Monday, 25 May 2015

Is Pareto optimality the most misleading definition in economics?

John Quiggan thinks so (HT: Tim Haford). I often disagree with John but understand the different perspective he is coming from. But this post has me really perplexed.

John's post starts with a discussion of Pareto's political views, suggesting that his construction of the concept of Pareto optimality and his other main intellectual contribution, the Pareto income distribution, were motivated by an antipathy to government redistribution policy. This may be right, but that fact in itself doesn't make the the concept of Pareto optimality misleading or dangerous. 

On the term itself, John's first point is that the use of the word "optimality" is misleading. On this, I agree to an extent. Optimality suggests the result of an optimisation problem with a well-defined objective, but one of the first things we teach our students when invoking Pareto optimality is that there are many different allocations that are Pareto optimal, and the Pareto welfare criterion (the value judgement that making someone better off without making anyone else worse off is a good thing), is silent on how to compare these different optimal allocations. Indeed, typically the first thing undergraduate economics students see after encountering Pareto optimality is the two welfare theorems, the second of which specifically refers to different Pareto optimal allocations, and how all can be sustained by a competitive market given an particular allocation of property rights. Yes, optimal is a poor choice of word, but the context in which it is used does make it clear that it doesn't imply the single-best (by some notion) outcome. 

But then John says: 
Recognising the inappropriateness of describing radically unfair allocations as “optimal”, some economists have used the description “Pareto efficient” instead, but this is not much better. It corresponds neither to the ordinary meaning of “efficient” nor to the meaning with which the term is commonly used in economics, which is also misleading, but in a different way.
A few comments are in order here: First, the "some economists", surprised me. I thought that "Pareto efficiency" was overwhelmingly the preferred term for the concept. I quick google of "Pareto optimality" and "Pareto efficiency", yielded 263,000 hits for the former and 377,00 for the latter, which is a way smaller ratio for the latter than I was expecting, but still a majority. Second, I thought that Pareto efficiency corresponds exactly to the way the term "efficiency" is used in economics. In fact, I always teach my students that if the noun "efficiency" is used without an adjective, it is always Pareto efficiency that is implied. I would be interested to know how our commenters perceive the term. 

John suggests instead using "opportunity cost". 
The concept of opportunity cost gives us a better way to think about the possibility of making some people better off while no one is worse off. If such possibilities exist, then there are potential benefits that have no opportunity costs. Conversely, if there is a positive opportunity cost for any benefit, then we can’t make anyone better off without making someone else worse off. So, a “Pareto optimal” situation may be described, more simply as one where all opportunity costs are positive.
This doesn't seem right to me. Opportunity cost is a tautological statement about scarcity, not about welfare. If I take resources away from some use (say private consumption) and use it for another (say the provision of a public good), and do it in such a way that it is Pareto improving, there has still been an opportunity cost. TINSTAAFL still applies: we didn't get the public consumption for free; it's just that we all preferred what we got to what we had to give up to get it. 

So while "Pareto optimality" may be a bit misleading, I don't think "Pareto efficient" is, and I'm not sure what is a viable alternative to what is a very useful concept. So let's get back to whether the concept itself is dangerous. 

The nicest thing about the concept of Pareto efficiency is that it expresses outcomes purely in terms of the values of the individuals on society, not the values of the particular economist or government, employing the concept. There are more things that we might value than just Pareto efficiency, but how we weight them is a personal value judgement. Best to leave them as separate concepts and report them all, rather than obscure the weighting value judgement in the construction of a single well-being metric. (That is the main reason I am nervous about moves to move beyond GDP to "Gross National Happiness", but that is the subject for another post.)

Where Pareto efficiency becomes dangerous is when it is confused with the Kaldor-Hicks notion of potential Pareto improvements and then implicitly used as a welfare measure. Recall that according to this notion, a policy is desirable if in principle it would be possible to implement it and then make side payments where the winners compensate the losers even if those side payments are not made. Of course, it would be rare for an economics course to put that principle in front of students and suggest that it is a reasonable one, but sometimes, in taking the view "economists can talk about efficiency, but have nothing to say about equity", economists make it all to easy to confuse "we are only qualified to talk about efficiency, not equity" with "only efficiency matters, not equity". This does not mean in any way that we should abandon the concept of Pareto efficiency or change its name; we just need to be more careful to be clear that it is not a single measure or well-being. 

Groser on Canada

I like our Trade Minister:
New Zealand Trade Minister Tim Groser has attacked the Canadian milk production system, saying the industry belongs in the former Soviet Union and its market should be open to competition. A Canadian dairy industry analyst has come out to say he can not fathom New Zealand Trade Minister Tim Groser’s aggressive attack on the Canadian milk production system, in which the minister said the Canadian dairy industry belonged in the former Soviet Union and its market should be open to competition.
Bruce Muirhead, Associate Vice President of External Research at the University of Waterloo in Ontario, said Groser’s attack was misplaced and the New Zealand minister was "playing with fire".
Groser's far closer to right about this than Muirhead.
US milk producers want the Canadian dairy market opened too, but for the moment they are setting their sights on Fonterra in New Zealand.
They have gone on record as saying that if Fonterra isn’t fundamentally changed, it represents an unfair advantage for New Zealand and they are going to oppose NZ inclusion, at least Fonterra’s inclusion in the TPP (Trans Pacific Partnership) final agreement.
I'd reckoned the play here would come post-TPP: after we'd signed up, the Americans would launch antitrust action against farmer-cooperative Fonterra to block NZ milk imports. That could change where Obama's trying to cobble together a coalition to get fast-track authority though.

