Paul Walker

Dr Paul Walker is an economist at University of Canterbury. He has expertise in microeconomics, institutional economics and industrial Organization. He blogs for The Dismal Science.

Robert Pindyck on climate models - The Dismal Science

Sep 03, 2013

Robert Pindyck has a recent NBER working paper that looks at one of the critical tools used in climate policy:
Climate Change Policy: What Do the Models Tell Us?
Robert S. Pindyck
NBER Working Paper No. 19244, July 2013 The abstract answers the question in the paper's title:

Very little. A plethora of integrated assessment models (IAMs) have been constructed and used to estimate the social cost of carbon (SCC) and evaluate alternative abatement policies. These models have crucial flaws that make them close to useless as tools for policy analysis: certain inputs (e.g. the discount rate) are arbitrary, but have huge effects on the SCC estimates the models produce; the models’ descriptions of the impact of climate change are completely ad hoc, with no theoretical or empirical foundation; and the models can tell us nothing about the most important driver of the SCC, the possibility of a catastrophic climate outcome. IAM-based analyses of climate policy create a perception of knowledge and precision, but that perception is illusory and misleading.

Freedom in ideas matters - The Dismal Science

Aug 30, 2013

In their recent book, "How China Became Capitalist," Ronald Coase and Ning Wang argue that the market in ideas matters for the future well-being of China. Coase and Wang deplore China's lack of a free market for ideas and the damage that this has wroug...

One up for a carbon tax - The Dismal Science

Aug 20, 2013

A new NBER working paper looks at Carbon Taxes vs. Cap and Trade: A Critical Review. The paper by Lawrence H. Goulder and Andrew Schein sees advantages in a carbon tax when compared to a cap-and-trade.

The abstract reads:

We examine the relative attractions of a carbon tax, a “pure” cap-and-trade system, and a “hybrid” option (a cap-and-trade system with a price ceiling and/or price floor). We show that the various options are equivalent along more dimensions than often are recognized. In addition, we bring out important dimensions along which the approaches have very different impacts. Several of these dimensions have received little attention in prior literature.

A key finding is that exogenous emissions pricing (whether through a carbon tax or through the hybrid option) has a number of attractions over pure cap and trade. Beyond helping prevent price volatility and reducing expected policy errors in the face of uncertainties, exogenous pricing helps avoid problematic interactions with other climate policies and helps avoid large wealth transfers to oil exporting countries.

Keynes on “The Road to Serfdom” - The Dismal Science

Aug 12, 2013

It is well known that John Maynard Keynes said of Hayek's "The Road to Serfdom": In my opinion it is a grand book [...] Morally and philosophically I find myself in agreement with virtually the whole of it: and not only in agreement with it, but in de...

The why (or why not) of vertical integration - The Dismal Science

Aug 07, 2013

At the Latent Paradigm blog Seth Goldin asks Why would a firm choose vertical integration? Part of Goldin's answer reads,

Why would a profit-maximizing firm choose vertical integration? Recall from Coase that firms exist to minimize transaction costs. If transaction costs between lessors and lessees are high enough, vertical integration is attractive. According to the widely cited 1978 paper by Benjamin Klein, Robert G. Crawford, and Armen A. Alchian, we might see vertical integration from a specific kind of transaction cost: post-contractual opportunistic behavior. A production technology with high fixed costs that cannot be recovered by being scrapped into alternative uses will tend to be vertically integrated into the rest of the product’s production process. What are some implications of this? The paper explains:
  • Fisher Body once supplied specialized metal dies that would stamp entire automobile bodies for General Motors. Fisher repeatedly tried to extract monopoly rents from GM, but eventually, in 1926, the companies merged.
  • Oil refineries are usually vertically integrated with oil pipelines, but not with oil tankers. An independent oil refinery would be hostage to a monopsonistic pipeline lessor, but an oil tanker has a potential appropriable rent near zero, because an oil tanker could easily be repurposed for shipping other goods.
  • Owners of highly perishable crops are quite vulnerable to collective demands by their laborers. Slavery was a form of vertical integration, but now, absent slavery, long-term labor contracts with unions consist of rigid wages with layoff provisions so that employers can’t opportunistically claim false reductions in demand.
  • Franchise relationships mimic vertical integration because, although a franchisee is technically an independent firm, the franchisee is essentially renting a brand, and is subject to certain controls by the franchisor.
  • Specific capital investments that have high fixed costs and can’t be easily repurposed could be subject to opportunistic behavior by workers, so the owners of firms tend to own specialized capital investments. Owners of firms use detailed employment contracts to prevent the appropriation of specialized capital by their employees. Such detailed employment contracts mimic the function of vertical integration.
The interesting point about the Klein, Crawford and Alchain argument is that Coase rejects it! As Klein himself  summarised the situation,
I have always considered my work with Armen Alchian and Robert Crawford (1978) on vertical integration to represent an extension of Coase's classic article on "The Nature of the Firm." By focusing on the "hold-up" potential that is created when firm-specific investments are made by transactors, or what we called the appropriation of quasi-rents, I believed we had elucidated one aspect of the Coasian concept of transaction costs associated with market exchange. We hypothesized that an increase in firm-specific investments, by increasing the market transaction costs associated with a hold-up, increased the likelihood of vertical integration. This relationship between firm-specific investments, market transaction costs, and vertical integration was illustrated by examining the contractual difficulties that existed when General Motors purchased automobile bodies from Fisher Body and the corresponding benefits that were created when the parties vertically integrated.

