as his comments on it here.


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Turkey's Coup D'?tat and Geospatial Data Analysis with Akin Unver

Sat, Mar 11, 2017

Today's guest is Akin Unver of Kadir Has University. He uses geospatial data to study political events such as the attempted coup in Turkey in 2016.

The coup was an attempt by certain rogue elements of the Turkish armed forces to oust President Erdogan. However, unlike past coups in 1960, 1971, 1980, and 1997, the Turkish people documented and coordinated their opposition to it on social media in real time, leaving a rich record of events as they unfolded.

Akin's research, which was featured in an extensive and detailed article for Foreign Affairs, shows how, when, and where the opposition to the coup occurred. He shows, for instance, the importance of mosque networks in coordinating resistance. And while the media put a lot of importance on Erdogan's personal appeals through FaceTime and Twitter in galvanizing support, the data show that resistance started organically almost as soon as the coup began, hours before Erdogan appeared on television to rally support.

The discussion delves deep into specific details of the coup and the resistance, while also touching on other areas of Akin's research. Towards the end, we discuss the technical side of working with geospatial data.

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Innovation, Invention, and Britain's Industrial Revolution with Anton Howes

Fri, Mar 03, 2017

This episode features Anton Howes of Brown University. He is a historian of innovation, and in this conversation we discuss his work on the explosion of innovation that occurred in Britain between 1551 and 1851. You can check out his Medium blog for some of the articles we discuss.

Anton has collected a data set of over 1,000 British innovators who worked during this period. He has documented their education, their experience, and their relationships with one another. Some of the interesting patterns that emerge in his data are the large fraction of innovators who developed technologies in industries outside of their areas of expertise, as well as the high degree of interconnectedness between innovators.

Innovation, it seems, is a mindset; one that can be spread from person to person like a contagion. As far as Anton can tell, this mindset seems to have spread from Italy and the Low Countries during the Renaissance and taken hold in Britain to usher in its Industrial Revolution. With his view of innovation as a mindset, Anton's work complement's Deirdre McCloskey's work on the origins of modern economic growth.

Our conversation concludes with stories about some particularly interesting innovators, some of whom were also pirates!


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Regulation, Discretion, and Public Choice with Stephen M. Jones

Fri, Feb 24, 2017

What follows is an edited partial transcript of my conversation with Stephen M. Jones. He is an economist for the US Coast Guard. However, we are discussing his own research, so nothing in this conversation should be taken to represent the official views of the US Coast Guard.

Petersen: So Stephen, let's start just by defining regulatory discretion. What does that mean in this context?

Jones: Sure. So, I think first off, we should probably define regulation because when Congress writes a law, they pass the law on to regulatory agencies and it will say something to the effect of "agencies: issue a regulation." So, when we talk about regulations this point isn't always clear because people just aren't familiar with this process. The regulation is a statement that kind of clarifies existing congressional law or is written in direct response to congressional law. And this could be as specific as, say, Congress can direct an agency to set an exact amount of pollution that is permitted for an industry to as broad as saying something like "protect consumers from unreasonable risks." And then the agency has room to interpret that statement as wide as it wants to.

So, when I talk about agency discretion what I'm really talking about is Congress wrote a rule that gave the agency power to issue legally binding rules that may or may not trace directly back to Congress.

Petersen: Yes. So, in the example you use with the pollution, Congress has something fairly specific in mind---a specific type of pollution---but the agency might have to clarify and to say what counts as pollution and how much they're measuring it and maybe they might establish a quota system, they might have specific rules for specific firms. And in the other example you gave, which is just protecting consumers from unnecessary risk, in that case they can basically write rules as if they were their own legislator, they're essentially doing what Congress is ostensibly meant to do. Is that correct?

Jones: I'm not sure I would go that far. So, there are various theories of the purpose of the regulatory apparatus in the bureaucracy. Some people---I cite them in the paper---Baumgartner and Jones and Workman have one that is called 'The Politics of Information' and I forget what the other is called, it was written in 2015. And their theory instead is that Congress gives the agencies discretion because Congress doesn't know the problems it needs to solve and so the agency is kind of like the specialists that you subcontracted to figure out what Congress wants them to solve without actually knowing, say the relevant information to determine that.

That's one theory. You've got other people like Philip Hamburger notably, who has written a whole book on how administrative law, which is another word for regulation, is unlawful and so he goes through sort of the common-law tradition and cites numerous pieces of evidence to say, exactly in the way that you put it, that it's a deep legislative function and only Congress should be performing that.

And so, whether that's true I think depends on a number of different assumptions that aren't always discussed directly in the literature. That would be my interpretation if that makes sense.

Petersen: Right. And of course, we're approaching this from an economic standpoint so there are important public choice issues involved with this. The same rule whether it's written by a legislator or a bureaucracy---a regulatory agency--- it's the same rule and so in principle, there should be no difference. But the important thing is that the agency and the Congress may have different incentives and may write different rules. That's what I interpret as an important underlying theme in your paper.

Jones: That's most certainly true. So, that's actually one of the things that frustrate me greatly about reading a lot of these other, I think, great researchers who don't in my opinion sufficiently consider the role of incentives. To couch it in Baumgartner's or in Jones' and Workman's terms, okay, let's assume that the purpose of the bureaucracy is to create the information that's necessary to solve the national problems, whatever these supposed national problems are. Why would you assume that bureaucrats would supply the right amount of information in the right ways consistently throughout time?

And it's not clear to me that those incentive systems are ever worked out; or if you do work them out, I don't think it actually shows that bureaucrats are beholden directly to Congress. So the big terminal literature, which comes from McNollgast, which is McCubbins, Noll, and Weingast, in the 80s is called Congressional dominance. They basically say that because Congress writes the rules they structure all the incentives and have all the tools at their disposal to monitor and police agencies. And I'm just deeply skeptical that that works as well as they describe.

Petersen: Right. Your paper mentions the Administrative Procedure Act which is sort of an attempt by Congress to keep these agencies in check. Could you describe that act and what exactly it does?

Jones: Sure. So, the Administrative Procedure Act is the main document that governs how agencies regulate. It defines the process by which regulation is made. And the chief component is that it really says before an agency issues a regulation it has to go through notice-and-comment. And what that means is when it sends out a rule it issues it in the Federal Register, which is the government's journal of record, and then it allows everybody to comment on this rule, and literally anybody will comment on these rules, and the agency is legally required to respond to all comments.

So, the basic theory is this, it's kind of got a two-part mechanism here. On the one side, it's a sort of direct structural constraint and doesn't really affect agency decision making because all it's really saying is you have to send out all rules---if the fire alarm is triggered it acts like a fire alarm. So, if you get a whole bunch of comments it's a really easy way for Congress to tell, "oh there's a problem with this policy" or it's a contentious policy because all of these people commented it and it's really loud, it's like a fire alarm. But it doesn't necessarily mean that an agency, that an individual bureaucrat in that agency really feels that alarm. It's more like it'll just be triggered, make sure just do something that doesn't trigger that alarm and you should be okay.

The other way in which it might change agency behavior is that by forcing agencies to publish rules they reveal a lot of information and in the rule itself you have to describe, say, the cost of the benefits. You have to describe whether or not it has impacts on Native American tribes, or on the Federal structure, or various other executive orders that have been issued. So, one of the main ways in fact that notice-and-comment system has changed is executive orders that define how in a very practical sense these final rules will be constructed. And so, they're all today reviewed in an office inside of the OMB---the Organization for Management and Budget---and the office is called a wire at the Office of Information and Regulatory Affairs. And so, they're responsible for reviewing all regulation and they are an Office of the president. So, some people then conclude that the President has all this power, in effect, of rulemaking in general.

Petersen: I guess the idea of the President is that it's the executive branch and so it executes and it sort of makes sense that these agencies that are executing laws would ultimately be beholden to the President. It sort of fits. So, do you know quantitatively how many comments? Are these regulatory agencies writing regulations and getting hundreds of comments every time, or is it rare to get even one comment?

Jones: It depends on the agency and it depends on the rules. So EPA because many of its rules will have national effects, and then there are national environmental organizations that you can say are key stakeholders in the outcome of all these rules could very easily generate hundreds of thousands of comments. And so, they'll actually have computer programs that scrape the comments and kind of try to sort them in the boxes. You have other organizations, like FRA for instance, they might have a rule that only gets 30 comments.

Petersen: Sorry what does FRA stand for?

Jones: Sorry, that's the Federal Railroad Administration and that's one of the two main regulators of railroads in the United States. The other regulator, the Service and Transportation Board, is primarily focused on business practices, antitrust type issues, and FRA is focused primarily on health safety and welfare of anything railroad related. So that's everything from, say, the occupational safety of railroad workers to the safety of passengers on trains. And so, the Federal Railroad Administration might only get 30 to 40 comments on a normal rule, they might even get less than that. It really depends on the rule itself.

Petersen: And typically, this would be if a rule affects my business and I might pay attention to the new rules coming out in my industry and if one I thought was going to be detrimental to my bottom line if I work for or run a private business, then I would comment. Is that the typical thing that happens?

Jones: Probably. I really think the diversity of interaction is so high it's really hard to characterize exactly what normal public commenting looks like. Because it could be everything from "I'm a regulated businessman who wants this," there might be somebody on the other side who benefits directly because the new rule sets a standard and the standards organization writes in and says your standard isn't strict enough. It could be something like there's a proposed rule that the Federal Aviation Administration, which regulates commercial flying, or anything air related at all pretty much, and they have a rule on the use of cell phones on planes. They've got about 5,000 comments, 6,000 comments. It's quite a number. Once you get above 100 that's usually quite significant. And a lot of those could be something as simple as "we just think phones shouldn't be on planes" and just average citizens writing in upset at the very concept of a phone being on a plane. So, there's quite a diversity of interactions between the agency and public on that.

Petersen: So, getting into the main topic of your paper you discuss what you call channels of influence. So, what are those and why are they important?

Jones: Yes. The way I think about it is this. I think the chief question of the bureaucracy literature is who does this regulatory bureaucracy exist for? Does it exist for interest groups? Does it exist for Congress to ultimately provide information that Congress needs? Does it exist for the President to carry out the President's wishes and his policy? Or does it exist for the bureaucrats themselves which is the one I also like to emphasize because the literature on that one is not very common today. It was more common I think about 30 years ago but the framing of it is a little different.

And so, my point is to say each one of these separate groups should have an effect on the outcome itself of the final rule which changes say the regulatory set. Some rules may be demanded by bureaucrats, some rules are demanded by interest groups in Congress. If I were to put it in the econ speak---because I'm writing this paper probably more for a political science literature---but if I had to put it in an econ speak my I'm kind of saying you have four different demanders for this product and so who is the regulatory agency really supplying this for? It's I think really how I'm thinking about it.

For the full conversation, listen to the episode.


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Canada's Cartel Problem with Maxime Bernier

Fri, Feb 17, 2017

What follows is an edited transcript of my conversation with Maxime Bernier. If you like his ideas, I encourage you to go to his website to learn more about them.

Petersen: You're listening to Economics Detective Radio. Before we start let me give a quick disclaimer that although today's guest is a politician this show is nonpartisan and doesn't endorse any particular candidate for office. My guest and I are also Canadian so we'll be talking about some Canada-specific issues. I know I have an international audience but sometimes it's fun to learn about what's going on in other countries. So I hope you'll listen nonetheless. And now on to the episode.

My guest today is Maxime Bernier, he is the Member of Parliament for Beauce, Quebec and a contender for the Conservative Party leadership race. Maxime, welcome to Economics Detective Radio.

Bernier: Thank you very much for having me.

Petersen: So, our topic today will be Canada's economy and its economic policy. There's a lot to get to on this topic but let's start with the positive. The Fraser Institute's Economic Freedom of the World Index ranks Canada as the fifth freest country in the world, actually tied for fifth. We're well ahead of our neighbors, the Americans, who come in at number 16. So, to start our discussion, Maxime, what is Canada doing right with respect to its economic policy?

Bernier: First of all, I think that this was the ranking that the Fraser Institute did a year ago, if I remember very well, and at that time we had a balanced budget when we were in government and also we were successful in lowering taxes for every Canadian. And I think that's a key when you speak about more freedom you must also have less government and a limited government in Ottawa. And I think that was the goal of the Conservative government when we were in government.

And also we have a lot of free trade. That's very important. We signed free-trade agreements with I think, if my memory is good, 45 countries. So, when you have more free trade like that, Canadians are able to buy goods from every country and they are able to also export products. So, that's helping also.

More free trade, less government, lower taxes and I think that's a big reason why we are there now.

Petersen: Yeah, there's a pretty general economic freedom, and you mentioned that that ranking came out last year and we have had a change of government recently so let's see if we can keep our high position.

But let's move on to some specific areas where we're not so free. Let's start with telecommunications. Canadians have some of the most expensive cell phone bills in the world. You personally did some work in deregulating the telecommunications sector when you were Industry Minister in 2006-2007. Can you talk a little bit about the changes that happened then and where we are now?

Bernier: Yeah, at that time we wanted to deregulate the telecom industry, mostly the regulation that was imposed by the CRTC. We were successful in doing that, and afterwards I think we had a little bit more competition in Canada in telecom.

But we didn't have time to also abolish the restriction on foreign investment in telecommunication. And so I think that would be the next step to take to have a bit more competition. And so that's why in my program I have a very strong platform about deregulating and also abolishing the prohibition on foreign investment in telecom and also in the aviation sector. So like that, corporations from outside Canada will be able to invest here in telecom and that will help Canadian consumers, who will have more choices and lower prices. But it was the deregulation that we did---that I did when I was Industry Minister---that was the first part of the deregulation. So now we must go ahead with abolishing the prohibition on foreign investment in telecom.

Petersen: Right. The vast majority of Canadians live right on the border with the United States and if you just step across the border suddenly you can buy a data plan for much less. One thing I was struck by when visiting the United States was that people just watch YouTube videos when they're on their mobile data. And you don't see that in Canada because it's so incredibly expensive. So, I wouldn't be surprised if we allow the American companies to sell to us if we wouldn't get exactly the same plan they're getting which would be great.

Bernier: Yes, I just want to add that Verizon, I think they wanted to come to Canada but they were not able to. They had created a Canadian corporation and all that and at the end, they decided not to come to Canada like their operations in the US. So, I think that will be a big step if we are successful in abolishing the restriction on foreign investments. That would make a difference for Canadian consumers.

Petersen: So, we have a similar issue with the airlines. It's very, very expensive to make a domestic flight within Canada, for instance, flying Vancouver to Toronto is about twice as much as flying L.A. to New York even though they are similar distances. So, do you want to comment on that situation? We only have the two airlines West-Jet and Air Canada. Could that be similarly fixed?

Bernier: Yes, you're absolutely right. If you want to fly from Canada to another country it is still competitive, but if you want to fly in Canada, inside the country, from example Montreal to Toronto, or other cities like that, it is very expensive. Because, like you said, we have only two main carriers in Canada: West-Jet and Air Canada. And we don't have like other countries a low-cost carrier.

So, we need to have one and I know that some business entrepreneurs want to create one low-cost carrier but their funding, their capital it's coming from the U.S. and from U.K. And you still have the same things in aviation, we have a restriction on foreign investment coming from other countries. So, that's why we must abolish that and like that we'll have a low-cost carrier and that will compete against Air Canada and West-Jet. That adds more competition, more choice and at the end lower prices.

So, I know that the Federal Government and the Minister of Transport, they're looking at it right now because these entrepreneurs want to create that corporation, a low-cost carrier. And they're ready for that. They're looking at it right now so, I hope they will abolish that but I'm not so sure. This is why for me, I have a platform that is based on more freedom and less government and it will be always good for Canadians. That is why I'm pushing that very hard, I wrote to the Minister about that to be sure that they will abolish foreign restriction in the investment in the aviation sector.

I don't know if they will do it but if not I will do it when I will be the leader of the party and Prime Minister.

Petersen: Yes, I hope you succeed in that. This one is a particularly important one because if airfare is expensive then more people drive and driving is statistically much more dangerous. So, you have more highway fatalities. I personally drove over 1,200 kilometers to visit family over Christmas. So, I'd really love to have an option to fly cheaply but it's just out of reach at our current airfare prices.

We also have a problem here in Canada, a similar related problem with cartels. We tend to create cartels in a lot of industries and we have one set of policies called Supply Management that applies to poultry, dairy products, even maple syrup (which is very quintessentially Canadian) keeping these prices artificially high. So, could you talk a bit about Supply Management for those who maybe haven't heard of it?

Bernier: Yes, Supply Management it is a legal cartel for dairy, poultry and eggs and the like. The producers on the Supply Management are able to fix high prices for these products and they are fixing the production also. That's why it's a cartel, they're fixing the production for the Canadian market and they are fixing the price, every year they increase the price of these products.

So, I am the only candidate for the leadership of the Conservative Party of Canada and also the only member of Parliament who's speaking for Canadian consumers and that wants them to save $2.6 billion every year. Because that's the cost of keeping that cartel and for a family the cost is $500 every year. I want them to be able to buy poultry, eggs, and milk from other countries---they want to export that---but because we have tariffs at the border of 300% on products coming from other countries to be sure that the dairy producer in Canada will be able to fix high prices for their products.

So, for me, if you believe in a free market you must abolish that and I don't want to do work for 19,000 farmers that are on Supply Management, I want to work with 35 million Canadians. And I think that's the most important for me and actually, the farmers just represent 10% of the farmers and all the other farmers in Canada, like the beef producers and all the other farmers are not on the Supply Management, they are operating in a free market. So, it is not fair and to be fair we need to abolish that but because as a special interest group they are very powerful and they're very well connected with the politicians, they were able to keep that privilege for a very long time and I think now it's time to speak for Canadian consumers and that's what I'm doing so I hope to be successful with that.

Petersen: Ironically Facebook has been serving me advertisements from the Canadian milk producers and their tagline or slogan is Canadian milk is worth crying over, or spilt Canadian milk is worth crying over, or something like that. And the irony is that if they supply too much milk, because of Supply Management they actually have to dump it to keep the price high. So it is really just wasting perfectly good milk and poultry.

Bernier: Yes. If they produce too much they cannot export their surplus because it's a subsidized milk. So that's why it's bad for them. They are producing good products, good milk, good dairy, good poultry, and eggs and I want them to be able to export their products to other countries and right now on Supply Management they can't because they have the responsibility and the obligation to produce only for the Canadian market.

Petersen: You mentioned the 300% border tariff on U.S. dairy. I think in the U.S. they have a different policy where they actually subsidize it and keep the price artificially low. But we had this strange situation a few years back where Canadian pizzerias were smuggling in black market mozzarella over the border and got caught. You shouldn't have to smuggle mozzarella cheese. If we had a free market, there would just be one price for mozzarella cheese and you wouldn't get a benefit by smuggling it.

You mentioned that you're really the only one calling for an end to this Supply Management policy and yet our Prime Minister for almost a decade, Stephen Harper, has a Master's degree in economics. He must have known that this policy was not good for Canadians. And most of the MPs are smart people, they must realize it, but is it as simple as the cartels themselves just making big donations and buying protection for this policy?

Bernier: First of all, you're right, when we were in government that was the policy of our government to keep that cartel, that Supply Management system. All the members of the Conservative Party of Canada voted in 2004 in a convention to protect these farmers and after that when we were in government in 2006-2007, that was the policy of the government, and that was the policy of the government until the end, until 2015.

And I think that at that time we didn't want to displease the cartel and that special interest group. And I tried to fight for that on the cabinet table but I wasn't successful. Most importantly, I think now I'm able to do it and I will ask---if I'm the leader of the Conservative Party---I will ask the members to decide on that and to review their policy statement that they did more than 12 years ago, and I hope the members will abolish that and they will believe in a free market also for producers on Supply Management.

Petersen: Have the supply managed industries been pushing back against you? Have they been taking out ads or funding your opponents? How are they trying to protect their cartel status?

Bernier: For sure. It's an important cartel in Quebec and in Ontario, they want to do everything for Maxime Bernier to not be elected. And so I think they are buying memberships to vote for the leadership of our party to be able to vote because, as you know, you need to be a member.

If you want to be a member and support my candidacy you can go on my website www.maximebernier.com and you'll be able to become a member for only $15. But, yes, the dairy producers are working to be sure that I won't be elected.

But there's more Canadians than dairy producers. So, I'm working hard to be sure to be successful because they want to keep their privilege and we'll see what will happen. And it's easy for them because I'm the only candidate who wants to abolish that and speaking for Canadian consumers, so they can vote for all the other candidates and they will have somebody who will support their special interest.

Petersen: I hope you succeed. And you're right there are more Canadians than supply managed firms or farmers that benefit from this particular policy. But you have this issue of the cost being dispersed and so although there are fewer farmers who benefit from the cartel and from Supply Management there may be a lot more motivated per capita. So, I hope you can succeed in getting over that, sort of, public choice hurdle. But my cynicism kind of says that it's an uphill battle.

Bernier: Absolutely. But also, I must say that the other farmers that are not on Supply Management, they have a huge interest also for that cartel to be abolished because it's not fair for them. Each time Canada is negotiating a free trade agreement with another country they have access, for example, Canadian beef will have access to the other country's market, but they won't have the full access because we're not giving full access to their milk, poultry, and eggs. So at the end, they are paying a little bit for that and they don't have the access that they would have otherwise. And they understand that. So the other farmers that are not on Supply Management have the interest to be sure that we have all these steps that can counterbalance the special interest group.

Petersen: I wonder about that because if beef and poultry are substitutes then you would think that the beef producers would want their competitor to have higher prices than they do so people would maybe buy more beef. But there is the issue of the international agreements.

You've called for the privatization of Canada Post and the removal of its monopoly on letter mail. That's another area where Canadians pay more, not just for letters but also parcels shipping to and from and within Canada is much more expensive than it is in the United States and other places. So could you talk about what the legal status of Canada Post is and what both parcel shipping and regular mail are, what the legal status of both of those is?

Bernier: Yes, you're absolutely right. Canada Post is a state-owned enterprise and I think in 2017 we must do like other countries and privatized that. They are charging at a huge cost because they are not competitive, they have huge expenses and they're not so efficient.

So, my thinking about that is, these are not services that Canadians need to be delivered by a government entity. We have a private sector for delivery and I think that it is not an essential service for Canadians any more. And they are using Canada Post less and less with emails and all that, and so we must do like in Belgium, like in U.K., like in France and privatized it.

Also, they're charging very high prices for their products. So, if we have more competition, that will help and at the end that's the solution. But they want to keep that and for me if you want to speak for Canadian consumers you must go ahead and do that reform, that's my proposal.

Petersen: Yes, it's such a big issue because in other countries that have much cheaper shipping, people are opened up to the whole global marketplace, you don't have to go to your local store to buy any particular good, you can buy it online and have it shipped to you. But for Canadians, you're adding $10-$15 to the price and so Canadians aren't really online buying things nearly as much as, for instance, our neighbors the Americans.

And when Canadians want to run online businesses and maybe ship things to other people to stay competitive they often have to drive across the border and ship from the United States because it is just so much cheaper.

And Canada Post has a legal monopoly on letter mail which is a little bit odd. Why should one particular government entity have the legal right to ship our mail? It's kind of an odd historical anomaly that we could be rid of.

Bernier: And you have to think the price also. It's not a free market. It is them who are fixing the price because, like you said, they have a legal monopoly. That's what I want to do, I want to be sure that we can have competition there.

Petersen: You've also called for reducing trade restrictions within Canada. This is one of those things that is so odd, is that we're one country, ten provinces, but we restrict many goods from being shipped within our own country across borders. So for instance alcohol. If you have a craft brewery or a winery in British Columbia it's very hard to ship it to even Alberta right next door. Can you talk about some of the internal trade restrictions that we have in Canada?

Bernier: Yes. We have a lot of them in these kinds of industries, but for me it is a bit of a shame that after 150 years we don't have an economy of exchange in Canada, because that was the goal of the Fathers of our Constitution. The fathers of our country, they wanted to have an economic union and we don't have that because of some restrictions, legislation, and regulation by provinces.

So, my goal is to be sure that we'll have an economic union. And to do that, it's against the Constitution and so I want to be sure to have a team in Ottawa of civil servants that will look at all the regulations and the legislations that are imposed by provinces and to bring provinces in front of the court when they don't respect the Constitution. Nobody has had the courage to do that and I think it's time to do it. And that will be the only solution because I cannot change the legislation or regulation at the provincial level and at the federal level we must respect the Constitution.

But I can assure Canadians that we'll do everything for the provinces to respect the Constitution. That's why we're going to bring the province in front of the court and the court will decide if it's constitutional or not. And I think it won't be because it's clear in the Constitution that we must be able to sell and buy goods from any province in Canada. That would be the solution. Because if you ask the provinces to do that, they have the problem and they cannot find the solution. So, that's why every year you have a meeting with the premier at the provincial level and they're saying, you know, we will abolish trade barriers and all that and it is not happening.

And they're the problem and they're not able to do that. They want to protect their own little market it is not good for Canadians, so we must do something at the federal level and that's what I want to do. I want to do a strong analysis of every regulation, legislation that provinces are imposing, legislations that are against free trade and after that bring them in court and the court will decide. And in the end I'm sure it will be unconstitutional and maybe when you do that, in five years after that, you have a real economic union in Canada like the fathers of our Constitution wanted.

Petersen: Yes. One wonders what is even the point of having a country if you're not going to have at least free trade within your borders? That seems to be the main benefit of all confederating and joining into one country instead of being 10 smaller countries.

Do you have any concluding thoughts, anything we didn't cover that you'd like to say?

Bernier: First of all I want to thank you for giving me that opportunity to speak with your people and if they want to know a little a bit more about our economic policy, they can go on my website www.maximebernier.com. Everything is there and I'm very proud of our platform. It's a platform that is based on individual freedom, personal responsibility, respect, and fairness and it is a platform that is based on real conservative values and the values of Western Civilization. So, if people like that they can become a member and they can vote for the leadership. I appreciate that you gave me this opportunity and maybe another time we can go on and speak about other economic issues.

Petersen: My guest today has been Maxime Bernier. Maxime, thanks for being part of Economics Detective Radio.

Bernier: Thank you very much and have a nice day.


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DonorSee and the Future of Charitable Giving with Gret Glyer

Sun, Jan 29, 2017

What follows is an edited transcript of the first part of my conversation with Gret Glyer, creator of DonorSee. For the full conversation, listen to the episode.

Petersen: My guest today is Gret Glyer, he is the creator of a new app called DonorSee. Gret, welcome to Economics Detective Radio.

Glyer: Thank you for having me, Garrett. How are you?

Petersen: I am great! So, DonorSee is a charitable giving app with a very interesting twist which---we'll get to the app itself in a little bit---but first let's start with some background. Tell us a little bit about yourself and how you got involved with the nonprofit sector.

Glyer: Sure. So, I graduated from college in 2012 and immediately started working at a rental car company and did that for about a year and did really well. And I was promoted very quickly and I was told by upper management I was going to skyrocket through the ranks and that whole idea of being very successful having six or seven figure income, getting a company car, that kind of stuff, was just a depressing thought to me because I didn't want to wake up in twenty years and be really good at renting cars to people.

So I started looking at a bunch of different ways to find something more fulfilling, more around doing work that I cared about and I decided to go overseas for a year and I found an opportunity to go to Malawi, Africa. So I went over there, I spent a year as a math teacher and I really loved being over there. Teaching math wasn't exactly my vocation in life but being in a very impoverished area and being a part of helping those people, that was something that I found a lot of fulfillment and gratification in. So I spent another two years out there and then I came and I was out there, I did a whole bunch of different crowdfunding stuff and I got involved.

I started a charity and a few other things and then when I came back---about six months ago---that's when I started this new company DonorSee. It's kind of in the nonprofit sector, but I've also been telling people it's kind of like the anti-charity. There are so many negative connotations associated with what charity is, and how people understand it, and how effective it is, and how much they waste money that I almost don't want to be associated with non-profits or with charities, I'd almost rather be considered like the opposite end of the spectrum. So, in some ways it is in the nonprofit sector in some ways it's the farthest thing from it.

Petersen: Yeah, well I'm hesitant to describe it as the Tinder of charity but it's almost like that. So, you're not a tech person, you're not a computer programmer but you come from, well not charity, but from the helping others in poor countries angle. How did you get to this point where you can start a tech startup?

Glyer: Yes. So, basically, you can do anything you want as long as you have the resources to hire people who do the stuff that you can't do.

So, I came up with the idea back a year ago, actually in January, and I spent the next two months developing it and writing out a business plan for it and getting screens made to see how it would look, and what the flow would be like, and how people might use it. And then I paid a guy online who lives somewhere in Eastern Europe and he---I think it was Ukraine---and for a relatively small amount of money he made a basic very buggy first draft, like a prototype, and I used that.

And I took it to investors to show them what the app was like. And they believed in the idea, they believed in my vision for what the app could be and how it could disrupt the charity sector and so forth. And so they saw that and they decided to provide me with investment money and I was able to use that money to hire the tech people and hire a marketing team and all that kind of stuff. So, that was how I got from having no technical background to running a tech company myself.

Petersen: Yeah that's great! So many idea people are also sort of averse to hiring others. You know a lot of people have great ideas and flounder because they try to do everything themselves. I do something similar on a smaller scale, but I outsourced a lot of the things for the podcast so I can focus on the parts of it I like, the interviews, the sort of high-level thinking side and also so I can finish my Ph.D. which I promise I will eventually. And you know it's just good to hear you taking this smart approach.

Let's get into the app itself. I actually did, I went to your website and I installed the app. So if someone listening were to install the app and booted it up, what would they see?

Glyer: The app it looks most similar to---when someone opens it, it reminds most of them of Instagram when they open it up. So they open it up and then you see you can scroll through this list of pictures and descriptions underneath. I think the one thing that might look different is that each picture has a little circle at the bottom that shows the progress of how much money has been donated.

So, each picture is actually a project and that project could be providing a wheelchair for a kid in Malawi or providing hearing aids for a little girl in India or education or any number of things. And you see the picture, you see the description underneath and then you have the opportunity to donate to any of those things and the progress bar tells you how much has been donated. So, if there's 25$ left you can be the person to donate that final 25$ and get it out to that person who is usually in a very urgent or desperate situation.

They open it up, they see this list of projects and then they can pick where in the world they want to give to, what kind of project they want to give to, in what way they want to be involved and we have all sorts of different stuff from over 30 different countries. And when people give, the thing that is very---so far there's nothing special about it, this is pretty much like every other thing that you've ever heard of except for maybe it being on an app---the thing that makes us special is that when you give to one of our projects you will get relatively quickly a visual update at some point of how your money was being spent.

So, let's say you gave to that kid who needed the wheelchair. You actually get to see a picture of that boy being fitted for the wheelchair and getting his wheelchair and going out, how his life is improved because of that. Or the girl who needed hearing aids; you'll get a video of that girl hearing for the very first time. So, we provide very strong connective visual feedback on every single donation. That's what makes this different than anyone else that's out there.

Petersen: Right, and the great thing about doing it through an app is that you can get that warm fuzzy feeling in the feedback in the knowledge that you've had an impact, which is not always clear. With a lot of charities, you give them some money and it goes into their general revenue, you don't know if you actually gave that goat to that far-off person or if it went into marketing to get more money to---I mean hopefully---to buy more goats but maybe just to market some more.

And if we want to look at the distant end of the spectrum in terms of warm fuzzy feelings per dollar actually spent helping a poor person, we might look at something like Habitat for Humanity where they fly people with no building experience from the West at great expense to a poor country to build buildings that nobody wants that have to be torn down because they're so poorly built, just in order to get---I guess they pay some kind of fee---and eventually a little bit of money goes to the people in the country.

But there's just a lot more effort put into that warm fuzzy feeling. I think we as humans are a little flawed in needing it. We need that feeling in order to do good in the world. It's not enough to just abstractly know. Could you compare your charity to some of the others?

Glyer: Yes. So, I lived in Malawi for three years. So, most people have seen what charity is kind of like from the American side of things. They give five bucks to a charity and then that charity bugs them every week for the next year, asking them for more money and they never show where their money goes. And they promise they're constantly saying "Hey, we're doing all these amazing things, we're helping 10,000 kids here and 5,000 kids here," and they throw all these confusing numbers at you but they never show you anything. And they're responsible to no one.

And you can go to Charity Navigator and you can kind of see all of these percentages going here. But ultimately, you can make up all of those numbers, numerical transparency is a complete farce. So if you've ever given money to a really big charity, I'm sorry, but there's a good chance that it's been blown. There are a few charities I would highly recommend and they are doing really good work and in general that's like one in 50.

The vast majority of charities are blowing your money. I say that as someone who lived in a third world country for three years and was on the other side of the world when that money was supposedly being spent. So, I was there when the executives of these big charities were coming and staying in nice hotels, eating really nice meals. And I was there when I saw tons of shoes---I've seen in Malawi a warehouse full of shoes in boxes that were never distributed but they were reported as distributed. There's no accountability whatsoever, there's no transparency and anyone who tells you "oh, we have unprecedented transparency." Well, prove it, show us. In general, no one's doing that.

So, I think what we do differently is we really do show you visually. If you gave money to a lady who needs a sewing machine. You will get to see her using that sewing machine and there's a good chance you'll get updates months or even years down the road of how that sewing-machine has improved her life after that one-time donation because our model is just a superior model to what most charities are using.

Listen to the episode for the full conversation!

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Money, Markets, and Democracy with George Bragues

Fri, Jan 20, 2017

What follows is an edited partial transcript of my conversation with George Bragues of the University of Guelph-Humber. We discussed his new book, Money, Markets, and Democracy: Politically Skewed Financial Markets and How to Fix Them. This is his second appearance on this show, you can hear the first one here.

Petersen: So your book looks at the interaction between Democratic politics and financial markets. In your introduction, you quote the Greek Prime Minister Alexi Tsipras, who claimed that "democracy cannot be blackmailed." And this was in the context of the 2015 bailout referendum that would have helped pay some of the massive Greek debt but at a cost of forcing them to adopt fiscal austerity. So, can you talk a little bit about that situation and how it played out and also what it tells us generally about the relationship between democracy and finance?

Bragues: Yes, sure. That situation has its origins about a year or two after the financial crisis of 2008. The financial crisis of 2008 initially arose out of the subprime mortgage sector in the United States. It affected banks worldwide that were holding or otherwise exposed to the subprime mortgage assets.

But then as one of the spillovers of this crisis we had pressure on countries in southern Europe including Portugal, Spain, and Greece. And so it all came to a head in 2010 and back then it was Nicolas Sarkozy and Merkel, Germany's chancellor---who's still around---was a player, and they came up with a framework to bail out these countries including Greece.

So, as part of those bailouts, Greece had to comply with various conditions including the fiscal austerity measures that you mentioned, there was a privatization that had to be done but it didn't go so well and so in early 2015---if I remember these dates correctly---Tsipras is leading what was then a sort of outsider party, one of the two major parties in Greece. And so they thought that they would take a different approach to the previous Greek government which was to play ball with mainly Germany and instead of playing ball with Germany and trying to use measures to get their budget under control they thought that they would try to essentially threaten the breakdown of the financial system. a breakdown of the euro unless Greece were forgiven their debt or otherwise given more lenient measures.

The European establishment wasn't buying into that. So this is when Tsipras went to a vote, a referendum on a bailout package. He won that vote, that is to say, the Greek people voted resoundingly against the European establishment of the time, but that ended up not really mattering. The European establishment said basically we want our debt paid, we're willing to renegotiate the debt and you have to comply with these conditions.

And so that was a situation where democracy and the markets came into play. The Greek government was hoping that by creating a crisis in the markets through a democratic act, one of the most democratic acts you can imagine, which is a referendum---because in a referendum the people vote directly on a policy---that they were hoping that democracy would have its way---through the markets---would have its way. It didn't work out.

So, I start my book off with that event because it nicely and dramatically---the Greek situation is still ongoing---but it nicely illustrates how politics and the markets interact. And politics today in most of the developed world means democracy and this interaction between politics and markets, while known, while recognized, I don't think its full implications have been recognized and that's why I decided to write a book.

Petersen: So, with the bailout referendum---this is a massive debt---I believe it was 177% of Greece's GDP?

Bragues: That's correct, yes. It's probably different now. It's probably higher now, I haven't looked at the latest numbers.

Petersen: Even if they paid their entire output and didn't eat or consume anything, it would still take them almost two years to pay it off, which of course is unfeasible. And then they were trying to refuse to pay it off and I suppose they were hoping that markets would have a big reaction and then when they didn't their leverage was gone. They didn't have the bargaining power they thought they had.

Bragues: That's correct. The markets the next day---the referendum took place on a Sunday---and the next day the markets were down---not down significantly, specifically those in Europe, which would be more closely impacted---and the euro which was the key financial instrument in this entire drama barely reacted at all to the referendum result.

Now, part of that was because by this point---I mentioned before that this is a drama that had started back in 2010---the reason why the markets' reactions were muted by this time, much of the debt that the Greeks held were no longer held in private hands. In other words, they were not held by private market players, whether that be pension funds, commercial banks, hedge funds, and other institutional investors but they had been effectively transferred to the government, whether to taxpayers or to central banks who had started---even though this goes against the Maastricht Treaty that brought the euro into being---the Central Bank started buying European bonds, and I'm talking here specifically about the European Central Bank.

So, that's how it's played out. It's still currently playing out because Greece is back in the news because part of the deal that was made in the aftermath of the 2015 referendum is that Greece would still have to comply with various fiscal policy requirements and in order to get additional disbursements from the so-called troika, and the same party is in power, Tsipras continues to be in power and they still as you'd expect they would rather pay less debt or at least pay the debt on less onerous terms.

Petersen: The odd thing is that people keep lending them money when they're so resistant to paying back their loans.

Bragues: Yes, and that brings up the larger question I talk about in the book which is the role of the bond markets. The bond market is it is one of the biggest of the financial markets.

In the book I go through the main ones. These would include the stock market, the derivatives market, which has grown dramatically since the early 1970s, I go through the currency market, which is the biggest one, at least on a per-day trading rate. But the bond market is huge.

The bond market is a lot bigger than the stock market, it doesn't get as much public attention as the stock market does. It is not the subject of a cocktail party conversation the way the stock market is, but the bond market is huge. It is a major lifeline for governments---most governments today. It's hard to think of an exception among the democracies now---most governments today do not finance their expenditures, their infrastructure, their social programs through taxes. They run deficits and those deficits have effectively become perpetual.

If you go back to the early 1970s---and we can come back to the issue why the early 1970s is such a critical date---but you go back the early 1970s, you do find countries from time to time running fiscal surpluses, or running balanced budgets, but for the most part they're running deficits, and so as a result since then we've seen a sustained increase in the level of public debt as a percentage of GDP. And so we're getting close to levels that we haven't seen since World War Two among the OECD nations.

So, the bond market is a key player. I argue in the book that the bond market is an enabler of the worst fiscal habits of democratic states, that democratic political systems have an inherent tendency to overspend, and that the bond market becomes a very enticing place that politicians look to in order to finance the spending that helps them get them elected.

And so then the question arises why do the bond markets keep on buying the bonds of these increasingly indebted states? I'm not sure I have the complete answer to that question. That was one of the questions that really got me thinking as I was writing the book. I think tentatively the factors are these: the key one is the desire for safety that seems to be very strong in the human psyche. So, I think we have to go into psychological explanations for this.

The thing about government bonds, unlike bonds that you would buy, say, from a corporation, which is the other major sector of the bond market, government bonds are backed by taxes and taxes have to be paid. They are coerced from people. You don't pay your taxes, you'll either get fined or in a worst case scenario you end up doing time. A corporation doesn't have the same ability to gather money. It has to rely on the voluntary decisions of the buyers of its products. So, if you buy a bond in General Motors, or you buy a bond in Bell Canada or something like that, your ability to get money from that bond---and a bond is effectively, by the way, a loan that an investor extends to an entity, a government or corporate entity---so you buy a bond from Bell Canada or from some other private company, you've got to rely on the fact that they're going to be able to get people to buy their goods and services voluntarily.

When you buy a government bond, you have the assurance that the entity who is supposed to pay you back the money has the power to force people to give it money and so that makes government bonds safer, in general, all else being equal than corporate bonds. And since people do crave safety, they do crave security---I don't want to get too much into the depths of human psychology here---but there's a deep-seated desire to avert risk and this is well known. Among financial academics we talk about it all the time, we talk about it in terms of risk aversion as being part of the model that we used to depict investor behavior.

So, this is such a powerful desire to have safety when you invest your money, to know that if you plunk 1,000 dollars now and you're promised 2% interest, you will get that money back and a 2% interest at some future point in time. So, I think that's the most powerful driver for the demand of government bonds and that demand is so strong that investors will overlook the fiscal health of the countries to which they are effectively lending to.

I think the other factor is legislation. There you look at the regulations specifically pension funds but also banks and so on have to operate under, if they're required to have a certain percentage what are deemed to be safe investments in their portfolios---by the way this also includes insurance companies---and safe investments invariably encompass and tend to get restricted to government bonds and so there's a built-in legislatively driven demand for government bonds and this plays out

significantly with the commercial banks because they have to show to regulators that they have a certain level of core equity in their balance sheets. You look at these regulations---these are the Basel regulations---they have traditionally incentivized banks to buy their country's bonds. So, you've got a situation where Greek commercial banks tend to own a disproportionate amount of Greek government bonds or Italian commercial banks own disproportion amount of Italian government bonds. So, you have the banking sector effectively forced through legislation to have to finance the country's debt.

Petersen: So just as a part of doing business, if you're a bank, you have to show that you're safe. There was this issue during the financial crisis of these AAA rated mortgage securities and if you think about it in terms of just supply and demand and all these things, it's not clear why the rating is so important. But then when you think about needing to prove to a third party that I am safe, then what others think that your assets are worth or how safe others think they are, becomes really important.

And at least there's sort of a perverse element here where if you're lending to Iceland or Greece you can maybe get a higher return while still maybe appearing safe because you say, "well I've got all these government bonds," but the fact that they're not safe is why they can give you that higher return. And if you're managing a bank you want to earn a high return but you still want to appear safe and if you lose money you want to lose money when everyone's losing money so that you can say "hey it's not my fault, not personally at least."

Bragues: That's another factor too that everyone---and John Maynard Keynes, I don't agree with everything he says, but he's pretty good on this point, on the behavior of investment managers. You have a huge incentive as an investment manager to go with the crowd because if you're right with the crowd you can bask in the general adulation that all investment managers are receiving at that point in time, you're generating nice returns for folks. But if things go awry, the crowd becomes more important as a kind of protection device against criticism because you can always say---as you point out---that this is a systemic issue, I couldn't do anything about it everybody else also was adversely affected.

And so that does tend to work in favor of government bonds and does tend to over inflate the level of demand for government bonds relative to what they should get if you had a truly free market, people were just free to buy whatever bonds they thought would fit their risk return preferences. I think that's a key factor as to why I believe that bond markets end up not being vigilantes.

There's this line Edward Danny, a well-known analyst on Wall Street, came up with this phrase 'bond market vigilantes'. I believe it was in the 1990s and it supposedly referred to this group of people in the bond market who were always on the lookout for countries that were running fiscal deficits, that were doing the wrong things economically, and that these bond market vigilantes would pick on these countries by selling their bonds, shorting their bonds, and then putting those countries in a bind supposedly by raising the interest rates that they would have to pay any time they issued bonds again.

But the reality is that the bond market vigilante---if it exists---it exists too late. You look at the history of the bond market---we're talking a couple centuries now the bond market is actually older than the stock market---you look at this market and the vigilantes only come up really late in the game when it's pretty obvious that the government in question cannot pay and so the bond market doesn't do---I would argue---the job that it advertises: namely, always keeping yields in line with risk. It does tend to underestimate the level of risk, specifically with when it comes to governments.

This is a partial transcript only. For our full conversation, listen to the episode.

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Medicine, Entrepreneurship, and Health Policy with Ray March

Sat, Jan 14, 2017

What follows is an edited transcript of my discussion with Ray March about the economics of medicine and health insurance. We had a fascinating and far-reaching discussion about health care policy, both in the United States and Canada, as well as some cases of entrepreneurship in the medical sector.

This includes a slightly awkward discussion of the development of sexual pharmacology, the early experiments with nitrates and Viagra, and the, uhhh, "firmness" those drugs produce. Enjoy!

Petersen: My guest today is Ray March of Texas Tech University. Ray, welcome to Economics Detective Radio.

March: Thanks for having me.

Petersen: So our topic today is the economics of medicine. Ray's research concerns entrepreneurship and regulation in medicine. Let's start by talking about this idea of entrepreneurship in medicine.

The medical field isn't like Silicon Valley. You can't just launch a pharmaceutical company out of your parents' garage. In fact, the whole field is tightly regulated and controlled by the government both in the United States and Canada, other countries. So how do people in the medical field still manage to be entrepreneurial?

March: Entrepreneurship is fundamentally a question about how do I find resources I have now and put them towards their best use and that will help me turn a profit and therefore we have market signals. You're right to point out medicine is a much more regulated area compared to other service industries but what makes medicine entrepreneurial is that there's always a void to discover, there's always a need to find better uses and better cures or better ways to treat patients.

And because the government is usually behind the curve in terms of the advancement of science---and this is particularly true in health science and medicine---there's always opportunities for entrepreneurship. And a lot of my research explains or tries to explore what are these areas of medicine or of health just more broadly that the government is not involved in because they're not necessarily aware that this is an emerging field. And that leaves room for scientists and more broadly entrepreneurs to come and fill in gaps.

Petersen: Okay. So, when you say the government is behind the curve, a big part of that is the Food and Drug Administration, the FDA, in the United States. And of course it has its equivalent in other countries as well. So, tell me a little bit about the FDA. So, if I discovered a new drug, what kind of process would it take for me to bring it to market in the United States?

March: If you want to go through the FDA procedure usually takes between 12 and 20 years and somewhere around a billion dollars of investment. You bring it to the FDA, you go through initial screening which is "Is the drug effective?" "Can it actually do what you purport it can do?" That's phase one. Phase two is a little bit larger clinical trial so instead of 30 people you go through 1,000 people. And you have to report that it's also effective.

Then you get into safety which is what the FDA was originally intended to do was to eliminate the worry that they were going to be unsafe drugs on the market. Then you have to go through a clinical trial about typically 3,000 people to show that it doesn't hurt them. Beyond that, you've got phase four which is approval, you get your drug approved and even the drug is approved, you are not quite off the hook.

Yet you still have to have post surveillance. And post surveillance is, it's approved but if we find any problem outside on the market or we find that we didn't pick up with something in our very detailed clinical study, we find there is some kind of problem, then we can remove the drug and that typically lasts 14 to 16 years.

Petersen: Okay, so it's an extremely long process. Long and costly and we hear sort of horror stories about before there was an FDA---before there was regulation of medicine---you'd have people sell snake oil or tonics, miracle cures that really just made people sick. Doesn't it help to have a process in place to prevent the kind of things that might damage people's health?

March: Absolutely. I wouldn't deny that it's not helpful to have processes in place to weed out effective treatments from ineffective treatments. The question that I'd like to mention is who does the planning? Do we need to have the federal government with the FDA come in and say if you want to prescribe a drug legally or use a medical device legally you go through our process or does it make more sense to open it up broader and have competition? And that is where the entrepreneurs would find ways to treat elements and diseases and in effect, those are weeded out through the market process.

Petersen: Yeah so what I like in your research is that you've actually found cases of course of both kinds: of the FDA sort, of the public government regulation of drugs and also private regulation or private discovery of new uses of drugs. So, let's talk about your paper on entrepreneurship in off-label drug prescription. So, you look specifically at the off-label uses for three specific drugs: Aspirin, Viagra and---I might pronounce this wrong---Minoxidil?

March: No, perfect Minoxidil.

Petersen: Yeah, Minoxidil. Okay. So, first what is an off-label drug use? And why does it matter?

March: The off-label use of a drug is using a drug for a purpose that's not approved for by the FDA.

So, in the case of Aspirin, Aspirin is approved for pain relief or in the paper I say it's not just used for pain relief doctors also prescribe it to prevent myocardial infarction and other heart-related conditions.

So, in general, when you use a drug off-label, you are saying I'm prescribing it for use that hasn't gone through the rigors of the FDA's regulation. It hasn't gone through the four phases and the post surveillance, which in the United States is perfectly legal. But the reason that off-label becomes very important---and full disclosure, in the United States one out of four drugs is prescribed off-label, that is, one out of four pills you're taking is not for the approved FDA use---is that it allows doctors and pharmaceutical companies to be entrepreneurs, to find the best alternative use of medication, which the FDA in theory, could do, but because the process of approving drugs is so long and costly and often lags behind what medical professionals typically find 15-20 years ahead of the pace.