Friday, 22 May 2015

Coasean biosecurity externalities

Michael Reddell beat me to the punch on this one.

The budget's imposed a customs levy on air travellers to cover the costs of biosecurity border enforcement. Michael makes the simple Coasean point:
  • A new tax on international travel.  I wonder if the government looked at the possibility of levying these costs on, for example, the apple and kiwifruit industries, for whose benefit most of the biosecurity apparatus seems to exist?  Are those industries really economic?
It's a bit beyond that. Somebody bringing hoof and mouth disease into the country would do rather more harm. But the simple Coasean point is that it takes two to make an externality. Either the agricultural sector will impose an external cost on the tourist sector, or vice versa. It isn't obvious which side of the ledger ought to bear the burden.

The rest of his post on the budget is well worth reading, as is his follow-up. I especially liked this potted history in the latter post:
The previous government in many ways deserves a lot of credit for keeping spending in check for their first six years, but the structural surplus in 2006 peaked at 4.7 per cent of GDP (OECD estimate). Those huge surpluses just set up an electoral auction in the 2005 election campaign.  No political party will ever want to be in the position of allowing their opposition to spend the surplus their way –  those choices, about priorities, are a large part of what politics is about.  And the large surpluses built up in the early 2000s didn’t even do much to ease pressure on monetary policy, because they were run up well before the peak pressures on resources (2005 to 2008).  Quite possibly, overall macroeconomic management in New Zealand over the last 15 years would have been a little better if piecemeal adjustments had been made throughout.  We’d never have got into a position where we had highly stimulatory discretionary fiscal policy in the period (2005-2007) of greatest pressure on resources (and on the exchange rate).  And it would also have avoided a situation where Treasury, applying its best professional judgement, finally determined only just before the great recession of 2008/09 that the revenue increases looked permanent.  A high stakes judgement that turned out to be quite wrong.  Fiscal institutions, and ambitions, need to take more serious account of the severe limits of anyone’s knowledge.  A Fiscal Council, as the New Zealand Initiative and the former director of the IMF’s Fiscal Affairs Department have recently called for, might explore some of these issues.  Or a Macroeconomic Council might?  Then again, our academics and think tanks might lead such debates.
The best case we can make for yesterday's budget is that it bought the government time to undertake the more substantial reforms to the benefits system behind the scenes: pushing towards outcome-based contracting, outsourcing service provision, running innovative experiments like Tamaki.

Maybe my expectations have been too high. Under the government's budgetary projections, conditional on continued fiscal discipline, by 2018 government spending as a fraction of GDP will be back to where it was in 2004 under Helen Clark. In 2008, I'd have been very happy for government spending to ever return to 2004 levels. So there's that. Conditional on continued fiscal discipline.

Minimum wage research - the state of play

Adam Ozimek summarises:
Criticisms of the state data approach motivated detailed examinations of how robust the models were to different specifications of pre-existing state and regional trends. Concerns about the sensitivity of the models led tobreakthrough research that focused on employment growth rates rather than levels. This research left the state data results more robust, and also helped explain why the older models sometimes found no effects. Concerns that states raise minimum wages when labor markets are booming have led to research using instrumental variables and federal minimum wage hikes in a state model, the results of which suggest significant job losses.
On the other side, criticisms of the original cross-border pair study led to pioneering research that looked at many cross-border pairs at the same time instead of focusing on one case study. Criticisms about whether the model could actually detect disemployment effects led to research showing that raising the minimum wage lowers job turnover.Other research using cross-border methodology found that while employment effects were small, raising the minimum wage put some firms out of business and led others to open, which implies that long-run job losses may be larger than those in the short run, as adjustments take a long time.
And the research has progressed. One recent paper used data that followed the same individuals over time. It found significant disemployment effects, and that the lost job experience hurt workers even after they eventually found new jobs. Importantly, this work showed that focusing on teenagers or fast food employment, common approaches in the earlier literature, can lead to underestimating the job losses.
A brand new paper suggests low-skilled workers move out of states that raise minimum wages. This new research raises the possibility that mobility and even housing markets may play a role in the effects of the minimum wage.
The historically unprecedented size of recent minimum wage increases means the risk of job loss is higher.
It'll be interesting to see what happens with the California minimum wage hikes.