It is clear from Coase's lectures that he considers our analysis not to represent an extension of his earlier work, but rather to be an alternative, incorrect explanation for vertical integration (1988: lecture 3). Coase recognizes that an increase in the quasi-rents yielded by firm-specific investments creates a hold-up potential. However, he argues that there is no reason to believe that this situation is more likely to lead to vertical integration than to a long-term contract. Although long-term contracts are imperfect, opportunistic behavior is usually effectively handled in the marketplace, according to Coase, by a firm's need to take account of the effect of its actions on future business. Coase claims that before writing his classic paper he explicitly considered opportunistic behavior as a motive for vertical integration, in particular as it applied to the General Motors-Fisher Body case, and explicitly rejected it.
The Klein, Crawford and Alchain paper has also lend to the soap opera that is the literature on the General Motors-Fisher Body integration. Some people claim hold-up drove the GM takeover of Fisher Body, some say there was no hold-up at all while others say there was hold-up by the Fisher brothers, but only after the takeover by GM and yet others blame the lawyers!

Read Baird (2003), Casadesus-Masanell and Spulber (2000), Coase (2000), Coase (2006), Freeland (2000), Goldberg (2008), Klein (1988), Klein (1996), Klein (2000), Klein (2007), Klein (2008) and Klein, Crawford and Alchian (1978) ... and then decide.

In short vertical integration is complicated. Modern organisational economics offers diverse theories of the boundaries of firms (i.e. theories of vertical integration). Such theories are based around various frictions or transaction costs; Knightian uncertainty, imperfect foresight or bounded rationality, small-numbers bargaining, haggling costs, private information, cost of processing information, costs of inspecting quality or imperfect legal enforcement. Given such costs internalising activities within a firm may be more efficient than relying on market transactions.

(HT: Knowledge Problem.)

  • Baird, Douglas G. (2003). ‘In Coase’s Footsteps’, John M. Olin Law & Economics Working Paper No. 175 (2d series), The Law School The University Of Chicago, January.
  • Casadesus-Masanell, Ramon and Daniel F. Spulber (2000). ‘The Fable of Fisher Body’, Journal of Law and Economics, 43(1) April: 67-104.
  • Coase, Ronald Harry (2000). ‘The Acquisition of Fisher Body by General Motors’, Journal of Law and Economics, 43(1) April: 15-31.
  • Coase, Ronald Harry (2006). ‘The Conduct of Economics: The Example of Fisher Body and General Motors’, Journal of Economics & Management Strategy, 15(2) Summer: 255-278.
  • Freeland, Robert F. (2000). ‘Creating Holdup Through Vertical Integration: Fisher Body Revisited’, Journal of Law and Economics, 43(1) April: 33-66.
  • Goldberg, Victor P. (2008). ‘Lawyers asleep at the wheel? The GM-Fisher Body contract’, Industrial and Corporate Change, 17(5): 1071-84.
  • Klein, Benjamin (1988). ‘Vertical Integration as Organizational Ownership: The Fisher Body-General Motors Relationship Revisited’, Journal of Law, Economics, and Organization, 4(1) Spring: 199-213.
  • Klein, Benjamin (1996). ‘Why Hold-Ups Occur: The Self-Enforcing Range of Contractual Relationships’, Economic Inquiry, XXXIV, July: 444-63.
  • Klein, Benjamin (2000). ‘Fisher-General Motors and the Nature of the Firm’, Journal of Law and Economics, 43(1) April: 105-41.
  • Klein, Benjamin (2007). ‘The Economic Lessons of Fisher Body-General Motors’, International Journal of the Economics of Business, 14(1) February: 1-36.
  • Klein, Benjamin (2008). ‘The enforceability of the GM-Fisher Body contract: comment on Goldberg’, Industrial and Corporate Change, 17(5): 1085-96.
  • Klein, Benjamin, Robert G. Crawford and Armen A. Alchian (1978). ‘Vertical Integration, Appropriable Rents, and the Competitive Contracting Process’, Journal of Law and Economics, 21(2) October: 297-326.