Petersen: Okay, but it seems contradictory that that would be legal because as you said the FDA is not just checking for safety, but for effectiveness. And if you're using Aspirin as a blood thinner, it hasn't been tested for that purpose. So isn't that a contradiction and shouldn't the FDA have some kind of interest in making sure these off-label drugs are effective?

March: So there's been put forth regulations on, or just people trying to get off-label drugs regulated so that you can't prescribe it for any use. And in some cases, there are instances where it is illegal to use a drug for off-label use. For example, if I'm a doctor, I can't prescribe you 40 Oxycontin in a bottle of liquor and then you can do physician-assisted suicide. I can't do that.

But the FDA, it does have some sort of an interest, from a public choice perspective, that they want to regulate all use of pharmaceuticals which it hasn't deemed safe. But I think this is where my research sort of comes into play here. The FDA is so far behind the curve, I don't think it's really aware of how these drugs are being prescribed.

And if we look at the case of Aspirin, Aspirin, the initial hypothesis put forth by Lawrence Craven---he was an entrepreneurial cardiologist---said that aspirin could be used to prevent heart attacks. This was in the 1940s. And a good period of 30 years went by before this really took off in the mainstream where this became a very common procedure to avoid heart attacks, or heart disease, other cardiovascular things. And the FDA only really got around to approving Aspirin in 1996---I believe this was the first year to approve it for preventative care. So, I think there is an interest on behalf of the FDA but I think it's also just the FDA is very slow. I don't think it's able to stay ahead of medicine or to regulate some of these uses.

Petersen: It's shocking to me that people would advocate to extend regulation to these off-label uses because if it's one in four pills in the United States, if you then banned those uses, wouldn't one in four patients then become sicker? Who's doing this advocating?

March: One of the key distinctions to keep in mind is keeping you safe is not helping necessarily, it's not curing you. And those are two distinct things a lot of people won't necessarily think through the implications of when they want to advocate the FDA should have more power.

Petersen: Okay, so that's one argument I've heard is that if the FDA approves a drug that then goes and poisons people and it turns out it wasn't safe after all then, it would be a huge political fiasco maybe the head of the FDA could get fired or definitely the people who were directly responsible for approving that drug. But if the FDA simply delays approving a drug and the same number of people die on account of not getting it---people whose lives would have been saved by it---then, the incentives are kind of asymmetrical. The error of omission is punished less harshly or not at all compared to the error of commission.

March: Absolutely. I mean that's the seen and the unseen. What's seen is that the FDA is keeping all these drugs going constrained or not, keeping them off the market because they want consumers to be safe and they want to run through these clinical tests again. But what you don't see is that people who are in dire situations that need this to feel better or to function or even save their lives. You don't necessarily account for that when you account for the cost of the FDA. So, it's one thing to say it's 20 years of approval and a billion dollars or 1.2 billion dollars to have the drug approved, but you also don't account for the lives that are waiting to get ahold of this drug.

Petersen: So, even though there's this huge process to sort of block, or to slow down drugs from reaching the market so that they can be tested and checked and made sure they're safe and effective. Still most drugs, when companies do develop drugs they earn most of their money in the U.S. market because of the strong patent system there. So, there's something to be said for having at least these incentives for the drug companies to develop these things and to keep technology marching along. Can you speak to some of the differences between the U.S. and other countries with respect to pharmaceutical development?

March: Well, in terms of IP---and you're absolutely right that IP is a critical component of a lot of pharmaceutical companies' balance sheets---because they're going to invest large sums of money and large sums of time. Then if they go and put their drug on the market and then a generic comes out four or five months later, then there goes the profit margin. So that's an important component of U.S. pharmaceutical companies, where certainly European and in some cases, the Canadian pharmaceutical come and try to get their stuff approved by the FDA so they can get stronger patent rights.

But a lot of that is somewhat misleading. So, for instance there's no real reason medically that you should have one drug or that one drug is necessarily going to treat a huge variety of patients. When drugs go generic, you don't see just a drug go generic and it becomes the same drug, you see generics vary in their chemical structure. This way it's not just the drug becomes cheaper because there's no patent preventing other people from making this pharmaceutical or engaging in this chemical composition, but they vary the composition so they can better suit other consumers. So, it's not necessarily the case that when drugs go generic they all become the same and just immediately the price drops. There's a better service towards the consumer market.

Petersen: Yes. So, having these patents, on the one hand, they create the incentive to develop new things but on the other hand, they take away all the benefits of market competition which includes not only lower prices but also some of these sort of marginal improvements and developments in serving more niche markets and things like that.

So, where do we see competition in the drug market? You have a paper called "The Substance of Entrepreneurship and the Entrepreneurship of Substances" which is a wonderful title by the way, do you want to talk a little bit about the entrepreneurship of substances?

March: Sure what I tried to develop, or what me and my co-authors tried to develop in that paper is you have entrepreneurial theory which takes various forms whether you look at the Kirznerian theory or Baumol's theory and we try to adapt that for what I do is the market for pharmaceuticals.

In that paper I examine off-label drug prescription too, but I try to explain how does the entire process work. So, given we have severe, very stringent regulatory structure set forth by the FDA and we have these conflicting patent rights, how is it that we actually see entrepreneurship in treating people? And off-label, one, it creates alternative uses of resources which is what entrepreneurship is in a nutshell, is find the best use for scarce means and then when they find better uses for existing drugs---so Aspirin, Minoxidil, Viagra like I talked about in my other paper---these findings get distributed through medical journals which is the system of how do we figure out which drugs are safe to treat various illnesses that we previously weren't aware of.

Pharmaceutical sales representatives are going to also play a role in doing that, but they're not supposed to disclose too much information about off-label drug prescriptions, that's another regulation. But fundamentally what you have there is a system of feedback. So, without the FDA's involvement physicians and pharmaceutical companies are able to find alternative uses for their drugs.

So, instead of Viagra being used to reduce cholesterol essentially or to reduce congestion in the heart, it's better used for sexual performance in males. And a lot of this was found in clinical trials which then got introduced in the U.S. market through voluntary tests which then became part of medical journals, which then were introduced into specialized medical journals to make sure that this information was distributed to urologists, or doctors of various disciplines and then that's how the market emerged for sexual pharmacology, which was largely an entrepreneurial act by urologists saying "We think sexual performance is not, for lack of a better word, all in your head. We actually think there's a physiological problem here and we think we can use pharmaceuticals to solve this."

Petersen: So, you're saying that the main purpose of Viagra, the one that we've all heard of, that was not its original use?

March: Oh no. Viagra was developed for heart congestion.

Petersen: Wow, I did not know that.

March: When you think of a little blue pill you think of erectile dysfunction for sexual performance, but no originally it was for---I'll tell the entire story, hope this goes to a family friendly audience---the story was this is developed in Britain, they started sending out these pills in an early clinical trial, they send them out to 30 or 100 middle-aged men, people you would think would be suspect for heart congestion and they send out the pills and they phone and they say "Okay, how is it? You feel like you have less heart palpitations? We will run your blood and we'll see what your actual congestion is."

And it didn't seem to be very effective in that, this is about halfway through a 30 day trial, and they say "Okay, well send the pills back" and then nobody sent them back.

So they were questioning "Why has nobody sent the pills back?" and they started getting reports, "Well it was actually helping with this other thing."

And then they said "Well we need to develop this drug for sexual performance. This is going to be a blockbuster."

Petersen: And before that there wasn't an interest in, or doctors were interested maybe more in saving lives. So it's almost like the market for sexual performance enhancing drugs sort of came from the consumers themselves. Before this nobody said "Hey you know what would we be great? A pill that enhances things in the bedroom." So, it's interesting. So they learned from the customers what their customers wanted.

March: Yes, in this case directly. The field of what's called sexual pharmacology---so treating sexual problems with drugs---it largely emerges in the United States originally not Britain, and it's in the 1950s. And it's a group of, I believe, is about half a dozen to twenty urologists treating urological problems.

They come to the conclusion that sexual problems are not all in your head, so it's not a psychological problem why sexual performance is not up to par, you're having these issues in the bedroom. It can actually be a physiological problem, so there's a problem with your sexual organs. And so they start experimenting with what were essentially nitrates, so things that affect blood flow and they start injecting them originally in themselves. So in the urologists' actual selves they would test that then test firmness, for lack of a better word, then they would say "Okay, we think this can help our patients we're going to prescribe these off-label."

Patients would go, they would increase their sexual performance, this starts getting out in medical journals. And then over across the ocean, you have Britain which sort of serendipitously comes across Viagra and finds out this little blue pill can actually do this too. They enter the U.S. market. So it's an international competition but it all originally starts with an entrepreneurial idea saying, "No, we think we have a better way to treat sexual dysfunction."

Petersen: Right. And yet they had to get over the idea that it was all---I don't know, this with would have been before the days when people also maybe believed strongly in mental illness because---the idea of something being "all in your head" in the age where we're all very aware that mental illness is an illness and it is related to physical things in your brain; the fact that something's all in your head doesn't mean necessarily that it's not real but this was the 50's, when maybe people philosophically didn't see things that way.

March: Right the 1950s---there was some awareness of mental illness in the 1950s---the 1950s is when you start to have anti-psychotics, it's when they start to see we can help people that have previously been institutionalized by giving them these drugs which uptake into the brain, which can help you alleviate manias and depression, or anxiety.

But the predominant theory for sexual dysfunction---it wasn't even called that back then, but what we can call for this podcast sexual dysfunction---was that this is a psychological problem so, the male couldn't perform---this is also true for females but what we were focusing on here is males---if the male couldn't perform it was some form of anxiety, so he needed to undergo psychotherapy or some kind of sexual therapy. And then he would go through that again and again until the point where he was comfortable enough performing sexually and that would somehow dissipate the problem.

But entrepreneur urologists come in and say "No." There's alternative explanations. It's not just that he has anxiety. It could be there's something actually physiologically wrong. And this is sort of a new idea because that, one, it's a whole new idea to say no the sexual performance is not always linked to your mental state or your perceived anxiety, but that we can actually treat this with injections, or with nitrates or with drugs and drugs that already exist on the market because we believe this is a blood flow problem.

They had it tested on themselves so they were pretty confident in their theory. But then to go ahead and give it to patients and then give patients the ability to self-medicate. All of this progress was a period of 20 or 25 years for them to progress to that stage to where ED can be treated---be self-treated really---without the use of psychotherapy which was inconsistently effective. And then we get to the point where you can just inject an oral tablet, that's where Viagra comes in. All of this comes about because of an entrepreneurial awareness to say "No, we don't think that the medical professional is treating this condition correctly."

Petersen: So, one thing you talk about in your paper is the idea of superfluous entrepreneurship. What is that and how has it occurred in drug markets?

March: Superfluous entrepreneurship as we go about it in this paper is the idea, given you're an entrepreneur in a regulatory state which prohibits you from discovering more effective ways to distribute goods, what happens to the goods you distribute? Are you distributing as effectively as you could without said regulation?

And one of the ones we analyze in the paper is the development of insulin. I'm sure you and your viewers are aware of what insulin is, a diabetic who can't produce his insulin or doesn't produce enough, the Type-one and Type-two, needs to inject that when he eats carbs so he can manage his blood sugar and avoid diabetic complications. So, when insulin originally hits the market we've got to go back to, I want to say the 1920s, when they first started doing animal insulin. We have pig insulin and we have bovine insulin which saved thousands of diabetics' lives at the time, but they have side effects. As you can imagine, insulin is a hormone, if you inject animal hormones in you, there's going to be some side effects.

And so by the time you get around to the 1940s we start finding ways, medical science advances enough to where we can synthetically produce human hormones, which is what modern insulin is, a human insulin. But the fear of the regulators is now that we can synthetically make hormones we don't necessarily know what are the side effects of synthetic hormones. And so in 1941 Congress passes what's literally called "The Insulin Act" which is if you're going to prescribe, or you're going to try to create a life-saving medication, which is what insulin is to diabetics, to Type-one diabetics especially, it has to go through additional rigorous testing.

So what that means is the release of human insulin on the U.S. market is delayed, so diabetics who need to receive their insulin are still taking bovine and pig insulin, which is okay but when there was a clearly better alternative being human insulin available, you end up with superfluous discovery so instead of investing time---and this is what happens in the insulin market---you invest time and effort into finding ways to reduce complications from injecting bovine insulin, or find ways to change the what's called the duration event, so how long insulin last in your bloodstream trying to find ways to manipulate that or make that better. You have a better alternative which is to immediately bring in human insulin and treat diabetics using that and that doesn't become possible in the U.S. market because of these delayed regulations. Eventually insulin does get on the market but you have a prolonged period where people are noticeably getting worse treatment than what's available.

Petersen: Right, and that's a very long period. I read in your paper they didn't approve human insulin until 1983 and did you say 1940s was when they discovered it?

March: I believe 1941 was when it was first available for clinical testing and this was all done in Germany.

Petersen: So 42 years.

March: Right, of taking animal hormones.

Petersen: Yes. So, the superfluous element of entrepreneurship is we have some kind of problem, people are willing to pay to have that problem solved. We have a cheap way of providing this subjective benefit to people, but the cheapest, best way that people would do in a free market is somehow blocked or illegal and so people entrepreneurship around regulation. Is that correct?

March: You certainly see that in illicit drug markets, but yes that's also true in some pharmaceutical markets. I want to get this drug approved in the United States. I have human insulin which is better than cow and so I want to get approved in the United States. There's a big market for diabetics in the United States but the additional regulation makes it tough. So, I can find a way to circumvent that, either bring it on the black market, the illicit drug component, or I have to say no I can't compete in the United States because it is going to take too long, I'm just going to prescribe it over here in Germany or in Asia.

And what that does, that just limits the entrepreneurial aspect of bringing better cures to market. So it's a superfluous effort you could say, marketing this drug in Asia or different countries in Europe instead of the United States. Those are all resources that could have been diverted towards something, or towards marketing the drug in the United States where you could argue it would be the highest value of use.

Petersen: Right. And in your paper you also talk about delta nine THC found in marijuana, which is a treatment for nausea. Can you talk about that? That's illegal of course because it's from marijuana.

March: That's an example where there's tons of medications out there for nausea, but the one you find in the medical marijuana derivative has been shown as particularly effective in difficult cases. So take cases where the typical forms of treatment which would normally help people---now we have more difficult cases---we're no longer allowed to prescribe these drugs we have to find synthetic uses of these drugs. So any time you take a synthetic use you're necessarily making the complications which you would face when the drug interacts with your body, they become a little bit more widespread. So you open yourself up to the treatment being less effective, but you also get more of a probability of these tail effects, where things you wouldn't necessarily see happen occur in your body.

So, you make the drug. In some cases it's less effective, but you also can potentially make it more dangerous, which is the superfluous act. I am trying to use synthetic drugs to treat cases or treat illnesses when there's a better alternative in the background. So, I'm just trying to find a new and better way to make a potentially dangerous drug safer when there are already safer drugs available.

Petersen: So a previous guest of this show, Mark Thornton, who you cite in your paper has argued that in the case of illicit drug markets, what the entrepreneurs do is to make them easier to smuggle by making them more concentrated, have a stronger effect for a smaller mass so they can be hidden in places where they're smuggled across borders or from the place they're produced to the place where they're sold. One example would of course be moonshine, so during the depression they obviously weren't selling low-alcohol-content wine because it would be so costly to smuggle that to people. They instead got the super strong moonshine and it was actually very dangerous. So, I suppose that's kind of an example of superfluous entrepreneurship, getting around the burdens placed on you, when in legal markets, of course, you don't have to always make things more concentrated and easier to smuggle because you don't have to smuggle them.

March: Right exactly. Entrepreneurship is finding---I have my product, I eventually face competition because I'm making a profit, how do I make my product better? And so when you have to change the institutional setting to where now I have a product that I'm selling but it's technically illegal to sell this product, where can I put my efforts best for us to continue making a profit?

In illicit markets it can just be the concentration, right? You mentioned the moonshine and the nine THC is another great example which is the main content of marijuana which people used to get high, you see the potency of these get much higher because that's primarily what you're trying to do is to sell the THC content to potential marijuana users. So instead of trying to find appropriate levels of THC or finding what you call niche, just accessories towards consuming marijuana which would differentiate the markets and serve consumers better, that is no longer profitable revenue and that's no longer a profitable or viable way to compete with people that are selling marijuana. Now it's how do I smuggle? How do I become a better or more active smuggler? And that's to raise the content of THC.

Petersen: Or to get people onto drugs like cocaine that are significantly more potent per weight. I guess the great point made by Thornton is that by criminalizing these things, by criminalizing milder drugs in particular, you create a market for stronger ones.

March: Right. Because that's how you compete on the margin for things like that. Yes.

Petersen: So what other kinds of entrepreneurship do you see in the United States in medicine? I've heard about people sort of getting around the medical system, joining collectives where they pay directly to their doctor, trying to get away from the sort of hybrid insurance system that you have down there.

March: That has become an alternative. And I don't know if I want to say an alternative market. But there has emerged a need for people to get outside of the larger insurance---that's the word I'm looking for---to get outside of the mainstream insurance market and to niche themselves into more specialized markets.

So, with the passage of the Affordable Care Act right now, everybody has to have health insurance or you pay a massive penalty. You've standardized insurance, which in some cases maybe there's nothing wrong in having a standardized package of insurance. When you try to blanket that over the population of the United States you leave out specialized cases.

So to give you a specific example what you see now in the market for diabetic treatment is now that insurance has become standardized to treat diabetics, you see less prescriptions written for specialized forms of insulin or insulin that acts faster or insulin that has a longer duration period. Now you see just generic insulin is being prescribed. Which is fine because the majority of diabetics are type-two diabetics and that's what they typically use, but then that leaves out cases of people with pancreatic cancer or type-one diabetics who need specialized insulin in order to better suit their individual illnesses, and you don't see that specialized treatment. So that leaves the market open for specialized insurance, or people that are going to co-ops, private alternatives where you pay into essentially a fund and 50 or so people will contribute 100 dollars a month. If one of them gets sick, they'll use the money in that fund to help this person overcome an illness they've come down with or any injury that's kept them outside of work.

I think a lot of those entrepreneurial aspects are trying to get out of standardized medicine, standardized insurance but again because all of this is more or less dictated by the government you don't have the wiggle room to compete on the margins, what you have to do is go completely outside of a highly regulated market. That's what you're seeing marginally with insurance. You don't see as much of that in medicine.

Medicine is a little more tightly controlled than insurance, even in the insurance market even today, but it's interesting. So, I think in the future there's going to emerge especially a larger market for these different forms of health insurance. It will help to treat people who have religious affiliations when they don't want to have insurance that helps to cover birth control or abortions for people that are in their group or they are pooled in the same insurance group. But also just people that aren't getting the kind of treatment they want. And this allows them to actually have health insurance for lack of a better word. I need a specialized form of treatment or I actually come down with a rare illness that the standard treatment is not going to help me with, I need to have insurance as a means to cover it and I think that's what you're seeing in the market with what you describe.

Petersen: Right. So, I live in Canada and we have single payer, which ultimately is like post-Obamacare having private insurance companies but then having everyone legally required to get the insurance and then having those insurance companies having the government dictate what they provide and require them to take on people with preexisting conditions. It's almost like just some sort of weird way of replicating single payer just while maintaining the veneer of a private system but in Canada we have single payer officially.

And there are some myths about it. So, we don't have socialized medicine per se. Doctors are not public servants but they can only accept payment from the government on your behalf, so sort of like maybe a private prison in the United States where they're kind of private but the only customer they can legally take on is the government.

March: Which you wouldn't typically describe as a market. The market is to serve the consumers.

Petersen: When the consumer is like a private contractor, serving the government. But of course we also restrict---you're not allowed to buy healthcare or medical care outside of the single payer system. There have been some court cases recently with people trying to argue for a right to do this but the typical thing to do is to cross the border to the States or fly to Southeast Asia to get your unapproved---or in order to pay for your own medicine.

And the sort of justification for this is they don't want people competing up the prices of medical services, medical goods. I guess they like their monopsony status as the only buyer of medical services. But whenever I find myself arguing against the system or saying something to the effect of "Hey this is a pure private good, why don't we let the free market provide it the way we do with our food and shelter and other things that are very important for living?" I get really smart people arguing against me and some of the things they say are "Can you point to a country with free market healthcare that works?" and I have to say "Well there isn't a country with pure free market healthcare" Singapore is 50/50 and maybe that's as close as you get.

But I guess to get to my question, why does every country intervene so strongly in medicine? What is it about medicine that that makes people really want to control it and have it centrally planned or regulated?

March: Sure. I think that's the fundamental question of health economics. Analyzed from the perspective of an economist, how much is the market able to take care of the sick or those less able to take care of themselves and how much do you need state interference or government involvement to make a successful health company or healthcare system work? The way I'd like to think about health economics if we get outside of just focusing on insurance or treatment of rare illnesses or pre-existing conditions or asymmetric information and all these complex issues that people like to point and say, "See that's where the market fails in healthcare, that's why you have to have a government."

Fundamentally what we're looking at is how do you deal with uncertainty? We have more or less ways of assessing risk, where we know your risk increases of lung disease if you smoke a cigarette as a simplified example. But how do we purely deal with uncertainty? So, I'm an insurance company and I take you on as a client, I don't know your health status. Various regulations make it impossible for me to find that out. But I don't know your health status. I don't know if in five years you're going to develop cancer, if you're going to be healthy for the next 30 or 40 years. How is it ideal with that as an insurance provider or if I'm a doctor how do I know you're going to use this pharmaceutical responsibly or how do I know that these other clinical trials I've seen where this has helped the patient with your condition is going to help you because there's heterogeneity in how people respond to things.

But fundamentally this uncertainty both in the provision of healthcare and in medical science itself, these permeate medicine. We're never fully going to be able to reduce the uncertainty. There's always going to be that element of the simple fact that we don't know. And I think that provokes the idea in a lot of people's heads that with no centralized plan we're not able to address this uncertainty. So we need to have the government come in and say health premiums need to be this or guarantee a system where even if you don't have health insurance you'll be taken care of if you need to go to the emergency room. Or if you come down with a very rare illness there will be pharmaceutical stock up in the hospital.

I just think that in general, the uncertainty drives a lot of people to look toward centralization or to develop a centralized plan to try to mitigate that. But a lot of those efforts are somewhat short sighted because when you centralize things you don't take advantage of the uncertainty aspect of anything you just put all of the decision-making power within a federal bureau, the FDA or the federal government or even the USDA to some degree. At least in the United States, I know Canada has similar governmental bodies up there.

But when you do that you divorce decision-making from the knowledge and you also divorce it from the incentive, like when we talked about what if the FDA doesn't have an incentive to release potentially dangerous drugs? Or as a pharmaceutical company if they see profits, they absolutely would, even if it is somewhat risky. So, I think the motivation primarily in why we don't see free healthcare or a free market in health insurance or competing systems of determining whether drugs are safe or effective is that there's a primary fear with people how do we address this uncertainty.

Petersen: So there are various elements of the uncertainty. If I'm an insurance company I might worry that the people who come buying insurance, there's an adverse selection problem so the people who come to me for insurance are going to be the people who are the least healthy or the people who expect, for some reason that maybe I can't observe, to get sick. And that means based on the fact that only people likely to get sick are coming to me, I need to charge very high premiums for my insurance. And so it's the classic market for lemons problem: The very fact that someone's selling you their used car maybe tells you that the car is a lemon. And the fact that you think it's a lemon means you won't pay very much for it, meaning that anyone who doesn't have a lemon wouldn't be willing to sell.

So, at least with that, it seems that pooling everyone into the same pool helps. But on the other hand you do lose competitiveness. So, one example I've heard is the cost of rhinoplasty---the plastic surgery to make your nose look better---since that's not paid, since governments perhaps rightly see that as it's not life-threatening, it's not important and we're not going to pay for it, you pay for it yourself. And we see that the cost of a rhinoplasty has fallen dramatically over the years. And whereas life-saving surgery, you look at healthcare and housing and I guess university tuition, those are the three big things that consistently go up in cost over the years.

Do you know a lot about the market for plastic surgery?

March: Not a whole lot. I do know that because it's not regular you have means of competing and you have essentially competition to provide you with care to make your nose look better or for facial reconstructive surgery and similar things.

I do know that a lot of cases like when you get breast augmentation you have to replace the inserts or whatever they're called. You have to replace those every set amount of years and you get routine inspections to make sure there's nothing going on with the surgical procedure, nothing wrong with the implant and all of that is done privately. So, it's interesting because getting plastic surgery is not necessarily a simple procedure. Just because the FDA is not involved in the procedure because there's not federal guidelines about when or when not you can do this procedure, how the procedure should be performed, it doesn't mean that the procedure is simple.

As you pointed out, it's not life-saving but it's still surgery and there are still risks and complications. What we typically don't hear, with the exception of maybe a few TV shows, that sort of shock people, we don't hear about these horrible things going wrong on the surgical table when people get nose jobs. And I think a lot of that has to do with because they have to compete to make sure people are happy with the outcome but they also have to make sure, again if the procedure is safe and its efficacy. You look better when you're done and nothing happens to you or receive complications, you get infections from surgeries. So you do see that a lot in the United States.

I want to go just briefly back into the adverse selection problem which I think is broadly the main argument for why you need to have government involvement in health insurance. Because you have that selection problem where only sick people want insurance and then insurance companies only want to provide really minimal standard care so you have that sort of mismatch and that would be a bad scenario for all. But to the extent that's true, it's based upon how is the insurance company is able to segment the market.

So, if you're comparatively healthier than me and you just want to have catastrophic care, so something that if you were involved in a horrible accident and nobody could have planned for it, you need to have emergency care. You pay pretty low premiums and then the deductible is higher whereas someone like me I'm a type-one diabetic who needs to have consistent care throughout their life in order to maintain their health, their premiums should be a little bit higher but then the deductible should be a little bit lower since I have to keep taking insulin.

But the problem is if they're not able to segment the market, and I think the reason they can't segment the market is because it's illegal to segment the market. What you don't have, they are two different forms of insurance. You don't have the insurance for sickly Ray me, or healthy you.

You don't have means to compete on those margins, all you have is various plans. You buy into them, you have health insurance costs go up because there's less competition and the reasons we have explained before. So a lot of what you see with the adverse selection problem is a lack of marketing and the lack of marketing stems from the fact that it's illegal to do a lot of the research that health insurance companies want to do.

Petersen: So, because deep down it seems so unfair that you could have a huge cost throughout your life just because you got sick through no fault of your own, we want people to pay the same. But then in doing so we create the adverse selection problem and it's sort of the old lady who swallowed the fly. We have to swallow the spider to eat the fly and eventually we're swallowing a single-payer healthcare system to put everyone in the same risk pool to deal with the problems that our initial minor intervention to try to make insurance more fair caused.

March: Right. So what we would end up doing in that situation is that you would have to pay premiums, I would have to pay premiums we want to equal them out because it's unfair that you should have to be subsidized me for lack of a better word. Well, that means that you end up paying more in premiums than you actually wanted health insurance, I would end up paying less because we have to even out.

More fundamentally if you want to address the fairness question---I think a lot of people do approach this from the aspect of fairness---is, one, why is it somewhat unfair for me as someone with a chronic illness to not have access to healthcare on a competitive market where I can decide which program I want, where I can assess my own risk, and where I can decide based upon my medical needs how at best to treat my illness; whereas someone like you who doesn't have a chronic illness places a completely different set of incentives? So when they pool us all they end up doing is limiting both of our choices. I think a fundamental question to ask there is which one of those is more or less fair?

Petersen: Right. So, what sort of institutional changes, big or small---obviously some things are more politically feasible than others---but what institutional changes would you like to see to improve on our system?

March: By "our" you mean the US system?

Petersen: Yes, or in the systems worldwide that have similarly been adopted for similar reasons by many different countries.

March: Sure. If we segment along the lines of there's health insurance and there's actual health products or health services.

I would primarily start with the approval of pharmaceuticals. And I say that because a significant portion of the illnesses and conditions in the United States are treated with pharmaceuticals. So, if we're able to allow competing access to approval processes, that would drastically lower the cost of drugs. If you lower the cost of drugs, health insurance becomes less vital, certainly in my situation but in a lot of people's situations who need access to pharmaceuticals. The access to insurance becomes less important because there's less of a risk that you won't be able to afford the treatment if you need it.

And I think that would push back insurance into---for lack of a better word---a more appropriate role. Insurance is supposed to be, there's a potential down the road that something bad will happen or I will develop an illness, I'll get sick, I'll break something, whatever you want to call it. I don't know if that's going to happen but if it does I want to make sure my livelihood or my standard of living continues as best it can. That's what actual insurance is. There's a chance that you could crash your car someday. And if your car is totaled you want to have repairs, you want a new car, that's why you buy car insurance. But now when we have health insurance we say "oh no health insurance covers your routine doctor, it's going to cover some aspect of your drugs if you get a prescription, it's going to cover procedures from other people in this case because everything is pooled."

But you don't see your progressive car insurance company pay for your oil change. That's a different thing. That's routine care. And I think if you reduce the cost of entry into medical devices and pharmaceuticals, so you reduce back the power of the FDA, you would naturally see health insurance go back into the proper insurance role. You could make an argument on the other way too as if you let insurance companies compete, premiums would go down. People would self-select into consuming health care products or not consuming health care products more effectively. That would drive down the cost.

But I think the primary problem here is there's a restriction of access to medical devices and to pharmaceuticals and once you allow for a market and that health insurance no longer competes on those margins it would compete on margins of trying to ascertain risk of whether that would happen or not down the road.

Petersen: So when you talk about pooling or when you talk about making approval cheaper, is that the system where two or more countries agree that a drug only needs to be approved in one of the countries to be allowed in all of them?

March: That's one method. I was thinking more along the lines of within the United States could have private companies that would give you gold and silver standards of approval for pharmaceutical X and drug Y. And then people based on that would decide, okay I want to take this drug or I want to take that one, or physicians would have more access to information based on that than waiting for the FDA to approve. That's more what I was thinking about.

On an international level that gets interesting because developing a drug in Europe and in Canada is completely different than developing that in the United States. The difference in the rigors of the approval process is what drives a lot of those conflicts but in terms of how you agree that everyone is going to come up with the same approval process method, I'm less optimistic about that because I think there's a public choice story behind it. Pharmaceutical companies want the approval process to be tough. So, like you said you can't develop pharmaceuticals in your basement despite your chemical knowledge.

I do think there's more of a hope in the future though for less emphasis on FDA approval and more for private raters or private ratings to come in and say these drugs have been shown safe or for pharmaceutical companies to interact with private laboratories or clinical testing facilities to say, okay we passed these tests, and we communicate that our product is safe without the FDA

Petersen: Right. And at the very least you could remove the effectiveness criteria from the FDA. Just say that the president or Congress could just tell the FDA, your job is just to check safety. Now if people want to take an ineffective drug, as long as it's safe they can do that.

There's the idea of right to try. Have you heard of that?

March: I have a segment of that in one of my pieces. I think that's very interesting because that's completely illegal action but you have certain states that will say okay if a drug is within phase three---that's when we start to do the safety testing with the FDA---and you say someone has an illness, they're in an insufferable pain, we know they're going to die, let's give them a shot to take this drug. And whether or not that helps or not is kind of secondary but it's a circumvention like we talked about earlier of the going around the FDA, which is a federal governing body, you are not supposed to be able circumvent that at the state level.

But you go around and you give people access to potentially life-saving medication. But me being more of a market-oriented economist, I wonder what if you did that not just for life-saving drugs but for other drugs? And granted there are risks with every single drug, basically including water has certain risks to it. But given that there are risks associated with every drug, what would emerge in a freer market where you could better ascertain the safety of these drugs or the efficacy of these drugs?

Petersen: So do you have any closing thoughts, anything we didn't mention?

March: I guess one last concluding thought with regards to health economics I just want to reiterate that health economics is fundamentally a question about which set of institutions is best able to deal with uncertainty. And uncertainty in the sense where we just don't have clearly defined answers. Who would be better able to protect the population of a country from an epidemic or who would be better able to take care of the mentally ill, which is a set of illnesses we don't know very much about, or who is better able to find alternative uses of pharmaceuticals given their potential potency to be able to help people, and the potential side effects?

And the debate is still very lively. It's to what level do we need centralization in order to answer these questions and to what level do the discovery processes of the market---for lack of a better word---how are we able to address these questions better? My research asks a question of if you don't have centralization what is the alternative? What are examples---not necessarily of entirely free health care systems---what are examples of private mechanisms working in the medical field and thus far I've found pretty convincing results that the private market is able to handle some pretty difficult situations, some pretty uncertain situations and when compared to the centralized alternative they fair fairly well.

Petersen: My guest today has been Ray March. Ray, thanks for being part of Economics Detective Radio.

March: Thanks for having me.


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Early Modern London, Wages, and the Industrial Revolution

Fri, Dec 23, 2016

What follows is an edited transcript of my conversation with Judy Stephenson.

Petersen: You're listening to Economics Detective Radio. My guest today is Judy Stephenson of Oxford University's Wadham college. Judy, welcome to Economics Detective Radio.

Stephenson: Thank you very much. It's nice to be here.

Petersen: So, our topic for today is economic history. Specifically we’ll be looking at some interesting research Judy has done on wage rates in the early modern period in London. This period is particularly interesting because it's the start of the Industrial Revolution which leads to a dramatic increase in the growth living standards and of technology and that trend of course is what has shaped our modern world and made it different from the world of the past. So, it's very important of course to understand this period if we want to understand the world as it is now. So Judy, start by giving us historical background. What was the world like in the period you study?

Stephenson: Well, I work mostly on researching London, so urban environments. And London is very developed in this period between about 1600 and 1800. And London becomes the biggest city in the world during this period and as the biggest city in the world it's hugely vibrant, some of the largest merchant houses in the world are there, banking is advanced and developing. Most of the occupations of London are tertiary or service sector, even at this early date.

The river is a huge source of both transportation and work, the port is where much of the capital, both physical and financial, from around the world comes through the city, and the professions and bureaucracy are well established in London in this period. It's growing at all levels of society, from the very poorest to the very richest exponentially. So, if you look at the population growth overall in the U.K. in the late 17th century from 1500-1600 to 1700, that actually is pretty much stable or slightly declining. But the population of London grows by a third or something in that period.

London is this hugely vibrant commercial social and cultural center and it's pretty much overtaken Amsterdam, which has come to the end of its golden age in the mid 17th century, right at this period. So, although the world more generally and in a wider sense can be typified by pre-industrial or agrarian values, London is very commercial in this period.

Petersen: Okay, so, if I were to get in a time machine and go back in time, maybe London would be more familiar to me, would seem, feel more modern than almost any other place.

Stephenson: I think it would be very familiar to you the way of getting around would be a sedan chair or a carriage. You can hire them on the street, in fact you send your boy out to get one. It looks very like Uber, it's a gig economy.

And most people working in unskilled, or who didn't have a trade or didn't have a profession or skill probably didn't have steady jobs. They thought of themselves as having work that they could rely on, but it wasn't wholly reliable and they definitely didn't have a contract that would keep them going, they probably didn't have many rights either. And they probably worked at two or three things and everything---the traditional literature about London in this period is one of inequality. So the very very poor literally scavenging on the streets among the smut because the streets were the sewers in those days, and the very very rich living in these incredibly grand environments with retinues and servants.

It's a golden age for the aristocracy after they had a pretty rubbish time in the 16th century. It's a golden age for the aristocracy, it's a golden age for art, for architecture, for all these things but it is also a period of desperate poverty and mortality. The plague doesn't die out in London until the end of the 17th century, but still very very high infant mortality and living standards are nothing like they become in the later 19th century, after they sorted out all those things. But from a commercial point of view, you might well recognise it.

Petersen: It's very interesting---and of course the whole period is interesting---but it's particularly interesting for what it becomes, really. The rest of the world starts becoming more like London, starting in this period.

Stephenson: Yes.

Petersen: And so you study wage rate of some of the day labourers and the workers in that period. How have economic historians gone about measuring things and getting data that far back in the past?

Stephenson: Well, data on wages and prices for this period was originally gathered by a guy---Thorold Rogers---who was a 19th century historian who started collecting wages and prices in the mid 19th century and finished 40 years later, literally a broken man. These are seven volumes from around England and he basically went into any long run institution where there was an archive or records, as they were called in those days, and just noted the quantities and prices found in the books.

But it was a huge project way before the days of even print noting, before the days of an efficient typewriter, let alone a computer. It was pretty haphazard as to what he was actually recording but it's very accurate. But he tended to take down labour costs or wages as day rates, and what he mostly found were builders because he was in big Oxford colleges and places like Westminster Abbey which had buildings from the 13th century and had required a lot of building maintenance and surprisingly he didn't find many other wages.

So this way of recording had a sort of half dependence. These day rates because they were the only ones that people could find it was assumed that wages---wage rates are very hard to find but there's always good ones for builders---and it was assumed that builders were the same everywhere in terms of skill levels so these could be comparative.

And Arthur Bowley---who is known as the father of modern statistics, an economist and statistician again working in the end of the 19th century and in the early 20th century---used builders in his first attempts to think statistically about an average wage, an average worker, and to establish a real wage. And Bowley’s work is absolutely seminal in the history of statistics, econometrics, and economic history. And he used Rogers' and others' wage rates of builders. And this tradition carried on as other historians gathered more rates, like Elizabeth Gilboy in the 1930s, and then Phelps Brown and Hopkins used all these people's data when they came up with the seminal Seven Centuries of Building Wages in 1955.

And what Phelps Brown and Hopkins had done was they took all those day rates from the builders, and then they took a series of wages and prices and they created a basket of goods and they offset the wages against the prices and they came up with an index of the real wage or living standards across the ages. And this has been the standard for measuring welfare since 1955. And because it's very difficult to find wage rates for the 18th century for some of the reasons I spoke about a minute ago---not many people have jobs, etc etc etc---the dependence on builders' wages continued until, with the most amazing econometric and advanced econometrics techniques that Greg Clarke and Robert Allen were using, they still use that data from the 1930s.

I think the latest good index Jeremy Boulton made in the early ‘90's, where he collected about 2,700 observations of wage rates. The key thing to remember here is all of these wage rates came from bills in the archives of the institutions. So they’re not really wages. In fact they are not wages at all. So, I don't know if you've ever worked for somebody and been charged out by the day, have you?

Petersen: I have not, but my wife is charged out, she works in data science and yes, she gets one wage and she's charged out to other firms at a different rate.

Stephenson: And what she's charged out is higher, right? So, when I worked in advertising, I cost my clients about 1,800 pounds a day, I saw about 350 of that. What a bloody enormous margin, actually. You got to look at how IPG were not making a really stonking profit on that but you know there's overhead and those kinds of things.

Well, in the 18th century everything, but particularly in the building trades, that's exactly how you dealt with masons or bricklayers or carpenters or labourers. And any economy that has to organize production---and the building they were organizing was pretty big, the Great Fire of London destroyed the old city and was completely rebuilt in about a decade---there's some serious organizational coordination mechanism problems of making all that stuff happen. And the 18th century way of doing it is contract it out. Firms are a series of sub-contracts and so the way wage rates have been collected were the sums that were paid to contractors and what those contractors pay their men were substantially lower than those wages that Phelps Brown and Hopkins had used, or Robert Allen had used and Rogers and people have recorded.

Petersen: Okay. In your paper you mention Robert Allen and he had a hypothesis that based on these faulty rage weights that high wages in London were a contributing factor in kicking off mechanization in the Industrial Revolution. So, can you talk a little bit about that hypothesis and how your new look at the data has, I suppose, called it into question?

Stephenson: Yeah. So, Allen has made the most seminal contribution to the study of the Industrial Revolution. So, the Industrial Revolution is the savored big debate in economic history really and it's a favorite big debate for lots of parts or disciplines within economic history. The history of technology people like it because of the gadgets, the history of macroeconomics and supply and demand people like it because of the factor prices, the history of the organizational people and sociological people like it because of the institutions in the factories.

So it has this broad appeal for everybody who's interested in the economics of the long run. Essentially, the core issue around the Industrial Revolution is it's unexplained. Why did it occur in England before anywhere else? It's this naughty problem that had never really been adequately explained until the early 2000s. Then there were two competing---well not two competing but two complementary---explanations by sort of giants of economic history in the same period.

So, Bob Allen explained it through England being a high-wage economy and Joel Mokyr explained it through a series of innovations and enlightenment and how that brings about sort of an intellectual enlightment in scientific innovation. Allen’s theory was the economists’ theory and still is. And essentially what he proposed is that the high wages of England incentivized the owners of production to substitute capital for labour.

Essentially because of the way series are constructed when you take all those comparative wage series of Amsterdam, London, Milan, Florence, Madrid, Antwerp, Strasbourg, when you sort of put them all together as a real wage series in the long run, the English wages looked substantially higher by comparison, particularly after 1650. It looked like the cost of labour for capital in England was much higher than it was in the rest of North Western Europe or Italy, where you had the traditional textile industries and banking, where there was some quite advanced commerce in places. Allen argued that the high wage economy first of all created those incentives but that also it had created higher human capital and skills, attracted capital to it, to prepare England for industrialization in the long run. But that the trigger was induced innovation through relative factor prices.

And part of his theory also was that coal was cheap and available in England, which is very hard to argue that it wasn't, the coal in China is in Mongolia, the Dutch don't have any they've got coal in the Ruhr, of course. But you know coal has been at the center of English energy requirements for a very long time as Tony Wrigley has written about in a very distinct way actually in a lovely book called Energy and the English Industrial Revolution, which is the kind of thing your children could read.

So the relative factor prices between energy and capital and labour were unique in England is Allen’s argument. So, obviously if you find out that the wages are 20% to 30% to even 40% lower than Allen thought, that presents a problem for that theory.

Petersen: I believe I heard once that Germany had coal but it had to be transported over land and so was as good as useless to them before the age of the steam engine and trucking. Coal is really important. And so Robert Allen felt that high wages in London and in England were important but it seems like this issue of measuring the contract rate instead of the wage rate casts doubt on that, or even---does it close the whole gap between London and the rest of Europe?

Stephenson: Good question. And that really depends on what sort of organizational form or coordination mechanism was in place in other countries.

So,I've looked into this with Amsterdam and Antwerp quite a bit already. I've done some work with Heidi Deneweth who works on the Low Countries on economy and building particularly. She's at Ghent. And we're finding in the way that building is organized in Amsterdam, in London, is that in London very much the state has completely outsourced everything. So, the city doesn't employ people directly, that's too much hassle. It seems like the cost of management to something is very high in England because they outsource everything: the navy, the supply, the whole thing. Bits of the navy are integrated into it, but a lot of it, particularly the supply to it, is outsourced and all building is outsourced. Whereas in Amsterdam the city still employs people who are digging dikes, and looking after canals, and doing maintenance work on public buildings. Whereas in London the comparable projects which would be stopping London Bridge from falling down, or wharfing the fleet ditch and making these canals and things. Those are given to large contractors and the contractors are solely responsible for labour.

Whereas there is some relationship between labour and the city, people are directly employed in Amsterdam, this is indicative only and we need to do a lot more work on comparing contracts in the same types of organizations. And then there's a guy called Luca Maccarelli, who is an established Italian historian of the building industry and industry in Milan generally and he has looked at some of the data for the wages for Florence and Milan particularly and he has shown that the day rate was only part of the wage there. In fact the contractors were throwing food, bonuses, cash savings, access to places to stay, and all sorts of perks at workers to try and induce them to work. So the wage in Italy was probably a little bit higher. In fact, Mark Reilly has said that we've understated Italy’s by 15-20% and then the person who's done the most work on France so far is Vincent Geloso, who's shown that the Strasbourg wages are probably problematic.

But all this comparative stuff is at a really early stage. And we need people to get out into the field, the way I've been in the field in London, and look at more the form of employment and the form of the wage in those places. And really understand, the figures that we've got are they real or have they got other sort of recording factors like I've shown in London? So it's too soon to say although we started work on that.

Petersen: So, for the modern era we have people collecting data and they're making a big effort to collect the same data across time and across place. Surveys asking the same survey question to everyone, or government data and making sure it's collected in the same way every year but when we're going back to the past, of course there was no one in the year 1700 collecting data on Italy, and London, and Amsterdam, and all these different places. And so we have to stitch it together from what is available and often that's very different datasets.

Stephenson: Exactly, and different types of records. So, it may be the case that all the records are a bit skewed and you know there'll be a new schema once we have all the new data together that does reproduce the Allen’s story. And remember that we need to take the prices of goods into account. It's a real wage calculation he's done not just a nominal wage calculation. But until we've done that, what we do know is the living standards in England were not what Allen thought at the moment but you've got to do the whole comparative thing to know.

Petersen: So, how do you distinguish the skilled from the unskilled? How do you make sure you're comparing the same kind of labour?

Stephenson: That's a good question. Traditionally pretty much everywhere in Europe we've gathered two types of wage: a skilled wage for what we call craftsmen and craftsman are people who have completed an apprenticeship, who are qualified, that's the idea. So, a mason who has studied seven years in England---doesn't seem to be as long anywhere else---or a carpenter who has studied in the long run. So, who has invested time in the development of the human capital and acquired skills and then we think about the unskilled person as a counterpoint as being the labourer.

And this is another important distinction because you know building labourers are actually of two kinds: there's the completely unskilled guy. Actually there are three kinds: there's the completely unskilled guy who's basically just handing them nails or wheeling a barrel around. But then there's the more skilled or semi-skilled assistant who actually is doing a lot more than that, who is preparing the work for the craftsman, who knows which tools go with which materials and who is fully assisting a craftsman and they couldn't really do the work without them. And you call that semi-skilled. And then there's a labourer who is hired really for their brawn. They've got a premium for being extremely strong and what you tend to see in building accounts is people who are actually hired by the load. They get 2 shillings and 8 to move a ton over a day or something---and probably need more than one man to do that---but so there's a brawn premium in these labourers or unskilled.

And actually from Phelps Brown and Hopkins onwards we've taken this semi-skilled or brawn wage to be the unskilled wage, but these people aren't unskilled. Whereas the unskilled, the guy wheeling the barrel, or just picking out nails was paid a lot less than those. So, if the rate for the semi-skilled guy was 18 pence a day in 1700, the rate for the unskilled guy was 12 to 14. So you can see there's a considerable premium in here. That's another thing that colours our understanding of welfare because usually it's the unskilled or subsistence wage that the macroeconomist is interested in. They relate unskilled and subsistence even though they maybe should not. It's that unskilled wage that is an indication of supply and demand in the labour market, and the draw of that. So taking building labour to a semi-skilled to be unskilled leads to some problems because it implies that unskilled people in London could afford four times the subsistence basket of welfare goods in 1700, when actually they could barely afford two.

So, if you're going to use a welfare basket these rates have a real issue and the distinction between skilled is…

Petersen: So, the reason maybe we care more about unskilled wages is because that's the wage that you'd expect to see in other places in the economy. For instance unskilled work in agriculture or working in a shop or things that we don't have data for we can sort of guess because presumably there's a labour market and people have mobility and if there was too big a gap between wages for different unskilled jobs then people would move, they’d arbitrage away that difference. So your paper, it has some sort of case studies. You have data from particular construction projects. I thought those might be interesting to go through. So, one of them is the reconstruction of St Paul's Cathedral after the Great Fire of London, which is a massive project, could you talk a little bit about that?

Stephenson: Well, yes it's a famous project because the old St. Paul’s had stood since I think the 14th century. It was this you know cultural and emotional symbol for Londoners apparently, and it had been redesigned---the front had been redesigned---by Indigo Jones, the kind of father of classical architecture in England. And it was completely destroyed by the fire and this was a sort of symbolic task to rebuild and so Christopher Wren hailed the King, came up with the design and you know Wren is pretty much the father of modern architecture and he's this enormous intellectual as well as architectural figure, he's very much part of the enlightenment.

So the project lasted about 35-40 years, so they declared it finished in 1711 and the Great Fire was 1666 and it's still there today, absolutely intact, it survived the Second World War. So it's this incredible and very emotive building. The interesting thing from a work point of view is it's very much a craftsman's building, it's not an artist's building. So there is sculpture there, there is painting but nothing like a European cathedral like St. Peter's, St. Paul’s is very much a display of English craftsmanship and baroque style and most of it is stone faced.

So, I have these wonderful papers, which are the day books of one of the Master Masons, one of the contracting masons who built the south west tower on the west front. His name was William Camster, his father was also a contracting mason on a separate contract and in the network of masons who served, ran and worked. We’d ran over 30 or 40 years and he was on site for about 10 years of the project from 1700 to 1709 or so and some after and I have his day books right, years of this, where he records every single man that was working for him and what they paid him. So, it's got an appeal because you can go and see what they did---which is very rare---working on the 18th century that you get some wage records and you can actually see the product as well. So, it's quite nice from that point of view.