Thursday, 21 May 2015

From coal-tit to cannibalistic spiders

XKCD's spider explainer has been making the rounds. And one part reminded me of Gordon Tullock.
In 2009, the Back River Wastewater Treatment Plant found themselves dealing with what they called an "extreme spider situation." An estimated 80 million orb-weaving spiders had colonized the plant, covering every surface with heavy sheets of web.[10] The whole thing is detailed in a fascinating and horrifying article published by the Entomological Society of America.[12]
What was the total force of gravity from all those spiders? First we need their mass; according to a paper titled Sexual Cannibalism in Orb-Weaving Spiders: An Economic Model, it's about 20 grams for males and several times that for females.[11] So even if you were standing next to the Black River Wastewater Treatment Plant in 2009, the pull of all the spiders inside would still be only 1/50,000,000th that of the Sun.
The paper models when the female spider will eat the male rather than mate as a function of number of potential males around for mating and other food sources. So opportunity costs and relative prices.

Gordon Tullock founded the field of bioeconomics when he observed that the Coal Tit seemed to apply rational choice in its food search, or at least that one could improve on an avian ecologist's modelling by putting it into that framework. He later founded the journal Bioeconomics.

Here's Janet Landa's summary:
Tullock’s (1971) first published bioeconomics paper titled, “The coal tit as a careful shopper”, was published in The American Naturalist, a scientific journal sponsored by The American Society of Naturalists.

According to Tullock, the inspiration for his coal tit article was provided when he read a book by David Lack (1966)—an avian ecologist—in which Lack summarized the work of J. Gibb (1958) on the coal tits’ consumption of eucosmid moth (Ernarmonia conicolana). Because Gibb used a diagram which, to Tullock, looked somewhat like the economist’s demand and supply diagram, this led Tullock to develop Gibb’s idea by explicitly formulating coal tits’ foraging behavior as an economic optimizing problem by comparing the coal tits’ behavior to that of a careful housewife comparison-shopping in the cheapest market: the coal tit would seek its grubs in those areas where the energy cost would be lowest; in other words, coal tits:
... are maximizing the return to their labor in searching out food supplies... . Presumably, they have inherited an efficient pattern of behavior resulting from natural selection which would eliminate inefficient heritable behavior patterns (p. 77).
Tullock (pp. 79–80) ended the article by saying:
It may surprise biologists and certainly will surprise economists to learn that it is possible to use segments of economic theory to explain biological phenomena. Nevertheless, it seems to me that the problems of biologists are difficult enough so that they should seek help wherever it seems to them that their particular competence may be of value. This essay is, then, an effort, to establish a minor link between two fields that at one time were very closely connected, but have grown apart.
Alas, the 1991 spider paper doesn't cite Tullock.

Next time you see a member of the Swedish Academy who failed to vote for a Tullock Nobel, kick it in the shins for me.

Wednesday, 20 May 2015

A plain English censorship primer

The good folks at the Office of Film and Literature Classification Office tell us they've updated their plain English guide to the censorship laws to reflect the recent legislative changes.

I find anecdotes can be helpful.

Suppose that your 17 year old brings some friends over to watch Game of Thrones. They're all aged 16-18.

If they're watching it on Sky, it's ok. The broadcast comes after the watershed and comes under the Pay TV code of the Broadcast Standards Authority. The warnings are advisory and do not carry legal penalties for viewers.

If instead they're watching it on DVDs you'd purchased, you are in breach of Section 125, which makes it an offence to supply, distribute, exhibit or display a publication contrary to its classification or to allow another person to do this. The fine is up to $3000.

But, now that you know that Game of Thrones Season 4 Episodes 7 & 8 are considered R18, you've supplied it with knowledge that it's age restricted. And so it's Section 126, which has imprisonment for up to 3 months or a fine up to $10,000.

If they'd watched it on Netflix or Neon, you'd be in the same trouble as you'd be in if they'd watched it on DVD.

This kind of plain English explanation can be particularly helpful in explaining precisely how wonderful our current regime is. We can't blame the Censor's Office for this - the legislation is idiotic and needs an overhaul.

But we can wonder about whether it's reasonable to set a rating that makes it illegal to watch a show on DVD that is legal to watch on broadcast. The Censor's Office has RP13 and RP16 ratings it can use allowing children to view the material only when with a parent or guardian. Is it really sensible to set anything that can air on Sky TV as having a harsher rating than RP16?

Tuesday, 19 May 2015

Host responsibility - dairy edition

Since the New Zealand healthists seem determined to rocket us down the slippery slopes from tobacco to alcohol to sugar, let's think about how host responsibility might apply to dairies.

Bars are prohibited from serving alcohol to those who are already intoxicated. That's host responsibility. The healthists want to ban dairies near schools from selling sweet stuff to kids. But is it really all kids who are the problem here, or just the obese ones?

Host responsibility should mean, if applied appropriately here, that dairies shouldn't be banned from selling lollies to kids, just to obese kids. Just like bars aren't banned from selling beer to all people, just to intoxicated ones. They'd have to use a judgement call on who's over-the-line, just like bartenders do. Maybe there could be a training programme.

You'd probably need additional penalties for thin kids who intermediate and on-sell lollies to their friends.

To be clear: I totally oppose this. But do I oppose it more than a blanket ban on all kids buying lollies? Do you?

Note too the great classist implications of banning kids from buying from dairies near schools but not from supermarkets or high end chocolate shops. Maybe we need to refine the host responsibility proposal to target only obese kids who look poor. Because that's what's really intended, isn't it?
But not high end chocolate milk?