The fair-trade movement does more harm than good - The Dismal Science

Jul 30, 2013

Or so argue Amrita Narlikar and Dan Kim in a recent article in Foreign Affairs. A short summary of the Narlikar and Kim article reads,

Despite the claims of its champions, the fair-trade movement doesn't help alleviate poverty in developing countries. Even worse, it is just another direct farm subsidy of the kind most conscientious consumers despise. In the long term, the world needs free trade, not fair trade.
This article is the one discussed in the most recent EconTalk.

Narlikar and Kim open their essay by noting,
Although the concept of ethical trade has existed for a long time, the institutionalization of the fair-trade movement did not begin in earnest until the late 1980s. In 1989, the World Fair Trade Organization was founded, and in the years that followed, various fair-trade certification and labeling processes emerged. A product is granted a fair-trade label once its producers have met a list of social, economic, and environmental requirements. The stated purpose of the fair-trade movement is to give economic security to producers in developing countries -- often of unprocessed commodities such as fruits, live animals, and minerals -- by requiring companies and consumers to pay a premium on the market price.

Until now, any questioning of the fair-trade movement has been limited to the micro level. The movement has faced repeated criticisms, for example, for the relatively expensive fees that producers must pay to get a fair-trade label, which make it ineffective for many poor farmers. Another area of concern is just how lucrative the process is for middlemen and retailers. Finally, several studies show that very little of the premium that consumers pay actually reaches needy producers. Consumers might be surprised to learn that only one or two percent of the retail price of an expensive cup of “ethical” coffee goes directly to poor farmers.

The adverse effects of fair trade are even more worrying at the macro level. First, fair trade deflects attention from real, long-term solutions to rural poverty in developing countries; and second, it has the potential to fragment the world agricultural market and depress wages for non-fair-trade farm workers.
An interesting statistic is that in 2010, retail sales of fair-trade-labelled products totalled about $5.5 billion, with about $66 million premium -- or about 1.2 percent of total retail sales -- reaching the participating producers. There has to be a better way of helping poor farmers. Having only 1.2 cents out of every dollar spent on fair-trade products reach the target farmers is a hugely inefficient way of helping these people. If people wish to help these farmers there has to be charities out there that can transfer more than 1.2 cents per dollar to them.

Also a more efficient and straightforward way to help poor farmers is to remove the massive OECD subsidies and tariffs we see on agricultural products. In other words, a move towards free trade is needed.

Kling on non-profits - The Dismal Science

Jul 26, 2013

Arnold Kling writes,

James Piereson writes,
For much of U.S. history, nonprofits have operated as a check on government by providing private avenues to serve the public interest. Unfortunately, American charities—and more broadly, the entire nonprofit sector—have become a creature of big government…

The publication Giving USA, which tracks charitable spending, reports that the government now supplies one-third of all funds raised by not-for-profit organizations.

… According to a recent report by the Chronicle of Philanthropy, government funding of such charities grew by 77% between 2000 and 2010, while private support for such groups grew by just 47%.
I keep emphasizing that the main difference between non-profit and for-profit is that non-profits are accountable to donors and for-profits are accountable to customers.
While I agree that non-profits are not accountable to their "consumers" I don't agree that they are accountable to their donors. If they were for-profit status would work. In fact the use of non-profit status is largely because they are not accountable to donors, the non-profit status is a way of signalling to donors that they will not (or are less likely to) be ripped off.

Imagine that you are a possible donor to a firm the outputs of which you can't easily verify. If the firm is for profit then the profit maximising thing to do is take the donor's money and do nothing at all. Remember the donor can't verify what you have done with their money. The donor's money is then pure profit, you have no costs since you haven't actually done anything. You just tell the donor you have done lots of things. The revenue from the donor is then profit. If you are non-profit then you can't capture profit in this way since there are no profits to be distributed by definition. This gives a lesser incentive to rip a donor off since any rent seeking must be done via other higher costs methods