So, from an economist's point of view the interesting thing is the way that they contracted the construction because they just started out one contract at a time and then if it worked, they’d go "Yes. We'll do that again." So, they had these repeated idiosyncratic contingent claims contracting going on and on and on and obviously disputes arise and they resolve them, or people drop out and they get new contractors. But the whole thing is basically on a rolling contingent claims contract what Oliver Hart and Holmstr?m said could never happen. Oliver Williamson would have had his head in his hands.

But the other notable thing is that the contractors financed this really because the Crown didn't pay them. It did pay them but the Crown and the city, they leveraged the coal tax but mostly people waited two or three years on contracts to be paid. So, the cost of financing that was just swallowed up by the contractors, it was in the price. And that's one of the reasons why you see a margin on labour and materials. But the interest costs for St. Paul's were as a total of the entire bill over 35 years about 20%, and very little of that had been lent by citizens and the city, a lot of that had come from the contractors themselves through just rolling over bills.

Petersen: That's interesting. So, we know not only what they were paying their day labours, but also implicitly we know the interest rate for that time.

Stephenson: We do. Yes, 6% for to and from the cathedral. Six percent on an annualized basis. Stephen Quinn and Temin and Voth have found higher rates, above 8% for some private lending around the same time. And it is likely that these contractors will have had to have done some private borrowing or lending within their networks to keep rolling this finance over. Because they will have bought the stone, they will have paid the carter, they will have paid the labours who are working for the carter, they will have paid the craftsman, so they may have well have to borrow to do all those things but 6% is what they got from the cathedral.

But the real question is then, so these networks of supply chains are surviving on that kind of finance. So really big contracts essentially on a very high level of trust or a very high level of interest. We need to do more work to find out which, but it does seem like these networks---because they repeatedly contract---they have good information and it's more effective than you would imagine those types of contracts to be.

Petersen: And of course they're contracting---it's the government paying for it ultimately right?

Stephenson: Yes, and it's financed through the coal tax which is also interesting. Bearing in mind the price of coal is relevant to development at this time. The coal tax was levied at a shilling a cauldron after the Great Fire to rebuild the churches for the city and then it was maintained through and into the Georgian period by parliament who kept sort of either adding to it or continuing it and apparently it was detested and greatly avoided.

But we definitely need some more research on how this work, and how people avoided it, and and what it did to coal consumption. Because you find in the accounts that the coal tax, they're expecting this much per year from it and consistently about 10 to 15% less comes in. So they have to turn to the city or to commissioners and people who might have money to borrow from them and tide it over. So financing the thing was unconventional.

Petersen: So, we usually think of government debt as being highly safe at least in the modern period but back then it may not have been.

Stephenson: Yes, and I don't know what the connection to other Treasury things are and Bank of England and everything. At the time it looks like it's just private between St. Paul's and the commissioners for St. Paul’s and either citizens or contractors and that it wasn't actually securitized as a state promise, but there may have been connections. It's something I haven't delved into enough.

Petersen: So, another construction project, in this case it's a maintenance project, is the famous London Bridge which of course in the nursery rhyme "London Bridge is falling down" which apparently was true. Can you tell me a little bit about that?

Stephenson: So, well London Bridge was it was built the end of 13th century and it's 19 stone piers across the Thames. It must have been the most fascinating and amazing structure, it stood for pretty much 500 years, but by the end of the 16th century in the early 17th century it is falling down.

And the Thames because this sort of development further up river as well, the Thames is actually a very strongly flowing tidal river at this stage and the force of the water force through those 19 piers is wearing away. So they built wooden starlings, so they built a wooden constructions they look like boats around the piers, trying to guide the water through and these of course made the problem worse and they made the waters faster. So to pass under the bridge in a boat at high tide apparently you could drop 10 feet through the rushing rapids beneath. So you pay the shootsman who was contracted by the bridge to guide you through the piers. And it was really quite dangerous.

So, the bridge has a number of maintenance problems: the first is the starlings the mason repairs. The second is until the mid 18th century the bridge was covered in housing just like Ponte Vecchio in Florence as a proper living bridge the housing was also in a state of disrepair and some of it owned by the bridge and some of it owned privately. So the bridge tried to take over the property that isn't theirs and then get rid of the housing that isn't working, it's falling into disrepair over this period.

And there's a guy called Mark Leighton who's written a brilliant thesis at the University of Leicester all about how the bridge masters and the City of London get rid of the housing in the mid 18th century.

But essentially the bridge is the only crossing from side to side, from north to south or vice versa until 1750. There isn't another way to cross the Thames. There was a little wooden bridge up in Putney in 1729. London Bridge it's got all of the infrastructure of London basically. And so it's hugely congested and falling apart. So, the maintenance bills are are huge.

Oh yeah as well. So as well as the starlings you then have water wheels which are basically bringing the water from the New River Company and the Thames to give water to the city. So those are also in operation, these whole teams of little engineers looking after the water wheels. So it's a really busy bridge it's got people scrambling over it all the time looking after it, not before the shootsman or anybody else doing any work on it and those people were paid not very much.

The master craftsmen were paid for their contract and got a really good rate for looking after the contract, and then they hired others piecemeal so they'd hire well-known carpenters or masons. But they'd never have regular days or regular work and then the labourers were paid by the tide.

So at high tide you could work on the bridge or you could work on the upper bits of the bridge if you were in a boat; at low tide you could access all those damaged starlings and piers. So at low tide they worked in boats and that meant that in the winter you might only get four tides in the week depending on when the tide and the light coincided, in the summer you could maybe get 11 and then when they didn't need any work done you wouldn't get any tides at all.

So, there were quite a number of people. It varied from teams of 12 to teams of 80 or so who were employed in this fashion in a piecemeal just waiting for a little sort of bit of peace work on London Bridge. So, it's an interesting bit of contact with the sort of materiality of the world as well, everything was literally ruled by when the water came in.

Petersen: Right. And since it's such a long period of time, I suppose you can get a decent time series of that change in the wages over that period.

Stephenson: Yes, from a labour economist point of view, one of the fascinating things about the 18th century is this persistence of rates, particularly for labourers, it's a very monopsonistic market it's a classic monopsonistic market. It's a wage posting. One where employers basically will see who will come at this set wage and what happens is they don't change the wage.

The fluctuation happens around the number of days worked. So people don't turn up, or don't get work when there is less to do. The number of days fall away and when there is high demand, an upward-sloping curve, the number of days go up for everybody.

But a transaction cost analysis would suggest that the 18th century employer understood the costs of such information very well indeed because they weren't going to have any asymmetry of information. They were going to post ‘this is what you get,’ particularly the unskilled hand and the time or the amount of work that you got was how the fluctuations and the dispersion occurred.

So there's a lot more work to be done on that because nobody's really ever looked at this kind of market in those modern terms, understanding it as monopsonistic or having search or information costs.

And it's only with these levels of micro data that we can begin to understand that it might have worked like the labour market we know. Until about 20 years ago people thought---until much more recently actually, the last paper I can see about this is in 2007 by Leonard Schwartz---that essentially before 1840 it's a market dominated by custom not by market forces. But on a micro analysis it looks very much like there are just the kind of market forces at play that we understand today. So, wage posting at the lower level, a little bit of wage bargaining at the skills level, and supply and demand do actually equilibrate but not through the rate, through the number of days worked, which of course brings about the income.

Petersen: So, the third construction project you discuss is the Westminster Bridge, which I suppose is that that second bridge you mentioned earlier.

Stephenson: Yes, the second bridge, the cross rail of the 18th century.

Petersen: Is that interesting from an economic history point of view, we have a lot of data from that?

Stephenson: You get less data because I don't have anybody's nice little book saying who came in and on which day, so I don't have the number of days' work for Westminster Bridge.

The interesting thing about Westminster Bridge is the different kinds of contract. Everybody, they were making contracts for hundreds of thousands of pounds with the masons and engineers and they also had a contract with a guy who had a horse and three piles for 27 pounds for the year. So, you've got this variation in value or risk from a financial point of view which is quite dramatic.

But the key thing is that at Westminster Bridge you find the tide and the day model as well. So a much smaller number of days than you would expect that are actually billed to the institution, but this means of paying by the tide, which protects productivity from an employer's point of view. So that also occurs at Westminster Bridge.

And what you find is that people are doing quite advanced and quite dangerous work, but without the danger money. They were given gin instead. So they sank caissons, this is one of the earliest uses of caissons designed to create the piers. So these things are experimental to say the least, and they put people in diving gear into the caissons and it must have been terrifying, you know, what if the stuff gave way and they went under the Thames. In February, because that's the time you want to be in the Thames! You know, in 18th century diving gear. And got them to work on the masonry or on the carpentry on the bed of the river for the same rate as you could be having quite a nice comfy time carving out something simple, or doing some basic maintenance work on a couple of windows on some bridge houses. So, yes very dangerous work. There seemed to be a lot of skill available, ready to do that work at those kinds of rates.

Petersen: So, where do you see this research program going in the future?

Stephenson: There's obviously an issue about the rate of welfare, the real wage and welfare in the 18th century and to be honest if we're going to make a serious contribution to that, we need to start looking at people who aren't builders.

I've started a project with the Cambridge Group for the History of Population and Social Structure, where I spent a year before I went to Oxford, on London occupations. Because that Cambridge group, they are the masters of working on occupational structure in the long run in England and we are sampling institutions that bought goods and services widely. And the kind of bills and the kind of businesses that they deal with to understand what sort of people were employed where. So, to try and get some welfare and some wage data beyond builders that we can normalize and use properly.

I think the second direction for this research is to understand how labour markets worked. Was there such a thing as custom? Because one of the old things we believe about the Industrial Revolution, and this idea doesn't really stand up anymore, but it's something that's still emotionally alluring for a lot of people, we see the Industrial Revolution as that sort of capitalism thing and our version of capitalism got going.

But if people already understood transaction cost economics, and Christopher Wren writes like Oliver Williamson sometimes, then maybe the market didn't start then, maybe they already had a view of the market. And there are some organizational things that we need to be looking at from that point of view.

Essentially the 18th century will always be interesting because it is a free market. It is unregulated, there's no corporation tax and the finance is not state controlled at all. This is before the gold standard, this is before states get interested in managing money in a big way. There is monetary policy but it's not in the same way we conceive it now. And so labour and capital have a relationship that is unencumbered by the state, by government, by regulation.

So what is the outcome of that? Was it a race to the bottom, was there any equilibrium, what happened? So, there's a contribution to be made to studying that as a sort of a history of ideas thing as well. It's hugely rich but those are broadly the three things that are on my agenda right now.

Petersen: My guest today has been Judy Stephenson. Judy thanks for being a part of Economics Detective Radio.

Stephenson: Thank you very much. I very much enjoyed talking to you.


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Wrongful Convictions, Exoneration, and Criminal Justice with Samuel Gross

Fri, Dec 16, 2016

What follows is an edited transcript of my conversation with Samuel Gross.

Petersen: You're listening to Economics Detective Radio. My guest today is Samuel Gross of the University of Michigan Law School. Sam, welcome to Economics Detective Radio.

Gross: Great to be here.

Petersen: So our topic for today is criminal justice, in particular, we're going to be looking at the issue of wrongful conviction. Dr. Gross was part of the establishment of the National Registry of Exonerations which has provided valuable data in this area. So let's start by talking about the registry. What is it? How was it developed? And what was your part in it?

Gross: I'm the founder of the registry. It was created because after doing work on false convictions and exonerations for half a dozen years it became clear that the only way to get any sort of systematic information on exonerations that have occurred in the United States would be to put together the wherewithal to collect that information directly because nobody else was doing it. There's no official system for gathering information on exonerations or for that matter a single legal definition of what is an exoneration. And from there this project just took off on its own and became what's now a lasting institution that's in the process of handing over to other people to run.

Petersen: Okay, so let's talk about the how an exoneration is defined in the registry. It's a case where someone has been convicted and then later that conviction has been overturned and presumably not just on a technicality but because the person was actually innocent---somehow managed to prove their innocence. Is that correct?

Gross: Something like that. The thing that we're interested in studying is false convictions. Convictions of people who are actually innocent. The problem is there's no way to know when that's happened directly because in cases where by assumption people have made errors, the juries and prosecutors and judges who considered the cases have made errors in deciding who is guilty and who is innocent. It would be foolhardy and presumptuous and not particularly accurate for us to believe that we're going to be better at deciding after the facts which cases involve those sorts of errors and which don't.

So, what we've done instead---instead of trying to make any judgment of our own about guilt or innocence based on whatever information we can collect from second or third or fourth hand sources---what we do instead is to consider cases, to classify cases of exonerations if they meet the following criteria: First, the defendant has to have been convicted of a crime, not just charged, the conviction has to be completely removed. That is, at the end of the process the defendant has to have no legal consequences from the original conviction which means the conviction was entirely overturned by dismissal, or by a pardon, or in a small number of cases---or by the acquittal over retrial---or in a small number of cases by one of the few procedures that are available for people who are exonerated posthumously, after they're dead. And then in addition, the process that led to that result has to include substantial evidence of innocence that was not available at the time of the original conviction.

If the case meets those criteria we include, if it doesn't we don't. Our belief is---and it's a hypothesis---is that this produces a conservative classification for actual innocence, for errors in determining guilt at trial. We know of quite a few cases of people who are very likely to be innocent who are not included by these criteria in particular. Quite a few cases of people who reach that result having the conviction entirely removed from the record without the production of new evidence of innocence. For example, cases in which the conviction was reversed and then they are dismissed want to appeal because there was insufficient evidence to convict at trial unless some other evidence comes up before the conviction is reversed don't generally count.

And our hypothesis is that we include a very small number of cases of guilty people who did meet these criteria. Although there are no doubt some, it's possible, but the process that it takes to get convictions reversed and dismissed in this manner in the United States is very difficult and as a result as far as we can tell there are not very many misclassifications of people who did prison based on the underlying crimes but meet the criteria for exoneration. That is the best we can do.

Petersen: One thing I learned from your research is that the average time it takes a wrongfully convicted person to be exonerated is 10.1 years. So it seems like the system is stacked against it.

Gross: It changes depending on the mix of exonerations we have. In the moment it's probably gone down a little bit, but that's about right. Ten years is close to the average

Petersen: Looking through the registry I noticed some interesting patterns that I wonder if you'd like to comment on. So for instance, I was surprised by how few of these exonerations were about DNA evidence. It seems like it's actually more common for a witness to recant their testimony or for other non-DNA things, but I guess looking at media or just my own intuition I would have thought that DNA would be the big factor in a lot of these.

Gross: And that's a very common misconception. I think most Americans think that exoneration is the second word of a two-word phrase that begins with the letters DNA. And that's of course, as you know, not true. DNA exonerations have always been a minority and in the past 10-15 years, they are an increasingly small minority.

The number of DNA exonerations has been relatively steady over the past 10 years, about 20 a year, and the number of not DNA exonerations has been going up rapidly. The basic reason behind this is the DNA, which can be very telling and provide extraordinary strong evidence of guilt or of innocence, is only valuable in a small range of cases. It depends on having biological trace evidence that identifies a particular person as the person who committed a crime.

That's relatively straightforward in the case of sexual assaults---rapes in particular---where the trace evidence that's left is very hard to explain except as a consequence of the crime. So if you recover semen from the body of a rape victim and it's identified by DNA as coming from a particular person and that person is not a consensual sexual partner of the victim, then you have the rapist. Assuming that rape really did occur. But if it's a question of identity, which is the case in most of the rape exonerations we know about, that tells you both who the person is if you can identify the profile---and in the case of exonerations who it is not---because DNA comes asymptotically close to being a unique identifier in that type of DNA evidence.

But that's rape cases. Some other violent crimes produce DNA evidence that is as valuable or nearly as valuable. Usually murder cases in which there's blood evidence sometimes, other types of biological trace evidence, perspiration, epithelial cells from the skin and other bodily fluids and that can identify people under circumstances where you can determine from other evidence that the biological sample that was retrieved could only have come from the person who committed the crime.

But most crimes don't have that. One of the things that's clear in the registry, for example, is that there are almost certainly many many cases of false convictions in robberies that are not exonerated because they don't have the type of evidence that's available in rape cases. And in many rape cases there aren't either, but both robberies and rape cases that resolved in exonerations overwhelmingly are cases in which the suspect was misidentified by the victim or by sometimes more than one victim. There are three to five times as many robbery cases of this sort as rape cases---maybe more than that---and they are typically cases in which errors are more likely because the victims may only get a sidelong glance at the robber whereas rape cases almost by definition require much more close contact with the perpetrator.

Nonetheless, despite the fact of the numbers suggest we have many more exonerations in robbery cases. Rape exonerations outnumber robbery exonerations by about 3-5:1. And the reason of that is because the rape cases can be exonerated by DNA but the robbery cases can't because you don't have DNA for the type of conduct that's involved in robberies. You don't have DNA that you can retrieve from threats that are made or guns that are waved or even guns that are used. And as result, those cases are not exonerated at all. Now given the huge disproportion between the cases in which DNA is valuable, and cases in which DNA is never going to play any role, it's not surprising that the great majority of exonerations don't involve DNA. But the availability of DNA in the small number of cases---comparatively small number of cases---in which it is valuable does make those cases ones in which the possibility of correcting a terrible mistake is considerably harder.

Petersen: So, you mentioned the increase in recent years in non-DNA exonerations. I was looking at the data and in 2011 there were only 73 exonerations in the Registry, but in 2015 it had more than doubled to 157. So, I wonder what's changed in recent years to make that number increase so much?

Gross: It is a general change and then there are particular---couple particular strands that stand out. The general change is that the resources that are devoted to reinvestigating cases where defendants were convicted and there are now doubts about the accuracy of the convictions are increasing year by year. And the willingness of everybody involved, the criminal defense attorneys but also more importantly prosecutors, police officers, and judges to consider the possibility that someone who was convicted is innocent has grown greatly.

They have come to recognize that mistakes happen and the more exonerations occur the more people realize that this isn't just a once-in-a-lifetime event. And that's I think the force that is behind all of the specific changes that occur.

The two strands that have made the most difference in these numbers are---in the last 10 years, I think---are, in the past four or five a proliferation of Conviction Integrity Units across the country. These are specialized units within prosecutors' offices that focus on issues having to do with erroneous convictions. And for the most part, the ones that are most effective, look at cases within the jurisdiction in which there is a possibility that the wrong person is convicted and they work to re-investigate and sometimes exonerate the people involved. They have contributed an increasing proportion of the cases that we see. And to the extent of this becomes more widespread they might someday be a majority of all exonerations.

There are something like 25,000 local prosecutorial offices in the United States. I don't have the exact count now, I will in several weeks but my guess is that by now we have something like 30 Conviction Integrity Units around the country which represents a larger proportion of the population than that would suggest because those are some of the most populous counties, but it's still a minority of all cases where the local prosecutor has any organized interest in the issue. And then there is a particular pattern that came up in one county---Harris County, Texas, where Houston is located---that contributed, I think it was 40 some exonerations last year and 40 some so far this year and 30 several years before that. And that's a back-log of cases of defendants in Harris County who pled guilty to possession of drugs and then after they pled guilty the Houston police criminal lab tested the substances they received from them to determine whether they, in fact, contained drugs and found that the material that was the basis for the conviction included no controlled substances whatever.

We ran into a number of cases as that over the years but starting in 2014 the attorney who runs the Conviction Integrity Unit in the Harris County district attorney's office noticed there was a whole bunch of these cases and they were being handled very haphazardly and put together a program to identify them all, to clear the backlog and to set up procedures for getting the defendants exonerated and they're still working through that. The thing that's interesting about those cases is that, that procedure testing drugs that were seized from people, the supposed drugs that were seized from suspects after the defendants have already pled guilty to something that as far as we know doesn't happen any place else in the country or didn't---now I think a couple of other jurisdictions have begun to do it at least occasionally---but it's just that there may out there be thousands of cases a year of defendants who pled guilty to possession of drugs when in fact they were not in possession of any illegal drugs. Although they could be exonerated by quite a simple process, it doesn't take an elaborate investigation just running the drugs through the police lab, which could be done. Except in Harris County, until the last year or two nobody's ever done that.

Petersen: That's so strange. Were they caught with a little baggie of oregano or powdered sugar and just everyone assumed it was drugs?

Gross: It's a whole lot of different things but it's a good question. In some cases, they were arrested for possession of pills that were identified by the police officer as likely or actually being a controlled substance---often Xanax---and then tested by the lab and found not to be Xanax. Sometimes ibuprofen, sometimes some other over-the-counter medications.

In some cases, they had the smallest amount of white powder. One woman who ended up in the paper had white powder on her face because she had the habit of eating flour, which some people do, eating flour mixed with water and was left with some white powder around her mouth. In cases like that, where small amounts of white powder or something else were tested, they were subjected to field tests for drugs which have become notorious in the past year or two because they are so unreliable.

Field tests for drugs are not admissible evidence in court to show that the substance involved was a controlled substance but they're considered good enough to perform the arrest. Then what happens is the defendants who were arrested on these charges show up in court three days later and if they can't make bail, which seems to be true in basically all the cases that we know about---perhaps with a few exceptions---then they're given a choice that amounts to this: Plead guilty today and you'll get some perhaps suspended sentence and go home immediately, or another week and you'll be home in three days, or something like that, or a short-end by Harris County standards where drugs sentences are three weeks or two months or something like that. Or plead not guilty and then you'll be held in jail because you can't make bail for months, after which you'll go to trial and if you are convicted, and obviously you might be because some cop and some test said you were in possession of drugs, then you'll get perhaps years in state prison.

No doubt many people refuse to plead guilty in that situation because they're innocent. But some who are innocent do plead guilty and those are the ones we find out about.

Petersen: Right. So that process of being prosecuted, even when you're innocent, can sometimes be more costly than simply pleading guilty. Especially in the small cases.

Gross: If it's a low-level charge and you are held in pretrial detention, the process can be much more costly than a conviction after trial. In Harris County you could spend six months in jail or longer. So, I've heard stories of people who spend a year or more in jail waiting for trial. If you can make bail, then that's still a heavy cost. Having a trial hanging over your head and having to come back to court repeatedly is not a walk in the park. But if you're held in jail for that period it's an extraordinary cost. It obviously disrupts your life and it may tear your family apart, you would lose your job, you may not be able to get other employment, and so on.

Petersen: So one of the things we've learned in recent years is just how easy it is for police to get people to falsely confess, or to falsely accuse someone else of a crime. In fact, I think the number was 12% of the cases in the registry were false confessions and I believe it was a majority involved witness making false accusation or committing some kind of perjury. Why do people confess to things they didn't do, first?

Gross: Well, those are two different issues false confessions and perjury or other false accusations. Although there is sometimes an overlap. I don't think I agree with the statement that it's easy to get false confessions. In some cases, no doubt it is, but the false confessions that we know about are overwhelmingly in murder cases. And as far as we can know---but the information we have is not that good---they appear to be the result of long interrogations. Long would be the ones that really stand out, sometimes they take place over days, two, three days or longer with the defendant sometimes being questioned in relays by different officers.

But even interrogations of three, four hours or five hours---which is eternity if you're being questioned unrelentingly by police officers---are fairly uncommon. This costs the police quite a bit. It involves usually more than one officer over that period of time. Certainly one officer taking off that whole period of time and a fair amount of preparation. So it's not done very much, except in homicides, and it does happen in other cases but I think two-thirds or so of the false confessions that we know about are homicides cases, maybe more than that.

What's surprising to many people---and those working in the area have gotten used to it, but still somehow surprising---is not that it's easy to get people to falsely confess, but that people will falsely confess to murders that they didn't commit, that they had nothing to do with. It seems like such an unbelievably strange and self-destructive thing to do but it happens and it happens time and time again.

And what we see in these cases and what other researchers have shown, is that it's much more likely if the suspect is in one of two general very vulnerable categories: if the suspect is a teenager, or the suspect has some type of mental disability, is intellectually disabled and mentally ill. Those two groups are, as far as we can tell, much more likely to falsely confess than other people who are subject to these interrogations. They are very far less likely to be able to resist the pressures, they're more likely to respond to authorities or more likely to believe the promises and threats that are implied if not directly made in the process of interrogation. They're more likely to become hopeless, and they're more likely to---much more likely---to not grasp the seriousness of what's going on.

One of the most common things that people hear when they talk to a suspect who falsely confessed later on and ask why did you do it is "I confessed because I wanted to go home. I just told them what they wanted to hear so they'd let me go." Which of course does not happen or "I confessed because I just couldn't stand it anymore so I told them what they wanted to hear but I didn't think anybody would believe it. How can anybody take this seriously?" And they think that because they're there and they've been experiencing this onslaught going on for a while and they imagine that anybody knows what happened would say "why would anybody take seriously what somebody says after hours of being badgered and humiliated and lied to?" But of course, the jurors and the judges hear the confession at the end typically don't know what happened but they have a confession that has the defendant's name at the bottom.

Petersen: Right. So the other thing I was asking about is the false accusation. A lot of this comes in child sex abuse cases. There's a pattern in the data.

Gross: Yes, that's correct. Child sex abuse cases are overwhelmingly the cases in which there is no DNA or other physical evidence of the sex abuse. They are typically made on the accusations. The crimes are typically made anywhere from weeks to years after they occurred, way too late to have any kind of physical evidence.

And that as far as we can tell is accurate as well as inaccurate child sex abuse accusations. The children who were victimized by adults many, perhaps the majority, probably never report the abuse at all. And those who do, everybody understands, will not necessarily do it right away. Sometimes they have to be encouraged, but that means that false accusations are very hard to detect because what do you have? You have the nine-year-old girl who says that her stepfather molested her in some way, repeatedly over the period of a year. So ending a year or more before she ever tells about this. Nobody can figure out exactly what happened or what date this occurred, where people were, whether anybody else could have observed it, etc. The details of a crime that occurred in that context are essentially impossible to recover. To defend against it using evidence of timing, or the presence of other people, is generally impossible.

It becomes a contest of credibility and that means that if somebody is motivated to lie in the situation---and we see that in the cases that result in exoneration---the defendant may well be convicted and that will be the only evidence. And there are many of these cases in the registry. And they seem to often include cases which we don't find out about until years after the exoneration took place.

Often cases got little attention in the time for exoneration. I don't think we can come up with anything like an estimate of how come, but we do know that they're not rare.

Petersen: Moving to a different topic, you co-authored a paper published in 2014 on the rate of false convictions among death row inmates. I should say, I first heard of this study when someone quoted a statistic from it, the statistic that at least 4.1% of death row inmates are innocent, and my first thought when I heard that was that it couldn't possibly be right because nobody should have the tools to measure such a thing. So I read the paper and I was impressed with the method. So could you talk a little bit about the methods you used to get to that statistic?

Gross: Well, I have to agree with your initial intuition because having worked in this area for decades, 20 years ago I would have said this is not something that can be estimated. The proportion of false convictions can't be estimated because false convictions, are by their very nature, unobserved and for the most part unobservable.

You can't just have to find whether somebody is innocent or we wouldn't have false convictions. A lot of things are unobserved. We don't know the rate, the proportion of prisoners in the prison who have been exposed to tuberculosis, but we can test that if we want to. We can test a sample. But this isn't anything you can test. So the question is "Is there any way to come up with an estimate?" And in general, it's impossible because you don't have anything like the post-conviction information that will be necessary to come up with a clue as to how frequently innocent people are convicted and for what it's worth in the United States our background criminal justice statistics on convictions in general, are so bad that a comparison of people who are convicted is nearly impossible to define.

Death sentences in the United States are just different. They're different in two ways: First, we have through the Bureau of Justice Statistics a database that tracks everybody sentenced to death in the United States with reasonable precision from the time they're sentenced until the time they're removed from death-row by execution, or by death from natural causes, or by exoneration or by the most common means which is being re-sentenced to life in prison. And second we have an extraordinarily high rate of exonerations in death-sentence cases. Hundreds of times higher than for other crimes. And the reason for that is---depending on what you're comparing it to---perhaps only 10 or 20 times higher than other murders but much higher than other felonies in general and vastly higher than misdemeanors.

And the reason for that is that someone who is under sentence of death almost always will have access to resources to reconsider the possibility that he or she is innocent that are simply unavailable to almost everybody else who has been convicted of a serious crime in the United States. They're going to be represented by attorneys with few exceptions from the time they're convicted until the time they leave death-row, their cases are all subject to review in private courts which is not generally true for other people sentenced in the United States and in almost all cases there are multiple levels of review.

The resources that are available for attorneys are much greater and probably as important as any of that, the legal system itself---and judges in particular are much more interested in considering the possibility that people who might be executed could be innocent than they are in considering the innocence of anybody else including defendants who are sent to prison without the possibility of parole---and are much more open to reconsidering cases where new evidence of innocence comes up.

So the net result is a rate of exoneration that is vastly higher than any other type of case. Which means that if you just look at the rate of exoneration and compare it to the overall number of death sentences that occurred in the time period where the convictions which produces exoneration occurred you already get quite a high number, about 2.3% if you limit yourself to cases that are old enough so that by then anybody who will be exonerated probably was exonerated. That's a paper that one of my co-authors---Barbara O'Brien---and I published several years before the one you are referring to.

So that already gets you to a number that is surprisingly high but it's still going to be an underestimate. An underestimate because that also takes into account the many cases of defendants who are sentenced to death who are innocent, who have not been exonerated. The paper you mentioned tends to deal with that by focusing on one of the features of the process of exoneration and review of the cases of defendants who were sentenced to death and that is something I already mentioned.

If you're sentenced to death in the United States chances are you will never be executed. What will probably happen is that eventually, by one means or another, your sentence will be reduced from death to life in prison and you will be taken off death row and reassign to the general prison population and then you will die in prison as too many defendants who were convicted of murder and sentenced to life in prison and not sentenced to death. When that happens, the pressure to make sure that no innocent person is executed, which is the backbone motivation for the extraordinary high level of exonerations in death cases, is removed. The defendant is no longer under threat of death and the extraordinary resources and attention that that defendant gets go away. And as a result, what you see is the death penalty exonerations that occurred are overwhelmingly in cases of people who still remain under sentence of death and are on death row. And then once the threat of execution is removed, the rate of death sentencing drops back, as far as we can tell, basically to the same rate as other murder cases.

So the question for us was is there a way to estimate from the pattern of the cases that we know about---in particular, their histories as they wend their way through this process---what the rate of exoneration would be if defendants who are sentenced to death remain under threat of death indefinitely? That is, subject to the type of searching investigation and reconsideration that's available to defendants who might still be executed.

And there is a technique for doing that, which you're very likely familiar with, and that's survival analysis. Figuring out how to do it is a somewhat complicated process but we went eventually through and that produced the estimate that you see, which is 4.1%. Obviously there's a great level of uncertainty attached to that. But it is a legitimate estimate of the rate of false convictions in that context, given the assumption the underlying rate of exonerations is a decent measure of innocence. And that requires a sensitivity analysis, which we also go through in the paper.

And that leads to, I think, a solid conclusion that this is a conservative estimate of the rate of innocence among defendants who were sentenced to death. It's the lower bound of the point estimate, but it really means something between 3.2 to 5 point something percent. It's hard to know what it means, but it's somewhere in that range of 1 in 20 to 1 in 30. Which, I have to say, I was surprised how high it was.

Petersen: So where do you see this research program going in the future?

Gross: Well, unfortunately I cannot see duplicating that type of estimate for any other categories cases because we do not have that information. We don't have the background information on the cases themselves, which is necessary to do the survival analysis. You actually have to know how many cases survived, what the trajectory of each case was through the legal system and you don't have a glimmer of that except for capital cases. And second, the exoneration rate is much lower. So you can't make the leap from the exoneration rate to the false conviction rate. It would be much more tenuous.

Our estimate at the end amounts to saying that we detected something like 40% of the innocent people who were sentenced to death in this period in the United States. The rest, the great majority of them ended up in prison---under sentence of life in prison---without the possibility of parole and will probably remain in prison until they die.

Some number of them were no doubt executed. Although it follows from the same logic that leads to this estimate, that that will not be anything like 4%. That of the 12,000 of people who've been executed, if they were being executed in proportion to the number of people who were convicted who were innocent, it would be like 50 or something like that. But since so much of the process is geared to avoiding executing innocent people and that produces such a high exoneration rate, my guess would be much lower than that. It would probably translated into execution of probably 10-20-25 of innocent people over the past 30 some years. But that's it.

Again we don't know, we can't say which cases they are. But can we do the same thing for robberies, or kidnappings, or for that matters non-capital murders? I can't imagine that.

Petersen: My guest today has been Sam Gross. Sam thanks for being part of Economics Detective Radio.

Gross: My pleasure. Take care.


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The Basic Income Guarantee, Freedom, and the Welfare State with Otto Lehto

Fri, Dec 09, 2016

What follows is an edited transcript of my conversation with Otto Lehto.

Petersen: You're listening to Economics Detective Radio. My guest today is Otto Lehto of King's College London. He is formerly the chair of Finland's Basic Income Network. Otto, welcome to Economics Detective Radio.

Lehto: Oh it's my pleasure to be here.

Petersen: So our topic for today is the basic income guarantee. Otto, you approach this idea from the perspective of political philosophy, so let's start by discussing that. How about we start by talking about two of the major figures in political philosophy: John Rawls and Robert Nozick. What do each of them have to say about the welfare state and where do your views diverge from theirs?

Lehto: That is a good point to start indeed, although it is I think a bit lamentable that we have to start from those two figures because they have dominated the discussion so much during the last 50 years. In fact, it's very hard to have a conversation outside the boundaries set by those two figures, but they're both geniuses. They set the stage for the discussion, certainly in philosophy but also in public policy in many respects.

So, let's start with John Rawls. John Rawls really was a towering figure in Harvard, really starting from the 60's and throughout the 70's. He wrote this book, A Theory of Justice, which is considered one of the really truly great books in political philosophy that revolutionized the way we think about these subjects. But the short version of his theory, which is very influential even up to this day, is that people in societies should look at the framework of living with each other as a cooperative game where we all try to sort of not only maximize our own position but also to make the whole game fair for everybody. And so he called his theory Justice as Fairness, where people are entitled to a certain respect and autonomy, certain liberties as members of the democratic community where they can pursue their own ends. But they're also entitled to a redistributive scheme if they happen to be among the worst-off people in the society. They are entitled to redistributive transfers.

This framework sounds very familiar and indeed it should because it reflects the social democratic reality in which most Western societies operate. And even in later years he said that actually his philosophy, even though it starts from first principles and proceeds from there, is actually meant to be a philosophical justification of the intuitions that people in Western democracies---liberal democracies---have.

So, you combine liberal ideas of individual freedom with these notions of the welfare state and so on. So that was the foundation of Rawls' system.

So that's Rawls' system but Nozick came along and he found a place for himself in the same institution, that is Harvard, and he wrote a critique---a respectful critique---but a very thorough and deep critique of Rawls' theory. And he ended up justifying a minimal state that libertarians are very fond of. And he effectively said that no, people should just be seen as individuals who have some fundamental rights---he calls them side constrains---that people have a certain respect that they are owed by other people and it is very wrong for people to violate their personal boundaries and this includes the State.

The state has actually no right to violate the sort of inviolable right to property rights that individuals have. So every form of taxation, that features very prominently even in Rawls' system, is theft. So, that is of course a very prominent theme in libertarianism. So his book---which by the way is really brilliant philosophically, it's not only just a standard justification of libertarianism but it's actually one of the great books in philosophy because it's so rich and powerful and full of interesting ideas and strange examples and brilliant footnotes and all that---but that lay down the other side. And so the debate in intellectual philosophy and history in the last 50 years or so has been largely dominated by these two figures: Rawls' Theory of Justice on the one hand, a justification of social democracy with a liberal bent, and then on the other hand Nozick's Anarchy, State and Utopia, which is a justification of libertarian taxation-is-theft ideology. So that is the framework in which we find ourselves.

Petersen: So there are these two competing extremes. You quote John Tomasi's critique of both of them. Would you like to summarize that for me?

Lehto: Yes. John Tomasi wrote a wonderful book in 2012 called Free Market Fairness where he actually tries to combine these two perspectives. And he says that actually there's a whole tradition that we're forgetting here when we focus only on these two---as you put it, they are both at extremes---although at least for Rawls himself, he's often considered a centrist. But in many ways, he represents this kind of---from a perspective that Tomasi points out---the perspective of classical liberalism even though the Rawlsian center-left position, he's actually seen going fundamentally wrong in many ways, even though that is the unquestionable framework in which people today operate.

And I should say, when I say that Rawls and Nozick laid a framework, it's not as if there is 50% on one side and 50% on the other side. Perhaps in politics, like the left-wing and right-wing ideologies have maybe about 50% on each side depending on the circumstances. But in philosophy certainly, Rawls has been the one that dominated the discussion and there are actually very few Nozickians around.

But Tomasi points out that even with this seemingly very credible and too wonderful system that Rawls lays out, there is very little attention paid to issues like individual freedom especially in the domain of economy. And the lack of respect for people's freedom of choices in economic matters is actually a major shortcoming in Rawls' system. And this is exactly what Tomasi points out and from the perspective of classical liberalism which he raises to the standard of something that we should actually take more seriously than we have today. He points out that actually economic liberty is something we should insert back into the conversation in a serious way without however on the other side falling down the assumption that Nozick makes---and a lot of libertarians make---that the only justification for all economic liberty necessarily leads to a justification for the night watchman state or the minimal state of libertarianism where there is no role for government to provide public services and all that.

And so this false dichotomy that Rawls and Nozick have put out has sort of made it difficult for people like myself and Tomasi and Matt Zwolinsky and people who consider themselves followers of the legacy of classical liberalism to lay out the more complicated, but I think more interesting, case for a system where robust economic liberties are combined with certain welfare state elements. Certain elements of taking seriously the power of the state to actually increase the real opportunities of people rather than just being a system of theft as Nozick calls it.

Petersen: So that's where something like the basic income guarantee comes in. Can you summarize what that is and how is that different from the welfare states most countries currently have?

Lehto: Right. Basic income guarantee, first of all, is defined as a regular payment to all citizens or residents of a political community that is given uniformly to all citizens. All people get the same amount and people get it without bureaucratic discretion. So it is given automatically or almost automatically to all people either in the form of a direct cash transfer to their bank account or in the form of a tax break system as in the form of negative income tax which is actually a form of basic income.

So this system is supposed to, and it is a way, to replace the bureaucratic complexity and the nightmarish disrespect for human autonomy and human freedom that lies in the center of the current welfare state system in my opinion and certainly in the opinion of Tomasi and other people who I'm referring to. So the basic income guarantee is superior to the current system and it differs from the current system in the sense that it actually operates under the principle that we shouldn't use the state to guarantee specific favors to specific people, we shouldn't use the state as a one-upmanship mechanism whereby one group of recipients carries for the favor of bureaucracies, tries to---and in a way infiltrate---the mechanisms of the state to redistribute money and resources to themselves or to groups that they favor against the interests and desires of other groups because this leads to a spiral of negative-sum game in the political economy. And I think welfare states today in this sense have become victim to this overzealous one-upmanship of special interest group politics and basic income is a way to overcome this problem.

Petersen: So the basic income guarantee, is it really a break from business as usual? It seems like it's a marginal improvement on the system we have now, but I guess you're suggesting that the system we have now encourages a lot of rent seeking, it has a lot of payments to different groups, it's needlessly complex. I could list some other problems with it. There are the so-called welfare cliffs where poor people face implicit marginal tax rates sometimes of a thousand percent, or some absurdly high amount because their benefits are clawed back when they earn a little more income. So there seems like there's a good economic justification for basic income. Is your work focused on the classical liberal philosophical justification for having a hands-off welfare state?

Lehto: Yes, in a way. The fundamental debate is truly between these two perspectives of whether it's a pragmatic justification for reform towards a slightly saner and slightly more useful and purposeful and beneficial system, or on the other hand, is it a requirement of justice that we have something like a basic income guarantee. And I think that really the truth is somewhere in between.

First of all, I think it certainly is a pragmatic improvement over the current system but I should point out already at this point that when I'm advocating for basic income I'm not advocating for basic income without demanding widespread reforms in other areas of life in the welfare state. I am indeed calling for massive restructuring of many of the mechanisms of the welfare state partially just to accommodate for the fact that we are taking basic income as the policy paradigm that we're trying to implement. Because if we take that as the policy paradigm, then we necessarily must reform the existing bureaucracies, tax system just to accommodate for the fact that we are taking this new system into effect.

In addition to this, I think that the whole framework of regulations, the whole framework of massive interventions into the economy, into the private life of citizens have to be addressed as serious violations of the capacity of the welfare state to truly increase the welfare of its people. Because my opinion is that the welfare state has failed because it has failed to address the proper means to achieve its own ends that it claims to have. Use of improper means to achieve its ends is the reason why the welfare state is failing so miserably everywhere in the world today. That it's claiming to be for the welfare of its citizens, but if you look at it in terms of its overall effect in many ways it fails.

Petersen: So, when I think of the policies that I'd like to see replaced by a basic income guarantee they're not just strictly welfare transfers. There's a theorem in economics called the Atkinson-Stiglitz theorem. It says that when you have an optimally designed progressive income tax scheme, basic income with a progressive income tax would be something like that, then it doesn't make sense to have additional programs designed to redistribute. And some of the programs that I think are basically focused on redistribution are things like protecting taxi drivers from competition from companies like Uber and Lyft, or a lot of the interventions into medicine are designed to make sure that people who get sick don't also become poor. And of course, if you had something like a basic income, every taxi driver could lose his job, he wouldn't fall below that minimum level. And so could at least in principle---if we were going to make sort of an ideal political bargain---a basic income guarantee would come with a lot of free market reforms ideally. Is that basically a big part of the reason why so many libertarians---such as Milton Friedman and Friedrich Hayek---have supported versions of a basic income?

Lehto: Well yes indeed, it has the feature of being compatible with a total abolition of the rest of the welfare state, or major portions of the welfare state. And in fact people like Charles Murray have recently proposed exactly that, a replacement of the welfare state by the means of a basic income given to all citizens as the second-best option to a complete free-market society. And people like Hayek and Friedman were also of the opinion that the majority of those transfers could be replaced.

So the thing with money is that money is a universal means of exchange and the uses of money and the need for money are as varied as people and situations. And when we think of basic income we don't think of it in terms of being for a particular purpose or for particular people or for particular circumstances unlike the current measures. And so it has the virtue---and perhaps the vice depending on your point of view---of being this universal situation, a neutral ground. And so indeed we can come up with hundreds of scenarios where a basic income could be useful for people. Obviously, some of those are covered by the current redistributive schemes within which by the way I would include things like farm subsidies, many forms of corporate welfare and so on.

So basic income has the virtue and vice of being neutral as regards purposes and situations. The only thing really is that if you don't have any other sources of income then you will get a basic income without having to beg for it from anybody either in the government or in the world of charity for example. So, yes indeed, people who are forced out of work to circumstances---whatever those circumstances happen to be---are able to survive, the people who are forced out of the labor market entirely for a reason---one reason or another---people who have temporary or permanent conditions that affect their capacity to find work will be covered up to this level, and people who perhaps want to take some time off to take care of their family, people who want to take some time off to study, to plan ahead, to perhaps think about starting a new company, they have some ideas but they don't have the means of funding yet, that allows people to focus on doing what they think is best for them at the moment. So it has almost an infinity of purposes precisely because there is an infinity of human beings and human desires that in a pure realistic society will have to be taken into account. And a welfare state that tries to measure what people truly need, or what circumstances need to be taken care of, fails precisely because it can never count the infinity of the variety of ways in which people end up in need of money in society.

Petersen: So before this welfare state that we currently have---the welfare state as it currently exists largely is a creation of the 20th century. But in the 19th century and early 20th century a lot of what you had was mutual aid societies and things like that. And I think a hard core maybe a Rothbardian libertarian who maybe still cares a lot about the poorest among us might say, why have a basic income? If we just had nothing there would still be the civil society and we could create something like a mutual aid society. Are there advantages of---is there reason to do this through the state, I guess is my question.

Lehto: As a very wide-going and deep-reaching utilitarian, for me it's all about checking what robustness criteria institutions might have, and what institutional arrangements we could come up with and seeing how they perform in the real world rather than in the realm of ideal theory. And we have some evidence of places where mutual aid societies worked and we have some evidence of places where forms of welfare state that are highly bureaucratic and oppressive and paternalistic have operated and both of those have several features that I think we can wish to want to get rid of.

So I think that if we look at societies where mutual aid societies were the sole means for people to survive I think they actually did a relatively good job in many cases but I think they failed to provide the sort of guarantee of security that I think a good society would wish to provide for people. That is, if we rely on the means of mutual aid societies you will get perhaps even a superior alternative to many forms of welfare state in the long run and I'm completely open to the idea that free markets can provide a very robust system of welfare. And actually that to me is one of the reasons why I consider myself a libertarian defender of a welfare state because I think that the libertarian part comes from actually understanding that markets are a good way of producing welfare and the opportunities available for markets and other forms of voluntary transfer, including mutual aid societies, are a way of providing a wide framework of security and services and other forms of protection.

But I think that they provide a patchwork which leaves a lot of people outside in a number of circumstances. And I think this fact that they have a lot of holes in the way into the system, they have a lot of uncertainty about guaranteed income and lot of uncertainty about who gets covered, who is seen as being worthy of being helped, who is seen as being worthy of being protected by a benevolent charity and so on, means that we need to have a system of making sure that people don't---perhaps out of no fault of their own---fall through the cracks of the free market system and the same goes for the welfare state. I think they actually are surprisingly similar the welfare state and the free market utopia, they both provide this patchwork framework where some people are protected, some people are not, there's a lot of uncertainty about who gets what, who gets protected, and who doesn't. And so actually in both systems, people fall through the cracks and this is exactly the reason why I think basic income guarantee can be a superior alternative to either of those.

But again we have to see what happens when we actually implement basic income, there could be a lot of unintended consequences. So we need to take those into account as well but at least on the side of theory, I think the idea of guaranteeing basic income, I think it's both desirable and practicable because we know how to do it technocratically and theoretically. I mean there's nothing so difficult with guaranteeing basic income via bank transfer to all citizens for example.

Petersen: So one virtue of the basic income guarantee is that it seems to be actually politically feasible within our current system and it has got some interest in recent years. We mentioned at the start of the episode that you were part of the effort to bring a basic income to Finland so could you tell me about the political situation there? I've heard that they're looking at bringing in a basic income guarantee.

Lehto: Yes, indeed. And here I'm being brutally pragmatic. Finland is not going to turn into any sort of libertarian utopia that I would wish for and certainly there are elements of paternalism there that are not going to go away. We still regulate the sale of alcohol in a very, I think, outrageous fashion for example and there are a lot of elements in the system that probably will keep us on the level of adult children for a long time. But as far as the welfare system is concerned, there is considerable consensus now that something like basic income would be a desirable reform. And this is seen by the majority of the population and by more than 50% of the M.P.'s in the parliament, basically from all parties with of course different proportions in different parties.

But yes indeed the center-right government is actually going with the basic income pilot experiment starting next year. It's I think a well-planned pilot. They have a lot of experts because we believe in experts in this country and in Finland the sort of reliance on experts is both good and bad in many ways. It always seems to suggest that there is a group of people who can define the perfect system but in this case I think they've done a pretty good job with planning this two-year pilot. We shall see what happens. It's certainly not ideal and the government is already bungling with some of its promises and how it is going to be organized.

But the basic premise for people who may not have an understanding or an idea in their mind of what this actually means, it means that basic income in the Finnish context would be the guarantee of something on the order of 500 to 600 to perhaps 800 Euros per month per person. And this would replace the various forms of unemployment benefits, sick leave benefits, student benefits and various other forms of benefits and Finland obviously has a lot of those already in place. And the complexity of the bureaucracy is such that even the experts who run it are surprisingly candid about their ignorance, about the complexities and mutual dependencies of the various benefit structures so that it's a maze that not even the experts can navigate, let alone regular ordinary people who are supposed to be the beneficiaries of the system. So a lot of people don't know how to apply for help, a lot of people don't know what benefits they're entitled to, and there's a long delay in getting the results of one's application for particular benefits---months, sometimes even the years. And a lot of people fall through the cracks in that fashion that I mentioned earlier.

And so I think we've come to the point almost by necessity, where this system is seen almost universally by all as in need of reform and basic income happens to be the form of this reform that is most universally seen as the one we should pursue even though of course there are still people who are very skeptical of it in many ways. But yes, indeed they're planning this experiment where they're giving something like 500 Euros to a few thousand people across Finland. It's a very small experiment, but there are people who will call for its expansion I'm sure in the years to come. That will be definitely a very interesting experiment to see how that goes.

Petersen: It seems like with the current system being so complex, it's almost like a part-time job just to collect benefits. You need to build expertise and you need to fill out the right forms and it takes a lot of your time and in many ways that makes it something that competes with the labor market for your time and your efforts and your human capital development. Seems like a basic income would be a good way to get people back into the labor market simply by virtue of freeing up their time to pursue something else. Do you see the political movement towards basic income making progress in other countries as well?

Lehto: So yes experiments are undergoing in a number of countries. In addition to these, Netherlands, Canada and U.S. experiments and the Finnish case of obviously which I'm most familiar with, there is a very interesting experiment going to start in a few years in East Africa organized by the charity Give Directly who are already advocates of this idea of giving cash transfers to people. They have been doing that for a number of years now with quite good results according to many independent researchers. They've been giving cash transfers directly to people and they've shown great results. So they are actually expanding this idea and organizing again a privately funded experiment that they planned around for ten years, I think, or at least a number of years in East Africa.

And this should be quite interesting to see how the basic income experiments in rich countries and poor countries compare and perhaps they can help both in different ways, because obviously countries where welfare states exist are quite different from places where they don't. So any help or any form of monetary transfer will help people in African countries proportionally more than they do in rich countries, but I think both situations and both contexts can certainly benefit from direct cash transfers and basic income.

Petersen: Give Directly is a charity that I support and I really like what they're doing. I especially like how they take such a quantitative approach. There are so many charities that just start with "wouldn't it be nice if people in this village had this thing?" And then they bring it to them and they don't really stop to say can we measure, were we cost effective in improving their lives? Did we do a good job? Could something else of equivalent cost have made them better off? Give Directly is doing a great thing by bringing a lot of this sort of quantitative approach to charitable giving and I'll have a link at the show notes page to Give Directly if you want to contribute, if any of the listeners want to contribute, I highly recommend it.

Lehto: Absolutely. For a little bit, just to say about the reasons why cash transfers are so great. By the way, I should say that there are perhaps a few charities that are even more helpful in certain contexts. For example, direct malaria helping efforts, efforts to eradicate diseases perhaps, have an even higher rate of efficiency but those are pretty much the only ones that are more effective than giving people cash. And the reason why giving people cash is very good is that first of all, they stimulate markets where they don't exist and where markets do exist they operate in a way that maximizes the preferences and satisfaction of the people concerned. They operate as a way of giving people welfare in the most efficient way possible.

And the theoretical foundations of these can be found for example in neoclassical economics, of course, where the superiority of cash transfers have been posited for example in the Chicago School since George Stigler and Milton Friedman and others. There's a wonderful paper by Brennan and Walsh on the desirability of cash transfers over in-kind transfers from a game theoretical Pareto perspective. So that's also quite interesting how the theory also matches the empirical research here.

And just again to go back to the very foundation of the welfare state. I think that's been the biggest mistake of the welfare states today that they fail to take into account how welfare truly fundamentally is the satisfaction of the desired ends and needs of the people themselves as they themselves see them. It shouldn't be the satisfaction of some criteria of goodness that the state bureaucrats measure and determine. It really should be ultimately up to the people themselves what they value, what they pursue, and what needs they see themselves as having and thus giving money to them is the best way to make sure that they actually get to satisfy those preferences which they have rather than those preferences which some bureaucrats think that they should have.

Petersen: If I may ask one final question. Some supporters of the basic income guarantee have suggested that we could do it as a swap. We get rid of our current costly welfare system and bring in the basic income guarantee and often you'll hear the suggestion that this could be revenue neutral. Is that a realistic possibility?

Lehto: It is a realistic possibility in cases where quite extensive welfare states already exist. And obviously it depends on the level of basic income and I'm actually in favor of starting low where that is the most politically feasible option. But I'm also quite a quite supportive of the idea of starting high where that is politically feasible. So in countries like the welfare state in Canada and many other places. Starting from the level of where the current welfare state benefits are it is compatible with the goal of making it neutral as far as the effect on state budget is concerned. Although I think that it will be very hard to make it completely neutral in that regard. I think it will by necessity always cost something.

But what it will cost is heavily overblown in many estimations because many people simply do not understand how to calculate the costs and they simply add up some figures of everybody gets this amount of money and multiply that by the number of people and voila you get the proposed cost of this program. But that's obviously nonsense that they don't understand what they're talking about. And they really should have a look at the actual models because in all models what happens is you reform the tax system at the same time which means that for most people, middle-class and upper-class people---or middle income and upper-income people, to be more politically correct---the income that they get from basic income actually is a zero sum addition because actually, they ended up paying their basic income back in the form of taxes that I've been raised to match accordingly the need for basic income funding. So, even if there is no criteria that you don't give basic income to people above a certain range of income, nonetheless those people in the upper brackets will end up paying back their basic income due to the taxes that have been raised. But the taxes that are raised do not have to impose unbearable burdens on those people either, because again for most people it is just a nominal transfer of funds and it's withdrawn from their bank accounts at the same time.

Petersen: So are there websites, books? What can you recommend to people interested in this topic? What should they read?

Lehto: Well I think for those who are philosophically minded, I certainly recommend reading the classics of the libertarian welfare state stuff. Things like Friedman's Capitalism and Freedom where the negative income tax fee is featured. Friedrich Hayek's Constitution of Liberty is a great book and it also features a defense of guaranteed minimum income. And more recently John Tomasi's Free Market Fairness, and I would recommend people to read the blog Bleeding Heart Libertarians they have been advocating for basic income but also debating it. And also proposing this similar thing that I'm doing which is trying to combine Rawls' and Nozick's intuitions into something like a new coherent whole.

And just follow the news, read up on the models, follow up on what the governments and many of these countries---Finland, Netherlands, Canada---are doing. And go to basic income networks website. Just Google basic income earth network. B.I.E.N it's called---Basic Income Earth Network---and you will find more about basic income.

Petersen: My guest today has been Otto Lehto. Otto thanks for being part of Economics Detective Radio.

Lehto: My pleasure. It's been fun.


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Supersonic Flight, Technology, and the Overland Ban with Sam Hammond

Fri, Nov 25, 2016

What follows is an edited transcript of my conversation with Sam Hammond.

Petersen: My guest today is Sam Hammond. He's a policy analyst at the Niskanen Center. Sam, welcome to Economics Detective Radio.

Hammond: Hi!

Petersen: Our topic today is supersonic air travel.

Sam has written an article titled "Make America Boom Again" along with co-author Eli Dourado which revisits the U.S. Federal Aviation Administration's ban on supersonic flight over the United States. So Sam let's start at the very start. Let's start by talking about the history of flight. How do we get from the Wright brothers to supersonic flight?

Hammond: Well I think the most notable thing about the early history of aviation is how quickly and how rapidly we innovated. So the Wright brothers flew their initial voyage, their milestone flight in 1903 at seven miles per hour and within forty years we were already breaking the speed of sound. And actually very shortly after that not only were we breaking the speed of sound within military jets but we were on the cusp of commercializing it through the Concorde.

So, what characterizes the early history of aviation is really rapid innovation. Part of that was driven by obviously two world wars but also that trickled out and percolated into the commercial space. That brings us to today. So in the progress that we made in air speeds in the first say 40 to 50 years of manned flight, we've actually regressed since then.

Petersen: Okay, so the Concorde starts flying in I believe it's 1969 and the subject of your paper---the ban brought in by the F.A.A. on supersonic travel over the United States---comes in just four years later in 1973. So what happened in that four-year period? How did we go from rapidly advancing to banning what was at the time the latest technology?

Hammond: It really began in the 60's. Everyone was seeing the progress that was being made in supersonic aircraft. And it was widely appreciated that it was only a matter of time before it would be commercialized. And there was actually a bit of a race going on between European countries and America of who would develop the first and the best supersonic jet. Because at the time, you know, this is way before Reagan deregulated the airlines. So these were the national projects almost akin to the space race.

So in the 60's the F.A.A. and NASA began investigating whether supersonic airplanes could fly overland, because obviously they had them already in the form of military jets. And so they conducted a number of tests. One of the most important and famous tests was the test over Oklahoma City. So in 1964 the F.A.A. began a test over Oklahoma City where supersonic jets---military jets---would fly over the city eight times per day for six months continuously. And these were just regular old military jets, nothing about them was designed to mitigate the sonic boom. So eight times a day people in Oklahoma were hearing the sonic boom. It was rattling their windows. And at the end of it---at the end of the six-month period---even though about 75% of the people they asked said that they could tolerate the booms indefinitely, there were tens of thousands of complaints. And that's when the F.A.A. examined the complaints and rejected the vast majority of them as spurious. And that led to this huge public backlash.

And so that was picked up by a guy named Richard Wiggs who founded the Anti-Concorde project. So the Concorde was being developed in the 60's by a partnership between France and Britain and it sort of represented the frontier of technology---not just aviation technology but technology in total---and Richard Wiggs had this view of the environment and technology as being in conflict. So he believed that as technology advances, we lose touch with our natural environment. And he was actually one of the most innovative, maverick early environmental activists. They're commonplace today but he was actually a pioneer.

And so he took the complaints that occurred in Oklahoma City and his philosophy of environment and technology in conflict and began one of the most successful environmental NIMBY campaigns in history. He organized academics, he organized the residential associations near airports. He took out full-page ads in The New York Times. He got people to call their congress people. And so even though this was all becoming organized even before the Concorde was in use in 1973, it persuaded the F.A.A. and Congress to institute a ban on supersonic flying overland. So there is no jurisdiction over the ocean of course, so when the Concorde eventually came out it was able to fly over the ocean. This was their attempt to handicap the Concorde's success.

Petersen: It's so strange to me that the government would fly supersonic jets over one city eight times a day for six months as an experiment. I mean when you experiment, usually you have to get the consent of the people you're experimenting on and that's what I'm familiar with but it's so---

Hammond: This was a different time.

Petersen: Yes, so 1960s! To just experiment on an entire city against their will and just see what happens.

Hammond: Yeah, I mean, any student of US history knows that our toleration for human experimentation has gone down quite a bit from the 60's and 70's. And if anything, flying a supersonic plane over a city was probably one of the least egregious things that was going on at the time.

Petersen: Yeah well, tell me about sonic booms. I'm not a physicist so use small words.

Hammond: Okay. So, if you've ever seen a speedboat drive through the water, it creates a wake in its path. And the same thing happens with planes only it's air. And air is in three dimensions so there's a cone, a wave that goes past an airplane as it flies through the air displacing the air in front of it, pushing it aside. But of course the speed of sound---and we get the concept of the speed of sound because sound is moving through air and so sound can only move as fast as air can move---and so when you approach the speed of sound you're pushing the air in front of the plane. You're pushing it, basically compressing against the air that's already there and so you reach this thing called the sound barrier where upon crossing the sound barrier you produce a shock wave where the air is becoming compacted and compacted and compacted and basically it's like the waves are on top of each other. And that creates a shockwave which radiates around the airplane and will reach the ground as this loud booming noise.

Petersen: So it's not only loud---I've noticed in your paper---some people said it could break windows or damage buildings.

Hammond: Right. So a lot of this goes back to---again---the Oklahoma City experiments where the fighter jets were flown over the city eight times a day. Sonic booms are shockwaves. There is no limit to how powerful a shockwave can be. So in principle sonic booms can break windows. In practice, they are about two pounds per square foot.

This is this what the Concorde was approximately. And two pounds per square foot of air pressure is pretty weak. There were studies done in the 70's when the Concorde became active. And they found that it could do damage to old Civil War architecture and stuff like that and if you already had a window that had damage it could crack that window. But for practical purposes, buildings can withstand up to 11 pounds per square foot pressure before experiencing damage---Nasa's tested that extensively.

So nonetheless the myth propagated in part because there were people in Oklahoma who claimed that their plaster cracked or that their windows broke. And so when the F.A.A. investigated it and basically threw out most of the claims as not being credible, that caused a big backlash and also caused a huge public relations disaster for the F.A.A. and for supersonic overland more generally and created this myth that it's very easy for a sonic boom to break their window. It's just not.

Petersen: So the ban applies just over the United States. How do we know that that is what has stopped the progress of supersonic flight? After all, you'd think that there's the whole rest of the world and maybe transatlantic or transpacific flights could sustain a supersonic aviation industry?

Hammond: So, there's a lot of variables going on. First of all---as I mentioned earlier---all the supersonic projects up to this point---except the Concorde---were abject failures. The US had one called the Boeing 2707. It just never got off the ground, in fact, in the industry aerospace engineers have a term for this. It's called a "boomdoggle"---a play on boondoggle---because countries that tried to produce a supersonic jet just ended up pouring literally billions of dollars down the drain.

And you can't blame that on supersonic per se. That's a failure of central planning. I would say the same thing with the Concorde. The Concorde flew for 27 years. And at times it made money but you have to remember it was never designed with any commercial intent. It was designed to be a commercial airplane but it had no market testing. It was mostly a piece of a diplomatic or political gambit that Britain was using to try to get into the European Common Market.

And so when Kennedy proposed the 2707 as a competitor, he also didn't do market tests or see what the demand was, he looked at the Concorde which sat about 100 passengers and said we need to do better than France so let's make it 300 passengers. And instead of flying at Mach two---twice the speed of sound---let's fly at Mach three---three times the speed of sound---so it was just the one-upmanship of nations, had nothing to do with whether it was market viable.

And so the case I make is that, if you had a private sector in airplanes---which at the time we didn't really, at least in supersonic, it was all government driven---the first entry point, the natural entry point would be some kind of smaller business-jet. Because frankly if you don't know which routes are going to demand the most passengers you want to start small. You don't want to jump right to a 300-seat passenger jet. The Concorde was only 100 seats, as I said, and it routinely had trouble filling its cabin.

But the thing with business jets---and there have been about half a dozen rigorous market analyses done in the last ten years that have found there is a demand for supersonic business jets---the thing about business jets though is they fly overland about 75% of the time. You're going from regional airports to regional airports.

And so if the natural entry point to sort of begin on the supersonic learning curve, learning which routes have the most to manned is a smaller business jet, you're going to have to begin by flying overland. And then once you discover which routes will bear more people you can expand the capacity of the airplane and ultimately I think a private sector would work its way up to having a 100- to 300-seat passenger jet once it had established that the demand existed. And also big part of that is driving down costs, of course. The Concorde was the Concorde it never iterated it. The first model was the last model.

In commercial aviation more generally in subsonic aviation we've learned over time how to reduce costs. Even though we fly a slower today than we did 50 years ago, subsonic commercial airplanes are vastly more efficient and we've achieved that efficiency because we've learned over time.

Petersen: Okay, so the natural entry point is maybe carrying businessmen between New York and L.A. say, but that's illegal. And so the industry isn't able to sort of clear that hurdle. Is that basically what you're saying?

Hammond: Yeah, I mean if you have a 12-person business jet. First of all, it's difficult to get a jet that small to have the range to even go across the ocean. You know you wouldn't necessarily being going from coast to coast in a small business jet right away. You might be going from New York to Houston, or something like that. The point is that you don't know. You don't know which routes are going to bear fruit, a priori.

The Concorde flew between France and Britain and the U.S., but It also had roots into the Caribbean and lot of those routes have ended up being canceled in the 80's in part because they just kept losing money, but it was because they had tried to plan it all out a priori, as if they could just deduce which routes would make money.

I don't trust that model. I think you have to begin by building something small that you know will meet demand and then expanding from that. And the most important part about this is there's open a confluence of technology in just the last 20 years. I have no illusions that supersonic business jets would have been a thing, say, in 1990. I think a lot of this is a recent phenomenon that's why supersonic overland is an idea whose time has come. There's just been such a breakthrough in technology, in reducing the intensity of sonic booms. And that has been really the biggest hurdle is getting the intensity of sonic booms to a level where people will tolerate it.

Petersen: Right. So it seems like the F.A.A., when they banned supersonic flight, the concern was noise but they banned speed as sort of a proxy for noise. But what you're saying is that's a bad proxy you can have the speed without the noise.

Hammond: Exactly. So it was an overreaction. What we advocate in our paper and at supersonicmyths.com is to replace the ban with a reasonable noise standard. Subsonic airplanes already adhere to a variety of noise standards, noise rules. If the issue is really noise---and we believe the issue is basically noise---the F.A.A. should just set a noise standard, say, 80 decibels, something like that, that would be like a lawnmower going by your house. And then let the market try to get below that line. The F.A.A. stance right now is that it will set a noise rule once it sees a supersonic airplane demonstrate that it can go below the noise that it finds acceptable. But it has never stated what it will find acceptable. So it's a sort of reverse order of operations where the F.A.A. wants to hear something that is quiet enough before telling us what is quiet enough.

Petersen: And if you're Boeing and you're going to invest millions of dollars building an aircraft that does 80 decibels and the F.A.A. says 'not quiet enough' you're out millions of dollars.

Hammond: That's right. And so today the biggest and really only large quiet supersonic project is still within NASA. NASA has been working on quiet supersonic technology pretty much continuously since the mid 80's under a variety of different project titles. And they're the only ones who are able to do it because it's federal money. They have no skin in the game. They do use contracts with, say, Lockheed. But those are still federal contracts. We would like to see more competition in this space.

NASA is firm in its belief that a quiet supersonic jet is possible as early as 2020. How much sooner would we have gotten to that if we had the private sector involved?

Petersen: Almost certainly much sooner. If we look at private space companies like Space X, they're an order of magnitude cheaper than NASA. They're much more efficient and able to launch rockets into space for a fraction of the cost that NASA has. So, maybe if we use that as our model, then however much NASA has spent on developing supersonic, divide that by ten and maybe that's what the private sector might cost.

Hammond: Could very well be. The other thing is that, even today, NASA's effort is directed at the big passenger jets. And part of that is out of this democratic aspiration. They're the government, so they're trying to build something that the everyman could ride. But it's pretty common in new technologies for the early additions or for the early adopters to be of a sort of luxury class.

You can think about Tesla's business model where they begin with a roadster and a luxury car---which is really only affordable to millionaires and the very wealthy---with the game plan that they're going to have a low volume high profit or high revenue car and reinvest those profits back into developing cheaper and cheaper versions until they get to a mass market version.

We argue that that's exactly how the supersonic learning curve probably works as well. You want to begin with business jets which will of course be a luxury flying supersonic getting from New York to L.A. in two hours instead of five or six. It is worth it to some people. But those early models will of course be expensive. It will be expensive to ride not just because it's new technology and we haven't figured out how to drive down costs, but because a lower capacity means you're dividing the cost by fewer people. But over time those companies can reinvest, build bigger designs and drive down costs until you get to the point where virtually anyone can afford it.

The company Boom, which is developing a supersonic jet for over the ocean, is projecting to drive their costs down to about $5,000 a ticket to go across the Atlantic, which is on par with business-class and first-class tickets. So they're projecting that for their own costs. It could very well be the case that that technology and that those cost estimates are probably similar for first models in the over-land market as well. And that's a far cry from the Concorde which cost about $20,000 per flight. So going from $20,000 a ticket to $5,000, that's what this one company is projecting and it's only their first model.

Petersen: Right. So if something like Tesla cars or cell phones had to get permission through the political process when they were being developed, then maybe someone in the 90's would have said "Why should we allow cell phones if only rich people are going to use them?" And in the 90's they might have been right. But of course now we all have cell phones, and I guess what you're saying is in the 2020s or the 2030s we might all be flying at supersonic speeds when we go on our vacation.

Hammond: I believe that. Elon Musk, in his Hyperloop paper, discusses the most efficient way of getting from point A to point B. And he argues in that paper---it's sort of an offhand comment he makes---but he suspects that for any city pair that's over 900 miles apart the most efficient way of getting from that city to the other city is supersonic.

Petersen: So that's most pairs of big cities.

Hammond: Not just most pairs of big cities but the average flight distance, not from where the passenger is starting to where he's going, but the average takeoff to landing for a passenger plane is about 900 miles. So that suggests that if that is an efficient distance for supersonic, the average flight could be flown efficiently at supersonic.

Petersen: One issue that your paper goes into is that some people have alleged that supersonic aircraft---because they fly very high---might damage the ozone layer. Is there anything to that?

Hammond: I won't say there's nothing to it, but it's been vastly overstated. I'll put it that way. This goes back again to the Concorde and the early environmental movement's objections to it. At the time the understanding of atmospheric science was very very poor compared to today and there were concerns that because the emissions from an aircraft include nitrogen oxides---which are a class of molecules that will bind with oxygen in the atmosphere to destroy ozone---that because the Concorde flew so close to the stratosphere---which is where the ozone layer begins---that these emissions could lead to the depletion of ozone.

That's been rejected. The most alarmist versions of it were rejected. In the 70's people were claiming that if the Concorde or a fleet of Concordes were permitted to fly that we'd see catastrophic ozone collapse. That did not come to fruition obviously, the Concorde flew for 27 years. More recent studies now that we have large models of the atmosphere, simulated models of the atmosphere, have determined that a supersonic aircraft flying within 50 to 60,000 feet should in theory be ozone neutral. The reason is because there's actually this countervailing effect where a little bit lower in the atmosphere the nitrogen oxides actually produce ozone, and a little bit above in the stratosphere it depletes ozone. And if you're flying right on that line they roughly cancel out.

Petersen: Okay. There were some fears in the 80's and 90's of other things we're doing seriously damaging the ozone layer. But was that a much larger threat than supersonic flight?

Hammond: Well it was just a different sort of threat. There are different emissions in aerosols and so forth, CFCs. But out of the concern for the ozone in the 90's we got the Montreal Protocol and the Montreal Protocol is an international agreement to control the emissions of things that will deplete ozone and as supersonic makes its comeback, they will have to be fully compliant with those protocols.

I still recommend that going forward there should be more research into this. Even since the Concorde retired, we have better models of the atmosphere and I'm sure there's actually teams that NASA and MIT that are studying this right now.

Petersen: It can't hurt to look into it. But it seems like once something is banned or, you know, once the government sort of gets its hands on it and says "we're not so sure about this" we become incredibly risk-averse, we look at every possible downside and ignore the huge upside of just having a whole other industry and all that consumer surplus that you get from having an entire market that wasn't there before.

Hammond: What I would say is the state of knowledge right now with respect to supersonic and ozone is well established enough to not worry. The catastrophic versions of the concerns have been utterly rejected. Even the more modest versions of it are called into question by the fact that, there seems to be this band around the around 60,000 to 50,000 feet where supersonic emissions are ozone neutral. There, of course, should be more study but we don't have to wait for those studies. The studies we already have are sufficient to suggest that we shouldn't be waiting for more data. We already have enough data to begin today.

Petersen: It seems like there are two models of innovation. At one extreme end is the development of new drugs, where we have years upon years of vetting and studies and you have to comply with many requirements before you can get your new drug on the market and it costs billions of dollars. Adds a lot to the price of developing new medicine. And then there's the other model where somebody just makes something and we start using it. And maybe we worry about the implications, but by the time anyone thinks that "hey maybe this is a bad idea" it's already been universally adopted.

So something like Facebook, where we were all already on Facebook before people started complaining "Hey what if this is ruining our social interactions or something?"

Hammond: Or maybe all the fake news sites. Destroying democracy.

Petersen: Yeah that's topical right? Facebook is now worried about its role as one of the main places young people get their news, or a lot of people get their news, and some things go viral that are not true or and might be misleading and might affect, say, the outcome of elections.

Hammond: Apropos of Facebook and that topic, myths and misconceptions and viral falsehoods and urban legends, those are not new phenomena. That's why I had to create supersonicmyths.com. Because around supersonic, there's just a lot of misconception because there are a lot of people who think they're experts on the Concorde and think that the Concorde proves that supersonic is not economically viable. But they don't really understand that well.

Petersen: Right and you could use the same sort of logic to say, "Look how costly the moon landing was. It's clearly impossible at that cost for any kind of space tourism or space commerce to be economically viable." But the issue is that the moon landing was very very expensive, but it was run by the U.S. government which tends to make all its activities very expensive. A future space tourism company might be much much cheaper and we just don't know until we see it, how much cheaper.

Hammond: So I guess I should just comment a little bit on what the new technologies are that have made supersonic overland viable. And they really break down to three: first engines---jet engines---have become a way more powerful, way more efficient. They're way more capable in every way. So, the Concorde used an afterburner on its engine, which means upon takeoff it basically dumped kerosene and lit it on fire and that's why if you watch old videos of the Concorde taking off you see this trail of black smoke coming up behind it. That's the afterburner. Incredibly fuel inefficient, you're just burning fuel. This is what it needed at the time to get the extra boost, to get into the air, because it had to climb to 60,000 feet---which takes quite a bit of energy.

Today we have vastly superior engines. In fact, most subsonic aircraft, most passenger planes that you would fly in any consumer flight are capable of going supersonic. They have a top speed which is subsonic but if you put them in overdrive you can go supersonic and in fact, the company I mentioned earlier---Boom---is using off-the-shelf engines to reach its max speed.

Second is carbon fiber. So, the shape and the aerodynamics of shape matter a whole lot to supersonic and supersonic overland. The way we reduce booms is by affecting or altering the airfoil around the airplane. So, essentially you can use the shape of the airplane to modify the waves and smooth the waves out. So you don't have this like sudden shock and sudden dip. Instead, you have sort of this gradual rise and fall. And mostly when the human ear detects loudness what it's detecting is suddenness. So you can dramatically reduce the perception of loudness by modifying that airwave and you do that by modifying shape. Most planes are constructed of aluminum, which you can shape reasonably, but not nearly as much as carbon fiber and carbon fiber has become basically a commodity in recent years. It means basically any shape you want is incredibly cheap and incredibly strong.

The third and final, probably most important thing is the power of computers and computer simulation. So prior to the early 2000s, I would say, when what's called computational fluid dynamics was really coming up. These are computational simulations of how fluids waters and airs move around shapes. That requires a lot of computing power which we've only recently achieved. Prior to that,

if you want to design and test a prototype for a supersonic aircraft you would have to literally build a model and rent a wind tunnel, and then you'd have to have instruments try to imperfectly measure how the wind is moving around the aircraft. That is incredibly costly. So, computer simulation has really democratized. Some of the researchers who've done work on this are just grad students. They have software engineering expertise and they construct algorithms that will search through the space of all possible aircraft designs and try to find the one shape that reduces the sonic boom the best. And then because we have carbon fiber we can go and pour that shape and have the exact shape we want.

Petersen: So it used to be, not only did you need the air tunnel but you had to---if you wanted to test 100 wing shapes---you had to physically build 100 wings. Now you tell a computer "here's 100 wing shapes," hit compile, come back the next morning and you have your simulated sound profiles?

Hammond: It's actually even cooler than that. Instead you tell the program what you're looking for, and what you're looking for is a shape that will reduce the sonic boom to whatever level you're aiming for. Basically you give it an objective and then instead of trying to design 100 designs and let it test 100 designs, you give it an objective and then it searches through literally hundreds of thousands of designs that it evolves on its own. Some of these algorithms are genetic in nature, so they evolve like biology evolves and they try to go down paths and try to find exactly what shape reduces or hits the objective. And you can have multiple objectives. You can even include the objective of low sonic boom, but you can also have that tempered by the objective of efficiency---fuel efficiency.

Shape and size obviously you'd want to put into the objective function. We don't want this airplane to be ten miles long. It happened to be the case that the longer, more slender aircraft cut through the air better but a computer doesn't know on its own that a ten-mile long airplane is not feasible. So you basically give it multiple objectives and you hit play and you let the algorithm do its work. And it can literally iterate through hundreds and hundreds of thousands of designs.

Petersen: And this is achievable by grad students just with software that is available, or you can get on a grad student budget?

Hammond: Well, I imagine these are big research projects. They have university backing and industry does that too. But it's a single fixed cost instead of a repeated variable cost of having to rent a wind tunnel every single time you want to test.

Petersen: So it sounds like despite the fact that there's been a supersonic ban and despite the fact that there is no supersonic industry, or no supersonic commercial flights going on in the world today, we still had advancement, but it's been mostly on the technology side, on the theoretical side. What we haven't seen is actual supersonic flights and testing the water, testing the market. I saw in your paper that you go through some estimates of the potential size of the supersonic market. Do you want to talk through some of those?

Hammond: Sure. There has been by my count seven market analyses. Most of them from the mid-2000s till today. The estimates range from 180 supersonic business jets to over 600. So, these are companies like Gulfstream Aerospace, which is a leading business-jet manufacturer. They've done actually two or three of these market analyses. And they foresee up to 350 units for just themselves. So 350 business jets that they could produce over ten years. That is quite a demand.

Petersen: And they're looking at things like whose opportunity cost of their time is high enough that they would pay maybe a few thousand extra dollars, maybe several thousand in order to save a few hours. And right now there are C.E.O.s, there are wealthy people who maybe live in the United Arab Emirates but want to commute to New York and right now that means sitting on a plane for---gosh I don't even know---it would be like 15 hours or something. If it could be six hours, for most of us, we might prefer to sit on a plane longer and pay significantly less. But if your time's really valuable, if you run a multi-million-dollar company, it really can be worth it to save some of your time, even at a high cost.

Hammond: Of course it's possible if you had supersonic overland to leave New York and go to London and then come back to New York on the same day. There are people who would love to do that. I think what gets missed in this it's not just about going faster for its own sake. This makes the world smaller, it makes you rethink travel. So in addition to these American analyses, there have also been some surveys. One survey did a survey of business jet operators and importantly they asked them to basically state an estimate from zero to 100 what the likelihood is that they would buy a supersonic business jet if they could. When they asked that under the condition that there is still an overland ban the number was zero, so zero percent of people. The average person said that there was zero chance they'd buy a supersonic business jet if they can't fly overland but in the case that the ban is lifted, that number jumps to 50%. So half of the businesses that were surveyed would see a chance.

Petersen: That's further evidence that it's not just that supersonic is unviable, it's that this legal restriction is in a very important market which is flying over the United States. That's what's killing the supersonic industry.

One other the thing I saw on your website was, you talk about the tradeoff between noise and fuel efficiency in the context of airport noise restrictions. Could you tell me, how does that tradeoff work?

Hammond: I think that one of the biggest barriers to the F.A.A. is the issue of airport noise. The F.A.A. has worked with I.K.O. and I.K.O is the UN's body who deals with aviation standards. They've worked for literally decades to try to ramp up the stringency of noise around airports and they're pretty proud of what they've accomplished. If you live near an airport today it's a much quieter experience than it would have been 20, 30, even 40 years ago.

But this comes with a tradeoff. The way aircraft reduce noise is they have a bypass ratio. So at the extreme, you have a turbo-jet, which means all the air passes through the jet and then you have jets which bypass air around the jet. So, you have the jet in the center and that's what's pushing, propelling the plane forward. But then you also bypass air around the jet to basically insulate the noise. But that comes with a tradeoff. So the more air you bypass, the quieter it will be, but also the more fuel and the less thrust you get. And it happens with supersonic because you're going from sea level to 60,000 feet potentially, you actually have to really take off at a steep angle and you have to push up. You have to really get up high, basically, and so you could make the argument that we should tolerate slightly lower airport noise standards for supersonic at first, so they can use lower bypass ratio engines and therefore less fuel when they're making their incline.

Petersen: So there's another paper from Mercatus, also written by your co-author Eli Dourado, and that one talks about the number of airport noise complaints that come from a really small concentrated number of households. I found that very funny.

Just how concentrated are the airline airport noise complaints?

Hammond: Let me say first that what we recommend for airport noise standards is stage three noise standards, which are what we currently use. So, currently if you live near an airport and you see a plane taking off and you can hear it slightly, that's the stage three noise standard. We're advocating that supersonic abide by that noise standard. That noise standard is being phased out for stage four and later stage five, which will be even stricter. So we're not saying anything like "Oh we should let planes be super noisy," we're saying "let supersonic planes be as noisy as the ones that we currently have taking off, and just give them a bit of a window before they're phased into these newer, more stringent noise standards that are coming down the pipeline."

Eli's work with Raymond Russell, they found an amazing data set that includes records of who is making noise complaints, airport noise complaints. And they have them by airport and the astonishing thing they find is that these airports are getting sometimes tens of thousands of noise complaints every year but when they drill down into the data, it is just a handful of people making all the complaints.

So a few examples. I live near Ronald Reagan Washington National Airport and in 2015 they had 8,760 noise complaints. Two individuals at one D.C. residents accounted for 6,852 of those complaints. So, two people in one building accounted for 78% of the complaints. They have a report called "Airport Noise NIMBYism: An Empirical Investigation" where they go through all the airports that have this data and they find evidence of the sort of concentration of complainers at every single airport. So, it's a pretty surprising thing and I think it's important to get this information out there because as we know from when the Concorde was banned overland, residents’ associations are a pretty powerful group to mobilize in opposition to something like this, and Congress people have the perception that---like San Francisco in 2015 had almost 900,000 those complaints to San Francisco International Airport. These are constituents, we want to reduce noise this is obviously something they care about. But in fact, in San Francisco's case, only 53 individuals accounted for 25,000 of the complaints. And those 25,000 were all during a single month---the month of October---which meant that the average person was making 477 calls per person. So, 30 days in a month, that's a lot of calls every single day. And this is San Francisco so wouldn't surprise me if there were some enterprising software developers who figured out a way to make complaints automatically.

Petersen: So robot calls. It might be crazy people calling in a complaint every single time they hear an airplane, or it might be clever people robotically calling in a complaint every time there's an airplane. Except that I guess they didn't anticipate that someone would notice that all these calls were coming from the same location which kind of undermines their objective which would be to reduce noise in those areas.

Of course, if you bought your house after the airport was already there making noise then economics says that that noise should already be priced into the value of the house. The person who loses is the person whose house is next to an empty lot and then the government announces "Hey we're going to build an airport here." You'd expect the change in home prices to happen immediately when that's announced and then every following owner has already accepted that cost and they've had cheaper real estate prices as a result. So, if you buy a house next to the airport and then try to pressure the airport to make less noise you're sort of trying to boost your property value when you already paid a discounted rate. You are already compensated for accepting that noise.

Hammond: And not only that. But when people have done rigorous cost-benefit analyses of U.S. aviation noise standards and they consistently find that the costs of making airplanes less efficient on takeoff is greater than alternatives which include creative land use policies, like building in barriers that block sound near communities and stuff like that. So, if you have a community living very close to an airport, one alternative is to set global standards which say airplanes are to fly less efficiently and make less noise, or you build a wall. You build up a barrier or some insulation to protect the community from the noise. But the main point of this study that Eli and Raymond did---which by the way, if I remember this correct, is Mercatus's most downloaded paper in history---the main point is that we shouldn't be basing innovation policy, particularly something that can have very high impact, on a few crazy people and enterprising robot callers.

Petersen: People who are affected by having less efficient aircraft, having slower aircraft, more expensive air travel just so outnumber the small number of people who live near airports. And you could get them all double-ply windows and help make their houses more soundproof. Probably much cheaper than hamstringing the entire airline industry.

Hammond: Absolutely. I just want to recapitulate some things. Supersonic overland is today feasible. It can be economical, there are companies chomping at the bit to try to develop something that will be quiet and affordable. The only thing standing in their way is the F.A.A. and a public perception that the Concorde proved that supersonic is not viable. The F.A.A. could act today, it could issue a noise standard and allow developers to shoot for that standard. Even if a bill is passed today, what the F.A.A. wants to do is coordinate internationally with I.K.O. and I.K.O. is the UN body that---it's not a regulator---sets standards.

The F.A.A. has a prominent role in guiding us towards standards, but it's an incredibly slow process. I.K.O meets every three years. If the F.A.A. were told to remove the ban tomorrow and they wanted to coordinate internationally, would mean we have to wait about three years. I.K.O. is meeting this year, obviously they're not going to talk about it this year---the agenda is all set. So they're going to be talking about it three years from now and then they'll be finalizing those rules three years from then. And then the F.A.A. will take those rules, propagate them globally and then we will have another two or three year regulating period where there's a notice and comment and everything else.

So we're talking about ten years just to change this stupid ban that is obsolete and I think that speaks to a more fundamental problem in U.S. policy and regulation, which is, we create these massive bottlenecks. And it's no surprise that it happens to an idea that is such a no-brainer, like creating a noise rule for supersonic instead of a ban. You can find other examples in every other industry of every other emerging technology, where there are these obsolete rules that are getting in the way of better, more efficient, more affordable, faster technology. And even if they can be rolled out tomorrow, have to go through at times a decadal process of approval. So, I think it's no wonder that productivity innovation seems to be at a historical low.

Petersen: My guest today has been Sam Hammond. Sam, thanks for being part of Economics Detective Radio.

Hammond: Thank you.


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The Second Ehrlich-Simon Wager with Joanna Szurmak

Sat, Nov 19, 2016

Today's interview features Joanna Szurmak of the University of Toronto. Our topic for today is the second proposed bet between Paul Ehrlich and Julian Simon. Joanna has written a paper titled "Care to Wager Again? An Appraisal of Paul Ehrlich's Counter-Bet Offer to Julian Simon" along with coauthors Vincent Geloso and Pierre Desrochers, both former guests of this show. We mentioned the original Simon-Ehrlich bet briefly in my conversation with Steve Horwitz, but in this episode we talk about it in more detail.

Julian Simon had a cornucopian vision of development and humanity. In his view, things are getting better as we develop new ideas for improving our lives and our world. Paul Ehrlich has precisely the opposite vision. He has been predicting environmental catastrophe since the 1960s.

Julian Simon famously challenged Ehrlich to a wager. Simon challenged Ehrlich to choose any five commodities whose prices were not controlled by governments, betting that their inflation-adjusted prices would fall rather than rise. While Ehrlich was very publicly predicting the depletion of many commodities, Simon challenged him to put up or shut up. The five commodities Ehrlich chose---copper, chromium, nickel, tin, and tungsten---all fell in price between 1980 and 1990.

The subject of Joanna's research is the counter-bet Ehrlich offered Simon in 1994. Ehrlich, along with climatologist Stephen Schneider, bet that 15 trends would worsen between 1994 and 2004:

  1. The three years 2002–2004 will on average be warmer than 1992–1994.
  2. There will be more carbon dioxide in the atmosphere in 2004 than in 1994.
  3. There will be more nitrous oxide in the atmosphere in 2004 than 1994.
  4. The concentration of ozone in the lower atmosphere (the troposphere) will be greater than in 1994.
  5. Emissions of the air pollutant sulfur dioxide in Asia will be significantly greater in 2004 than in 1994.
  6. There will be less fertile cropland per person in 2004 than in 1994.
  7. There will be less agricultural soil per person in 2004 than 1994.
  8. There will be on average less rice and wheat grown per person in 2002–2004 than in 1992–1994.
  9. In developing nations there will be less firewood available per person in 2004 than in 1994.
  10. The remaining area of virgin tropical moist forests will be significantly smaller in 2004 than in 1994.
  11. The oceanic fishery harvest per person will continue its downward trend and thus in 2004 will be smaller than in 1994.
  12. There will be fewer plant and animal species still extant in 2004 than in 1994.
  13. More people will die of AIDS in 2004 than in 1994.
  14. Between 1994 and 2004, sperm cell counts of human males will continue to decline and reproductive disorders will continue to increase.
  15. The gap in wealth between the richest 10% of humanity and the poorest 10% will be greater in 2004 than in 1994.

Simon declined the second bet because the measures were both too difficult to quantify and too disconnected from the thing Simon was actually interested in: human welfare. Simon explained it as follows:

Let me characterize their offer as follows. I predict, and this is for real, that the average performances in the next Olympics will be better than those in the last Olympics. On average, the performances have gotten better, Olympics to Olympics, for a variety of reasons. What Ehrlich and others says is that they don't want to bet on athletic performances, they want to bet on the conditions of the track, or the weather, or the officials, or any other such indirect measure.

Joanna, Vincent, and Pierre have gone to great lengths to figure out who would have one on each of the 15 points had Simon accepted the bet. Listen to the episode to find out!

[Note: The sound quality drops about an hour into the episode. Skype failed and we had to switch to a telephone line.]

Other links:

Here is a 1998 interview with Julian Simon detailing his Cornucopian worldview.

Pierre Desrochers and Vincent Geloso wrote a detailed article on the first bet.

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The Upside of Inequality with Ed Conard

Sat, Nov 12, 2016

My guest today is Ed Conard, here to discuss his recent book, The Upside of Inequality: How Good Intentions Undermine the Middle Class. He is a visiting scholar at the American Enterprise Institute and a former managing director at Bain Capital.

His 2012 book, Unintended Consequences: Why Everything You've Been Told About the Economy Is Wrong was a New York Times bestseller. Because his business partner Mitt Romney was running for President at the time, many people expected the book to be a defense of the one percent. It wasn't, but this new book is!

We had a wide-ranging discussion that touched on inequality, immigration, entrepreneurship, finance, and housing.


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Space Debris, Governance, and the Economics of Space with Alex Salter

Sat, Nov 05, 2016

What follows is an edited transcript of my interview with Alex Salter about the economics of space. The first half deals primarily with the issue of space debris, while the second half deals with the possibility of private governance in space. There's something in this episode for everyone to enjoy, so I hope you'll listen, read, and share it with your friends.

Petersen: My guest today is Alex Salter of Texas Tech University. Alex, welcome to Economics Detective Radio.

Salter: Thanks very much for having me.

Petersen: Our topic today is the economics of space. Alex has written two papers on the subject. The first is entitled, "Space Debris: A Law and Economics Analysis of the Orbital Commons." The second is, "Ordering the Cosmos: Private Law and Celestial Property Rights."

So Alex, let's start by talking about space debris. What is it and why does it matter?

Salter: So space debris is basically junk in space that no longer serves any useful purpose. So as you can imagine, since the first piece of space debris launched up in 1957---which was the rocket body from Sputnik I---a lot of orbits around the Earth, especially low Earth orbit, have become kind of cluttered with space junk. And the reason it gets cluttered is because no one has an incentive to clean it up.

It's a problem because a lot of this stuff is big enough and moving fast enough that if it strikes something like a communications satellite, it can take it out. So the probability of a collision right now that will cause serious damage is currently low, but there are a lot of worries among scientists who study the problem that as debris occasionally collides with more debris, you get a sort of snowballing effect of the clutter. So if we're going to get a handle on it, it needs to be earlier rather than later.

Petersen: I think intuitively it seems like the sky is so big and satellites are so small that we'd never have to worry about collisions. So why is that not the case?

Salter: So there's obviously quite a bit of room up there, but the problem is that some orbits are more valuable than others. In particular, geosynchronous orbit, which is I think 36 thousand kilometers above the Earth, is a really valuable place for specific satellites. And also low Earth orbit is a valuable place for specific satellites. Now, there's still a lot of room there, but it's significantly restricted. If my communications satellite is taking up a particular orbit, your satellite can't be in the same place. So there's only so much of it to go around, and again, what we're really worried about is debris colliding with something, which creates more debris, which can collide with more stuff. We're really worried that snowball effect, which is sometimes called the Kessler syndrome after the scientist who first wrote about it.

Petersen: So the odds of a single collision might be low, but given one collision, it becomes much more likely that we'll have two and three and four---a chain reaction of collisions.

Salter: Exactly. So right now the probability of collision is pretty low over the life of a satellite, for example in low Earth orbit, it's no more than one in a thousand. But conditional on getting hit, that can cause a pretty serious business disruption and economic losses, and as you said, given that one increases the likelihood of all future collisions, it's kind of like a positive feedback loop. So that can get pretty nasty pretty quick.

Petersen: Have there been any collisions in the past?

Salter: There have been many collisions in the past. I think the most notable one was actually intentional. In 2007, China performed an anti-satellite test, where it purposefully took out one of its old satellites that was no longer useful. And it created, I think, about a hundred and fifty thousand new pieces of space debris with that one anti-satellite test. So I'm not aware of any instances of grave, private sector disruptions caused by space debris collisions, but honestly unless there's some means of cleaning this stuff up or it de-orbits on its own, it really is only a matter of time.

Petersen: So, you make a distinction in the paper between access to orbit and particular orbits. Can you explain what those are?

Salter: Right. So access to orbit is basically getting your payload up into space. If you have a communications satellite, it's getting it to the orbit you want. And economically that has the characteristics of a public good. The standard definition of a public good in economics is anything that we like which is not rivalrous in consumption and non-excludable. So if I consume one more unit of it, that doesn't stop you from consuming more. And also non-excludable, the second part, means it's costly or very difficult for me to stop other people from enjoying that. So both of those characteristics fit getting a satellite into your desired orbit---going through space to get to where you want to go.

Once your satellite is in position though, a particular orbit has the properties of what we call a common-pool resource. It's rivalrous---if I have it you can't also have it---but it's also non-excludable. I can't really stop you from using it. As orthodox public finance theory will tell you, sometimes the provision of those goods, public goods and common-pool resources, are difficult because if they're non-excludable you can't stop people from enjoying the benefits and so that limits the incentive for producers to make the stuff in the first place.

Petersen: Right, so in order to prevent someone from launching a satellite into your orbit, you'd have to somehow police every potential launch site on the globe, which of course we can't do. And that's what makes it [non-excludable].

Salter: It's incredibly expensive and therefore not really feasible.

Petersen: Right, so from reading your paper I know other researchers have looked at this problem and they suggested taxing people who create space debris. So do you want to comment on that suggestion, and maybe what are the pros and cons of taking that approach?

Salter: Sure. Let me first start by saying that the case for a corrective tax here stems from the fact that we have a common-pool resources problem, or a public goods problem. Nobody owns orbit, and so nobody really has an incentive to worry about how clean it is. If I'm launching a communications satellite, I don't really worry that I'm also imposing a cost on other potential launchers with my useless rocket body. So if everyone thinks that way, then the debris problem becomes unmanageable. So there is a textbook rationale for some correction to what we call this external cost in economics. Because nobody owns orbit or access to orbit, nobody has an incentive to care for it or clean it up. At least not as much as we would like.

So the argument for a corrective tax is basically, we want to bring the private costs of polluting space more in line with the social costs of polluting space. So if you tax a polluter, someone who's contributing to space debris, you raise the expensiveness of creating debris. And as economic theory will tell you, when something gets more expensive, all else being equal, people will do less of it. That's the theoretical argument for what's called a Pigouvian or corrective tax.

The problem here---and this is not specific to space debris, this is specific to all taxes correcting external cost problems---is that you don't really know how big to make the tax in order to get to the efficient amount of pollution mitigation. And even if you did, you have to take political economy considerations into concern. Corrective taxes are not run and operated by benevolent social planners. They're typically run and operated by bureaucracies, and bureaucrats have their own incentives to which they respond. And the incentives facing politicians and bureaucrats may not be the same as incentives for contributing to social efficiency or maximal wellbeing.

Petersen: Right, so we might worry that the body that determines the tax on potentially space-junk-producing private actors might be less concerned with the externality and more concerned with their own revenue and so set the tax not at the social-welfare-maximizing point but at the revenue-maximizing point.

Salter: Right, that's one potential worry with that sort of a solution. Again I want to emphasize, though, that's in the abstract. It's still very very difficult---in fact I would even say impossible---to know what the right size of the tax should be. I think that there is an inherent knowledge problem that sometimes gets overlooked at the expense of the incentive problem that you just talked about. Both are very important, and they're related, and they complement each other in terms of the critique, but they are distinct problems. And public policy has to be able to present credible solutions to both of those problems if we're going to argue that a corrective tax would improve social welfare.

Petersen: Right, so you launch a satellite, maybe you leave a piece of large debris like a rocket body, but you also create a risk that the satellite will explode or be hit by something and create a snowball effect of more debris. It's really hard to compute the net cost because you not only need to know how likely is it to create more debris and how likely is that debris to impact something. You also need to know the value of the future satellites the debris might impact, which means forecasting the future of space and the future of the economy and all these things into the deep future. Have other researchers at least tried to tackle this problem? Are there some attempts?

Salter: There have been some attempts, and as you noted, any estimate is going to be very imprecise because there's a lot of variables moving in the background. But you could look at scientific studies that estimate the damage to useful communications satellite or other valuable space equipment from a collision can range anywhere from 20 to 200 million. That's a reasonable interval for estimating the damages if you count not just the initial collision but also the potential snowballing which can destroy other things.

And you can also look at what private companies are doing right now to get an appreciation of the magnitude of the problem. For example, if you're a communications satellite launcher you can buy insurance for your communications satellite. In 2011, market premiums for these kinds of space risks totalled about 800 million dollars. And also in 2011 there were about 600 million in claimed damages. So private actors are spending a lot to insure themselves against risks such as these and that in combination with some of the scientific studies can help build your intuition for understanding that we're talking about a lot of money here: a stream of valuable services into the future which can be risked by space debris.

Petersen: So we do have a ballpark estimate, but nothing so precise that we could set an optimal Pigouvian tax even if we had a government that was benevolent enough to try to reach that optimum. So in your paper you suggest alternatives to the Pigouvian route. In particular you suggest potential private solutions. So what private solutions are there to reduce the creation of space debris?

Salter: That's a really interesting question because the standard response that economists would give to externality problems seems impractical here. Usually when you have an externality problem, a public goods problem, the solution is to create property rights. Property rights align incentives so if we create property rights to a common pool resource, that will cause people to take better account of the effects of their behaviour on others. But how do you really create a property right to something like an orbit? Is it a specific volume of space? How big is it? Under what conditions can somebody else move through it when your satellite is not in that orbit?

I think in this case we have to take seriously the idea that creating property rights to orbit and to access to orbit is simply too costly. It's not feasible given the costs and benefits of the situation. I think the most promising way forward in this particular issue is using market mechanisms to mitigate the problem.

So in order to talk about market mechanisms I need to do a little background on international law. There's this treaty, the 1967 Outer Space Treaty, which basically says among other things that nations retain jurisdiction over the stuff they put in space. Now that's important because if debris is big enough to be tracked, we can tell more or less who made it. So if you have, for example, a piece of Chinese space debris, it's technically contrary to international law for a US organization to go up there and do anything without the Chinese' permission. So if the US wants to do something it has to take care of its own space debris. If the Chinese want to do something, they have to take care of their space debris.

Given that constraint, I think one potential is for the US government to auction off contracts to go and mitigate this stuff. Another potential is instead of auctioning off contracts to go remove it, auctioning off a contract to debris itself. One thing that's not often realized about space debris is that a lot of that stuff is valuable metal, material, that's already in orbit. The most costly part of space commerce is actually getting stuff out of Earth's gravity. So if you have debris that's currently up there that can be re-used, perhaps at a later date for in-situ manufacturing and repairs, then that's a valuable asset. Firms should be willing to pay for that. So I think we need to look at market mechanisms within particular nations to address this problem until and unless we can get a more favourable framework in international law.

Petersen: So something big like a rocket body has a lot of scrap metal that you don't have to burn fuel to get it there because it's already there. That's really interesting. So it could be a resource in itself.

But then there's the issue of much smaller debris, something that isn't a resource in itself. A paint chip or a little fragment of debris that is not useful and is more of just a pure hazard. How would you deal with that?

Salter: That's extremely difficult. I'm not sure that there is a good solution to that right now. My guess is there has to be a technological solution in the sense of just developing thicker plating for spacecraft. Because a lot of that stuff is so small that it can't be tracked, but it's still big enough that if it hits you, you're going to be in trouble. I think that the only way to really be safe against something like that is just to wait for material to get more robust. And that's obviously not going to solve the problem but it's going to mitigate it.

Petersen: It's too bad. In science fiction they would just say "raise shields" and it would be dealt with, but I guess we can't do that.

Salter: That's another imaginative technological innovation and maybe something like that will be feasible some day. There's an actual technological literature on this, of people thinking up contraptions and devices for going out and removing specifically that kind of debris, but none of them are economically feasible and I think most of them aren't even technologically feasible at this point. We just can't even make the stuff apart from economic considerations.

Petersen: So there's a future in building technology to deflect or remove tiny bits of debris from Earth orbit. I don't know if you saw the move Wall-E? It was a Pixar film.

Salter: Yeah.

Petersen: Yeah, humanity had to leave Earth because it was too full of garbage, and there's the scene where not only is Earth covered in garbage but its orbit is full of old satellites.

Salter: Right.

Petersen: The ship is just sort of pushing its way through comically. But in real life, it could really happen, but it wouldn't be so easy to just push through it. It would be flying so fast and hit you with such force that it would likely cause serious damage unless you could defend against it somehow.

Salter: Right, this stuff is moving fast. In low Earth orbit it's going about seven to eight kilometers per second. And there's about 300 thousand pieces of debris that we know about that can destroy a satellite upon impact. So obviously, even if it's small, the fact that it's moving so fast can cause you some serious problems. If we get to the point where we develop strong enough technological---not like energy shielding---but the strength of metal and the strength of materials to push through that, we're a ways off from that. I don't even think that's on the horizon.

Petersen: And of course there's the issue that if it makes the satellite heavier, then it becomes much more costly to launch it. So there's the issue of being able to make something strong enough to withstand an impact while light enough to be able to actually launch it in the first place.

Salter: Right. As always there are tradeoffs, which is precisely why economics has a valuable perspective to offer on this problem.

Petersen: So let's move on to your other paper which deals with property rights in space. It starts with a discussion of the 2015 SPACE Act, signed into law by President Obama. What can you tell me about that act?

Salter: So the SPACE Act is largely intended to guarantee that the US government will do something to protect commercial entities' property rights to celestial resources. Celestial property rights, basically. There's no specific commitment to what that protection will look like, it's more a statement of intent to encourage private sector development and exploration of space by the US government saying, "Look, we know this lack of property rights thing is a problem. We just wanted to let you know that in the event of a dispute, we are going to protect your property rights as governments are supposed to do.

The problem with that is that we get into some pretty thorny issues with international law. Again, talking about the 1967 Outer Space Treaty, which was signed by all of the current spacefaring nations, Article II of that treaty states that nation states cannot extend their territorial jurisdiction into outer space. And a lot of legal scholars think if a government is protecting private property rights, it's de facto extended its territorial jurisdiction over those rights. So if deep space industries or planetary resources, asteroid mining companies, eventually go out and claim an asteroid, and Uncle Sam says, "Yep, we'll recognize and defend your claim to that asteroid," many legal scholars say that's a de facto extension of territorial sovereignty to that asteroid, which Article II of the space treaty explicitly forbids.

So we're in a bit of a sticky situation international-law wise. At best the legal framework is unclear and at worst the 2015 SPACE Act contains provisions that are not compatible with existing international law.

Petersen: It seems like the 1967 treaty was a little bit short sighted in blocking people from owning parts of space. I guess it was during the Cold War and you can see why the Americans would not want to Soviets claiming the moon or vice versa.

So recently, Elon Musk unveiled a plan to send colonists to Mars some time during this century. And if you literally have a colony there on Mars you're going to need property rights. And to have a treaty that might be a hundred or more years old at that point blocking that, it seems like a hurdle that we'll need to clear. People could potentially just ignore the treaty once they're on Mars.

So, what kind of solutions do you see for this problem in the future?

Salter: Well I think that international law on this should be expanded and clarified on this just for clarity's sake. I don't think we need to rely on publically protected and enforced property rights to get things like space commerce or Mars colonies or all that cool science fiction stuff that actually now doesn't seem so infeasible.

If you look throughout history, there are many, many examples of legal systems that are purely private and voluntary. And they are purely voluntary because the property claims underlying that legal system are self enforcing. We don't need to rely on the state, a monopoly enforcer of social rules. We don't need to rely on the state to enforce our property rights. Given the situation we find ourselves in, I will respect your property rights because it's in my self-interest to do so and you will respect my property rights because it's in your self-interest to do so. And it seems like that's incredible. If there's no monopoly enforcer protecting things, how can we have a viable legal order? But again if we look throughout history we see lots and lots of examples of these private legal regimes.

In fact, one of them exists today. International trade law is almost entirely privately produced. International trade is almost entirely privately governed. And it's not hard to see why: there's no international super sovereign that can enforce property rights over disputes if Al is from one country and Bob is from another country. And so given that problem, traders going all the way back to the middle ages had to come up with a body of voluntary and self-enforcing law if they wanted to exchange across political boundaries. And it turns out that this law has worked out very, very well. The basics haven't changed in pretty much a thousand years and while it's being applied in newer and more interesting ways, the foundation is solid. And I think that the situation in which international traders find themselves in today---"international anarchy" because again there is no international super sovereign---closely matches the situation that commercial entities would find themselves in in doing space commerce. So I think that there's a lot of potential for existing international and commercial trade law to provide a governance framework for outer-space commerce going forward.

Petersen: Yeah, there's a quote from your paper I wanted to read, that deals with these international frameworks going back to the middle ages. It says:

Following the collapse of the Roman Empire in the West, the volume of international trade shrank considerably. The legal infrastructure provided by the Empire no longer stood, and the transition away from this order caused significant commercial disruption. By the ninth and tenth centuries, trade was recovering. Across Europe, a professional merchant class emerged and developed mechanisms to resolve disputes over property rights and contract enforcement, even when subjects were from different polities and thus no national court had jurisdiction.

So can you explain more about how that system developed, and how something that we developed here on Earth a millennium ago, how can that apply to space? They would seem to be very different settings.

Salter: So they're different settings geographically, but I think the economic and legal problem is the same: facilitating coordination and cooperation among disparate entities when there is no possibility of turning to something like a state to serve as an overarching referee and arbiter. And so the medieval law merchant, called the Lex Mercatoria, was basically a self-enforcing system of property law and the legal rules that went along with it.

And what's interesting about that is that when we think of law we normally think of a body of rules and then we talk about applying those rules in specific circumstances. This most closely works the other way. Law is created whenever international traders enter a contract. And provided that commercial instrument became widespread and actually helped traders achieve their goals---and was mutually beneficial of course---then arbitration courts overseeing merchant disputes would come to see that sort of contractual arrangement as valid. And so the arbitrator is less making law than recognizing law---a body of rules for coordinating behaviour---that actually exists.

So if I'm a trader form some country in medieval Europe and I'm trading with another guy in another country, obviously I can't turn to my king to enforce my property rights because he doesn't have jurisdiction over your country. You can't turn to your king to enforce jurisdiction. In some situations maybe Church court can act as a venue for arbitration and dispute resolution, but most of the time what they did was---if they had a dispute---they would find some neutral third-party merchant who was an expert in the area and say, "Look, we have this dispute. Here is this contract. I think I was supposed to do X, my trading partner disagrees. He thought I was supposed to do Y. Can you help us sort this out?" The arbitrator, using his expertise, would look at it and come to a decision, and for the most part they were complied with voluntarily. Because if you went to commercial arbitration in the Lex Mercatoria system and then you ignored a ruling, you would become known as a defector, as a cheater, as someone who didn't act or uphold his or her word. And international trade was a relatively small and close-knit community and so that information would get around. You'd be branded as someone as not worthy of doing business with.

And so you could cheat and get a payoff now, but you would risk that no one would trade with you in the future. So you'd be losing all future business, which is why most agreements, both for the medieval law merchant and the current law merchant---the current system of international commercial law---are actually complied with and adhered to voluntarily.

Petersen: OK, so what kind of legal disputes do you see potentially arising in space? What sort of resources might people come to have conflicts over?

Salter: Good question. I think the most obvious one, at least to me, is probably with asteroid mining companies. So if I go land on an asteroid and I want to mine it for valuable minerals, do I own the entire asteroid? Do I own just a portion of its surface? What happens if there's water underneath the asteroid and someone wants to go in and get the water while you're getting the minerals? How deep, literally geographically, down into the center of the asteroid do my property claims go? And water, once you're actually in space, is pretty valuable because it's used for making rocket fuel, essentially. And also, water is very heavy. As we discussed earlier, it's really expensive to get water into orbit. So if there's water already in space, in an asteroid, that's a valuable resource. People are going to want that. What happens if you want the minerals and I want the water? But me going to get the water creates a situation where you can't go and get the minerals. Maybe my mining operation is in the way of yours. Those are very real disputes that there are actually very real analogues of here on Earth that we're going to have to go and settle in space.

Petersen: I'm reminded of, during the California gold rush they developed an elaborate set of rules for how large a claim an individual gold miner could mine. And how you would draw the lines between different people's claims, and they established de facto courts to deal with claim jumpers. So we're thinking that California during the gold rush might as well have been outer space, it was so far from the rest of civilization. And so we're more or less thinking that something like that would occur.

Salter: Exactly. Economically, I think this situation is very closely analogous. Gold miners in California are outside of the reach of the formal US Government. They're in the metaphorical Hobbesian jungle, a state of nature with respect to each other. Orthodox theories of social cooperation says they shouldn't be able to cooperate and yet they clearly did, historically. The gold rush is a really interesting period of American history to study for that.

There's also a book by scholars Anderson and Hill called The Not So Wild, Wild West. We have this impression from Hollywood that the American frontier was a violent and lawless place, when in fact most likely the opposite was true, because people knew that they didn't have access to formal dispute resolution mechanisms offered by the US Government they had to come up with their own. And they worked relatively well.

And I think that's the situation we find ourselves in in space. There are governments "nearby" but given current international law they can't actually extend their jurisdiction into space and therefore mediate space-related disputes. Or at lease some disputes. And so we have to have space tourism companies coming to agreements with asteroid mining companies coming into agreements with communication satellite providers. There needs to be a body of voluntary and self-enforcing rules, and again I think that there are numerous historical examples you can point to that should lead us to be actually pretty optimistic about this. Private law is not just feasible but it is also desirable because it has some pretty nice consequences in terms of creating incentives for making and stewarding wealth.

Petersen: So, the nice thing about private law, you sort of alluded to it earlier but Hayek makes this distinction between law and legislation, and the nice thing is it's adaptive. When you encounter new issues and new problems you set new precedents that can change and adapt with the circumstances. That's one major advantage of private law, right?

Salter: It's important to recognize that that's not unique to private law. That also exists in the common law legal system that exists in the Anglo-American tradition. So the benefits of specifically private law---I think we're talking about private law here as opposed to some sort of common-law extension into space which again, Article II of the space treaty seems to say that's not OK. So given that, are these adaptive features of a purely private legal system good enough to facilitate social cooperation and basically get people to not fight with each other? And I think they are. It's sort of a bottom-up process for discovering rather than creating law.

There are many rules that are probably equally feasible. It's a question of finding the rules that best give individuals incentives to act in a socially responsible way. And we also want those rules to provide for orderly, quick, and low-cost dispute resolution. People are going to disagree; it's inevitable. What we want is for a legal system that is sufficiently adaptable so it can tend to specific circumstances, but also sufficiently general that individuals can form reliable expectations of their trading partners' behaviour. And as Hayek pointed out, private law is one kind of law that has that dual feature that we like so much: adaptability yet at the same time predictability.

So it's not the case that only private law can have that. That's not what I'm saying. I'm saying that private law can have that, and given current international law, that's the only ball game in town.

Petersen: So, when you said about clarifying the rules, do you feel that if the governments of the world were to say right now that, "disputes in outer space are not our jurisdiction, you're on your own," and codify that and maybe have another treaty, do you think that would hasten the development of these private mechanisms?

strong>Salter: I think it would. The private mechanisms are only going to arise as needed in a private law system. When there's no actual dispute and no actual thing being tested, there doesn't need to be a rule for overcoming one party's disputes or claims against the other.

So I personally actually not only think that private law is desirable in space just because of current international law. I would actually like to see space kept "safe" for private law. Because it has all these nice, socially beneficial properties in terms of aligning people's incentives and giving them the information they need to do good things.

And if you look at the most likely counterpart---imagine international law were amended---what's likely to happen is there would be some international governance body, a regulatory body that's given authority over space activities. And once we embrace that sort of bureaucratic regulatory solution, that comes with all sorts of political economy and public choice problems. How do the regulators get the information necessary to make good rules? What are the incentives to make good rules?

I think that several schools of economics and legal thought have shown that in this case embracing a top-down regulatory solution would actually be pretty dangerous. So I would like to see international law clarified, but I would also like to see private law prevail in space.

Petersen: Right, and if we're talking about particularly humans in space, as in the case of a Mars colony, it would seem to be undesirable to bring our baggage and our governance here to a place as distant as Mars. The people there are likely to face all sorts of their own problems. And if there was part of Mars that was governed by, say, the US Government you would almost face the same problems the Thirteen Colonies had being governed by the British. You have this vast gulf between the people who are doing the governing and the people who are being governed. So could a Mars colony function on private law?

Salter: Wow, that's a fascinating question and one that I didn't tackle in the paper. That's actually a little beyond my expertise in this area. I don't see any reason why it couldn't, simply because I don't see the economic and legal problems that potential Martian colonists would face are any different than people on the international law merchant scenario would face. Or individuals in medieval Iceland---who had their own body of voluntary and private law---face.

I think the best analogy for these sorts of situations is the economic literature for what is sometimes called "analytic anarchy." And people are sometimes scared of it because the word "anarchy" is in there. But all anarchy means in this context is we don't have recourse to a nation state to solve our disputes for us. So if we're going to get governance, we're going to have to find a way to do it ourselves. It has to be voluntary, it has to be agreeable to all parties, and it has to do a good job at facilitating social cooperation.

So how do people actually do that when they don't have access to the nation state? Which is again pretty new in human history. So if you're looking at any time prior to 1648, there's got to be some way of generating order. And if you look at history I think you have a lot of examples of proprietary communities and voluntary communities which can be models for a Martian colony. So to make a long point short, I don't see any evidence that a Martian colony cannot be purely privately governed. And I don't think we have any reasons to think so because the problems they're going to face have been faced historically and overcome by people in various times and places.

Petersen: Do you have any closing thoughts about the future of space and the role of economics in helping us achieve our goals there?

Salter: I think that economics is going to be particularly useful in helping us highlight exactly which potential problems are worth caring about and, of those problems, which ones deserve or merit public policy responses. So, for example, I don't think there's any reason to be afraid of creating a private law governing space. I'm actually encouraged by that prospect.

But that doesn't mean that domestic agencies, especially national agencies, don't have a role in making space a formidable and habitable environment. We just spent the first half an hour talking about space debris, right? And there's lots of things that US agencies can do to mitigate space debris for example. Various agencies can have a rule, and there are such rules in place now, saying if you're going to orbit a space craft you’ve got to provide for de-orbiting the debris and also de-orbiting the space craft when it's no longer useful.

So economics, and particularly the economic way of thinking, can help us identify, OK this anarchy in space problem is not actually a problem. Private law is viable, so we don't have to worry about that. Oh, space debris is a problem because we have this common pool resources problem, externality problems, and the usual solutions---taxes and or property rights---aren't feasible. So we need to find some other way, maybe harnessing market mechanisms at the margin to address these. And I think the economic perspective is going to do a good job at cautioning us at taking a top-down approach at space governance.

The temptation is huge to say, "OK, we're on the verge of major space breakthroughs. Let's sit down and write down a body of rules that's going to govern space." That's really dangerous because there's no way that you and I sitting in our armchairs can see all the eventualities or problems that people will confront in space. And so the rules that we write are almost certainly going to have little to no relationship to those problems, and therefore won't help commercial and or government actors solve those problems. So figuring out what's important and avoiding the temptation to engage in what Hayek called "The Pretense of Knowledge." Thinking that we can learn and know and plan more than we can actually do.

Petersen: My guest today has been Alex Salter. Alex, thanks for being part of Economics Detective Radio.

Salter: It's been a pleasure. Thanks again for having me.


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Re-thinking the U-Curve of Inequality with Vincent Geloso

Tue, Nov 01, 2016

What follows is an edited transcript of my conversation with Vincent Geloso.

Petersen: My guest today is Vincent Geloso of the Free Market Institute at Texas Tech University. Vincent, welcome to Economics Detective Radio.

Geloso: It's a pleasure to be here.

Petersen: So the paper we'll be discussing today is titled "A U-curve of Inequality? Measuring Inequality in the Interwar Period" which Vincent has co-authored with John Moore and Phillips Schlosser. The paper casts doubt on the claim from, most notably, Thomas Piketty and others that inequality fell from the 1920s to the 1960s and rose thereafter. So, Vincent let's start by discussing the inequality literature prior to this paper. What is this U-curve and where did it come from?

Geloso: The U-curve is probably the most important stylized fact we have now in the debate over inequality and the idea is that, if you look at the twentieth century, there's a high point of inequality in the 1910s, 1920s and then from the 1930s onwards up to 1970s, it falls dramatically to very low levels and re-increases thereafter, returning to 1920s-like levels of inequality. So the U-curve is the story of inequality in the twentieth century. It's mostly a U.S. story because for other countries it looks less like the U-curve than an inverted J. So it's higher in the 1920s, it still falls like in the U.S. but really increases much more modestly than the United States in places like Sweden, or France, or Canada. But the general story is that there was a high level of inequality at the beginning of the century well up to the mid-second-half of the twentieth century and it re-increased in the latter years and then we have been on a surge since then.

Petersen: So, a lot of this is coming from Thomas Piketty, who of course wrote the surprising bestseller "Capital in the Twenty-First Century." Could you talk a little bit about where his data came from?

Geloso: Okay, by the way, this is where there's a failing on my part which I think I always find funny; an anecdote to tell about Piketty. I'm originally from Quebec, so I am a French-Canadian, I speak fluent French. His work started coming out in French first and I initially started to write elements of the paper we're discussing today back when it was only in French. And then I told myself, "There's no point, it's only a French book, nobody reads French. What's the point of writing a paper about a book that no one will read?" Biggest mistake of my career, I guess, not writing that paper before.

But anyways, besides that, his entire argument is based largely on his most influential paper---which I think was published in 2003 in the Quarterly Journal of Economics---which was using tax data. So, the records, the fiscal statistics to create measurements of income inequality in the United States and the advantage of that is that since the income tax started in 1910s you've got a long, long period of measurement of income inequality with the same source.

So it's a great advantage because a lot of the people before like Kuznets, like others had to use residual estimates, different sources, they were amalgamating different sources together and it was always a problem because you couldn't create one homogeneous time-series of inequality. You could get a rough idea and there's a few papers---for those who read economic history stuff---there was a paper by Lindert and Williamson in the 70s in research in economic history and you can see their first graph in that paper was a series of different measures of inequality. They were all pointing to the general similar shaped curve but they were all from massively different statistics, different sources. So one was the 50:10 ratio of earnings, another one was a measure of income, the other was wages and they are all different measures, they are not perfect.

You can get a good idea, a rough idea but you cannot have a continuous time estimate which is what Piketty innovated by using the tax-wealth with Emmanuel Saez, recreating this long continuous trend in data from 1917 to the modern day. And they keep updating it regularly to include the new data on a yearly basis.

Petersen: So tell me about tax avoidance. How does that affect things?

Geloso: Okay, this is where the existing data that all the different sources had---Piketty made advancement. Rather than having variance across different sources, he was eliminating that variance. But there's still an issue of variance within a source. So it's not because you have used a homogenous source that the quality of the data contained within the source is consistent. There's actually quite a lot of variance in data quality because of the way the tax system was done.

So a lot of the debate today for the data for today has been---has there been such a large increase in inequality as Piketty and Saez and Atkinson and others have been pointing out? And the reason for that was largely because, as Alan Reynolds, as Joel Slemrod, and a few others have pointed out, the tax changes of the 1980s were so large that people shifted the way they reported income. They changed the way they reported tax liability. What used to be classified as corporate income became classified as individual income, and so you get an artificial increase because of a way the tax system has changed. And this is why a lot of people say, as soon as you correct for the effect of changes in tax reporting behavior, you actually get a much more modest increase of inequality.

But that's from 1980 to today with a massive tax change in the 1980s. If you go back further in time, to the interwar period the tax changes are much more dramatic. In 1913, the tax rate was 7%, went up to 15% in 1916 to 73% until 1921, went back down to 24% by 1929, went back up to 79% by 1939. Imagine, that's a lot of movements in the way taxes will affect behavior and it will affect reporting behavior. So, will you report, will you be as honest as you would be when you're filing taxes at 79%, as you are when you're filing taxes at 24%? So you're getting---because of these massive changes in tax regimes that are happening over very short periods of time---these massive changes affect the quality of the data set that Piketty is using for the left side of his U-curve.

The left side of the U-curve is probably inaccurate to a very high level because of tax avoidance, and this is where the economists in general failed to talk to historians because there's a few papers out there that did measure---especially in the Journal of Economic History---that did measure changes in reporting. So changes in tax avoidance occur basically to a large level by the top incomes, as Gene Smiley argues in the Journal of Economic History, for example, which Piketty has never cited neither Saez, neither anyone in the debate. And he did corrections, so he checked: Okay, when a tax rate went down from 73% to 24%, did people change their reporting behavior? Did more rich people start to report incomes? And the answer is 'yes.'

And as soon as he started doing corrections for that to control the "artificialness"---if that's a word---of the tax changes on affecting the level of inequality, he actually finds that the 1920s have a much lower level of inequality because of the reduction in tax rates and there was very little upward trend, especially when we're comparing with the Piketty, with the Mark Frank data, with the Kuznets data and it shows that as soon as you adjust for tax avoidance the left side of the U-curve flattens dramatically and it looks more like an L---an inverted L---or a J, but it doesn't look at all like a U-curve and that's just tax avoidance for the 1920s. The increases in the 1930s in tax rates would have had the opposite effect where people would have reported less income.

So, the level of inequality in the 1920s is overestimated in Piketty and it's underestimated for the 1930s. So you're kind of flattening the entire interwar period as soon as you consider the one issue of tax avoidance. And there are estimates out there in the Essays in Economic and Business History by Gene Smiley and Richard Keehn. Smiley's article in the JEH, which has been ignored in the literature, but which did check that people at the top of the income distribution are generally very sensitive to changes in tax regime in the way they report their tax liability.

Petersen: So, today they would do that by maybe registering---having their money in the Cayman Islands or Ireland or the Isle of Man, their tax shelters abroad. Was the avoidance different in the 1920s? I expect it would be harder to enforce taxes given that the income tax was so new and there were all these changes and they didn't have electronic records, or how did it work?

Geloso: You're thinking of avoidance in a very negative term which is the illegal part, which is what has somewhat permeated the public debate and I have this reflex myself. I think of avoidance always in that way. But avoidance is sometimes just planning your taxes, your sources of income, differently. One example would be---and it's not really applicable to our case---parents can put their kids on company payroll because it's cheaper dollar for dollar relative to giving them an allowance from after-tax personal income.

So, people can change their behavior in their way to get money, in the way they report their income. So you can pass corporate income as a personal income or personal income as corporate income. You can deduct expenses one way or another. And one way or another it comes to affecting the quality of the data set. And it does matter, because if you look at the 1980s when there was a rapid change in the income tax rate, which was much more important a change than the change in the corporate tax rate, it led people to change the type of incorporation they were in, so they became S corporations, so corporations that were not subjected necessarily to the corporate income tax. So, it affected the way people reported, classified their income and it appears artificially the income inequality statistics.

The 1920s' equivalent was municipal bonds. Municipal bonds were assets that delivered incomes but they were not subjected to taxes so this was like a tax shelter that was completely legal and that rich people used in dramatic amount to reduce their tax liability. So, when people think of tax avoidance it's generally this idea that people just reorganized their classification of income to make sure they have the smallest liability possible and in a situation like that, what you get is a much different level and trend of inequality because of the changes in tax regimes that induce changes in tax reporting behavior.

Petersen: So is Piketty not adjusting for this at all? He's just taking the tax data at face value?

Geloso: He's trying some stuff but he gets a lot of the tax history quite wrong and what alerted us to this is that Gene Smiley's paper, which is not in an obscure journal, it's in the Journal of Economic History which is considered a top tier journal in the profession of economics---it's not AER, it's not QJE, but it is a very respectable journal. And Smiley's article is also very cited. There's a large number of citations of that paper and Piketty just ignores it. And you skim through his book and the discussion is always brushed aside and these effects of changes in tax regimes is always minimized as if it was not important.

But tax avoidance is only like a fraction of the problem, because if you look, there's another issue that's much more dramatic than tax avoidance. Alone the issue of tax avoidance, if you take Smiley's stuff, changes the narrative dramatically but that's just our first shot in this debate with me, John, and Philip. It's our first shot, the second shot is that filing requirements were nowhere close to what they are like today. And actually this is something funny, the idea of Piketty is that you can create a series assuming tax compliance for a country that was founded on a tax revolt which is---for a historian---kind of a weird assumption built in the way he does his history part. And if you look at it, one of the example is that you look at the changes in wages of people---wages for unskilled workers, wages for mining workers, for agricultural workers---they do not evolve at all like his bottom 90% of income behaves, it behaves actually very differently.

So, in our paper we show that the quality of what's at the bottom of the income distribution is dramatically different, so wages go up much faster than the income of the bottom 90%. And this is wages.

So, you think what, maybe hours are going down? No they're not in the 1920s and 30s---well in the 30's they're going down---but in 1920s hours are actually staying stable and in some industries are actually slightly increasing. So you should not see what Piketty's data suggest, which is that there was stagnation in the income of the bottom 90%. There was declining unemployment, there was rising wages and hours remaining relatively stable.

It's impossible to reconcile these facts with those of Piketty without considering that there might be problems in the way people filed their taxes. And this is where the entire thing breaks down and you look at, for example, the number of tax filers that were actually there. And you look at that as a percentage of the American population, up to the 1930s---so until the Second World War---there's never more than 6 or seven 7 percent of population that files in tax reports.

Petersen: And you'd expect it to be the wealthier people too, who are filing right? Because you have people below a certain income, they don't file income tax, right?

Geloso: Exactly. This wouldn't be a problem if your distribution of people behaved equal to the distribution of the general population and the movements were the same. It wouldn't be a problem. The thing is when you look at the number of adjusted tax returns which is what Piketty and other people like Estelle Sommeiller or Mark Frank do. They try to re-correct this issue of a very small number of tax reports that were actually filed in and they get an idea---and this is figured too, I think, in our paper. There's a steady upward trend in the number of adjusted tax units but when you look at the actual number of tax units it moves so much. It goes up and down and it doubles in the span of two years, then it reduces by half in the span of another two years and these are such large movements in the number of tax units that it's hard to see that this might be a representative sample of the American population.

Differences in reports and such changes in our reporting---and the number of reports I should say---suggest that there is actually a problem in the quality of the data. And this is where we're saying that if you combine this with the observation that wages were increasing, unemployment was falling, and that hours were more or less stable, and that you add this fact of the massive changes in tax returns, you can easily question the quality of the data from the 1920s and the 1930s.

This is where we're coming in and we're saying, no, the people who reported taxes were very volatile. They were rich people who reacted to changes in income taxes. Lower income individuals also were very much tax resisters. There's an entire story told by David Beito. I think it's with University North Carolina Press. He has a book on tax resistance in the United States during the 1920s and 30s and there's actually a large documentation of anti-tax leagues that have massive memberships of common individuals who are resisting filing taxes at that time.

So it's quite plausible to say that, if there's such a difference in wages, in hours, in unemployment what they and these massive changes in the number of tax returns filed, it suggests that probably the poor people just didn't file in their taxes. So, any movement at the bottom of the distribution does not exist according to Piketty's data. But there were movements at the bottom. There were people who moved from poor Kansas to Illinois. They were still in the bottom 90% but by moving from farming Kansas to Chicago to work in a garment industry, they get a gain in income but that is not captured in Piketty's data because it's highly likely that poor individuals tended to file fewer tax returns and were probably more hostile to filing them, and the rich were just reacting to changes in tax regimes. So, the tax filing requirements would actually lower the level of inequality overall from the 1920s and 1930s.

So, the tax avoidance issue would change the trend and the issue of tax filing requirements would drop the level because we're not capturing bottom incomes properly. So you're changing the U-curve progressively as each of our critiques is embedded in the argument you actually progressively bring down the left side of the U-curve and it looks more and more like a J, or an L, or a hockey stick.

Petersen: I remember in 2012 Mitt Romney got in trouble for pointing out that 47% of the population doesn't pay income tax. So if Mitt Romney were running for president in the 1920s, I guess he would have said something like 94% of people are not filing and paying income taxes. Is that right?

Geloso: Exactly. That would be a very accurate. Well it's 94% of people. The taxes were based on households, but still 6% and then later on after the Second World War it jumped above 40%. So there's a massive change not only in tax regimes in terms of rates, but filing requirement regimes, which will also change the tax behavior of individuals. And not only that, this is something that actually, it was buried in a footnote of Smiley's article which is---still I will point out not cited by Saez and Piketty---but it's so rigorous and it contains so many pieces of information that are crucial.

Until 1938 public sector employees were not mandated to file in taxes. This is an unknown fact. Until 1938 they did not have to file in taxes. So this is actually a very very big factor. So in terms of wage earners, so not everyone, it excludes farmers, but all wage earners, 12% of them were government workers. This is a substantial share of the workforce and not only that, their earnings are slightly above the rest of the workforce and the increase in their earnings is above those of the other workers in the United States in that period. But they're just not considered in the tax distribution. So until the public salary Act of 1939---which was debated in the Senate in 1938-1939, the 1.2 million federal employees---this is a large number---were drawing large wages and they're just not included in the statistics based on tax data.

This has a massive impact on the level of inequality. Public workers were not in the top 1%, they were not the richest, they were not poor and they were earning much more over time. I'm not trying to debate whether it was efficient government spending or if they were paid at actually providing public goods that people actually did want. But set that issue aside, they had higher wages than the average representative of a sizeable share of the workforce and their wages increased much more importantly than other ones.

So you're affecting the trend. You're affecting the level and you add this other issue and then look again, imagine the U-curve in your head. Tax avoidance, it changed the trend. It made it less, it made it much lower in the 1920s than it was. It increased it relative to the Piketty data in the 1930s. The entire level then is reduced by adjusting for tax filing problems and then if you tried to adjust the issue of public sector employees who didn't have to file in their taxes you drop the level again, so it's looking less and less like a U-curve than what Piketty claims.

So, we haven't made all these adjustments, we're just stating facts that should be known in the inequality debate. Our goal is later on to test each of our points. We're sending such a large number of criticisms that there's bound to be one that sticks in terms of the data quality. Because these are such huge data quality that it effects a major stylized fact about inequality: the U-curve. If today we believe that the U-curve---there's a debate over whether or not there's been such a large increase---everybody agrees that there's been an increase, but there's a massive debate over how big this increase is today.

Imagine how crucial it would be to correctly debate the level of inequality and the trend of the left side of the U-curve. And if we're having all these debates with all the survey data, all the census data, all the private big data stuff that we have out there for the modern era and we still have high level of uncertainty, imagine anything with all the points I've mentioned for the interwar period, the left side of the U-curve. Everything seems to indicate that's probably much lower. I'm not saying there's not a U-curve, maybe it looks like a ball, a very modest ball, or there's a slight decrease, there's a slight increase, but it's not Piketty's U-curve, it's not the same stylized fact. And it changes the narrative we should have about inequality.

Petersen: Yeah, I'll never forget one experience I had. It was the original Occupy movement and I went down to see the protests going on in Victoria B.C. where I was at the time and one guy just had a big sign where he had printed off a graph. You know, an inequality graph of the 1% versus the 99% from Piketty and Saez. I'm not sure if it went all the way back to the 1920s but really, that's sort of a very clear sign that these debates are expanding beyond academia and having a big effect on the public and their perception of the world we live in, the ideal policies that we should be pursuing. A big part of the U-curve narrative is to say look at how successful the policies in the 40s and 50s were at reducing inequality and of course if we do away with this U-curve then maybe those policies, all they did was bring more people into the data set.

Geloso: Yes, and it changes who reports in the data set. I know Phil Magness, who is joining our team with me and John Moore and Bill Schlosser. Phil Magness has been working on showing that a lot of the changes in our tax regime actually just mimic the entire movement of the income share of the top 1%. It follows what share of taxes they're asked to pay and it leads to changes in reporting and basically it's a story of tax regimes and it changes the entire narrative.

But what I find much more depressing---and this is a depressing fact---if just one of our criticisms lands and sticks, the U-curve doesn't look like a U. Let's say it looks like a J. So there's a mid-point in the 1920s and we've been increasing since then at a relatively high rate since the 1970s. So it fell from 1920 to 1970 and then it re-increased.

If you look at what caused the leveling from 1920 to 1970, a lot of it has nothing to do with state intervention, with the efforts at redistribution. There's probably a sizable share of it that has to do with that. But there's also a sizable, and probably the larger share, that comes from poor regions catching up with rich regions. If you look at for example the history of inequality in the United States you would see that if you decompose the variance---so what caused the inequality---for most of American history a large share of inequality was caused by differences between states rather than differences between individuals.

One way to see it, and I'm making a caricature here to get the point across, but you could have the same shape of distribution in income in Kansas and New York. But since the average in New York is much higher than in Kansas, you average the two in, you get a much higher level of inequality, so you can get like a Gini coefficient for the two of them of .4 but in each of them individually taken the level inequality is like .2. And this is what happens for most of US history. There are massive gaps between regions rather than gaps between skills, between levels, so Mississippi is poorer than New York for a long period of time. But in the 40s, 50s, 60s, 70s this gap basically volatilized, it began to disappear.

One of the massive story of the twentieth century---some economists are aware---is this massiveness of convergence between regions. So the South gets richer. Poor black people move from poor states in the South where they're sharecroppers, they move to the North where they become wage earners in garment factories, in manufacturing and their earnings grow dramatically. So there's a massive convergence during that period. But, if you think about it for a second, it means that the gap between regions and the gap between races is actually a big driver in the leveling part of the U-curve, but that has nothing to do with tax redistribution. It has nothing to do with this.

So, as soon as we integrate our criticism into the tax data, and we show that the U-curve looks less and less like a U, the left side of it makes it look less and less like a U. And you consider these two economic history facts that I've just mentioned, it's incredibly depressing to consider in the inequality narrative, to say well a lot of it is just stuff that would have happened anyways. There would have been a decline in inequality regardless of how much the state intervened to redistribute income because there was this convergence. And not only that, the leveling of inequality was not as great as we say it was. So it changes the entire story.

We have inequality and how to address the issue and, not only that, I will point out that across the same period the one thing that goes up relatively steadily is government spending to GDP. If you were to account for all our criticism and then consider which part of inequality was reduced by government redistribution, it becomes more and more depressing because it seems like the effect is much smaller than people believe.

This is where we're trying to disentangle all these elements to tell the correct story of inequality in the United States and it starts with getting the shape of inequality right. But look at the story I have just told you. As soon as we make this small change of properly assessing things, the entire narrative we have then changes. And this is why it's a dramatic fact to get right and which is why we're somewhat disappointed with Piketty's stuff because he's not making the right level of methodological discussion.

Petersen: Right. Piketty uses his narrative to push for large-scale taxes and redistribution.

Geloso: Yes. I'm not saying that what he does is bad. It was a massive improvement relative to what was there before. But his story has flaws, and these flaws tend to support his narrative. We point out the flaws that would support a different narrative, that point out that probably inequality is not as high as we say. It probably would have fallen up in the 1970s because of very natural forces and if you think about the fact that since the 1970s there's been a slight divergence---so, imagine the leveling of inequality between regions in the United States. The divergence fell until the 1970s, but it has increased modestly since then because of regulation on housing, things that limit mobility across states that the depress income growth in some areas.

So you end up with a slight divergence since then and it is caused by states. It's not caused by anything that the government is doing. It's really an issue of very regionalized factors and each time you consider each of these nuances in, the narrative changes. And it changes dramatically against the story Piketty's telling and it shows that the flaws are biased in favor of the conclusion he supported.

Petersen: Right. And I know Phil Magness has really criticized him on this, that he makes a lot of decisions where you could go one way or the other and they always seem to turn out his way. Which is maybe a coincidence, or maybe it's not really the best way to do social science.

You point out that there were big price differentials between regions so how does that play into the regional inequality story?

Geloso: So, we're basing our discussion on this part of a longer series of papers where each of the points we've discussed will basically be one paper in itself. Here we're just stating this entire case for skepticism, then we'll see how big the impact is. Regardless, even if they're all minor, they will all change the narrative. And prices, regional price differences are an issue in that.

So, when you compare nominal income across a country you are getting an idea of inequality but---you will agree with me. So, you're in Vancouver. I'm originally from Montreal. If I give you a dollar income in Vancouver and I give myself a one-dollar income in Montreal you think that dollar will go as far in Vancouver as it does in Montreal?

Petersen: I think it probably won't.

Geloso: Exactly. So you would expect that regional price differences will affect the level of inequality. And there's actually a lot of people that do that. Each time you make controls for the level of price differences, you actually find that the level of inequality falls modestly. But it falls.

But the thing is, the price differences that we have today between Vancouver to Montreal or between New York and the region of Mississippi are not at all what these gaps used to be in 1920 or in 1925. In 1925 the gaps would have been much, much, much larger and from 1925 to the 1940s there's been a convergence of prices across regions. So for the first 50 years, roughly, of the twentieth century you get a convergence of prices across regions. So if you just took nominal income without correcting for regional price differences, you would get a massive drop in inequality.

However, if you were to correct for an increasingly smaller mistake because, if you think about it, if the wage gaps used to be on average 25% in 1890, let's say, and they used to be 5% in 1950, the error is decreasing over time. So you're getting the level off by a smaller and smaller quantity over time. So it means that the trend changes. The smaller your measurement error caused by regional price differences falls, the less pronounced the fall in inequality becomes. So you get a massive drop in inequality as measured by nominal income, which is not what it is when you correct the regional price differences, so you put this in real dollars adjusted for purchasing power parity.

And not only that, the errors caused by regional prices actually also follow a U-curve. So the errors that would be caused by price level differences across regions declined up to 1950 but since then they've re-increased. So if before you're getting a lower and lower trend---a lower trend by a diminishing amount of error---that means the right side of the curve, that means the increasing disparity in prices across regions since 1950. It means that you're actually increasing nominal prices using nominal income across the country. You will underestimate the increase in inequality since then.

So there are actually massive measurement errors caused by this issue of regional prices. When I say massive, I shouldn't say massive because it's dishonest but it affects both the level and the trends. So it affects the shape of the curve and remember we're making all these criticisms to the U-curve story piece by piece. Each one of them has a small prickly effect on the shape of the curve. As soon as one or more starts sticking---and they're all documented otherwise for other periods---not prior interwar period, not a sufficiently as we'd wish to, which is why we're doing this project of massive data collection.

It changes the narrative, changes the story, changes the way the curve looks and it's not much of a U-curve anymore and the proper measurements get you a very different story of the evolution of inequality. And that different story forces you to change interpretations and solutions and the entire structure of the debate must change to reflect the higher level of precision that is required for that debate.

Petersen: So. I'm trying to think of why these prices between regions might fall in the first half of the twentieth century and rise thereafter. I suppose a lot of it would be real estate, housing?

Geloso: Exactly. So housing markets in the U.S. are more or less freer in the first half of the twentieth century than they are today. So most prices, if you can trade a good across borders it will arbitrage out price differences minus transport, right? So if goods are movable more or less as well, and you find it for food, for TVs, for durable goods, you tend to find that there's actually still convergence.

But housing, you can't really move a house. There's actually movable houses but they're not a massive share of the market. So you'd expect less ability---and I'm saying this as a euphemism---but you'd expect less ability for arbitrage with housing. The only way you can do arbitrage for housing is by moving around.

So I am in Mississippi and I see super high wages in New York. I move from Mississippi to New York. So in Mississippi there's one more housing unit available and in New York there's one less housing unit available. I've driven up housing prices in New York and I've got higher wages but housing is a little more expensive in New York and then it falls in the region where I left in terms of housing, so that real wages in that region converged. So there's a convergence in real wages by people moving around.

The problem now is that, there is very, very, very little ability to move around in the United States because zoning restrictions actually make it harder for people to come and exploit the productivity of large cities like New York. So it prevents this convergence in real terms across regions.

So a large part of the increase in inequality needs to be corrected for regional price differences, which is the argument about housing. And this is where it's probably that the soundest part of our argument is that the Rognlie papers that attack Piketty state that a large part of inequality was driven by rents towards housing, so the fact that income derives from housing is increasing importantly as a share of total income and has nothing to do with capital itself. It's really the artificial restrictions on housing.

And this is largely the problem the inability of people to move to where wages are the most important. This changes the narrative. So that's why the story of regionally correcting price differences is crucial and it's rarely done over a long time series data set. But given the evolution of prices in the United States since 1900, it will affect the trend dramatically.

It will affect the level, the shape, and this is not integrated in the argument. And this is why we're saying in this paper, each time you make a correction to get a higher level of precision, it's getting more and more plausible that the curve of inequality doesn't look like a U, it looks probably like an L, probably like a J, but not a U. So the early period of the twentieth century is not as high as people have claimed and there's probably been an increase since the 1970s. Not as much as some would claim, but the increase seems to have happened. The U-curve is probably just fictional. It is the result of poor controls or variations in equality of the taxes.

Petersen: We've discussed the housing issue on other episodes of this podcast but it's sort of a one-two punch to inequality, where the people who, you know, maybe have bought a house in the San Francisco Bay area in the 1980s, have seen the value of that house skyrocket. And so of course that would contribute to the upper end of that wealth distribution. And the people who live in Mississippi and might like to move to the San Francisco Bay area and work for Google, can't afford to do it because of the extremely high price of rent there. So, that's reducing mobility and exacerbating these regional differences and also directly increasing the wealth of people who own homes who are, of course, already on the wealthier side.

Geloso: Yes, in a static term, correcting for price differences across region. So if you were to take a picture of the economy right now and you make a picture of inequality based only on nominal incomes across the country---just using U.S. dollars---you'll get a higher level than if you correct for regional price differences.

However, it's quite likely that if you were to make a movie of how inequality evolved, the housing restrictions---and this is a comment that's outside our paper and it's just something I think it's worth commenting on---if you make it so that it's impossible to move from low-income Mississippi to high-income California, you're going to make sure that inequality stays high and probably increases.

If, let's say, there's a shock to international trade and Mississippi area tended to be manufacturing and people can't move from manufacturing to higher productivity jobs in San Francisco. So in dynamic terms, housing restrictions by preventing mobility prevent a strong equalizing source of income. So in static terms you get the level wrong, but in a dynamic term you're preventing the powerful force of mobility across the country---and this is something I like to point out---if you look for example, you bring someone from Italy to Canada in 1890, his income increased 300% as soon as he got to Canada. He was much richer the minute he set foot in Canada. You probably increased inequality in Canada---I don't know about if you decrease it or increase it in Italy---but when you move that guy away, you probably reduce global inequality. So by moving people to where the incomes are higher you level off inequality.

In the United States it's the same narrative, you prevent this equalizing force from working through housing restrictions and making adjustments for---this is beyond the scope of our own research---but making adjustments for the increasing restrictiveness of housing that prevents mobility, you will probably get a large part of increasing inequality in the United States or even in England, which is also a situation like that, and in France, is not the result of terrible market forces responding to terrible government policies.

Petersen: My guest today has been Vincent Geloso. Vincent thanks for being part of Economics Detective Radio.

Geloso: It was a pleasure.


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How Land Use Restrictions Make Housing Unaffordable with Emily Hamilton

Fri, Oct 21, 2016

What follows is an edited transcript of my conversation with Emily Hamilton about land use regulations' effects on affordable housing.

Petersen: My guest today is Emily Hamilton. She is a researcher at the Mercatus Center at George Mason University. Emily, thanks for being on Economics Detective Radio.

Hamilton: Thanks a lot for having me.

Petersen: So, Emily recently wrote a paper titled "How Land Use Regulation Undermines Affordable Housing" along with her co-author Sanford Ikeda. The paper is a review of many studies looking at land use restrictions and it identifies four of the most common types of land use restrictions. Those are: minimum lots sizes, minimum parking requirements, inclusionary zoning, and urban growth boundaries. So Emily, could you tell us what each of those restrictions entail?

Hamilton: Sure. So, starting off with the first, minimum lots sizes. This is probably what people most commonly associate with zoning. It's the type of Euclidian zoning that separates residential areas from businesses and then within residential areas limits the number of units that can be on any certain size of land. And this is the most common tool that makes up what is sometimes referred to as Snob Zoning, where residents lobby for larger minimum lots sizes and larger house sizes to ensure that their neighbors are people who can afford only that minimum size of housing.

Petersen: So it keeps the poor away, effectively.

Hamilton: Exactly. And then parking requirements are often used as a tool to ensure that street parking doesn't get too congested. So when cars first became common, parking was really crazy where people would just leave their car on the street, maybe double parked, or in an inconvenient situation near their destination. And obviously as driving became more and more common and that was just an untenable situation and there had to be some sort of order to where people were allowed to park. But street parking remained typically free or underpriced relative to demand. So, people began lobbying for a parking requirement that would require business owners and residential developers to provide parking that was off streets so that this underpriced street parking remained available. But that brought us to today where we often have just mass seas of parking in retail areas and residential areas, which are paper focuses on. Parking substantially contributes to the cost of housing, making it inaccessible in some neighborhoods for low income people and driving up the cost of housing for everyone who has been using the amount of parking that their developer was required to provide.

Petersen: So that's one where you can really see the original justification. And it makes sense, if you have a business and a lot of people are parking and it spills over onto the street then maybe that's an externality. And it seems reasonable for you to have to provide parking for the people who come to your business, especially if a lot of them are driving there. But we push that too far, is what I'm hearing.

Hamilton: Exactly. Yeah, it does seem reasonable but the argument in favor of parking requirements tends to ignore that business owners have every incentive to make it easy to get to their business. So, in many cases there's not necessarily an externality because the business owner providing the parking has the right incentive to provide enough to make it easy for their customers to get there. The externality really comes up when we think about street parking and Donald Shoup---probably the world's foremost expert on parking---has made the argument that pricing street parking according to demand is a real key in getting parking rules right.

Petersen: So, on to the next one. What is inclusionary zoning?

Hamilton: Inclusionary zoning is a rule that requires developers to make a certain number of units in a new development accessible to people at various income levels. Often inclusionary zoning is tied with density bonuses. So, a developer will have the choice to make a non-inclusionary project that is only allowed to have the regular amount of density that that lot is zoned for. Or, he can choose to take the inclusionary zoning density bonus which will allow him to build more units overall including the inclusionary unit and additional market-rate units. Typically, units are affordable to people who are making a certain percentage of the area median income, so people who might not have low income but who are making not enough to afford a market rate unit in their current neighborhood.

Petersen: Okay, so that's sort of forcing developers to build affordable units that they then will probably lose money on, so that they can build the market rate units that they can make money on.

Hamilton: Exactly. That's how cities make inclusionary zoning attractive to developers is by giving them that bonus that can allow them to build more market rate housing. In other cities, however, inclusionary zoning is required for all new developments so it really varies from jurisdiction to jurisdiction how it's implemented.

Petersen: So the fourth land use restriction you mention is urban growth boundaries. What are those?

Hamilton: So Oregon is the most famous example in the US of implementing an urban growth boundary. And what it is, is basically a state law that requires each city to set up a boundary around its edges, where for a certain amount of time no housing can be built outside of that boundary. And the idea is to gradually expand the city's footprint over time to allow the suburbs to expand a little further, but to restrict that suburban development using the boundary for some time period. Other examples like London's urban growth boundary I believe are permanent, so there are certain areas that can never be developed.

Petersen: So I believe we have something like this in Vancouver. We have farmland in the metro Vancouver area which---for context this area is one of the most overheated high-priced housing markets in the world---and we have this land that's just zoned for farms. And a lot of the time people don't even bother to plant crops, they're just holding the land for the day when eventually it can be rezoned into housing. So I looked it up before we went on and some of these plots are $350,000 an acre, which of course is not reflective of just how productive they are as farmland but of how productive they would be when they are eventually rezoned.

Hamilton: Exactly. Yes, very similar to Oregon's program. And a lot of empirical studies have been done on Portland's growth boundary because researchers can easily look at the block that are selling on either side of the boundary to see whether or not it's affecting land prices and several studies have found a very clear effect of the boundary in driving up the price of the land.

Petersen: And in Vancouver, the city is very reluctant to rezone. So, people are constantly applying and being denied but you know it's like winning the lottery having your bit of useless farmland rezoned to super high value housing. And people are just holding on to those dead lands in the hopes of winning that lottery which is kind of---it's a bizarre outcome.

Hamilton: It is. And urban growth boundary supporters often frame it as environmental regulation that's going to protect this open space. While encouraging people to live in more dense and transit and walkable friendly neighborhoods, but it's not as if Portland is free of other types of zoning rules. So at the same time it has this urban growth boundary it also has a lot of traditional zoning rules that limit the potential to build up while the growth boundary is limiting the potential to grow out. So it's coming from both directions.

Petersen: So, just how costly do economists think these regulations are? What kind of estimates do they have?

Hamilton: So, I think some of the most compelling estimates look at the macroeconomic effect of these rules. Because typically the most binding zoning rules are also in the most productive cities, where there's the highest level of demand for people to live. Because these are where the best jobs are as well as the best urban amenities, a lot of people want to live here. One study looking at this macroeconomic effect found that the three most productive cities which are New York, San Francisco, and San Jose---I should clarify; this is just looking at the effective growth within US---if those three cities lowered the burden of their land use regulation to that of the median American city it could result in a 9% increase in the level of US GDP. So, these rules are having just an enormous effect on economic growth. Not to mention the very substantial effect they have for individuals and making it difficult or impossible for people to afford to live in their desired location.

Petersen: So, you know, San Francisco that's where Silicon Valley is. And so we think of it as a place with super high productivity---tech workers working at Google---and yet with their housing market being one of the most restricted. So not only is there the loss from the housing market itself, that you could sell a lot of housing there and that would increase GDP by itself, but also there are people living in less productive areas doing less productive jobs, who could come and work for Google. But they can't because they've been priced out of the market. Is that where most of the effect comes from?

Hamilton: That's right. Yeah, I think the effect is also certainly at that top-end of the market where we're seeing all kinds of blog posts and articles about a person making six figures at Facebook who can't afford the Bay area. So those people might choose to go live in say Denver, or Austin, or a city that still has plenty of great jobs but isn't as productive as San Francisco or San Jose. But then we also see this down the income spectrum, where people who are in the service industry, say waiting tables, could make much more in San Francisco then they can in Houston, or wherever they happen to live. But their quality of life is much better in some of less productive cities because of the cost of housing and other areas of consumption that higher real estate costs drive up.

Petersen: One thing I've heard about a lot of these Californian coastal cities---I think it was Palo Alto---where not a single member of the Palo Alto Police Department lives in Palo Alto because you just can't live there on a policeman's salary, so they all have to commute in every day and then commute out every night.

Hamilton: Yeah, and for some of these hugely important needed services it just makes the quality of life of the people in those industries so much worse than it would be if they could afford to live closer to their job.

Petersen: Right. So, to summarize the labor market mobility of the United States in general has been greatly restricted by these land use restrictions. Even though the land use restrictions are local, this has an effect on the national economy.

Hamilton: Exactly right. And we can see this in the data where income convergence across areas of the country has greatly slowed down since the 1970's when these rules really started taking off.

Petersen: You argue that the costs of these restrictions fall primarily on low-income households so can you talk through how that happens?

Hamilton: Sure. It happens in two ways. First off, you have the low income people who are living in very expensive cities and these people might have to endure very long commutes---you talked about the police officer in Palo Alto who can't live anywhere near his job. Not that police officers are low income, but just as an example that illustrates the point. Or they have to live in very substandard housing, perhaps a group house that's just crammed with people maybe even illegally, in order to afford to live anywhere near where they're working.

Petersen: Yeah, I was going to say I thought those group houses were illegal from these very same land use regulations, but I guess people get around it.

Hamilton: Yeah, a lot of US cities have rules about the number of unrelated people who can live in a house. And certainly those rules are sometimes broken. That, I think, is clear to anyone who's spent time in an expensive city. You know, people have to live in these less than ideal conditions and waste too much of their time commuting in order to make that work. But the unseen version of it is the person who lives in a low-income part of the country and would like to improve their job opportunity and quality of life by moving to somewhere more productive, but they simply can't make it work so they stay in that low-income area without meeting their working potential.

Petersen: There was a study by David Autor---I think I cited it in a previous episode and got the author name wrong but it's definitely David Autor---and it was looking at the shock, the trade shock that hit United States when it opened up trade with China in the early 2000's. And it basically showed that a lot of parts of the country just never recovered. So, if you worked in particular industries---I think the furniture industry was one that was basically wiped out---and if you worked in a town next to a furniture factory and that was your job, not only did you lose your job, you lost all the value in your home because the one industry in the town is gone. And you can't afford to move to one of the booming industries like Silicon Valley or in another part of the country because they've so greatly restricted the elasticity of their housing supply. And that's not all, Autor's paper basically just shows that it took a very long time to recover from the shock and a lot of places didn't recover at all. But I really think that housing is part of that picture if you're trying to figure out why the US economy can't respond to shocks like it used to in the 20th century. That has to be a big part of the picture.

Hamilton: Definitely. And that trend, as far as people being able to leave these depressed or economically stagnant areas, this also comes out in the income's convergence as we talked about earlier.

Petersen: So, the other part of that, I saw in your paper, was not only are poor people hurt but rich people who already own homes have seen those home prices rise. So it's affecting inequality at both ends of the spectrum, correct?

Hamilton: Right, Bill Fischel at Dartmouth has done a lot of work on why it is that people lobby so hard in favor of rules that restrict development. And he terms it as the Homevoter Hypothesis, where people who own homes have a huge amount of their wealth tied up in their home and so they are in favor of rules that protect that asset and prevent any shocks such as a huge amount of new development that could result in a decline in their homes value. I think you talked about that in your episode with Nolan Gray on trailer parks.

Petersen: Yeah, we talked about William Fischel's Homevoter Hypothesis. So the essence of that is that people vote in local elections, and they lobby to restrict the supply of housing in their neighborhood, and that increases their wealth by, you know, increasing the land values in that area. How do you deal with that when there's such an entrenched special interest everywhere to push up land prices?

Hamilton: I think that's the hugely difficult problem. And at the same time as we have the challenges with the Homevoter system that Fischel plays out, we have a lot of federal policies that encourage homeownership as not just a good community-building tool but also as an investment. So people are programmed by the federal government to see their house as an investment in spite of economic challenges that it presents. David [Schleicher]---a law professor at Yale---has done some really interesting work on ways that institutional changes could limit the activity of homeowners and lobbying against new development. One of his proposals is called a Zoning Budget. And under a zoning budget, municipalities would have to allow a certain amount of population growth each year. So, they could designate areas of a city that are going to only be home to single family homes, but within some parts of the city, they would have to allow building growth to accommodate a growing population.

Petersen: How would that be enforced, though?

Hamilton: It would have to be a state law, or perhaps a federal law, but I think much more likely a state law that would mandate that localities do that. Massachusetts recently passed a law that requires all jurisdictions within the state to allow at least some multifamily housing. So it's kind of a similar idea. The state government can set a floor on how much local government can restrict development.

Petersen: So, what I'm hearing is that different levels of government have different incentives with respect to restrictions. So, at the lowest level if I'm just in a small district or municipal area and I can restrict what my neighbors build on their property, that really affects my home price and that's the main thing that I'm going to lobby for at that level of government. But if I had to go all the way to the state government to try to push up house prices in my neighborhood, it wouldn't go so well. The state government has incentives to allow more people to live within their boundaries. Is that the gist of it?

Hamilton: Yeah, that's right. It's easy to imagine a mayor of a fancy suburban community who simply represents his constituents' views that the community already has enough people, you know, life there is good and so nothing needs to change. But, I don't think that you'd find a Governor that would say "Our state doesn't need any more people or economic growth." So the incentives are less in favor of homeowners, local homeowners, the further up you go from the local to state jurisdiction.

Petersen: Right. I guess a big issue is that the people who would like to move somewhere but live somewhere else don't get to vote in that place's elections or in their ballot measures. And so there's this group that has an interest in lower housing costs because they might move to your city or your town, if they could afford it, but they're not represented politically in that city or town and so they can't vote for more housing and lower prices. But then when you go to the whole state level and people are mobile within a state, those people do have a say or they are represented and pricing them out of the places they'd like to live really is bad for politics, bad for getting their votes.

Hamilton: Right. So the Palo Alto police officer can't vote to change Palo Alto's policies but he can vote to change California policy.

Petersen: Right, because he still lives within California. So one of the other policy recommendations I saw in your paper is tax increment local transfers or TILTs. What are they and how can they impact land use restrictions?

Hamilton: That's another idea that comes from David Schleicher and I think it's another really interesting concept. The idea behind TILT is that a new development increases the property tax base within a jurisdiction. So, if you have a neighborhood, say a block full of single family homes that is allowed to be sold to a developer in order to build a couple of large apartment buildings, each apartment is going to be less expensive than the previous single family homes, but overall the apartment buildings will contribute more to property tax. And the idea behind a TILT is that part of this tax increment---which is the difference between the new tax base and the previous smaller tax base---could be shared with neighbors to the new development to kind of buy off their support for the development. So, those people who are in some sense harmed by the new buildings, whether in terms of more traffic or a change in their neighborhood's character, also benefit from the new building financially. So they're more likely to support it.

Petersen: So economists talk about Potential Pareto Improvements, where you have a situation where some people are made better off while other people are worse off, but you could have a transfer to make everyone better off. And what I'm hearing with TILTs is you actually do that transfer, you actually pay off the losers with some of the surplus you get from the winners. So everyone can be better off when you make this overall beneficial change.

Hamilton: Exactly. And sometimes communities do use community benefit as a tool to try to get developers to share their windfall and build a new project with the neighborhood. So they might say, "you can build an apartment building here, but you also have to build a swimming pool that the whole neighborhood can use at this other location," and in a way that achieves the end goal of buying off community support for new development. But it also drives up the cost of the new housing that the developer can provide. So TILTs have the advantage of keeping the cost of building the same for the developer, but still sharing that financial windfall of the new development with a broader group of people.

Petersen: Yeah, I really like these policy recommendations. It would be so easy to just say "land use restrictions are bad, let's not have those anymore." But these really have an eye to the political structures that we currently have and towards making progress within the structure we have. So I like that approach to policy or to policy recommendations. I think economists should maybe do that more often.

Hamilton: Yeah, looking for a win-win outcome.

Petersen: The one other one that I don't think we've talked about is home equity insurance, which sounds like a business plan more than a policy proposal. But how can home equity insurance help to reduce the costs of land use restrictions?

Hamilton: That proposal also came from Bill Fischel a couple of decades ago following on his work of the Homevoters theory. He proposed the idea that the reason home owners are so opposed to new development is often because they have so much of their financial wealth tied up in this house that they're not just opposed to a loss in their investment, but even more so, opposed to risk. So they want the policies that they see will limit the variance in their home equity and he proposed home equity insurance as a financial goal that could lower this threat and provide homeowners with a minimum amount of equity that they would have regardless to the new development. I think it's a really interesting concept but it's unclear, would this be a private financial product? Obviously the market isn't currently providing it, or would it be some kind of government policy? And while I do think it's very interesting, I think that we should be somewhat leery of new government policies that promote homeownership as a financial wealth building tool.

Petersen: Well, the funny thing is that usually with insurance, if you have fire insurance you want to minimize the moral hazard of that, you don't want people to say: "Well I've got fire insurance so I don't have to worry about fires anymore." But with this, you sort of want that, you have insurance on the value of your home and then actually your goal is to make people less worried about the value of their home so that they will be okay with policies that reduce it. It's almost the opposite of what you want with insurance most of the time. In this case you want to maximize moral hazard.

Hamilton: Yeah that's a great point and I think that's why it could only be a government product.

Petersen: Right. Because if the private sector was providing home price insurance to homeowners then the company that provided the insurance would now have an incentive to lobby against upzoning the neighborhood.

Hamilton: Exactly. Yeah it would create a new a new group of NIMBYs.

Petersen: Yeah, at first I thought 'Oh great!', well this is something that we can just do, without the government. You can just get a bunch of people together, who have an interest in making cities more livable and they can provide this financial asset. But that seems like there are problems with it that are hard to overcome within the private sector. So overall do you think the tide might be turning on the NIMBYs? Are people becoming more aware of this issue and of land use restrictions and their effects on housing prices?

Hamilton: I do think awareness is growing. There's a group popping up called YIMBY which stands for "Yes In My Backyard" as opposed to the suburban NIMBY to say "Not In My Backyard" to any sort of new development. And these YIMBY groups are gaining some traction in cities like San Francisco and lobbying in favor of new development to counter the voices that oppose new development. I am somewhat pessimistic, I have to say, just because from a public choice standpoint the forces in favor of land use regulations that limit housing are so powerful. But in spite of my pessimism, I'm seeing since the time that I started working on this issue several years ago, much more coverage of the issue from all kinds of media outlets, as well as much more interest in on-the-ground politics from people who aren't in the typical homeowner category.

Petersen: Yeah, and I am hopeful too. But I often see people blame other factors for high home prices. They blame the speculators. The speculators are always the ones that are pushing up home prices. And rarely, I think, do people blame restrictions, although the YIMBY movement is a happy exception to that.

Hamilton: Yeah, I think way too often real estate developers are framed as the enemy in these debates because they're the ones who make money off building new housing. But it's really the regulations that are to blame both for the inordinate profits that developers can make in expensive cities, and for the high costs of housing.

Petersen: Do you have any closing thoughts about land use restrictions?

Hamilton: I think that it's just really important to try to spread the message about the costs that these regulations have. Not just for low-income people but for the whole country and world economic growth. That's obviously a cause that I would think everyone would be behind: creating opportunity for people to live in the most productive cities where they can contribute the most to society and to the economy.

Petersen: My guest today has been Emily Hamilton. Emily, thanks for being part of Economics Detective Radio.

Hamilton: Thanks a lot for having me.


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Writing and Thinking Less Badly with Mike Munger

Fri, Oct 14, 2016

In this episode, I discuss the process of writing and being successful with Mike Munger. What follows is an edited transcript of our conversation.

Petersen: My guest today is Mike Munger of Duke University. Mike, welcome to Economics Detective Radio!

Munger: It's a pleasure to be on your show!

Petersen: So first I stole EconTalk's format and now I have stolen Mike Munger as well, so if Russ Roberts sends me a cease and desist letter, I'll completely understand why.

Munger: Russ and I have an open relationship. We both date other people.

Petersen: Oh good, good. I have many jokes I could make about that, but I won't!

Munger: Thank you for not.

Petersen: So, our topic today is going to be writing and thinking. Let's say that because, as we'll go through, the two are intimately related. So Mike wrote a piece titled "Ten Tips on How to Write Less Badly." Now you may be thinking to yourself, "Hey I thought this was an economics podcast! What does writing have to do with economics?"

Well, writing is what economists do and if you write either for your career, or your hobbies, I'm sure you'll find something in this discussion that will be helpful to you. So Mike, you start your piece by saying that you've seen many talented people fail because they couldn't or didn't write. I think the impression a lot of people get while growing up is that writing is the easy subject and that math and science are hard, so how is it that these talented people get tripped up by writing of all things?

Munger: Well, writing at all is not that difficult, I suppose like running at all is not that difficult. Most of us can at least run 10 meters. The point is that, if you want to be a professional economist, you are one of those people who actually found math pretty easy and you may not have practiced writing very much. So, I said, I've seen a lot of talented people fail because I was Department Chair here at Duke for 10 years and it's hard to get tenure at Duke, it's not a reward for past behavior, it's a hire. We are trying to guess if you're going to continue to produce interesting and important research after all material incentive to do that has been removed. Because once you have tenure you basically can't be fired. It's not quite true, but it's pretty close to true.

So you get six years, I've watched 8 people doing this while I was Chair. You get six years to develop your research agenda and to show that you are going to continue to publish after you no longer have any incentive to do that. Now, what a lot of people do is, for four years they'll work on a few things but not very assiduously and the last two years they will work furiously and they'll have two or three things forthcoming and say, well, like it's a video game, I've done enough to get tenure. What they're saying is, if you ever give me tenure I will never publish anything ever again, which not surprisingly doesn't work out well. So six of the eight people who came up were fired. And when I, as Chair, had to tell them this, they cried, they were surprised, which probably means that I am a bad Chair, but I had tried to communicate over and over again that they needed to develop a research agenda and the way to do that is to write about it, and to write about it every day. That doesn't mean that everything that you'll write will eventually be used, but again, I would go back to the running analogy. Or let's say a soccer game.

Suppose you knew those six months from now, you'll have a very important soccer game. You wouldn't wait until the night before the soccer game and practice all night. You would practice for an hour or two every day, recover, think about it, try to get better, but that's not how we do writing. All of us, who are at the level of thinking about graduate school and economics, are clever monkeys. We have always been good enough, that we can wait until the night before and write some bunch of crap and have it be good enough, because we're smarter than the other people. Well, now you're in with a group of people all of whom have always been able to do that and some of them are going to figure out that if you actually starts six months in advance, and work on the thing every day, and throw away most of it, time after time, and start over, your paper is going to be a lot better. And if you look at the books and articles that you think are important, the very things that got you excited about being in economics in the first place, none of those, not one, did the author stay up the night before it was due and write it.

Adam Smith worked for years on 'The Wealth of Nations.' He showed it to people, he talked to people, he went for walks and muttered to himself. At one point he was so obsessed with what he was thinking about, he walked right into a noisome sump, that is the chemicals leftover after you have tanned leather. He didn't even notice where he was going! It smelled terrible, he didn't even notice by sight or smell because he was so busy thinking about this stuff, that he had been working on for years and would continue to work on for years. So part of this is my own cri de coeur, my own cry from the heart saying, it's so hard to watch talented people fail when they could have succeeded, because they didn't get this simple message---you have to teach other people. Sometimes you do it in the classroom, most of the time you do it through your writing. If you don't get good at that, you're going to fail. So don't start. If you don't think you want to write, don't become an academic in the first place.

Petersen: Yeah, I guess another analogy is, you can be very naturally adept at swimming and that can make you an above average swimmer, but not one of those people swimming at the Olympics isn't both an above average swimmer naturally, and someone who has trained day after day, after day to be there.

Munger: Not just at the Olympics. This is if you want to enter a swimming contest at the local YMCA, those other people are on the top one half of one percent. They're not near the Olympics, but they're going to kick your butt unless you've been practicing and practicing and practicing.

Petersen: Yeah, and I guess undergraduate education is less like the YMCA; it's sort of the kiddie pool. You really can get by without practice, but you won't necessarily get much out of it.

Munger: You won't learn much about writing, and what you write won't be very good, it will just be good enough, that because you're clever and good at this you can produce something that the professor is going to read and say "Ok, I sort of see what the argument is, that's better than the others: A." So that's not a 'good enough' it's just a 'better that the other losers' who aren't going to get to graduate school in the first place. And by losers I mean, people who are going to have successful lives.

Petersen: Yeah, we have a funny definition of winning in academia.

Munger: It's not clear you're really want to win. Although, to be fair getting tenure someplace and having the ability to write every day about the stuff you are interested in, there really is no better life. The problem is with the six or eight and in my case ten years, because I had a hard time finding a job, that went before that.

Petersen: Yeah, so that's covered your first tip in that essay, which was, "writing is an exercise." The second tip was to set goals based on an output, not input. Can you explain that?

Munger: One of the things that junior people do and that graduate students also do is to define how hard they're working by how long they spend outside of their apartment and in their office and they might even be at their desk, they might be in a coffee shop. What they're not doing, is facing the terrors of that blinking cursor. So the difficulty with any metric based on inputs is that you're not thinking, "am I actually doing something?" A metric that's based on output focuses more on writing. Now, that can be misleading because you can write badly but the same thing would be true of running or swimming. Sometimes when you have a workout it doesn't go that well but at least you're doing it so you wouldn't define how hard you work out by how much time you spent in the gym. You would say what exercises you actually did. It makes no more sense than that to define how hard you work by how much time you spent in the office, going to other offices, drinking coffee, talking to people, checking Facebook. None of that actually counts. So you have to set very high goal, five hundred, seven hundred fifty words per day, every day, five days a week and you will be a famous and successful academic. That again is the sort of dirty secret since no one does this. A lot of economics articles are only ten or twelve thousand words. So if you write five hundred words a day and you end up throwing away three hundred of those words you're still every ten days going to have two thousand usable words. So twice or three times a year you're going to have enough to have a journal article even if you're throwing away 60% of what you write. And here's the other thing: you learn by writing. What I find frustrating is a lot of people will count reading as work and it's not.

Reading is an important input to work just like sleep and having a good breakfast. But in order to be an academic you have to write and the nice thing about writing is, you're writing along and you think, "oh right I understand this." You're trying to summarize the argument of some thinker and you realize "I don't understand it!" Now you go back and you read it, but you read it in a way that allows you to engage in a conversation with that writer. The nice thing about writing is that it allows you to communicate over time and space. I can look at something that was written 300 years ago and try to divine what was in the mind of that writer, what is he or she trying to communicate. And good writing creates in my mind an image or a logic similar to what was in that person's mind even though they're distant in time and space. So when I'm writing I read things differently. I've seen people count as reading, they go through a book, they go through an article they have three different colors of highlighting and they always think they're going to come back. None of that actually went through their brain. But if you're writing then you go to read something, you're looking for a specific question. You read better. So I actually ask my graduate students when they're working on their dissertation, on their third or fourth year, to put up a three by five card in their workspace that says: "Don't read, write! If you're writing you'll become a better reader."

Petersen: Yeah, there's an irony in someone who has gone through years of economics education, who could explain to you exactly why the labor theory of value is not correct, applying it to their own work implicitly.

Munger: Absolutely, it's "My day was valuable, I spent 11 hours at the office. Holy cow!"

Petersen: Yeah, my own version of that was at the end of my first year of my PhD, I spent a lot of time in the office and I realized that I spent so little time at home that I actually only went through I think one full roll of toilet paper. So it's sort of the metric being what I didn't do which was spend time at home and therefore in my own bathroom.

Munger: We get it. We get it Garrett. But it is interesting, that's necessary but not sufficient for success. Jim Buchanan always said, "The key to success is apply the behind." He didn't say "behind," he used a different word, but apply your behind to the chair. So you're actually in the chair at your desk and you are writing. Now for him that meant moving a pen across a piece of paper, for us it means typing on a keyboard. Either way, if you apply your behind to the chair---the actual chair at your desk, not the one in front of the desk of one of your friends so you can drink coffee and talk---you'll get a lot done. You'll learn a lot and you'll notice after just a couple of years that there's a divergence, not only in your ability to write but in your understanding of a lot of key issues because you've thought of these things pretty deeply. And the thing that's interesting about that is other people who haven't been writing may at one point have been ahead of you. Maybe they were better at classes but you have to learn to make the transition between being good at taking classes---which is why many of us want to go to graduate school---to being good at expressing our thoughts on paper in a way that other people find interesting. So the emphasis on classes is misleading, your first year in class, second year in class---you get A's but you haven't really developed your own research agenda. That's not as good as the person that actually practices, works on writing and after a year or two has developed a talent.

Adam Smith has an interesting story about this with the Street Porter and the Philosopher. So the Street Porter and the Philosopher are not as different as the Philosopher wants to think. The difference was the Street Porter spent a lot of time carrying bags and the Philosopher spent a lot of time reading and writing. Well after just a few years they seem like different people but it's because, hour by hour, the philosopher spent time writing. You can be the Philosopher. If you don't write, you're going to stay the Street Porter.

Petersen: Another tip you give is to find a voice. Don't just get published. But isn't getting published the point? What's wrong with making that your end goal?

Munger: Let's think about entrepreneurs. Suppose you have two people who fancy themselves to be entrepreneurs. One of them says, "I want to make profits, I don't care how." The other one says "I have a vision of this great product that's going to transform this industry." Who's more likely to make profit? The second, paradoxically the second. Well if I say "I don't care about what I write I just want to get published," my work is going to suck. It's going to lack any kind of imagination or motivation or the reader is going to look at it and say "I don't even understand why this guy is writing." But the person that's found something that he or she is passionate about is actually more likely to get stuff published. So paradoxically the way to be published is to be passionate about what you're writing. If all you're trying to do is get published, that's going to come through. It will just seem instrumental and not very interesting.

Petersen: Yes. So Scott Alexander writing at Slate Star Codex had an article recently where he made the distinction between what he called pushing and pulling goals, where a pull goal is when you want to achieve something so you come up with a plan and a structure. Whereas a push goal is where you have a plan and a structure so you'd scramble to try to find something to achieve. This strikes me as another version of the same thing where to just "get published," you know you want thirty pages double spaced with some graphs in there and you don't really care what your message is. That's just not a good way to write is what I'm hearing.

Munger: Right. It's not a good way to write good things and again Jim Buchanan, who is one of my heroes, when he would interview perspective job candidates, particularly people who were young, he would pose them a question. I'm not quoting him exactly but it was something close to this: Supposed you have three choices. A) You could be for or five years the most famous economist writing for The New York Times and be on talk shows. B) You can win a Nobel Prize. C) You can write something that people are still going to read one hundred years from now. Which one would you pick? And Jim was---he actually achieved B obviously, he won the Nobel Prize---but he was interested in people who at least had some aspiration to write something that someone's going to want to read a hundred years from now. Now you may fail in that, but if there's not something that you're working on that at least has that aspiration, then it's going to come across that your work is just shallow, superficial, not very important and honestly not really worth doing.

Petersen: That has got to be the hardest interview question I've ever heard.

Munger: Well he was pretty scary, I actually interviewed at George Mason and talked to him and I was desperate for this job. I really wanted the position at George Mason and it turns out Jim Buchanan found me wanting, so I went through this and ended up on the wrong side of that line and it has stuck with me. So, now I do try to have some answers to that question at least to myself. So I try to work on things that are of some importance, but it was terrifying to be interviewed by him anyway. And when he asked that question, you're really just trying to get a job, you haven't published anything, you're trying to finish your thesis, that sort of seems far away. But he was absolutely right to want people who have that kind of mindset.

Petersen: One of your tips is that everyone's unwritten work is brilliant. How is it brilliant?

Munger: Well in my mind I have an argument and the premises make sense. The logic by which those premises are developed and integrated makes good sense and the conclusion is important. Now the problem is when I write it down. It turns out there's some holes in it, and when I examine those holes and sort of work at them---it's like you're thinking about moving into an apartment and you touch the wall, the wall gives way and a bunch of cockroaches come out. Ahhh it's pretty scary! Most of us, these are the arguments that we have in mind, particularly if you haven't really been writing, and by writing I would count a model. So I have an intuition about how something's going to work. I work out the steps in the model and it turns out step four is "a miracle occurs here." Well you can't actually use a miracle as a step in an argument and that means the argument is not very good but you don't know that until you write it out. But that's why many people don't write it out. And one of the things that I talk about in the article is "don't be that guy," and the guy that I have in mind, I actually knew a person like this.

Most graduate students when I talk to them say, "oh yeah, I know that guy." The guy is a third or fourth or eighth year graduate student and you meet him in a bar or somebody's house and he's got a cigarette and in the other hand he has a drink. He takes a long hole in the cigarette and then for two or three minutes he tells you what his dissertation is about. And you say, "Holy smokes that's amazing! What you're going to do is so important!" And you tell somebody else that the next day at the office and they just laugh and say, "Yeah he's been working on that two-hundred-word speech for five years. He's never written anything." So you know, the young people are all terrified of this guy. The older people realize he's a loser because the older people all realize they have trouble summarizing their argument because they're in the middle of writing it and there are several places, where it says "a miracle occurs here." He hasn't thought about it enough to know where the impossible miracles will be required in his argument, he's just smoothed this over and he's practiced this pat little pathetic speech.

So if you're working as hard as you need to be you're going to be confused and miserable and not sure that it's right because only unwritten work is brilliant. If you're actually working on it you know better than anyone else where all the holes are and where all the places where if you touch the wall the cockroaches come pouring out. So don't be that guy. It's easy to be the hero. And notice that this 8th year grade student only hangs out with the first and second year grad student because these are the only people that still believe his crap.

Petersen: Yeah one of the most frustrating things about being human is how little connection there is between the way our brains seem to work, from when we're sort of observing ourselves from the inside, and the way they actually work. So when psychology really came into its own as a field, the psychologists quickly discovered that introspection really wouldn't get them very far because it's so misleading trying to study a brain from the inside and part of this is your brain can come up with some really half-baked ideas that seem so brilliant.

Munger: There's a lot of plausible things. It just turns out that a lot of those possible things seem to be false. And if what you do is practice making them sound more plausible, you can fool people but that's why we have con artists. So you're exactly right. Human beings are basically set up to accept confidence for authority but they're not the same thing. Authority is someone who's really thought about it has developed an argument. Confidence is someone who has refused to develop the argument and just believes out of faith that they're correct and they practice their little thought. So another way to put it, and you're right to bring up psychology because we can be fooled by confidence into thinking that it's authority.

Petersen: Yeah. If you've ever had a dream where you had a great idea in the dream and then you wake up and think, "Oh my God, that idea is so brilliant I've got to write it down!" And it's always just total nonsense because your sleepy monkey brain just made you think it was great.

Munger: That actually happened to me. I went to college in the 70's and there were substances involved and so under the influence of some substance I would have an idea which I was convinced was brilliant and would write it down and of course the next morning I thought, "Wow, that's really stupid."

Petersen: Oh no. At least you wrote it down. You didn't spend years pursuing it.

Munger: Even then I wrote it, yes.

Petersen: So one of the tips you have is to pick a puzzle. What do you mean by that?

Munger: Well it's often hard to get started. So there are two reasons to pick a puzzle, one is that it's actually interesting, and the other is that it's rhetorically useful to be able to engage the attention of the reader. So I give examples of different puzzles in economics. One of the most common is "Theory says this, empirical results say this, they are contradictory. What's missing from the theory or how has the empirical test been conducted badly?" Another would be "Person A and Person B have the same set of assumptions but they come to a different conclusion. What is it about their models that causes this divergence?"

So if you have a puzzle like that, and the most important one. The third one, the most important one is "Suppose that there's this phenomenon and we don't really understand it and then there's this other apparently unrelated phenomenon, we don't really understand that. What turns out when you think of it correctly, both of them are the result of this economic principle and no one has recognized the fact that we can tie all this together." So as theories become stronger, they generally become simpler and more general. So an increase in simplicity and generality means that you can bring more apparently different phenomenon under a single explanatory umbrella and that's interesting to say, you think this is different but it's the same. So it's both a good research technique if you can do it, and it's engaging to the reader. So if you're not sure how to start thinking in those terms then the easiest one here is "Theory says this thing, empirical results say this. Do we need a better theory or better testing?" Anybody can do that because the journals are just full of those kinds of contradictions. I'm not saying that's perfect but it's a good way to get started.

Petersen: Yeah, and economics has a lot of theories and a lot of empirical work and a lot of them point in different directions. So you don't have to look far to find those kind of contradictions. So another tip you give is to write and then to squeeze other things in. This is a scheduling thing. What would be the wrong way to schedule your writing?

Munger: Well there's the sort of macro or general approach and the micro part of it. The macro approach is to think, "I need big blocks of time to write. And since I have to teach a class and go to a class, I have to teach a section of a class, or I have a meeting that I have to go to, or there's a talk this afternoon, I can't write because I don't have time." Actually you can only write for about 20 minutes at a time. The problem is it takes you ten minutes of thinking to get to the point where you're thinking clearly enough to write so it takes you 30 minutes to write for 20 minutes and if you get interrupted you can't start again. It usually takes another 10 minutes to get started.

So it is true that you do need some blocks of time. But if you can just find an hour somewhere, that's enough for two of those 30 minute blocks, you can get quite a bit done. After you've been writing for 20 minutes you have probably have to stop get up and get a cup of tea, walk around because you can't concentrate for that long. So all you need is an hour or so to be able to write.

So the macro consideration is---don't think, "Well since I have two meetings this day I can't write anything." The micro consideration is when to find the particular hour or two that you're going to write. And what many people do is they schedule their meetings or classes they have to teach at times when they're the sharpest mentally and that's a mistake. What you need to do is find the time that you're sharpest mentally, for me it's first thing in the morning, for many people it might be late at night. I'm a little skeptical of the late night because they waste all the time between 9 PM and 1 AM and then they write for one hour and say, "Man I really worked 'till 2 o'clock. That was great!" Yeah but what about the four hours between 9 PM and 1 AM? So I'm not so sure about the late night people, but OK fair enough. Let's suppose they actually are using their time wisely.

Pick the time that you're the most mentally sharp and schedule your time to the extent that you can control it to make sure that is reserved for writing and schedule everything else around it and what I found is that I can take the time when I am least mentally sharp which is between about 3 and 7 PM and I try to schedule my teaching then. Now that seems cynical, but I like teaching so much. And there's the energy that you get back from students that are interested and interesting, it's like super caffeine. So you can actually get up for teaching or leading discussion sections or maybe even go in for a talk---at times that you otherwise would have wasted or would be down time because those are social. Those are things where you're getting feedback. Writing there is no feedback. There's no one saying, "yes that's interesting." It's just you thinking, "Lord, I can't finish this paragraph. I'm an idiot." So you need to be at your mental best to be able to get through that.

Petersen: I think for me it probably would be the morning. I've got to jot down all these tips. Of course, I'm a graduate student so this is especially relevant to me. When should I be writing, how should I be writing.

Munger: You're still forming habits and learning about yourself, but thinking in these terms means that you'll get a head start.

Petersen: You mentioned that taking 10 minutes to get into writing and then doing 20 minutes of good writing. I think that lines up with the research people have done on flow. The idea that people self-hypnotize into a very productive, very focused state. And then if you break your flow then it actually takes a while to get back into it. You're self-aware for a while you're not as focused, as productive.

Munger: So a two-minute interruption doesn't cost you two minutes it costs you 12.

Petersen: Yeah, you need to find a place and a time where those two minute interruptions don't happen.

Munger: Yes and it doesn't take long. If you can get an hour and a half or two hours 4-5 days a week, you will be a famous and successful academic.

Petersen: Yay! That's what we want to hear.

Munger: The good news is anybody can do this. I find it so frustrating that they don't. By that I mean anyone smart enough to get into graduate school has plenty of good ideas, they just don't write them.

Petersen: That is sad, because there's such a high payoff to getting the writing done. But I guess it's sort of a delayed reward where you need a lot of self-control to be able to seize that payoff.

Munger: Garrett, you're going to graduate school! Clearly you are interested in delayed reward because you could have a job at a Donut Shop and have your own apartment and have money be able to go to bars not worry at weekends. Graduate school by its nature is one of the most, the strongest ways of putting off any sort of satisfaction into the distant future. So yes, it's a later payoff. But why would you go to graduate school and then not do the thing that actually will result in the payoff that you've apparently planned for. Here's the thing, a journal article---when you're in graduate, when you're starting your career---a refereed journal article will inflect upward your career trajectory and earnings by at least ten thousand dollars, one article. If it's in a pretty top journal, it's twenty-five thousand dollars. So, if you write an article and publish it, that's twenty-five thousand dollars. There's nothing else you're doing that has a higher payoff. Yes, it's delayed but it's not delayed that much and you're already in graduate school; you're already living a miserable existence.

Petersen: I'm lucky because my wife actually works in the real world. So I'm covered but (chuckles).

Munger: All right. Yes, you can remind her that you married better than she did.

Petersen: Yeah, I mean I'm sure she doesn't need much reminding.

Munger: As long as she doesn't remind you of that.

Petersen: Oh yeah. Try to avoid that.

Munger: Well I see graduate students who will teach during the summer and get paid $4000. You can write an article in the summer. That's at least $10,000. It makes no sense, your discount rate would be have to be awful high. If your discount rate is that high, why are you spending six years in graduate school in the first place?

Petersen: Yeah, that is the question. But yeah, I suppose you could be credit constrained, but that's a whole other issue.

Munger: You'd have to be really constrained for that to make sense because you can probably eat just beans and oatmeal for a couple of months. And the payoffs to writing an article really are huge because the way that it works out is, the first job that you get is a 2-2 teaching load at a research school and smart colleagues and the ability to go to conferences because they'll pay for it, or a 4-4 teaching load with colleagues that hate you and their own existence and give no support, no outside talk. So even if the same person, a clone of the same person, starts in those two jobs, the difference in their career trajectory is going to be enormous! Plus you already have a journal article published, so you'll start with a higher salary. So that first job makes a big difference to where you'll be in ten years. So you have to be pretty credit constrained not to take that into consideration

Petersen: The way it works with the ten thousand, it's not that you get a ten thousand dollars payment it's that you get a bigger raise or a bigger starting salary.

Munger: With better colleagues, more articles, you have the ten thousand as the present value. Well, but again, an economist should understand present value and they're in graduate school so they must have a low discount rate. So those are the ones I would expect to say I'm not going to teach. I'm going to borrow against my own future earnings. I'm going to loan myself this money and live really cheaply and write an article instead of teaching.

Petersen: Oh man, I'm just jotting all this down. OK, "don't teach in the summer." Of course some teaching is important, you do need to become a good teacher.

Munger: Yes, the kind of teaching that we tend to do, in the summer is pretty different, but you should. There's no question, you should be able to point to one class that you have yourself designed the syllabus for and have primary responsibility for teaching and grading when you go on the market. So I'll give you one---over five years, yes you should have taught one class yourself.

Petersen: But TA'ing is not good. It pays but it doesn't pay as well as writing.

Munger: Right, and when you go on the market and they say what teaching experience do you have and you say well I TA'd four times, they're going to stare at you like you're an idiot because you are.

Petersen: OK so one tip you give in the article is to edit your work over and over. So what is the editing process like for you?

Munger: Well it's terrible. I've written a number of books, I just was yesterday working on an analytical book review that's about 15 pages long and I looked at it this morning and said, "half of this is unusable." So I crossed it out and started over, I was thinking it was almost done and then I thought, oh no this is stupid. So even just one day later, I looked at it with much more critical eyes. So I would say it takes me at least ten complete rewrites to get to the point where I think my article is worth showing to someone else and then they usually have comments that require me to rewrite it at least two more times.

So the difficulty is everybody's first drafts are bad. Now I do have a talent. I write extremely fast but badly. If you had to pick that would be a pretty good way to be an academic because I also edit fast so I can go through, I can do a rewrite pretty quickly and every time I rewrite it becomes dramatically better. So there are people who write very slowly but well, they are going to have more trouble because a lot of times you don't know enough about your subject. It's well written but the subject is not very good because you need to learn more about it. So I have to admit I learned this in some ways from a master. Douglas North was one of my dissertation advisors and Douglas North won the Nobel Prize in Economics in 1993. And Doug was famous for going and giving a talk, and it would be twelve pages long and have four citations, two to Douglas North, one to Adam Smith and one to more a recent economics paper. And the people in the audience would say, "Doug, this is terrible. If you were going to do this, here's what you have to do. You need to go read these five papers, all of them have written on your subject and they're better than yours." And he would write it down. He would write down their names he would make sure he got the citations. And next time he presented the paper, now it would have nine citations, before he started out with a five that had been suggested to him and he had added all of the suggestions and the paper actually wasn't terrible now but still people would see it and say, "Oh no, no, no, here's what you need to do." So he would go around---and it was almost as if he was outsourcing the references because he didn't read anything unless somebody said it was relevant---and he was outsourcing a lot of the ideas. And he would thank everyone, I'm not saying he was plagiarizing. He would gratefully acknowledge the suggestions of so and so in a footnote he might say this was suggested by so and so. But you write it, you go present it, you get comments, you think about it, you write it again, that is the way to be successful. And when it comes to editing, one of the things that you can avail yourself of---and this actually has become kind of a meme---people argue about whether they're "Munger compliant."

Munger compliant means that you have three articles in journals, and if you don't have three articles in journals all the time, you're not Munger compliant. Well the reason that that's important is, think in comparison to computer programming. So if I'm going to write a program or a job and send it to a computer, I don't stare at the code and try to make sure that the logic and syntax are correct. I submit the job and then it will come back with error message: here at this step you've left out a semi colon. So it won't run. You can't compile the code that you've written and it won't run. Nobody stares at the code to figure it out. They submit it to the computer and get back the error message. That's how journals work; you get this off your desk. You don't stare at the paper over and over again to make sure the code works, you send it to a journal. Now yes it takes a few months, that's why you have to have three papers out at all times, you have to diversify your portfolio of risk because there's a random element to this. Some good papers get turned down but some not very good papers get accepted because you get a lucky draw on the referee. So you send it out, it comes back, the referee says, "no no here's what you should do, add these five references." It's sort of like what Doug North did. And you do it, it becomes a much better paper. I've had some of my better papers turned down at five journals before they were finally published. And when they were published, they were pretty good, but that was because I had outsourced a lot of the research to smart referees. So you should think of that as machine-intensive debugging. Machine-intensive debugging means I don't debug my own program. I submit it to the computer and it comes back with an error message. Well I submit my articles to journals, they come back with three really smart people working unpaid as my research assistants. Now yes, they do say that "you're an idiot and your mother should never have been born," they make comments you want to ignore but by and large their suggestions improve your paper dramatically. So you should always try to be Munger compliant.

I told some of my graduate students, there will come a day when you will be upset when one of your papers is accepted because you will no longer be compliant. And a good friend of mine who is now a tenured full professor in England just wrote me and said, "Darn it, that finally happened. I got a paper accepted and I woke up in the middle of the night and I said, 'I only have two papers at journals! I have to go write something!'" That's a sign you're a success.

Petersen: Yeah, when you think about, I like what you said about the research assistants. If you wanted to hire twenty tenured faculty as research assistants you'd have to pay them thousands upon thousands of dollars. But you walk into a seminar room and give a bad talk and suddenly they're all throwing out suggestions and comments and they're being your research assistants for free.

Munger: And very helpful and they're grateful if you take their comment seriously. So that's actually---there's nothing wrong with doing that. The research enterprise is more collaborative than most people are willing to admit even to themselves, and the reason is because those useful comments come wrapped in, "you're an idiot." But if you can unwrap that and just take the kernel, the content of the message---because a lot of times when you give a seminar one of the problems with giving a seminar is you learn all the problems with the paper. And economists are pretty harsh and aggressive about making their criticism. Think of them as research assistants and it makes you much more receptive. I was surprised, Doug North---this was after he won the Nobel Prize---people would just viciously say, "This is completely worthless. I would be embarrassed to write this and I don't have a Nobel Prize. I don't see how you can do this." And Doug would just nod and then they would say, "Here's what you should do." He'd write it down and thank them it didn't make him mad at all, he didn't care.

Petersen: OK, so developing a thick skin seems to be an asset here.

Munger: No what you said is right. Think of them as research assistants. What do you care what your research assistant thinks of you as long as they help.

Petersen: Yeah, they do a good job they give you your suggestions, you sift through them and make your work better.

Munger: Often when I get back referee reports and they're harsh, it'll take me a day to get over them. Oh man, I thought this was a good paper and they didn't like it. But then I will literally take a printout and take a black magic marker and redact the parts that are just ad hominem attacks. I don't care about those. And then if you look at what's left, it's usually a pretty good structure for revising your paper.

Petersen: OK, yeah I'll have to do that.

Munger: It sounds simple and hokey, but you don't care about the things that are just saying this is terrible. I had one referee report that said I would rather hack my way through the jungle with a penknife than have to read this paper again and I thought "Ow!" And then I took a black magic marker and marked it out and the rest of the report was pretty useful. The question is why you would put someone else in charge of how you feel? So don't do that, you're going to be in charge of how you feel and you're going to use, to your own benefit, the fact that smart people made good comments on your paper.

Petersen: We have this sort of mythology of the solitary genius. Are you saying that that is not a way to live your life?

Munger: Oh no that's exactly how you should live your life, if you're a genius.

Petersen: But most of us aren't.

Munger: For the rest of us who are not, no, that's not the way to live your life. So absolutely, I know I have friends, in fact one of my colleagues, Melvin Hinich, with whom I had three books, was unbelievably smart. He was able to do things with very little effort and he would often just throw out ideas and let someone else write them up because he was bored with writing them. So if you're smart enough, yes you can totally do that. My message is, all you have to be is basically average intelligence for a graduate student and if you spend a lot of time learning how to write you will also be a success. Maybe more successful than that solitary genius. It's not fair but it's true.

Petersen: A part of it is humility. To realize when you are not a solitary genius and when you need help. But couldn't the genius also do better if he used other people as his research assistants and did all the things that a non-genius would do?

Munger: Sure. Yes, but they're not willing to spend the effort for the most part because they've never had to. There are people that are just so good at sprinting or so good at swimming, that as long as they practice pretty hard, they don't need to worry about learning other techniques. So, one of the reasons that I am a coach about writing is that I was such a terrible writer. Most people who are really, really good at something are terrible coaches because they have a knack for it. It's the people who had to scrap at the margin, and who weren't really all that good but managed to be at least somewhat of a success because they thought about technique and they focused on getting better. Those are the best coaches. In almost every sport that I know of, the best coaches were the marginal players and I was a marginal player. So the reason that I talk about writing is that I was terrible at it

Petersen: But you are now a success and we can all learn from your example.

Munger: I am now a Philosopher and not a Street Porter.

Petersen: Yes. So do you have any closing thoughts about writing? What's the core message you want people to take away from this.

Munger: Well, William Riker, who was one of the founders of the rational choice school of public choice in political science, said that most of the people who get into academics do it because they're interested in teaching. And a lot of times they're confused and they think that teaching involves work in a classroom with students. And that's important, but the real teaching is the one that takes place through writing because once you've learned something, if you actually understand it, you can explain it to someone else and the advantage of writing it is that you can communicate this teaching to someone distant in time or someone distant in space. So the most important teaching is writing and if you think of yourself as a teacher, it's really important that you work on your writing because that's how you're going to be able to communicate this understanding that you have. Understanding is ephemeral. A lot of times when you work on something for a long time, you think "Oh now I see it! That's actually simple." Well if you don't write that down it's going to be hard for someone else to replicate that moment of understanding. But if you do write it down and you explain it clearly, you've added something to the human capital of the world: what we're able to hand down, the things that we no longer have to think about because we understand them. The more you understand, the simpler things become.

Petersen: My guest today has been Mike Munger. Mike, thanks for being on Economics Detective Radio.

Munger: It was a pleasure Garrett, thank you.


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New York Urbanism with Stephen Smith

Fri, Oct 07, 2016

Today's guest is Stephen Smith, he is an analyst for a New York real estate firm.

Stephen did some research showing that at least 40 percent of the buildings in Manhattan could not be built under today's zoning regulations. In fact, the number is probably significantly higher. Classic landmarks like the Empire State Building, with its floor-area ratio of 30, wouldn't fly today.

Watch this time-lapse of the New York City skyline, and pay close attention to the kind of changes that happen in the earlier part of the video compared to the later part:

Before the twentieth century, the pace of change is very gradual. Two storey buildings are replaced with three storey buildings. Waves of development sweep through the city, replacing wood buildings with brick and stone and concrete.

In the twentieth century, we see a different kind of development. Pay attention to any particular small building and you'll notice one of two things happening: Either the building stays exactly as it is, or it is replaced by a massive skyscraper. There's no more gradual change.

This is caused by the city's adoption of land-use regulations. The first zoning code was adopted in 1916, but the really strict zoning came in 1961. Once this happened, tearing down and replacing a building meant pulling political strings to get it rezoned. Because of the significant fixed cost of getting a lot rezoned, developers opted to build a few extremely tall buildings rather than many moderately tall ones. Heavy restrictions in most of Manhattan led developers to concentrate development in the few places that would allow it. That's why Midtown built up while other neighbourhoods didn't.

New York's mayors tend to be pro-development, but its city councillors block development at every turn. The city council's behaviour is consistent with William Fischel's home voter hypothesis. The city council tends to defer to individual councillors on their own local issues, giving each councillor de-facto control over development in his neighbourhood. When authority is devolved to the hyper-local level, there's a strong incentive to block development to raise real estate prices.


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Democracy Versus Epistocracy with Jason Brennan

Fri, Sep 30, 2016

My guest today is Jason Brennan of the McDonough School of Business at Georgetown University. He is the author of Against Democracy, which is our topic for this episode. The first chapter is available on the publisher's website.

John Stuart Mill believed that getting more people involved in politics would make them smarter, more concerned for the common good, better educated, and nobler. In the intervening century and a half, we've gathered much more data on Mill's hypothesis, and the results don't look good:

The test results are now in. They are, I will hold, largely negative. I think Mill would agree. Most common forms of political engagement not only fail to educate or ennoble us but also tend to stultify and corrupt us." (p. 2)

Diana Mutz performed a study that found that people's belief that their political adversaries were evil and stupid predicted high political engagement. Many studies show similar results, where politics seems to exacerbate our biases along with our meanness and contempt for the other side.

Jason splits democratic citizens into three broad categories: Hobbits, hooligans, and Vulcans.

Hobbits are your average non-voter. They don't care or know much about politics, and they're happy to just live their normal lives without thinking about politics.

Hooligans are your typical political partisans. They are the die-hard sports fans of their preferred party. They are typically well-informed, but the information they consume is extremely biased towards their own side. They cannot pass an ideological Turing test.

Vulcans are people who see clearly through the morass of politics, understanding the arguments from both sides and possessing the social scientific knowledge necessary to select the best options. And just like the Vulcans from Star Trek, they're completely fictional! Or at least they're very rare.

While most of us like to think of ourselves as Vulcans, we're probably more like hooligans.

What if the Knowledgeable Chose our Policies?

Jason's preferred alternative to democracy is epistocracy, a system where more knowledgeable people have more control over politics. There are many forms this could take.

One way of instituting epistocracy is to impose a basic knowledge test on voters. While an econ 101 test would be desirable, it might raise objections from people who view economics as an ideological discipline. But there are many ideologically neutral facts that a voter really ought to know. For instance, someone who doesn't know which party currently holds power probably doesn't have enough information to decide which party is most fit to govern.

You could then restrict votes to only the people who pass the test, or you could weight votes from knowledgeable people more heavily.

Another option is the "enfranchisement lottery" where a random subset of the population (perhaps a few thousand) are selected to vote, but only if they undergo exercises to build their competence as voters. This is somewhat similar to how a jury trial works, where a legal decision is left to a random group of citizens, but only once they have received extensive instruction from a judge, lawyers, expert witnesses, etc.

Finally, you can set up a hybrid system with democratic and epistocratic elements. For instance, you could have a democratic body decide policy while an epistocratic body retains a veto. The Supreme Court functions in this way, since it grants a group of highly educated judges the power to overturn democratically supported laws.

Democracy is Not an End in Itself

Jason encourages his fellow philosophers to think more like social scientists. While philosophers tend to view democracy as an end in itself, social scientists are more interested in whether it has good outcomes. Does democracy promote economic growth more than other systems? Are fewer people persecuted under democracy than under other systems? Are people happier in a democratic system than they would be in an alternative system?

These are the sorts of questions we should be asking about our system of government.


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Urban Development, the Growth Ponzi Scheme, and Strong Towns with Chuck Marohn

Fri, Sep 23, 2016

Today's guest on Economics Detective Radio is Chuck Marohn, founder and president of Strong Towns.

Strong Towns is a non-profit that seeks to reform America from the ground up, starting with its towns and cities. It aims to promote healthy local economies by improving local governance.

The Growth Ponzi Scheme

Chuck began recognizing the problems in America's towns and cities when he was working as a civil engineer. He recounts a story of working in a little city in central Minnesota in the late 1990s. The city had a 300-foot pipe that had cracked, allowing ground water to leak in and overflow their treatment facility. Chuck proposed a $300,000 solution to fix the pipe. However, this was a tiny town with an annual budget of $85,000. So Chuck went to higher levels of government (the federal government, the USDA, etc.) to find someone to fund the project. They all said, "This feels like maintenance. We don't have money for maintenance, so you need to pay for this yourself." Since the feds would only fund expansion projects, Chuck devised a plan: He would propose the largest expansion project he could, then repair the pipe as part of the expansion. This wasn't so much deviousness on his part as it was standard practice in his profession. He designed a couple miles of new pipe, doubled their treatment facility, and as part of that he included repairs for the old pipe. This new project cost $2.6 million.

Everyone was happy about this project. The grant agencies were happy. The legislators issued glowing press releases and held a big ribbon cutting. Chuck got a big bonus from his company. The city was ecstatic. The only lingering problem was that this tiny city that couldn't afford to maintain 300 feet of pipe would now be left with a few miles more pipe and a larger treatment facility.

This is an example of one part of what Chuck calls the Growth Ponzi Scheme. This is when cities and towns expand in ways they can't maintain without further expansion.

There's a political reason why things like this happen. Building new infrastructure is very politically appealing. You can build a new highway and name it after a prominent politician, you can have a big ribbon-cutting ceremony, and you can get all sorts of good press for the project. Maintenance is less sexy; you close down a lane of some existing highway, delay everyone's commute, and then you don't have a ribbon-cutting or positive press for all the potholes you filled in. That's why higher levels of government have been paying for big projects and passing off the responsibility for maintaining them to local governments. These local governments become insolvent when the revenue from the initial big project runs out and the maintenance expenses come due.

This process leads to a form of development where the local tax base is not sufficient to pay for the infrastructure that supports it. When the expansion can't go on any longer, the infrastructure crumbles, the affluent people leave, and the community ends up locked in poverty.

What's Wrong with Big Box Stores?

Embracing this form of unsustainable growth has made our cities less dense and walkable. Instead we have heavily subsidized driving as a means of getting everywhere. One consequence of this has been the rise of big box stores.

The public debate on big box stores tends to miss the mark. The left says big box stores crowd out local businesses, which is true. The right says they pass the market test, offering lower prices and thus improving poor people's standard of living, which is also true.

What both miss is that these big box stores only pass the market test because they don't bear the costs of the infrastructure needed to support them. By subsidizing infrastructure, and by building our cities to be spread out and unwalkable, we make bringing groceries to the people unviable. Instead, the people drive to where groceries are.

In addition to the rise of big box stores, we've seen the demise of small town living. While small towns still exist, they used to have enough small businesses, shops, and grocers to allow a full and comfortable life without leaving the town. Today, small town life consists of driving to the regional hub, perhaps multiple times every week, to get many of your necessities.

What's Wrong with Hastings Street?

Chuck coined the term "STROAD" to push back against the interchangeable use of the terms "street" and "road."

A street is where value lives. Homes and businesses locate themselves along streets so that they can be connected to rest of the transportation network, but the street itself features narrow lanes, low speed limits, and good sidewalks because it's designed more for pedestrians and less for vehicles.

Roads, by contrast, are not meant to be valuable locations in themselves; they are optimized for transporting large volumes of traffic over long distances. They feature wider lanes and faster speed limits.

STROADs are an unhappy blend of both elements. Wide lanes and low speeds make them bad for both pedestrians and drivers. One example of a STROAD is Hastings Street in Vancouver, which tries to be a major thoroughfare for thousands of commuters during rush hour, while still catering to the many businesses along its ten-kilometer span.

Hastings Street

Because of its high volume of traffic and many stop lights, motorists can expect to average just twenty kilometers an hour on their commutes to downtown Vancouver.

Gentrification as Part of an Organic System

Chuck wrote an article titled "The Gentrification Paradox," in which he argues that gentrification was actually a healthy part of urban development in the pre-automobile age:

The pre-automobile development pattern was an organic process. It was both incremental and complex... Gentrification – investment followed by displacement – was part of the natural order of things and, as with any organic system, it had a positive role in making things work for everyone.

Before the twentieth century, cities would gradually grow and change over time. But we've used zoning laws to turn our neighbourhoods into unchanging time capsules. Cities used to be antifragile, to borrow a term from Nassim Taleb.

In the past, poorer people would buy property on the outskirts of town, on which they would live and run small businesses. Over time, as the city grew, these outskirts would gradually come to be incorporated into the urban ecosystem. These properties would become more valuable and they would grow with the community, perhaps adding a second storey and expanding the business.

You couldn't do this today. Building codes and zoning laws make any new development into a million-dollar endeavor. People with very little capital can't start with a small property and gradually increase its value over time. This makes the modern form of urban development much less equitable than it was in the past.

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Population Growth, the Ethics of Having Children, and Climate Change with Steve Horwitz

Fri, Sep 16, 2016

Today's guest is Steve Horwitz, he is the Charles A. Dana Professor and Chair of the economics department at St. Lawrence University.

Steve recently wrote an article titled, "Make Babies, and Don't Let the Greens Guilt Trip You about It." This was a response to an argument made by the bioethicist Travis Rieder, who was recently profiled by NPR. Rieder argues that it is immoral to have children because of the burden additional humans place on the Earth, in particular because of the risk of catastrophic climate change. Here's how that NPR piece put his argument:

"Back at James Madison University, Travis Rieder explains a PowerPoint graph that seems to offer hope. Bringing down global fertility by just half a child per woman 'could be the thing that saves us,' he says. He cites a study from 2010 that looked at the impact of demographic change on global carbon emissions. It found that slowing population growth could eliminate one-fifth to one-quarter of all the carbon emissions that need to be cut by midcentury to avoid that potentially catastrophic tipping point."

The problem with this sort of reasoning is that it views human beings as consumers and not as producers and innovators. Humans are able to contribute to the division of labour and to come up with ideas. That division of labour allows everyone to become more productive.

Rieder's ideas echo those of Thomas Robert Malthus, and he is wrong for much the same reasons. Malthus anticipated a world where the diminishing returns in agriculture and exponential population growth would lead humanity to subsistence in a few generations. As Malthus predicted, populations did skyrocket, but contra Malthus, people got significantly richer too. What happened?

Innovation happened. Along with that innovation, and contributing to it, was a finer division of labour created by population growth. As Adam Smith wrote, "the division of labour is limited by the extent of the market."

Humans create resources, not by violating thermodynamics, but by discovering better ways to satisfy our needs with the physical matter that exists. Resources are subjective. To a farmer 500 years ago, striking oil was a nuisance. It would ruin his crops and destroy the value of his land. Yet today, the very same oil is a valuable resource because we've discovered how to make it useful. Julian Simon challenged the idea that we're running out of resources, declaring human innovation to be "the ultimate resource."

Rieder and other environmentalists are different from Malthus in that they worry not about more people eating too much food but about them releasing too much carbon. A lot of this comes down to our estimate of the social cost of carbon. Rieder sees this cost as being so high, it outstrips all other concerns. He expects apocalyptic changes in the Earth's climate within twenty years.

Economists are not climate scientists, we aren't trained to be able to perform our own studies on the relationship between carbon emissions and global climate. But what we can do is look at the bulk of the published research. The two things we could say about this to someone like Rieder are, first, that he seems to have based his arguments on the absolute highest estimates of the climate impact of carbon, where a reasonable person might have looked at the median estimates. And second, people who have performed meta-analyses of this literature have found evidence of publication bias towards finding a larger impact, meaning the best estimate would be somewhat below the median estimate once we correct for publication bias. If the kind of climate change Rieder sees coming in twenty years is really more like two hundred years away, it changes the argument a lot.

With the costs of climate change so far out in the future, and the costs of abatement concentrated on the present, our cost-benefit analysis needs to account for the discount factors in such long time spans. The projects that have to be sacrificed today to abate climate change over the next couple centuries have their own benefits that need to be weighed against the costs of releasing greenhouse gasses into the atmosphere. It all comes down to opportunity cost.

Other links:

Progress Does Not Depend on Geniuses

Against Fossil Fuel Divestment with Pierre Desrochers

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Marx, his Errors, and his Continuing Influence with Phil Magness

Fri, Sep 09, 2016

This week's episode of Economics Detective Radio deals with the economic thought and continuing popularity of Marx. No, not Groucho! The other Marx!

My guest on the podcast is Phil Magness, a historian who teaches at George Mason University. Phil recently wrote a piece entitled, "Commie Chic and Quantifying Marx on the Syllabus." Recently, the Open Syllabus Project released a data set including thousands of college syllabi. To many people's surprise, Marx and Engels' Communist Manifesto enjoys massive popularity!

Phil took a closer look at the numbers and reached some startling conclusions:

1. Accounting for different versions of its title, Marx’s Communist Manifesto appears on a total of 3856 syllabi in the Open Syllabus Project database. That makes it the second most used text in academia after the popular writing style manual by Strunk and White (3934 syllabi) – a book that’s usually assigned to help college students with their composition habits for writing term papers.

2. Of those 3856 Communist Manifesto hits, only 103 – or 2.67% – are on syllabi in Marx’s own primary academic discipline, economics. The rest are in fields that venture far astray from economics, with the highest concentrations coming from the humanities.

3. Marx’s Communist Manifesto far exceeds the syllabus frequency of virtually *any* other author or work in all of human history with the possible exception of Plato. Here are the rankings for Marx and the most cited work of several major philosophical figures on the list (note: I intentionally excluded works that are textbooks or primarily literary and paired down the tail end of the list to give a rough sample):

Marx (Communist Manifesto) – 3856

Plato (Republic) – 3573

Aristotle (Ethics) – 2709

Hobbes (Leviathan) – 2671

Machiavelli (The Prince) – 2652

King (Letter from the Birmingham Jail) – 1985

Mill (On Liberty) – 1969

Foucault (Power) – 1774

Darwin (Origin of Species) – 1701

Augustine (Confessions) – 1694

Tocqueville (Democracy in America) – 1650

Smith (Wealth of Nations) – 1587

Rousseau (Social Contract) – 1427

Rawls (Theory of Justice) – 1248

Sartre (Existentialism) – 1224

Paine (Common Sense) – 1128

Locke (Second Treatise) – 1045

What could account for the popularity of The Communist Manifesto? Phil identifies two hypotheses: First, it could be the case that Marx simply is the most important thinker who has ever lived, beating out all but Plato by a wide margin. Second, Marx could be enjoying outsized popularity because university faculty outside of economics are overly enamoured with his thought.

The latter seems like the truth.

While Marxian thought does dominate some corners of philosophy, history, literary criticism, and many other subfields, we would expect classes in those areas not to focus on The Communist Manifesto but on Marx's other works. Das Kapital is in 1447 syllabi, right around Rousseau's Social Contract.

The Communist Manifesto is a political leaflet, not a work of deep scholarship. The fact that it dominates not only the works of other thinkers but also Marx's other works indicates that it is assigned primarily for its political conclusions.

How has Marx Avoided the Dustbin of History?

Marx' economic thought was rejected by economists even within his own lifetime. All of his economic analysis shared a fatal flaw: the labour theory of value.

Marx observed that capitalists earn profits above the wages paid to workers. In his framework, this would only be possible if the capitalists exploited the workers. This was met with an empirical challenge: If profits are the result of exploitation, how come profit rates aren't highest in capital-intensive industries? Instead they are relatively consistent across the entire economy.

Engels claimed that Marx would resolve this issue in the later volumes of Kapital. He even held a Prize Essay Competition to see if anyone could anticipate Marx' solution to this seemingly intractable problem. But the later volumes didn't offer a satisfactory solution.

Austrian economist Eugen von B?hm-Bawerk wrote the definitive critique of Marx, Karl Marx and the Close of His System. The marginal revolution of the 1870s, which laid the groundwork for all of modern economics, offered a simple solution to the problem that has stood the test of time: interest.

As B?hm-Bawerk points out, workers are paid when the work is performed. But capitalists only earn revenue once the final product is sold. So if production takes time, we must account for interest. A unit of currency today (gold, silver, dollars, pounds, etc.) is not worth the same as that same unit tomorrow or next year. Leaving aside inflation, people subjectively value money today over money in the future. When you adjust future revenues accordingly, profits are actually very close to zero throughout the economy.

This is the explanation that any modern economist will give you. So when a modern economist assigns Marx, it's to teach about his role in the history of economic thought, not to teach his ideas on their own merits. That's why so few economists are assigning Marx at all!

Marx the scientist may have fallen out of favour, but Marx the political theorist survived and thrived. Marx inspired the political left, and through a twist of fate his adherents came to power in Russia and spread his influence around the world.

Other links:

Venezuela, El Caracazo, and Chavism with Francisco Toro

Colonization After Emancipation, Phil's book on slavery

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Trailer Parks, Zoning, and Market Urbanism with Nolan Gray

Fri, Sep 02, 2016

Today's guest on Economics Detective Radio is Nolan Gray. Nolan is a writer for Market Urbanism and the host of the recently launched Market Urbanism Podcast.

Market urbanism is the synthesis of classical liberal economics and an appreciation for urban life. Market urbanists are interested in economic issues specific to cities, such as housing affordability and urban transportation.

Nolan wrote an article titled "Reclaiming 'Redneck' Urbanism: What Urban Planners Can Learn From Trailer Parks." As Nolan points out, trailer parks are remarkable in that they achieve very high densities with just one- and two-story construction. They do so while providing remarkably low rents of between $300 and $500, or $700 to $1,100 per month to live in brand new manufactured homes. They are also interesting in that the park managers provide a form of private governance to their tenants.

A century ago, there were many kinds of low-income housing available to people of lesser means. Low-quality apartments, denser housing, and boarding houses have largely been regulated out of existence. The remarkable thing about trailer parks is that they haven't been made illegal or untenable by regulation. The one thing trailer parks don't have is a mixture of uses, but they get around this by locating close to business areas.

Cities in Europe and Japan, which didn't adopt American-style zoning, have much higher density and more mixed-use neighbourhoods. Houston, which has taken steps to de-regulate, has seen more development of this sort recently. It seems like dense, mixed-use neighbourhoods pass the market test whenever they are allowed.

Sonia Hirt, in her book Zoned in the USA, explains why city planners became focused on separating uses. When these rules were first being adopted, industry polluted much more than it does today, so there was a health justification for separating them. But there were also superstitions, such as the idea that having children close to groceries would spread disease.

William Fischel's homevoter hypothesis states that local homeowners engage in political activism to prevent development, thus protecting their home prices. They may justify their opposition to development in terms of environmentalism or preserving local character, but homeowners stand to gain or lose a significant portion of their life savings depending on the price of their homes. This makes local politics particularly hostile to new development and denser, more affordable housing.

Meanwhile, people blame everything except land use restrictions for high housing prices. Foreign buyers have been a recent scapegoat in Vancouver, which adopted a tax on foreign buyers, thus popping its housing bubble. Airbnb is also blamed for high housing costs, though its effect is certainly negligible.

While housing is important because it is many households' largest expense, inelastic housing supplies prevent people from moving for labour opportunities. Autor, Dorn, and Hanson (2016) show how many local labour markets in America never really recovered from a trade shock with China in the early 2000's. Much of this may have been due to America's inelastic housing supply. When industries like the furniture industry were outcompeted by Chinese imports, the people who owned homes in furniture-producing towns lost both their jobs and the value of their homes. With home prices elsewhere being so high, many of these people chose to spend the rest of their lives on welfare rather than moving to find work. Ed Glaeser has written more on the costs of subsidizing home ownership.

Home ownership is a bad investment. Having a single, large asset take up a large part of one's portfolio is just bad investing, particularly when that asset's value is correlated with your labour earnings. While one can hedge one's home value against futures markets based on the Case-Shiller index, but few people do this.

Errata: I accidentally referred to The Simpsons character Frank Grimes as Rick Grimes. Rick Grimes is from The Walking Dead. Also, I wrongly said that the paper on the China shock was by Angus Deaton. Somehow I mixed him up with David Autor. Same initials, just reversed?

Other Links:

Jane Jacobs as Spontaneous Order Theorist with Pierre Desrochers

The California exodus to Texas is reflected in market-based, one-way U-Haul truck rental prices

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Venezuela, El Caracazo, and Chavism with Francisco Toro

Fri, Aug 26, 2016

Today's guest is Francisco Toro, he is the blog editor at The Caracas Chronicles, a group blog about Venezuela.

Venezuela has all the markings of a paradise. It has a lush, tropical climate and access to vast oil reserves. And yet, the Venezuelan government has run the country into the ground. As of now, all but the wealthiest Venezuelans struggle to eat. What went wrong?

It might surprise you, given Venezuela's current state, that the country was for many years a model Latin American country. Before 1989, Venezuela had a stable, two-party democracy. Its economy functioned when the price of oil was high, and it was free of much of the violence that plagued other Latin American nations. That changed in 1989 with an event known as El Caracazo.

El Caracazo refers to a series of riots that occurred in February and March of 1989, and their brutal repression by the Venezuelan army. The details surrounding El Caracazo remain deeply controversial among Venezuelans.

Before 1989, the Venezuelan economy was characterized by cronyism. Many industries were protected from competition both by tariffs on foreign goods and restrictions on entry by new firms. This arrangement could continue so long as oil prices stayed high, but with the fall of oil prices in the 1980s, the economy sunk into a malaise. The government was deeply indebted, and the incoming government tried to implement neoliberal reforms to save both the economy and the government's balance sheet.

Within weeks of the reforms, the riots that would become El Caracazo began. Here's where the controversy lies: Chavez and his supporters on the far left point to these riots as the people rising up against capitalism. But Venezuelans on the right point out that the reforms hadn't had time to take effect when the riots occurred, and therefore they were more likely a reaction against the ongoing economic malaise than the reforms.

In any case, Caracazo marked a turning point for Venezuela that would lead to the rise of socialist president Hugo Chavez, who would control the country until his death in 2013. Chavez' brand of Marxism was a throwback to the socialist regimes of the Cold War. His Venezuela was a mixed economy with very heavy restrictions on its capitalist elements. For instance, Chavez made it illegal to fire an employee for any reason. He imposed price controls throughout the economy. When oil prices were high, they propped up the rest of the economy. When they were low, the regime could borrow to paper over critical shortages. During this time, Chavez received praise from Western intellectuals on the left. Even as late as 2013, Salon was praising Chavez' "economic miracle."

In 2013, Chavez died and was succeeded by Nicolas Maduro. In 2014, the price of oil collapsed, causing Venezuela to default on its debts. The government has attempted to print its way to solvency, causing high inflation. The Chavez and Maduro regimes have kneecapped the capitalist system and replaced it with nothing. Toro argues that even Soviet-style central planning would be an improvement at this point.

There are clear pragmatic reforms Maduro could make to reduce the impact of the crisis. Yet he doesn't, and members of his government who speak out in favour of market-led reforms of any kind are summarily fired. Maduro listens to the advice of a Marxist economist named Alfredo Serrano, who is a mix between a hard-core Stalinist and a utopian campus liberal.

Yet despite the continually worsening economy, Maduro holds on to power. He also maintains the support of about a third of the population. Maduro's regime has managed to place the blame for the crisis on sabotage by a nefarious capitalist conspiracy.

Businesses that hold inventory for any length of time are at risk of having their warehouses raided and filmed as proof that the ongoing shortages are the work of capitalists hoarding goods. Maduro also scapegoats the many people who earn their livings re-selling price-controlled goods, a group that now encompasses one in six Venezuelans. As dubious as these claims are, the government controls the media and seems to have convinced a third of the population of this narrative.

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Against Fossil Fuel Divestment with Pierre Desrochers

Wed, Aug 17, 2016

Pierre Desrochers returns to the podcast to discuss the fossil fuel divestment movement in higher education. He recently co-authored a paper titled "Blowing Hot Air on the Wrong Target? A Critique of the Fossil Fuel Divestment Movement in Higher Education" with Hiroko Shimizu.

The fossil fuel divestment movement seeks to combat the environmental damage done by the fossil fuel industry by preventing university endowments from investing in fossil fuel stocks. More than 1,000 universities have divested themselves of fossil fuel stocks because of this movement's influence. There are a number of problems with this approach:

1. University endowments can't budge stock prices unilaterally.

University endowments are small potatoes in the world economy. Even if they could affect the stock prices of oil companies, they would just create an arbitrage opportunity for other investors to buy those stocks at discounted prices. This more than anything makes divestment an exercise in futility.

Camerer (1998) tried to influence prices in a horse betting market by placing large bets and then pulling them out at the last minute. He found that he was unable to budge prices even little. Divestment activists are trying to do what Camerer was trying to do, and they won't have any more success.

Some activists have internalized this criticism, and instead argue that divestment is important for symbolic moral reasons.

2. Universities will face higher risk if they choose to divest.

If university endowments divest themselves of fossil fuel stocks, they will be less diversified. Having a wide range of different (and uncorrelated) stocks allows a university endowment to hedge itself against risk.

Since oil stocks haven't given particularly high returns in recent years, activists have been able to argue that divestment makes sense from an investment perspective. But you can't predict future returns based on past ones. The prices of these stocks reflect the expected value investors place on them, so to the extent that the future profitability of oil companies can be predicted, the prices already reflect those trends.

Furthermore, if student activists are allowed to direct universities' investment activities, it may be difficult for universities to hire the most talented fund managers.

3. The movement is hypocritical.

While activists can't affect fossil fuel production by manipulating stock prices, they could affect it by demanding less fossil fuels themselves. And yet they attend their anti-petroleum protests in kayaks made from petroleum.

Activists want change without personal sacrifice. A round-trip flight from New York to Europe releases between 2 and 3 tons of carbon into the atmosphere, but few environmental activists are willing to skip their exotic vacations in favour of less carbon-intensive activities.

4. The alternatives to fossil fuels are not so great.

There's a lot of focus on solar and wind power as replacements for fossil fuels. But an electrical grid needs to work even when it is neither windy nor sunny, and storing power is costly. You need other sources of power to take up the slack when wind and solar can't deliver.

In a misguided attempt to appease environmentalists, Germany shut down many of its nuclear plants to replace them with wind and solar power plants. In order to keep consistent power, Germany has had to burn coal. But what would they do if they couldn't use coal to produce power when the sun and wind aren't working?

The UK's solution has been to burn wood pellets, which is arguably worse than petroleum for producing power.

An advantage of fossil fuels is that humans have been able to substitute them for energy that would have, in the past, been produced on the surface of the Earth. The more we extract from underground, the less of the Earth's surface needs to be dedicated to producing for humans. Indeed, global forestation has been increasing, not decreasing, over the past few decades.

5. The global transportation system depends on fossil fuels.

The Locavore's DilemmaThe Locavore's Dilemma

Fossil fuels offer a highly concentrated form of energy that is vital to transportation. While electric cars have made great advances in recent years, even the best can't travel nearly as far as a gas-burning car with a full tank. Electric cars are also prohibitively expensive for most people, and must be subsidized to compete with cheaper-to-produce gas-powered cars.

And of course, we drive around on asphalt, which is itself a petroleum product.

The advantage of having a well-functioning global transportation system powered by fossil fuels is that it allows regions to specialize in what they're good at producing. Pierre's book, The Locavore's Dilemma, deals with issues of food security. If you can produce tomatoes in fertile Mexico and ship them to frigid Canada, you don't have to expend the energy of building and heating greenhouses in places where tomatoes wouldn't grow naturally.

Works Cited

Camerer, C. F. (1998). Can asset markets be manipulated? A field experiment with racetrack betting. Journal of Political Economy, 106(3), 457-482.

Desrochers, P., & Shimizu, H. (2012). The locavore's dilemma: in praise of the 10,000-mile diet. PublicAffairs.

Desrochers, P., & Shimizu, H. (2016). Blowing hot air on the wrong target? A critique of the fossil fuel divestment movement in higher education. Frontier Centre in Public Policy.

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The Costs of Ethnic Diversity with Garett Jones

Fri, Jul 22, 2016

Garett Jones returns to the podcast to discuss the issue of ethnic diversity. There is a wide body of research showing that ethnic diversity can reduce the productivity of teams, firms, and even whole countries.

Williams and O'Reilly (1996) review dozens of studies showing that ethnic diversity has a negative impact on group performance. In the two decades since, more research has reinforced that result. Alesina and La Ferrara (2005) find that increasing ethnic diversity from 0 (only one ethnic group) to 1 (each individual is a different ethnicity) would reduce a country's annual growth by 2 percent. Multiple studies (La Porta et al., 1999; Alesina et al., 2003; Habyarimana et al., 2007) have shown that ethnic diversity negatively affects public good provision. Stazyk et al. (2012) find that ethnic diversity reduces job satisfaction among government workers. Parrotta et al. (2014a) find that ethnic diversity is significantly and negatively correlated with firm productivity.

This may seem strange to you. If you're like me, you probably enjoy diversity. You probably don't observe the problems of low morale and high marginal costs that researchers have found in ethnically diverse workplaces.

If that's the case then you, like me, live in a bubble. An apparent exception to the rule that ethnic diversity lowers productivity comes in high-human-capital groups. I say "apparent" because there hasn't been much in the way of direct study of this particular issue. However, some results are suggestive. For instance, the same researchers who found that ethnic diversity reduces firm productivity in general found that it increases firms' level of innovation as measured by patents (Parrotta et al., 2014b). Most of the people I know fall into this category of highly skilled, highly educated individuals, so it shouldn't be surprising that my experience (and maybe yours) is not the norm.

Given that diversity is so costly for organizations, there is a huge industry dedicated to diversity training to mitigate these effects. However, a recent issue of the Harvard Business Review argues that diversity training seems to be a general failure.

To the extent that diversity is a plus for firm profitability, firms will tend to seize this opportunity without the need for legal intervention. And indeed, there are some types of diversity that seem to have positive impacts on firm profit. For instance, a recent study by Alesina, Harnoss, and Rapoport (2016) indicates that birthplace diversity improves productivity. This is different from (and in this sample, uncorrelated with) ethnic diversity. People might all share the same ethnicity, but the evidence indicates that if they come from different places they tend to have complimentary skills that make them better at working together.

As Garett points out, this is roughly the plot of every movie and TV show ever made by Joss Whedon.

The causes of all these effects have been studied by experimental economists. (For an overview of the history of experimental economics, listen to my interview with Erik Kimbrough.) One way to test this is to look at how ethnically diverse groups play various games. In a study looking at the different ethnicities in Israel, Fershtman and Gneezy (2001) found that people did not discriminate against Sephardic Jews in the dictator game but they did discriminate in the trust game, indicating that discrimination was driven by a (mistaken) lack of trust in the minority ethnicity. Surprisingly, even members of the minority tended to discriminate in this way.

Glaeser et al. (2000) found that pairs are less trustworthy when they have different ethnicities or nationalities. The really shocking thing about this is that this study was performed on Harvard undergraduates, who we might think of as the people least likely to discriminate in this way.

Easterly, Ritzen, and Woolcock (2006) show that ethnolinguistic fractionalization has a negative impact on the rule of law:

Fractionalization and the Rule of Law

The basic story that Easterly, Ritzen, and Woolcock tell is that ethnic conflict makes it difficult to achieve a consensus on how the government should be run, thus leading to worse government.

Works Cited

Alesina, A., Devleeschauwer, A., Easterly, W., Kurlat, S., & Wacziarg, R. (2003). Fractionalization. Journal of Economic growth, 8(2), 155-194.

Alesina, A., & Ferrara, E. L. (2005). Ethnic diversity and economic performance. Journal of economic literature, 43(3), 762-800.

Alesina, A., Harnoss, J., & Rapoport, H. (2016). Birthplace diversity and economic prosperity. Journal of Economic Growth, 21(2), 101-138.

Easterly, W., Ritzen, J., & Woolcock, M. (2006). Social cohesion, institutions, and growth. Economics & Politics, 18(2), 103-120.

Fershtman, C., & Gneezy, U. (2001). Discrimination in a segmented society: An experimental approach. Quarterly Journal of Economics, 351-377.

Glaeser, E. L., Laibson, D. I., Scheinkman, J. A., & Soutter, C. L. (2000). Measuring trust. Quarterly Journal of Economics, 811-846.

Habyarimana, J., Humphreys, M., Posner, D. N., & Weinstein, J. M. (2007). Why does ethnic diversity undermine public goods provision?. American Political Science Review, 101(04), 709-725.

La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. (1999). The quality of government. Journal of Law, Economics, and organization, 15(1), 222-279.

Parrotta, P., Pozzoli, D., & Pytlikova, M. (2014a). Labor diversity and firm productivity. European Economic Review, 66, 144-179.

Parrotta, P., Pozzoli, D., & Pytlikova, M. (2014b). The nexus between labor diversity and firm’s innovation. Journal of Population Economics, 27(2), 303-364.

Stazyk, E. C., Davis, R., & Liang, J. (2012). Examining the Links between Workforce Diversity, Organizational Goal Clarity, and Job Satisfaction. In APSA 2012 Annual Meeting Paper.

Williams, K. Y., & O’Reilly III, C. A. (1998). A review of 40 years of research. Res Organ Behav, 20, 77-140.

Other Links:

Pseudoerasmus on Hive Mind.

Sam Bowman on Brexit.

Tyler Cowen on backlash against immigration.

Slate on the original "welfare queen."

A smart solution to the diversity dilemma.

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Brexit, The European Union, and the European Economic Area with Sam Bowman

Sun, Jun 26, 2016

Two days ago, Britain voted to leave the European Union (EU). The "leave" option won with 52 percent of the vote, leaving elites and the media frustrated with voters for choosing what they perceive to be the "wrong" option.

My guest today to discuss Brexit is Sam Bowman, Executive Director of the Adam Smith Institute.

The EU can be thought of as three things: A trade union known as the European Economic Area (or EEA), a currency union (the Euro) which Britain was never a part of, and a central regulatory body.

The EU has been around in one form or another since the 1950s. Although its primary function was always to facilitate trade among European states, its ultimate goal was to prevent Europe from falling back into the brutal wars that had consumed it during the first half of the twentieth century. The Union brought freedom of movement for goods and services and for people across member states.

This freedom of migration only became controversial after the fall of the Berlin Wall. Many poorer states in Eastern Europe joined the EU in the 1990s, creating the opportunity for large numbers of economic migrants to enter the wealthier states of Western Europe (a good thing, from my perspective!). Opposition to open migration was one motivating factor for some in the Leave campaign, but it wasn't the only factor.

Many older Brits who voted to leave did so out of a desire for national sovereignty. The most important legislative body in the EU is the European Commission, the members of which are appointed by the various states. There's a democratically elected European Parliament, but it is less influential than the Commission, having only the power to approve or reject proposals by the Commission.

The members of the Commission are appointed to specific roles. So, for instance, a Slovenian is in charge of transport policy for the entire EU, a Lithuanian is in charge of health and food safety, and a Portuguese politician is in charge of research, science, and innovation. Many in the Leave camp resented having British policy set by unelected politicians from other countries.

What's next for the UK?

While the Leave campaign may have won the referendum, they don't control policy going forward. The only thing that must occur is for Britain to exit the EU. It doesn't have to adopt any other of the Leave campaign's policy goals.

Sam argues that the best option for the UK would be to stay in the European Economic Area (EEA) and the European Free Trade Association (EFTA). This EEA option would maintain the economic benefits of free trade with the EU. This would place Britain in a similar position to Norway and Iceland, which both chose not to become EU member states while participating in the EEA. Britain could also aim for a trade agreement that is tailored to its particular needs, like that of Switzerland.

Brexit puts the EU in a bit of a bind. If they work out a favourable deal with Britain, other states might try to leave once they observe how painless it is. But if the EU adopts a punitive stance towards the UK it could send a bad signal to the other states. Just how voluntary is this club if you're punished for quitting?

Additional Links:

Sam Bowman on Twitter.

More details about the institutions of the European Union.

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The Age of Em, Whole Brain Emulation, and Humanity's Future with Robin Hanson

Tue, Jun 14, 2016

When I think of emulation, I think of retro gaming. My Android phone can easily emulate a Super Nintendo, a gaming console from the 1990s, and it can do that because the phone is much more powerful than the Super Nintendo and because we know exactly how a Super Nintendo works. My guest for this episode, Robin Hanson, argues that we may one day be able to emulate human brains. His book, The Age of Em, provides a detailed analysis of what a society made largely of emulated humans would be like.

Whole brain emulation is unlike my emulated Super Nintendo in many ways. With the brain, we're trying to emulate something that we couldn’t build ourselves. The challenge is in developing a sufficiently accurate model of each part of the brain that is necessary for it to function. If we knew how each node in the brain worked, if we could model it such that our node would take the same inputs, produce the same change in its internal state, and send the same outputs as biological brain cells, then all that would remain would be to find the precise network of cells in a biological brain. This could be achieved by scanning an actual human brain. The brain could then be emulated by a sufficiently powerful computer. The emulated brain would have precisely the same memories and thought processes as the person who was scanned. Hanson calls these emulated individuals "ems."

Hanson applies standard theoretical tools to the analysis of this em economy. Here are some of the implications:

1. Ems will be able to operate much faster or much slower than normal human brains.

The cost of running an emulation faster or slower is roughly linear in the speed. That means that for ems working on time-sensitive tasks, a race to develop some new technology first for example, they will likely work many times faster than biological humans, perhaps experiencing weeks or months in the blink of an eye. Ems that work alongside biological humans, for instance those engaged in services, would likely run at the same speed as we do. Ems could also run at slower-than-human speeds, which might be used as a sort of low-cost retirement for ems who have completed their working lives.

2. Most ems will probably live at subsistence.

We live in a world where the supply of human labour is limited by biology. Ems will not be so limited. Once a single em exists, making a copy will only be as costly as the processing power needed to run that copy. This means that the value of em labour will fall to the marginal cost of running an em. The em economy is a Malthusian economy, where the em population can vary instantaneously to keep up with the need for em labour.

However, subsistence might not be as bad for an em as it has been for most humans through history. Ems need not fear starvation or disease. Their consumption goods will all be simulated, and in a world of extremely cheap processing power, simulated luxuries would be cheap as well.

3. An em can work 99 percent of the time and go on vacation for 99 percent of the time, too.

This may seem paradoxical, but it follows from the possibility of creating and deleting copies at will. Suppose you have one em plumber. Each day he can make 99 copies of himself, in order to perform 99 plumbing jobs while he relaxes on a simulated beach, deleting the copies at the end of the day. While 99 percent of his processing power is being used to complete plumbing jobs, each em experiences a life of leisure followed by a single day of work.

4. Biological humans will be a true rentier class.

In a world populated by ems, the value of human labour will fall to near zero. An em brain can do anything a human brain can do, and ems will be produced until their marginal value falls to the cost of processing them. Biological humans won't be able to count on the value of their labour to sustain them, but they will earn vastly more from the wealth they already own. An em economy will grow very quickly, and thus will be able to give very high returns to the owners of capital.

5. The age of em might only last a few years before the next major change.

Robin compares the development of an em economy to three past changes in our society: The evolution of our latest non-human ancestors into humans, the move from a hunter-gatherer society to a farming society, and the birth of our modern industrial society. He observes that with each transition, the growth rate (measured as the increase in brain size before the evolution of humans and as economic growth thereafter) has increased and the period between transitions has shrunk. As ems will be able to experience far more time than we do, and since an em economy will be capable of extremely high growth, it won't take long for em society to produce the next radical shift. Perhaps just a year or two.

What will that shift entail? Robin declines to speculate, as there are too many degrees of freedom to predict with any degree of accuracy.


Additional links:

Buy The Age of Em on Amazon.

Read Scott Alexander's review of the book, which I mentioned during the interview.

Read Robin Hanson's blog, Overcoming Bias.


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Drugs, Prohibition, and the Suburban Overdose Crisis with Mark Thornton

Wed, Apr 20, 2016

Mark Thornton is a Senior Fellow at the Mises Institute. He is the author of many books, including The Economics of Prohibition (which you can access for free here), which is also the topic of this episode.

1. Does drug prohibition help stop poverty and homelessness?

The conventional wisdom on drugs is simple: you see drugs and drug abuse mixed with poverty and homelessness and it makes intuitive sense that drugs play a role in causing poverty. It seems to follow that by criminalizing drugs, you can take them out of the equation and help solve the other problems.

Mark disputes this conventional wisdom. First, the causation doesn't necessarily go from drugs to poverty. Poverty can cause people to abuse drugs and mental illness can cause both self-medication and poverty. Second, if you legalize drugs, they won't be sold on the street. Instead, they'll be sold by legitimate businesses with a particular interest in maintaining their reputation and not harming their customers. Prohibition is what creates the black market, which in turn generates violence, crime, and more potent and dangerous drugs, all of which exacerbate poverty. You can't clean up the social problems related to drugs by criminalizing them when criminalizing them is what caused many of those problems.

2. The Suburban Heroin Epidemic

Mark recently authored an article called The Legalization Cure for the Heroin Epidemic. In the article, he calls attention to the rising number of overdose deaths in the United States:

The number of drug overdoses in the US is approaching 50,000 per year. Of that number nearly 20,000 are attributed to legal pain killers, such as Oxycontin. More than 10,000 die of heroin overdoses. I believe these figures vastly underestimate the number of deaths that are related to prescription drug use.

The face of drug abuse has changed in recent decades. Rather than the homeless junkie we might picture when we think of addiction, the new addicts are middle-class people who have been over-prescribed legal opiates like such as Oxycontin and Vicodin. Doctors have been routinely prescribing these addictive opiates and many people turn to the black market rather than going cold turkey when their prescriptions expire.

The problem is that Oxycontin and Vicodin are very expensive on the black market, so many of these unintentional addicts turn to heroin as a cheaper substitute. The problem with buying black market heroin is that you don't know what you're getting. Different addicts need different doses, and you don't know what kind of dose you're getting and what it's been cut with. All it takes is one particularly strong dose to cause an accidental overdose.

3. American Foreign Policy and the Supply of Opiates

Afghanistan is the largest grower of illicit opium, and the supply has greatly increased since its invasion in 2001. The invasion destroyed the country's legitimate economy and many farmers turned to opium production. Being a huge and basically lawless country with a perfect climate for growing poppies, the global supply of opium exploded.

4. Political Lies to Support Drug Prohibition

Mark discusses the political circumstances around the prohibition of marijuana in the United States.

Marijuana prohibition went national with the passage of the Marijuana Tax Act of 1937. It too quickly changed from a measure to tax and regulate into an outright prohibition. Even hemp, the non-intoxicating form of cannabis was banned! When propaganda claiming that marijuana was deadly and caused insanity, violence, and criminal behavior was debunked (aka Reefer Madness), the "gateway theory" was born to fill the void. The gateway theory posits that while marijuana might not be addictive or dangerous, it would lead the user to try the hard drugs, such as heroin. This theory became the prevailing view in the second half of the twentieth century.

Commissioner Harry J. Anslinger made up this gateway theory on the spot when arguing for the prohibition of marijuana. Unfortunately, the argument stuck.

Recently, a quote by John Ehrlichman, Richard Nixon's domestic policy advisor (and Watergate co-conspirator) has resurfaced on the internet:

"The Nixon campaign in 1968, and the Nixon White House after that, had two enemies: the antiwar left and black people. You understand what I’m saying? We knew we couldn’t make it illegal to be either against the war or black, but by getting the public to associate the hippies with marijuana and blacks with heroin, and then criminalizing both heavily, we could disrupt those communities. We could arrest their leaders, raid their homes, break up their meetings, and vilify them night after night on the evening news. Did we know we were lying about the drugs? Of course we did."

This quote shows how drug prohibition has long be complicit with the politics of bigotry.

5. Progress Against the War on Drugs

Despite the sordid history of drug prohibition in the twentieth century, we've made slow progress towards a sane drug policy. Marijuana's many health benefits cannot be denied, and legislators are starting to take notice. Medical marijuana has been legalized in many places, and some places have even legalized it for recreational use.

Meanwhile, some jurisdictions have switched from treating drugs as a criminal issue to treating them as a medical issue. Portugal legalized all drugs in 2001. Some police chiefs have even unilaterally changed course in how they deal with addicts, offering help rather than incarceration.

We can only hope that complete legalization is just around the corner.

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Rome's Economic Suicide with Lawrence Reed and Marc Hyden

Sun, Feb 14, 2016

Ancient Rome went from a thriving civilization to a dystopia before its eventual collapse. My guests today explain how that happened. Lawrence Reed and Marc Hyden co-authored "The Slow-Motion Financial Suicide of the Roman Empire." Lawrence is the President of the Foundation for Economic Education, and Marc is a political activist and amateur Roman historian.

Many accounts of the fall of Rome focus on military problems and the barbarian invasions. However, the Empire was in decline long before the barbarians showed up to finish it off. The barbarians didn't kill the Roman Empire; the Roman Empire committed suicide. There were six important factors in the Empire's decline:

1. Political violence became normalized.

The populist reformer Tiberius Gracchus redistributed public farmland to Roman citizens. His reforms angered the Senate, and his political enemies clubbed him to death in 133 BCE. This was the first open political assassination in Rome in nearly four centuries, but it wouldn't be the last. Suddenly, it became acceptable for powerful Romans to kill their political enemies, and this would spell doom for Rome's republican government.

2. The Roman state gave ever-increasing amounts of free food and entertainment to the masses.

Despite having killed Tiberius Gracchus, the senate did not repeal his reforms in an effort to assuage the masses. Tiberius' brother Gaius Gracchus would take his brother's position and further his reforms, also introducing a system of subsidized grain for the masses. When Gaius also succumbed to political violence, most of his reforms died with him, but not the grain dole. The dole was retained and expanded, proving a huge burden on the Roman state. Successive generations of Roman leaders would buy political popularity with panem et circenses (bread and circuses). The Roman people came to value the dole over all other values. When the emperor Caligula was assassinated, there was a brief opportunity to restore the Republic, but the people preferred the rule of strong men who could provide them with ever more panem et circenses.

3. Roman armies became personally loyal to their generals rather than being loyal to the Roman state or the people.

In the early Roman Republic, the two elected consuls would raise forces from the eligible land-holding citizenry in times of crisis. These soldiers would return to their ordinary lives upon the completion of the war. This would change with the reforms implemented by Gaius Marius in 107 BCE. Marius expanded military eligibility to the landless masses and granted farmland to his veterans. He also set a precedent for much longer military campaigns (consulships had been ordinarily limited to one year). These changes made the soldiers personally loyal to their generals rather than to the Senate and People of Rome, and the generals would use their military strength to intimidate the Senate. Eventually they supplanted the Senate altogether, turning Rome into an empire with a series of strong men leading it as emperors.

However, the soldiers' loyalty only lasted as long as the wealth and land kept coming in increasing amounts, as future emperors would discover while wrestling with the Empire's deteriorating finances.

4. They debased the currency.

The silver denarius was introduced by Augustus with a silver content of about 95 per cent. However, successive emperors, facing ever-increasing demands on the treasury, both from the people who demanded panem et circenses and from the military who demanded ever-more land and money for their loyalty, needed whatever revenue they could get. When taxes would not suffice, emperors would melt down old coins and mint new ones with reduced silver content. During Trajan's rule, the denarius was about 85 per cent silver. By Marcus Aurelius' reign, that was down to about 75 per cent. Septimius Severus dropped it to 60 per cent, and his son Caracalla reduced it further to only 50 per cent.

Eventually this would spiral out of control into hyperinflation; emperors couldn't debase the currency fast enough to keep up with skyrocketing prices. By 268 CE, the denarius was just a bronze coin with a bit of silver brushed on its surface; the silver content was less than one per cent. Nor did they understand the connection between rising prices and currency debasements, which led to…

5. They instituted Draconian price controls.

Rather than halting the debasement of the denarius, the Romans instituted (predictably) disastrous price controls. Dicoletian issued his Edict on Maximum Prices in 301 CE. Diocletian set one price for the whole of the empire, from modern-day Iraq in the east to Britain in the west. In regions where the costs of goods were significantly higher than the legal limit, markets dried up, riots broke out, and many people were put to death for selling at too high a price. The law was so disastrous that it was eventually dropped.

6. They instituted onerous taxes.

Monetary reforms under Diocletian and Constantine switched the empire largely to a gold standard, which was an improvement over the hyperinflationary denarius. However, the benefits of this gold currency were not felt by those outside of the military and the bureaucracy; most people had to scramble to get enough gold to pay their taxes. People who couldn't pay were sold into slavery.

When the barbarian invasions came in the fifth century, the people welcomed them as liberators, freeing them from the yoke of the Roman tax collectors.


[Note: A phone rings in the background of the recording at 10:20. Don't be alarmed! Your phone isn't ringing.]

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Hive Mind, IQ, and the Wealth of Nations with Garett Jones

Fri, Dec 11, 2015

Garett Jones is Associate Professor of Economics and BB&T Professor for the Study of Capitalism at the Mercatus Center, George Mason University. His book, Hive Mind: How Your Nation's IQ Matters so Much More than Your Own is the subject of this episode.

The book deals with an empirical puzzle: IQ is a weak predictor for earnings. We all know high-IQ people who live paycheque to paycheque, and lower IQ people who succeed brilliantly. And yet, when we look at the relationship between nations' average IQ scores and their incomes, the relationship is strong. Nations with the highest average IQ scores are eight times wealthier than nations with the lowest IQ scores. How can we resolve this apparent contradiction?

Garett documents five main channels for the spillover effects of IQ:

1. Smarter people are more patient, they save more and build up more capital.

When economists test people's patience, high-IQ people tend to be more willing to wait for a larger amount of money in the future rather than taking a smaller sum now. This is important at the national level because savings tend to stay within a country* and fund investments within that country. That means living in a higher IQ nation generally means having more capital available to compliment your labour.

2. Smarter groups are more cooperative.

Economists use the iterated prisoner's dilemma as an idealized scenario where cooperation is at odds with people's individual, short-term incentives. Jones looked at the many times economists have studied this in experiments and correlated the cooperation rate in these experiments with the SAT scores of the schools the study participants were drawn from. He found that higher SAT schools produced more cooperation in the iterated prisoner's dilemma.

In later research, Al-Ubaydli, Jones, and Weel (2014) found that higher IQ groups were more cooperative, but higher IQ individuals were not. A high-IQ person in a low-IQ group would not foolishly cooperate when everyone else was defecting, but high-IQ groups could coordinate on a cooperative solution despite not knowing that they were in a high-IQ group.

3. Smarter people are more informed voters and are more likely to support market-oriented policies.

Caplan and Miller (2010) document the tendency for high-IQ people to think like economists.

4. Smarter groups make more productive team members.

Jones uses "O-ring" technologies (drawing on an idea from Kremer (1993)), in reference to the fatal part that cause the Challenger disaster, to show how high-IQ workers can be indispensable in many sectors of a modern economy. While many economic models assume substitutability between high- and low-skilled labour (e.g. three low-skilled workers can do the work of one high-skilled worker), O-ring sectors don't have this feature. When one mistake can completely destroy a project, low-skilled workers can have effectively negative marginal products.

5. Peer effects cause those with high-IQ peers take on the behaviours of high-IQ people, implying that low-IQ people in high-IQ countries will be more patient, cooperative, informed, and productive than low-IQ people in low-IQ countries.

It's well documented in the social science literature that people take on the behaviours of their peers. This effectively multiplies the positive effects of the first four channels by making low-IQ people behave like high-IQ people.

Jones sees a virtuous cycle between IQ and development. Higher IQs lead to better economic outcomes, and better economic outcomes lead to better health outcomes and higher IQs. But despite the great importance of this subject, people have been extremely reluctant to research differences in IQ between groups for fear of finding an unpalatable result. One of Jones' aims in writing this book is to make it more acceptable for people to do research in this area.

We also discuss Jones' recent debate with Bryan Caplan on the subject of open borders. Jones' work on IQ spillover effects give us reason to use caution in supporting open borders.


*This is actually another economic "paradox" that economists don't fully understand. One would expect savings to be invested where they face the highest returns, regardless of national boundaries, but that seems not to be the case.


Al-Ubaydli, O., Jones, G., & Weel, J. (2014). Average player traits as predictors of cooperation in a repeated prisoner's dilemma.

Caplan, B., & Miller, S. C. (2010). Intelligence makes people think like economists: Evidence from the General Social Survey. Intelligence, 38(6), 636-647.

Jones, G. (2008). Are smarter groups more cooperative? Evidence from prisoner's dilemma experiments, 1959–2003. Journal of Economic Behavior & Organization, 68(3), 489-497.

Kremer, M. (1993). The O-ring theory of economic development. The Quarterly Journal of Economics, 551-575.

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Icelandic Sovereign Money with Ash Navabi

Fri, Oct 30, 2015

Ash Navabi returns to the podcast to discuss his essay, "Will Iceland's Sovereign Money Proposal End Economic Crises?"

In April of 2015, Frosti Sigurjonsson, Member of the Parliament of Iceland and Chairman of the Committee for Economic Affairs and Trade, made a bold proposal to end fractional reserve banking and replace it with a system he calls "sovereign money."

Fractional reserve banking is the system under which banks create money by lending out a portion of depositors' money, keeping only a fraction to pay out on demand. One problem with fractional reserve banking is that the mismatch between banks' assets and liabilities leaves them exposed to bank runs and financial panics. To solve this problem, the central banks of the world function as "lenders of last resort" to save insolvent banks from going under. However, the more insidious problem with fractional reserves is that the injection of new money directly into credit markets artificially lowers interest rates and incentivizes entrepreneurs to take on longer term projects than the real savings available in the economy can sustain. Having central banks intervene to keep the cheap credit flowing does nothing to address this problem, and in fact makes it worse.

Under the Icelandic proposal, while there would be a 100% reserve requirement for private banks, the central bank would still be able to create money at will. Ash critiques this on the basis of the "Cantillon effect." The Cantillon effect is the phenomenon whereby the creation of new money transfers wealth to the early holders of that money. If a new dollar is created, the first holder of the dollar can use it to buy goods before prices have adjusted upwards. However, as people exchange the new dollar and use it to bid on various goods, the sellers of those goods will adjust their prices upwards to account for their consumers' greater willingness to pay. If you are the last to get hold of the new dollar, then you've been bidding against the holders of new money for a long time before seeing an increase in your income, thus making you poorer in real terms.

By centralizing money creation in the central bank, Sigurjonsson's proposal would enrich those to whom the central bank lends. In particular, the proposal would allow the central bank to grant money directly to the government to pay for government spending. Thus, the Cantillon effect would enrich those who are paid directly by the government at expense of those who aren't. Ash argues that this would invite cronyism, since those with the right connections will be able to benefit from these Cantillon effects.

In the end, it's not clear whether the sovereign money proposal would have been a net good or a net bad. It could have reduced credit expansion, but the cronyism inherent in the proposal could easily outweigh the positive effects.

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Violence, Lynchings, Civil War, and Witch Trials with Cornelius Christian

Fri, Oct 16, 2015

Cornelius Christian is an Assistant Professor of Economics at St. Francis Xavier University. His research concerns development economics, economic history, and the economics of conflict and violence, which is the topic of this episode of Economics Detective Radio.

Cornelius' paper "Lynchings, Labour, and Cotton in the US South" deals with violence against black people in the post-reconstruction South. Historians have hypothesized that there was an economic motive to lynchings, noting that more of them occurred when cotton prices were low. Black and white workers competed with one another in the agricultural labour market. Cornelius' findings indicate that lynchings were used by white labourers to scare black workers out of the labour market, thus raising their own wages. He finds that lynchings happen in the wake of economic shocks when agricultural wages are low. He also finds that, when lynchings occur in a given area, black people tend to migrate out of the area and agricultural wages rise for the remaining white workers.

In "Economic shocks and unrest in French West Africa," Cornelius and his coauthor James Fenske show that, while economic shocks matter as a cause of civil unrest, the institutional context matters. During French West Africa's colonial era, there were oppressive poll taxes that had to be paid regardless of crop yields. When negative economic shocks occurred, either because of low world prices for agricultural goods or poor rainfall, farmers were not able to pay these taxes and engaged in riots and political violence. In the post-colonial era, the poll taxes no longer exist and political violence no longer follows negative economic shocks.

Cornelius references recent research linking droughts during the Mexican Revolution to insurgency in particular areas. Areas that had particularly bad droughts during the Mexican Revolution produced larger uprisings, and that in turn affected the political and economic fates of these areas up to the present day. He also references Bruckner and Ciccone's 2011 Econometrica paper, "Rain and the Democratic Window of Opportunity," which shows that democratic change frequently occurs in the wake of negative economic shocks in Sub-Saharan Africa. Bruckner and Ciccone are testing Acemoglu and Robinson's (2001) thesis in "A Theory of Political Transitions."

We discuss the fall of the Soviet Union and some research showing that East Germans still expect the state to do more for them than West Germans. However, the younger generation's attitude is more similar to those of West Germans.

Cornelius' most recent research deals with witch trials in early modern Scotland. Unlike the other cases of violence he's looked at, witch trials happened more after positive economic shocks rather than negative ones. The reason, Cornelius discovered, was because early modern Scots cared a great deal that the proper legal procedures were followed in each witch trial. These procedures were costly, and so people could only afford to try and execute a witch when times were good. Witch trials are, essentially, luxury goods.

The common thread in Cornelius' research is that context matters. There's no one thing that causes violence in all times and places; it depends on the institutional context. In the post-reconstruction South, colonial West Africa, and revolutionary Mexico, negative economic shocks led to violence. However, this was not the case in post-colonial West Africa and early modern Scotland. History is not deterministic, so to understand history we need to understand the incentives faced by the individuals of a given time and place.

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Income and Wealth Inequality with David R. Henderson

Tue, Jul 07, 2015

…or How I Learned to Stop Worrying and Love Inequality.

David R. Henderson (http://www.davidrhenderson.com) is a research fellow at Stanford University’s Hoover Institution, and a professor of economics at the Graduate School of Business and Public Policy, Naval Postgraduate School, in Monterey, California.

Thomas Piketty’s Capital in the 21st Century (http://amzn.to/1LT9jLG) managed to do something unprecedented among equation-dense economic tomes, it became the #1 selling book on Amazon.com. The book tapped in to a hot topic among politicians and the general public: the high (and possibly rising) wealth and income shares of the top 1%. However, David points out that although the book was a best-seller, it wasn’t actually a best-reader. Amazon logs the sentences people highlight, and the top five most-highlighted sentences in Capital all appear in the first 26 pages (www.wsj.com/articles/the-summers-most-unread-book-is-1404417569). It seems that, at least among kindle readers, most people didn’t make it past the introduction. It appears that people buy the book to back up the views they already hold.

David thinks that the huge interest in economic inequality in general and the wealth of the 1% in particular was sparked in the 1990s by politicians, including Al Gore, and picked up by journalists like Sylvia Nasar (https://en.wikipedia.org/wiki/Sylvia_Nasar), before influencing the economics debate. Piketty has been able to ride this wave of public interest at what appears to be its crest.

David distinguishes between inequality of wealth, inequality of income, and inequality of power. Income inequality is the difference in the amount of income we each take in in wages, interest, dividends, and government transfers (e.g. welfare or social security payments), the four main sources of income for most people. Wealth should ideally include the total value of a person’s assets in addition to the stream of income he is likely to earn in the future, though this stream is more often ignored in wealth statistics. Wealth inequality is not the same as income inequality. Critically, since people earn variable income throughout their lives, income inequality doesn’t capture what we think of as the gap between “rich” and “poor.” Retired people who own two-million-dollar homes might have low incomes, but they certainly aren’t poor. Or, to use an example that’s relevant to myself, as a PhD student my income probably sits in the bottom quintile, and yet I can expect a much higher income after I graduate.

The major factor in both income inequality and wealth inequality (measured by current assets and not expected earnings) is age. Teenagers earn little or nothing, but they grow into adults and gain skills and education, their incomes rise, and they gain wealth through savings. Even if everyone had the same lifetime earnings, there would still be significant inequality in any given year since some people would be young low-earners, while others would be older, wealthier high-earners. And since the older people would have had the chance to accumulate wealth over a lifetime, they would have twenty times the wealth of their younger counterparts.

While there is a correlation between wealth and power, that correlation is by no means perfect. David gives the example of Bill Gates who discovered the hard way that when you have too little political influence, it can be costly. Gates was hit with a long and costly antitrust suit, after which he greatly expanded his lobbying efforts; he had learned his lesson. David agrees with Joseph Stiglitz’ argument (http://amzn.to/1LT9dDC), to some extent, that large accumulations of wealth are the result of rent seeking. Local governments restrict the building of new homes and developments that could expand the supply of housing. Thus, they keep real estate prices artificially high to the benefit of those who already own their homes. This is an example of successful rent seeking by homeowners to the detriment of non-homeowners. However, while Stiglitz would argue that this justifies a higher tax rate on the wealthy, David prefers the more direct solution of simply reducing or removing these restrictions.

The following are also mentioned in this episode:

  • Wealth Inequality in America (https://www.youtube.com/watch?v=QPKKQnijnsM)
  • Piketty and Saez vs. Burkhauser and Cornell: Who’s right on income inequality and stagnation? (https://www.aei.org/publication/piketty-and-saez-vs-burkhauser-and-cornell-whos-right-on-income-inequality-and-stagnation/)
  • Income and Wealth by Alan Reynolds (http://amzn.to/1LOy1Ma)
  • The Boskin Commission (https://en.wikipedia.org/wiki/Boskin_Commission)
  • Myths of Rich and Poor by W. Michael Cox and Richard Alm (http://amzn.to/1NOvEYR)
  • Mark J. Perry on individual income inequality (https://www.aei.org/publication/sorry-krugman-piketty-and-stiglitz-income-inequality-for-individual-americans-has-been-flat-for-more-than-50-years/)
  • Greg Mankiw’s favourite textbook (http://amzn.to/1Rihq8j)
  • Bernie Madoff (https://en.wikipedia.org/wiki/Bernard_Madoff)
  • The McCulloch chainsaw (https://en.wikipedia.org/wiki/Robert_P._McCulloch)
  • Lyndon B. Johnson (https://en.wikipedia.org/wiki/Lyndon_B._Johnson)
  • David’s review of Capital in the 21st Century for Regulation (http://object.cato.org/sites/cato.org/files/serials/files/regulation/2014/10/regulationv37n3-9.pdf)
  • David’s (unexpectedly) controversial EconLog post about ordinal utility (http://econlog.econlib.org/archives/2015/05/tyler_cowen_on_14.html)
  • Robert Solow’s review of Capital in the 21st Century (http://www.newrepublic.com/article/117429/capital-twenty-first-century-thomas-piketty-reviewed)
  • Matthew Rognlie’s response to Piketty (http://www.newrepublic.com/article/117429/capital-twenty-first-century-thomas-piketty-reviewed) and Randal O’Toole’s comment on Rognlie’s response (http://www.cato.org/blog/housing-wealth-inequality)
  • Branko Milanovi?’s blog on global inequality (http://glineq.blogspot.ca/)
  • David’s article on The Bottom One Percent (http://www.hoover.org/research/bottom-one-percent)
  • Peter Jaworski (http://explore.georgetown.edu/people/pj87/?action=viewpublications&PageTemplateID=360
  • Is Government the Source of Monopoly? By Yale Brozen (http://amzn.to/1HdvyI0)

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Civil Asset Forfeiture with Don Boudreaux

Sat, Mar 21, 2015

Don Boudreaux is a professor of economics at George Mason University. He blogs at Caf? Hayek. I invited him to discuss civil asset forfeiture on the podcast because of a conversation we had about it at a recent Mercatus Center colloquium.

Civil asset forfeiture is the practice of the state taking someone’s property on suspicion that the property has been used for wrongdoing, without having to charge the owner with a crime.

Civil asset forfeiture had its origins in British maritime law. The British had difficulties with pirates along the Barbary Coast. When the pirates were apprehended and their ships brought back to London, British courts had difficulty deciding what to do with these ships. The ships’ owners were outside the jurisdiction of British law, so the courts couldn’t try and convict them, but they couldn’t send the ships back to them either only to have them return to the seas with a fresh pirate crew! Parliament thus passed a law allowing the courts to charge the property itself with the crime if and only if the property’s owner was outside the jurisdiction of British law.

Civil asset forfeiture, in this very limited form, was part of American law from the beginning. In the late 19th century, when alcohol was prohibited in some states, law enforcers started using civil asset forfeiture to confiscate the property of those suspected of producing, trafficking, and selling alcohol. This allowed them to circumvent due process, as American law only guarantees due process rights (such as the right to a trial by jury, the right to an attorney, the presumption of innocence, etc.) to human beings, and an alcohol still is not a human.

The US Supreme Court ruled on civil asset forfeiture in the case of Bennis v. Michigan (which Don wrote about in a 1996 article coauthored with A. C. Pritchard). John Bennis was caught with a prostitute in the 1977 Dodge Dart he co-owned with his wife, Tina Bennis. As a result, the state confiscated the car. Tina Bennis, however, had no knowledge of her husband’s wrongdoing, and argued that she should at least be entitled to her half of the proceeds from the sale of the car. The case went all the way to the US Supreme Court, where then-Chief Justice Rehnquist wrote the majority opinion in favour of the State of Michigan. Rehnquist argued that civil asset forfeiture was constitutional since it had been a part of British law when the Constitution was adopted. Rehnquist neglected the fact that the civil asset forfeiture law at that time had only applied when the property owner was outside the legal jurisdiction of the court. John and Tina Bennis were both within the legal jurisdiction of Wayne County, Michigan where the car was seized.

Police usually seize the assets of those groups in American society that have little political clout. A young black man driving in an expensive car and carrying a lot of cash can be pulled over and have his car and cash seized on suspicion that he might be a drug dealer. White, middle-class Americans rarely face the blatant, unjust seizure of their assets.

However, in a recent case, the City of Philadelphia seized the white, middle-class Sourovelis family’s home after their son sold $40 of heroin on the front lawn. The Sourovelis family is now suing the City of Brotherly Love in a class-action suit with others whose property the city has seized (see Sourovelis v. City of Philadelphia). This case has drawn more public attention to the injustice of civil asset forfeiture, though still less attention than the issue deserves.

For more information on civil asset forfeiture, you can learn about it from the Institute for Justice, a DC-based public-interest law firm that works against civil asset forfeiture.

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Experimental Economics, Norms, and Prosocial Behaviour with Erik Kimbrough

Fri, Feb 27, 2015

Erik Kimbrough, assistant professor of economics at Simon Fraser University, is an experimental economist. In this episode, we discuss his paper, "Norms Make Preferences Social" which he coauthored with Alexander Vostroknutov.

Experimental economics began with Vernon Smith's double auction experiments in the 1950s. Smith wanted to test whether market participants could converge to the equilibrium prices and quantities predicted under neoclassical theory. He found that, indeed, the students in the lab did converge to the optimal prices and quantities, and experimental economics was born.

In the late 1970s and 1980s, the practice of testing game theory models in the lab caught on and became mainstream. One of these games, the ultimatum game, features two players dividing up a sum of money. The first play offers the second one an amount, and the second player can accept or reject. Rejection means neither player gets anything, so a (naive) game theorist would predict that player one will offer the smallest amount, a penny, and the second player will accept it. In reality, people often offer a 50-50 split, or 60-40. And when the person offering gets too greedy, say offering an 90-10 split, people routinely reject such offers.

What can explain this behaviour? To find out, experimentalists came up with an even simpler game: the dictator game. In this game (really not much of a game) one player decides how to divide up an amount of money between himself and another player. But even without the possibility of rejection, people still give others positive amounts.

What can explain this? Experimentalists believed that people were offering positive amounts to appear generous to the experimenters. In order to control for this, experimenters did double-blind studies, using code names and passing envelopes under doors to ensure participants that nobody would know if they kept the money for themselves. And yet people still shared positive amounts!

But how can we reconcile people giving away large portions of their money in a lab setting when they don't give similarly large portions of their income in real life? Experimenters realized that the money in the lab wasn't earned, so the participants may have conceived of it differently than money they felt they earned and deserved. So they had participants take a quiz, and awarded the right to be dictator to the highest scorer on the quiz.

Combining the double blind and earned income experimental designs, the experimenters were able to get 96% of people to keep the money for themselves.

One theory of why people share positive amounts is that people have preferences over payoff distributions. That is, they care about inequality. But this hypothesis is contradicted by the double blind and earned income experimental designs; neither of these affect the final distribution of payoffs, and yet they affect how much people offer in the dictator game.

Erik's conjecture is that people offer, for instance, a 50-50 split because they are adhering to a fairness norm. He uses a game where people are instructed to wait at a stoplight, even though they are paid to cross a virtual street as quickly as possible.

Indeed, the people who wait at the light, those who have a strong preference for following the norm, are also more likely to offer a 50-50 split in the dictator game. Furthermore, when the norm-following individuals play a public goods game, they are able to maintain high contributions to the public good.

You can read more about Erik's work at his personal website

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The Bubble Films with Jimmy Morrison

Fri, Feb 06, 2015

Jimmy Morrison is an independent filmmaker who is currently directing two films: The Housing Bubble and The Bigger Bubble. The Housing Bubble deals with the history of business cycles in America, spanning from the First World War to the 2008 crash. The Bigger Bubble deals with the aftermath of the 2008 crash. These films began as a single project, but Jimmy chose to split it into two films in order to tell the full story.

The films’ website provides a synopsis:

The Bubble is coming out at a crucial time in American history. Numerous films have blamed the free market for the economic woes of the country. Uniquely, Tom Woods has teamed up with experts such as Ron Paul, Peter Schiff, Jim Rogers, Marc Faber and Doug Casey to explain the economic problems America is facing and what is needed to restore prosperity.

You can’t watch the news today without hearing more calls for regulation. Deregulation is consistently the boogey man when it comes to sound bite explanations of this economic crisis. The public currently believes the government saved us during the Great Depression and that it will save us again today. America needs a simple economics lesson on this recession and Tom Woods has done just that in his book Meltdown. The Bubble successfully adapts Meltdown into a feature-length documentary.

The Bubble features interviews with numerous economists and financial analysts who actually predicted the housing crisis and recession. The people we are trusting to solve this problem claim no one saw it coming. The fact is Austrian economists predicted this recession years ago, and they are the only ones with the insight necessary to bring us out of this economic slide. This film asks them why this crisis happened, how we recover, and what America is facing.

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Finance and the Austrian School with George Bragues

Sat, Dec 27, 2014

This episode of Economics Detective Radio features George Bragues, professor of business at the University of Guelph-Humber, discussing his work developing a distinctly Austrian theory of finance. While there have been forays into finance by Austrians such as Mark Skousen and Peter Boettke, Austrians have not yet fully developed a complete and distinctly Austrian theory of finance.

George names five pillars of modern finance theory: (1) The capital asset pricing model (CAPM), (2) the Black-Scholes option pricing model, (3) the efficient markets hypothesis (EMH), (4) behavioural finance, and (5) the Modigliani-Miller theorem.

CAPM is a model that derives the value of assets based on the risk-free rate and market risk, that is, risk that cannot be diversified away. The Austrian response to this model is that there is no such thing as a risk-free asset, as risk is inherent to human action. An Austrian alternative to CAPM would incorporate the Austrian theory of a natural interest rate derived from time preference.

Black-Scholes, a model for pricing options—opportunities to buy or sell at a given price at some point in the future—assumes that price movements are normally distributed. Nassim Taleb has been forceful in his critique of this assumption; in his book, The Black Swan, he argues that returns are subject to so-called Black Swan events. Statistically, this implies a fat lower tail in the distribution of returns. George holds that, given Austrians’ skepticism about mathematics, there is little hope for an Austrian option pricing model. However, pricing assets was never the role of theorists, but of entrepreneurs.

The efficient markets hypothesis, developed by Eugene Fama, holds that the market price reflects all available information. This view holds economic equilibrium to be a normal state of affairs. The Austrian view is that equilibrium is an abnormal state of affairs; the market is always tending towards equilibrium, but it rarely reaches equilibrium. Austrian theory holds that identifying misequilibriums and arbitraging them away is the role of entrepreneurs. Identifying such opportunities isn’t easy; it requires prudence, or what Mises called “understanding.” If you believe the EMH, then Warren Buffet is not an example of someone with great insight and prudence; rather, he is someone who has repeatedly won a stock-market lottery.

Behavioural finance, developed by Robert Schiller, is a theory that argues that, contra the EMH, market prices reflect psychological factors rather than the real underlying values of the assets being traded. Behavioural finance has identified so many biases that it is essentially irrefutable. For instance, the gambler’s fallacy and the clustering illusion, yield opposite predictions. If a stock price has risen repeatedly, the gambler’s fallacy would hold that it is “due” for a correction downwards, while the clustering illusion would hold that the trend must continue upwards. Behavioural economists could thus explain a movement in either direction according to their theory, making the theory untestable in principle. Austrian theory avoids such psychological theorizing. Austrians hold that you can derive sound theory from the axiom that humans act, that they use means to achieve ends. Austrians have no particular qualm with bringing psychological factors into the analysis of economic history, but they don’t see them as part of economic theory.

Modigliani-Miller is a theory of corporate finance that says that the way a firm is financed, with more debt or equity, is irrelevant to its value. M&M holds that the value of the firm is uniquely determined by its discounted stream of revenues. Austrians might contend, in contrast, that firms financed through debt are exposed to greater risk in the case that they make entrepreneurial errors.

George is working towards an “Austrian markets hypothesis,” which would hold that markets are constantly endeavoring to achieve equilibrium, but never actually succeeding. Austrians can bring a greater appreciation of understanding, prudence, practical experience, and local knowledge to finance theory. These ideas have been wrongly impugned by modern quantitative finance, which has elevated theoreticians above entrepreneurs.

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Jane Jacobs as Spontaneous Order Theorist with Pierre Desrochers

Fri, Nov 21, 2014

This episode of Economics Detective Radio features Pierre Desrochers discussing the life and work of Jane Jacobs. Jacobs, born Jane Butzner, was a thinker and activist who wrote about cities. She spent her early career as a business journalist. When she started writing about urban renewal, she recognized the policy for the disaster it was. Jacobs became a voice for the general dissatisfaction with a policy that would bulldoze whole neighbourhoods, relocating the inhabitants into new buildings preferred by urban planning reformers and political elites.

The editors of Fortune Magazine invited Jacobs to write a piece about downtowns. Her piece, “Downtowns are for People” became the magazine’s most-discussed article. She developed the ideas in that article into her first and most famous book, The Death and Life of Great American Cities. The book launched her as a minor celebrity.

In New York City, she successfully opposed initiatives to “renew” Greenwich Village. She also opposed a plan that would have cut a highway through SoHo, Chinatown, and Little Italy. Eventually she found herself opposing the Vietnam War, and, fearing that one of her sons would be drafted, moved to Toronto.

Jacobs’ most important contributions to economics came in her second book, The Economy of Cities. Jacobs is essentially a spontaneous order theorist, though she never used that term. Her concept of entrepreneurship is particularly rich and dynamic. Unlike most economists (even Austrians) she has no urge to talk about how entrepreneurship leads us closer to equilibrium.

Her largest influence on the mainstream economics literature is the so-called “Jacobs externality.” Jacobs suggested that innovation would often come from outsiders to a given industry, so having many diverse industries clustered in a small geographic area would lead to innovation. The alternative thesis, associated with Alfred Marshall and later Paul Romer, holds that when a region specializes in a particular industry it allows knowledge spillovers to occur between similar firms. There has been significant empirical research to try to resolve these two opposing views, with Jacobs often coming out the winner.

Pierre can be found online at his academic website.

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TruthCoin, Prediction Markets, and Anarchy with Zack Hess

Fri, Oct 10, 2014

This episode of Economics Detective Radio features Zack Hess. Zack is working on a project called “TruthCoin,” a decentralized prediction market based on the technology behind bitcoin.

Prediction markets are a highly effective way to bring together dispersed information and insight into prices that reflect the likelihood of any future event. However, recent attempts to create centralized prediction markets have been thwarted by governments under antiquarian anti-gambling laws.

Enter TruthCoin. TruthCoin is a prediction market (currently in beta) that will not depend on any central server or organization. This online market will be dispersed among all the participants and thus more difficult to shut down.

Furthermore, TruthCoin will not depend on a central arbiter. The main difficulty faced by the creators of TruthCoin is in creating incentives for human arbiters to judge the outcomes of bets correctly. The solution is for judges to be set against one another, for each judge to get a higher payoff when other judges are wrong. Then any attempted collusion between arbiters falls apart.

Zack is an anarchist, and he sees a proliferation of prediction markets as a potential end run around the political class. Prediction markets where people could bet on the outcomes of given policies could force politicians to do what the prediction markets indicate is best. If, for example, a politician proposing a war claims it will have few casualties, a prediction market in “the number of casualties given that war is declared” could contradict the politician’s claim and make the war politically impossible.

You can find Zack on github, as well as the TruthCoin project itself. There is also a TruthCoin forum.

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Vampires, Zombies, and the Dismal Science with Glen Whitman

Sat, Sep 27, 2014

In this episode, Glen Whitman discusses Economics of the Undead: Vampires, Zombies, and the Dismal Science, a book he co-edited with James Dow. Glen is an economics professor at California State University and, unlike most academic economists, he moonlights as a TV writer. He first wrote for the TV show Fringe and now writes for the soccer spy drama, Matador.

The book’s website provides the following description:

“Whether preparing us for economic recovery after the zombie apocalypse, analyzing vampire investment strategies, or illuminating the market forces that affect vampire-human romances, Economics of the Undead: Zombies, Vampires, and the Dismal Science gives both seasoned economists and layman readers something to sink their teeth into.

Undead creatures have terrified villagers and popular audiences for centuries, but when analyzed closely, their behaviors and stories—however farfetched—mirror our own in surprising ways. The essays collected in this book are as humorous as they are thoughtful, as culturally relevant as they are economically sound, and provide an accessible link between a popular culture phenomenon and the key concepts necessary to building one’s understanding of economic systems large and small. It is the first book to combine economics with our society’s fascination with the undead, and is an invaluable resource for those looking to learn economic fundamentals in a fun and innovative way.”

Among the topics covered in the discussion are helpful hints such as how to meet the vampire man of your dreams, to choose what to bring on your trek across the zombie-infested wastelands you once called home, and to rebuild civilization after the undead apocalypse.

Human capital will be particularly helpful in the zombie apocalypse; it has immense value and goes wherever you go. Doctors are often depicted among the survivors of the zombie apocalypse, possibly because survivor groups would rather recruit a doctor than kill him. There’s an analogy to pirates, who would press valuable seamen like surgeons or carpenters into service rather than killing them (for more pirate economics, check out Peter Leeson’s The Invisible Hook).

Among the more unexpected chapters of the book is “Killing Time: Dracula and Social Discoordination,” by Hollis Robbins. Robbins connects the infamous Transylvanian villain’s ability to distort his victims’ senses of time to date- and time-keeping standards that some nations had adopted while others had not at the time the book was written.

You can find Glen online at econundead.com where he posts about the latest in undead economics news or on twitter as @glenwhitman.

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Migration and Open Borders with Nathan Smith

Fri, Sep 19, 2014

In this episode, Nathan Smith discusses the economics and history of migration and migration restrictions. Nathan is an Assistant Professor of Business Administration: Finance and Economics at Fresno Pacific University and regular blogger at Open Borders: The Case.

We start the episode by discussing the economic impacts of Nathan’s own migration to Fresno. Students gain, as he adds to the supply of economics professors, other economists might lose from his competition in labour markets, people looking for parking near the University might lose, as he slightly reduces the supply of available parking spaces, and property owners gain from his demand for housing. In general, anyone Nathan transacts with gains from the transaction, while those who he competes with may suffer some slight loss.

The big slogan among open borders advocates is that a significant reduction in migration restrictions could “double world GDP.” Nathan’s own most recent estimates show about a 91% increase world GDP, mainly because people would move from places where they can earn very little (e.g. places with dysfunctional institutions) to places where they can earn quite a bit more (e.g. places with well-functioning  institutions, complementary factors of production, highly developed networks of specialization and exchange, etc.). There are complementarities between human capital and unskilled labour. For instance, great managers are more productive when there are many workers to manage, and the workers are more productive where there are great managers.

Nathan’s estimates indicate that as much as 44% of the world’s population could migrate under open borders. This may seem high, but even conservative estimates would put the number of migrants in the billions. While migration would be hard for the first few migrants, diaspora effects would start to make the process smoother and more desirable. In the 19th century, when international migration was less restricted and more common, migrants would form communities within their new countries: there would be a Polish neighbourhood, an Irish neighbourhood, an Italian neighbourhood, etc. These diaspora communities would function as gateways to the new culture, giving people a place to settle while they adjusted to the language and culture of their new country.

Today, with the exception of migration within the EU, there are no countries with open borders. While migration is somewhat easier for high-skilled workers, there are still many barriers. People call high-skilled migration “brain drain,” but that is really a perverse way of characterizing it. Are workers’ “brains” their countries’ property? Are they to be kept as forced labourers for their countries’ benefit? In addition, the idea of brain drain is empirically questionable. If getting high skills is a ticket to a better life in a different country, the possibility of migrating increases the incentive to gain high skills, thus offsetting the loss of those who eventually emigrate.

When people can migrate, or “vote with their feet,” this puts competitive pressure on governments. For instance, governments’ ability to institute very progressive taxation is curtailed by high earners’ ability to move elsewhere. That the Soviets had to build a Berlin Wall to keep their citizens from leaving shows that the possibility of exit was threatening to the Soviet government.

Some restrictionists compare immigrants to the Visigoths in the Western Roman Empire. That is a poor analogy to modern migration, as the Visigoths migrated as a complete political entity.

Not only do immigrants assimilate into the existing industries, they are disproportionately entrepreneurial, founding new industries wherever they go. Nikola Tesla, Andrew Carnegie, Sergey Brin, and Elon Musk were all immigrants. During the era of open borders, many of the innovations (such as Henry Ford’s assembly line) were designed to be complementary with all the low-skilled labour made available by migrants. Much of our modern technological development is focused on economizing on low-skilled labour, but low-skilled labour is only artificially scarce in wealthy countries. Many basic tasks that high earners do for themselves could be contracted out to low-skilled migrants. Childcare, for instance, could be very inexpensive under open borders; skilled parents would not need to leave the workforce to raise their children.

Nathan sees hope for more open borders in the future. Migration restrictions are contrary to people’s consciences, which makes them difficult to enforce. This may slowly erode the restrictions. Furthermore, Christian churches are essentially supportive of open borders. There is hope for the world in moving towards open borders, but it will require moral will.

Nathan Smith can be found online at Open Borders: The Case.

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Price Theory and the Minimum Wage

Fri, Sep 12, 2014

The minimum wage is a contentious issue among economists, and yet it enjoys near-universal support among the public. In my view, public views of the minimum wage are simply the result of a lack of careful thought by most people. Daniel Kahneman’s theory that people, when faced with a difficult question, substitute a simpler question that they can easily answer, applies particularly well in this case. People answer the question of whether they would like people to earn more when the real question is whether government should mandate higher wages (I first heard this argument from Bryan Caplan on EconLog).

A purely empirical argument for or against the minimum wage is methodologically wrong-headed because empirics do not speak for themselves. Sound theory must be the economist’s first tool in understanding the effect of a policy such as the minimum wage.

Before we can understand something like the minimum wage, we must understand the role of prices in allocating factors of production to their various uses. The price of a factor signals to entrepreneurs that that factor is scarce, that it is needed elsewhere in the economy, and that the entrepreneur who can reduce his usage of relatively more scarce factors in favour of relatively less scarce ones can earn profits, while entrepreneurs who fail to do so earn losses. I give the example of a sandwich shop during an oil boom; the high price of labour caused by the oil boom leads the sandwich shop to substitute away from labour in various ways.

The oil boom in my illustration is irrelevant to the story. The sandwich shop would adapt to an increased price of labour no matter what caused it. If the cause is a minimum wage law, the people no longer employed making sandwiches are involuntarily unemployed rather than finding employment in some other industry.

Minimum wage opponents sometimes get into trouble when they draw supply and demand curves to illustrate the impact of the price floor. The problem with this is that supply and demand diagrams come with built-in assumptions that do not hold true in the case of labour markets. Low-skilled labour is not a homogeneous quantity being sold in a centralized market. The simple supply-and-demand story does not capture all the effects of the minimum wage. For instance, firms substitute between different sorts of workers affected by the minimum wage. In addition, the other terms of employment contracts can change in response to a minimum wage law, such as training and benefits.

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Virginia Political Economy and Entrepreneurship with Diana Thomas

Fri, Sep 05, 2014

In this episode, Diana Thomas discusses the relationship between the Virginia School of Political Economy and the Austrian School of Economics. Diana is an Associate Professor of Economics at the Heider College of Business at Creighton University.

The Virginia School is a branch of public choice, the application of the tools and techniques of economics to the study of political actors. The Virginia School’s founders, James Buchanan and Gordon Tullock, were the first to systematically apply a rational choice framework to the study of politics in The Calculus of Consent.

Two assumptions commonly made by neoclassical economists are the “benevolence assumption” and the “omniscience assumption.” The benevolence assumption is implicit in normative analysis of what governments “ought” to do, as this assumes that political actors are motivated to maximize the common good rather than pursuing their self-interest. This assumption is challenged by public choice economists. The omniscience assumption is at play in economic models that depict the economy as being in equilibrium, whereby nobody is misinformed of or surprised by economic reality. This assumption is challenged by Austrian economists.

The omniscience assumption implies that the economy should be possible to rationally plan, an idea that Mises and Hayek debunked in the socialist calculation debate of the 1920s and 30s.

As Diana states in her paper, Entrepreneurship: Catallactic and Constitutional Perspectives, “both Buchanan and Tullock reference Mises’ Human Action as the central reference for their understanding of methodological individualism.” The Virginia and Austrian schools also share common understandings of rationality and of self-interest.

Diana draws a parallel between Israel Kirzner’s distinction between calculative and entrepreneurial action and Buchanan’s distinction between reactive and creative action. While calculative or reactive action consists in simply responding to known incentives and constraints, entrepreneurial or creative action consists in envisioning a future that is different from the present and in acting on that expectation. Kirzner applies the concept of entrepreneurship to businessmen seizing anticipated arbitrage opportunities in the market. Buchanan applies the concept of creative action to political actors attempting to reform constitutional rules.

Buchanan conceives of constitutional rules as being made behind a “veil of uncertainty” since it is beyond political actors’ ability to predict in precisely what situations the rule will be applied, and whether their own self-interest will be served or hurt in those situations.

Diana believes that political action is more entrepreneurial than most economists recognize.  But while market entrepreneurship is guided by profit and loss towards those processes that best serve consumers, political entrepreneurship has no such guiding principle. Political entrepreneurs may innovate in ways that actually harm their constituents, but these innovations may nonetheless thrive and endure.

Poll numbers and bad press can motivate political actors, but these signals may not conform to the actual impacts of the policy. Good policies are often derided as evil, while bad policies are often popular. A US President can boost his popularity by declaring war, but US military ventures have a terrible track record in terms of their ultimate consequences (see Chris Coyne’s After War). Market innovations such as Lyft and Uber clearly benefit consumers, and yet there has been a political backlash against these popular businesses.

Public choice economists recognize that voters are “rationally ignorant,” since becoming informed about issues is costly, while the benefit is only manifested in better policy if the specific voter happens to be the swing vote in an otherwise tied election. Given these incentives, it would be irrational to be informed about policy, so it’s surprising that so many people vote at all. Diana explains it in terms of “expressive voting.” Voters vote because they want to express their views, not because their vote is particularly potent in shaping political outcomes.

Diana argues that policies aren’t particularly strongly affected by who is elected to office, rather they stem from institutional incentives. The median voter theorem demonstrates how, under plausible conditions, politicians attempt to please the most people by converging to a centrist policy. Another theory says that policy is not directed primarily by elections but by the lobbying efforts of special interest groups (see Olson). Since these groups get concentrated benefits from preferential policies, they have a strong incentive to agitate for them. Those who pay the costs of these policies (usually consumers) have only a small incentive to agitate against them, as the costs are dispersed among a great number of individuals.

Specific examples of policies made for the benefit of concentrated special interests are the US sugar quota, and Canadian customs duties charged for the importation of dairy products (leading to absurd cases of cheese smuggling).

You can read more from Diana Thomas at her professional website.

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Economic Calculation and Education

Fri, Aug 29, 2014

A key difference between Austrian economics and the neoclassical-mathematical economics developed in the mid-twentieth century by Paul Samuelson and others is the assumption by the latter that people are essentially omniscient. What neoclassical economists call "rationality" effectively means omniscience. When the agents in neoclassical models face any uncertainty, the uncertainty is always fully understood in advance; for instance, a stock's value tomorrow might be drawn from a normal distribution with a known mean and variance. Without the assumption of omniscience, the Austrian school faces the important question of how people can make economic decisions in a complex, uncertain world.

Ludwig von Mises' answer (see his 1920 essay, Economic Calculation in the Socialist Commonwealth) was that capitalist entrepreneurs calculate in monetary terms. That is, they use the prices of the immediate past as their starting data, and attempt to direct factors of production in such a way as to maximize the spread between costs and revenues. If their predictions of price changes are good, they earn profits. If their predictions are bad, they earn losses. Thus, their direction of scarce resources is subject to immediate and consequential feedback allowing a selective process for only the best entrepreneurial forecasting methods. Without monetary exchange and prices, the problem of directing factors of production to their highest uses becomes intractable.

An interesting thing about Mises' calculation argument is that it does not only relate to socialism, but to free, capitalist societies also. Mises states that, "Economic goods only have part in this system [of monetary calculation] in proportion to the extent to which they may be exchanged for money." Thus, when a good cannot be exchanged for money, for any reason, it is subject to a Misesian calculation problem.

One type of capital good that I have identified as facing a calculation problem is education. The present value of an education is nowhere represented as a market price. The rental rate of the education is represented in the price spread between educated and uneducated labour, but the present value of the education is not a price because the education itself cannot be exchanged.

The present value of the education would correspond to the expected discounted stream of income generated by the education, but this income is not represented in prices until years after the education is complete. Thus, students cannot use monetary calculation to allocate their time, funds, and efforts to being educated. They cannot refer to the present value price of the education in their initial estimation of the education's value, nor can they refer to that price to evaluate their decisions in real time.

In my view, the way to introduce economic rationality to education is to have a well-functioning market in student debt. Student debt can be priced in the market, and can thus be efficiently allocated according to monetary calculation. The value of a student loan is related to the value of the student's education. To the extent that the availability of credit can affect people's educational choices, lenders will be able to steer the allocation of resources towards more productive lines of education.

The student loan markets are not healthy, however, because of decades of government interventions intended to increase the availability of credit for students.

Garrett M. Petersen is an economics PhD student at Simon Fraser University. You can find him online at the economics detective blog.

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The Austrian Cult and Mathematical Economics with Ash Navabi

Fri, Aug 22, 2014

In this episode, Ash Navabi discusses whether the Austrian School of Economics is a cult and the value of mathematics in economic theory. Ash is an economics student at Ryerson University.

Ash wrote an article responding to recent criticisms of the Austrian school by Keynesian bloggers Noah Smith and Paul Krugman. Krugman approvingly referenced Smith's attacks on the “hermetic system that is Austrians.” Just a week later he made the following telling comment about the economics mainstream:

"And modern academic economics is very much an interlocking set of old-boy networks; to some extent this has become even more true since the decline of the journals, with most discourse taking place via working papers long before formal publication. I used to refer to the international trade circuit as the floating crap game — the same 30 or 40 people meeting in conferences all over the world, reading and citing each others’ work; it’s the same in each sub-field. And to some extent it’s inevitable: there’s so much stuff out there, and you have to filter somehow, so you mainly read stuff by people you know and people they tell you are worth reading."

Ash was quick to point out that, by the logic of the people who deride Austrian economists as "cultish" because they interact mainly with one another, each of the "old-boy networks" Paul Krugman refers to (that is, each sub-field of mainstream economics) must also be a cult.

Gary Becker, another Nobel Laureate, referred to the Austrian school as a cult in a letter to Walter Block. Becker's definition of a cult was "a small number of dedicated followers who speak mainly to each other, and interact little with let us call them mainstream economists.” This definition is problematic, to say the least. When people hear the word "cult," they don't think of Becker's dry definition but of animal sacrifice and mass suicide. The word "cult" also implies unquestioning devotion to the cult leaders, but modern Austrians frequently criticize Mises and Hayek, in highly un-cultish fashion.

Ash also wrote an article on mathematical economics versus so-called "literary" economics. John Cochrane recently referred to non-mathematical economics as "literary," a mild slur that goes back at least as far as the 1940s when Mises responded to it in Human Action. The Austrian method is not "literary" in the sense of using airy prose and fuzzy logic, rather it uses a highly rigorous form of verbal logic to derive causal chains from the basic axioms of human action.

Mathematical economics forces economists to start their analyses from unrealistic assumptions in order to put all problems in mathematically tractable terms. However rigorous the mathematics itself is, the foundation is flawed so the conclusions are flawed.

Austrians conceive of economic theory as a descriptive science rather than a predictive one. That is, pure theory cannot tell you how the future will turn out, nor is a theory tested by its empirical predictions. An entrepreneur can have a true theory of how the economy works, and yet he can still make wrong predictions if he misjudges the actual factors at play.

Ash can be found online at the Mises Canada blog page.

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Gold and the Great Depression with James Caton

Fri, Aug 15, 2014

In this episode, James Caton discusses the classical and inter-war gold standards. James is an economics PhD student at George Mason University.

Gold has many qualities that make it an ideal money: It is valuable, scarce, divisible, and easy to transport. It is also easy to verify the value of a given amount of gold: The Old Testament references weights and scales being used to measure gold. Ancient people could verify the purity of the gold by observing its water displacement.

Before 1870, only Great Britain was on a gold standard, while gold, silver, and other metals would circulate freely alongside one another throughout the rest of Europe. The classical gold standard began in the wake of the Franco-Prussian War, when the victorious Germany demonetized silver in favour of gold and the rest of Western Europe followed suit (see Caton on the deflation that resulted from the demonetization of silver). America converted to the gold standard in 1879 upon redeeming the Civil War greenbacks for gold.

The classical gold standard operated as a fixed exchange rate regime. As England was the center of global finance, the Bank of England held a privileged position whereby other central banks would follow the Bank of England to keep their currencies constant against the Pound Sterling (see Eichengreen and Bordo). This was the case until the First World War.

Europe's governments suspended the convertibility of their currencies into gold during the First World War. These governments created a great deal of inflation to finance the war, but they were reluctant to devalue their exchange rates after the war had ended. They wanted to return to their pre-war exchange rates.

At this point, the Fed did something crazy: It slashed the US money stock by over 40%, increasing demand for gold, and causing a general deflation. Before 1925, as gold flowed into the United States, the Fed did not increase the monetary base in tandem with the increasing gold stock, thus sterilizing the gold inflows' influence on prices. After 1925, when Europe returned to the gold standard, the Federal Reserve did increase the monetary base alongside the gold stock. The typical Austrian narrative about the Great Depression (see Robbins and Rothbard) blames the Fed for the 1920s inflation that created an unsustainable boom resulting in the eventual crash that became the Great Depression. However, James disagrees with the blame put on the Fed in this story, as the ratio between the base money stock and the gold stock was fairly constant from 1925 to 1929.

From 1925, the Bank of England was acting as Europe's central bank, holding most of Europe's gold. This was politically unpalatable for the French, who began hoarding gold in 1927, devaluing the Franc and causing gold to flow into France (see Irwin). Between 1927 and 1932, France went from holding 7% to 27% of the world's monetary gold. The resulting deflation exacerbated the Great Depression.

The Bank of England went off gold in 1931, sounding the death knell for the international gold standard. FDR devalued the dollar and outlawed private ownership of gold in 1933, ending what was left of the gold standard. Although this mitigated the ongoing institutional collapse in the American banking sector, the Great Depression continued on until after the Second World War.

See also: Irwin and Rustici on the Smoot-Hawley Tariff.

James can be found online at his blog, Money, Markets, and Misperceptions, and at the George Mason University website.

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