Monday, September 22, 2014

Short-Term Benefits of Climate Change Policy

If you're trying to get someone to start a project with long-run payoff, it's can be useful to point out that the project also offers clear short run gains. In that spirit, there is a strong case that the world's leading emitters of carbon should be looking for ways to reduce their use of carbon-based fuel solely for the short term benefits--even before taking the risks of climate change into account. Ian Parry, Chandara Veung, and Dirk Heine make this case in "How Much Carbon Pricing is in Countries’ Own Interests? The Critical Role of Co-Benefits,"  just published as IMF Working Paper WP/14/174. Parry also offers a short and readable write-up of the results  at the IMF blog.

The main insight here is that burning fossil fuels has a variety of more immediate health costs: for example, it typically evolves emissions of sulfur oxides, nitrogen oxides, and particulate matter. In addition, there are a variety of social costs of fossil fuel use in the transportation sector, including costs of traffic congestion and accidents.

Parry, Veung, and Heine readily admit that estimates of these kinds of costs are squishy. They write: "Given the uncertainties and controversies involved in quantification (e.g., how to value health risks in different countries) these estimates are best viewed as a starting point for discussion though they are based on conservative assumptions ..." For example, these estimated additional costs of using carbon-based fuels may well be on the conservative side. As the authors point out, they do not include adjustments for the environmental costs of extracting, storing, and transporting such fuels, nor for costs of the heightened vulnerability to economic disruption that comes from reliance on these fuels. Here's a quick sketch of some of the main points in their argument.

First, here's an overview of carbon dioxide emissions for the 20 countries that are the largest emitters of carbon. The solid blue bars show total emissions: thus, China leads the way, followed by the U.S., Russia, India, and then Japan. The red diamonds show "intensity" of emissions, which is the carbon emissions relative to GDP. Here, emerging market economies where manufacturing is a bigger part of the economy and emissions standards are typically lower often look worse that higher-income countries.

Here's a related figure showing for each country how much the main fossil fuels contribute to carbon emissions. For example, notice the very large role played by coal in China and India, the larger role for natural gas in Russia, and the relatively larger role for gasoline and diesel in the United States. Clearly, efforts to reduce carbon emissions would have different effects on fuel sources across countries.

Parry, Veung, and Heine then look at the existing taxes on various carbon-based fuels, and compare them with the cost. They find that just to counterbalance with the domestic effects of the use of these fossil fuels--in economic terms, to assure that those using these fuels are paying for the true social costs imposed by these fuels--the taxes on these fuels expressed in US dollars per tons of carbon would need to be raised in the following way. (Notice that Brazil is the one country, by this measure, which already taxes fossil fuels at a level  higher than needed to offset these other social costs.)

By their calculations, raising carbon taxes in this way would reduce carbon emissions as follows across countries:

Of course, as the authors note, these kinds of estimates should not be taken as precise. But I sometimes worry that with all the attention paid to climate change issues, pro and con, the old-fashioned problem of reducing conventional air pollutants gets too little attention. I'll add that carbon is not the only greenhouse gas, nor is it the only emission where the argument based on co-benefits is worth attention. For example, soot and methane are also air pollution problems that are implicated in climate change, but where reducing them would have also have immediate health effects. Other studies have shown that the costs of air pollution in the U.S. are high even without taking long-term climate change issues into account. The costs of air pollution and other environmental hazards in China are very large. The World Health Organization reports that air pollution is overall the world's biggest health hazard, although only  part of this is related to the energy sources that raise the risks of climate change.

Those who are most deeply concerned about climate change may raise concerns that focusing on domestic gains from reducing air pollution will not ultimately be enough, and that efforts to reduce carbon emissions to address climate change must go further. But the immediate issue is not what air pollution policies may need to be adopted in 2030 or 2060. If the case for reducing the use of carbon-based energy can be made right now, in terms of immediate health benefits, then that seems a useful starting point for discussion.

Friday, September 19, 2014

Michael Woodford on Targetting Nominal GDP and Other Issues

Douglas Clement has a lively interview with Michael Woodford, appearing in the September 2014 issue of The Region, which is published by the Federal Reserve Bank of Minneapolis. Here are some comments from Woodford.

Arguing for the advantages of having the central bank target the growth rate of nominal GDP
I had specifically suggested that announcing a target path for nominal GDP would be a desirable way to make an advance statement about the criteria that you would be looking at later. Now, I wasn’t saying that to suggest that that’s the only formula that would be valuable, but I thought it was useful to give a concrete example showing how the thing that I was talking about could be undertaken in practice. ... A nominal GDP target path would have the advantage of being a single criterion, yet one that conveyed concern both about the real economy and about the price level and nominal variables at the same time. It would have given an explanation for which substantial stimulus would have continued to be appropriate for some time to come. But it was also a criterion that was intended to reassure people that what looked like very aggressive monetary policy wasnot going to allow inflation to get out of hand. If inflation picked up very much, the FOMC would quickly have reached the nominal GDP target and then would have to restrain nominal demand growth in order not to shoot past the target path. The public wouldn’t have to be worried that we were pushing so hard on stimulating the economy that maybe we were going to let demand get totally out of control, and we were just not thinking about that because it wasn’t the fire that had to be put out this year.

How the Fed is likely to use interest rates on excess reserves as its main policy tool when it comes time to raise short-term interest rates 

I am not worried that the Fed is not going to have effective tools for implementing its interest rate policies. We have yet to reach the point where they do want to raise interest rates, but assuming that things evolve as everyone is currently anticipating, we are likely to reach it within the coming year. At that point, I think, there will be tools that allow them to do it. It will be an interesting experiment in monetary economics because the Fed will be attempting to control short-term interest rates in a situation where almost certainly its balance sheet is going to be unusually large. That means that there are going to be extraordinary quantities of excess reserves in existence, and this means that Fed control of short-term interest rates will not be achievable in the way that it always was in the past: through rationing the supply of reserves. ...
I think the fact that interest rates can be and are currently being paid on excess reserves is very important. Of course, the Fed asked for that authority from Congress back in 2008 before embarking on the large expansion in the size of its balance sheet. The reason, I think, is that it was preparing for this question that we are going to face within the next year or so: When you have this big balance sheet, have you given up control over short-term interest rates? The FOMC wanted to be sure the answer to that question was “no,” and it could do that by having the ability to pay whatever interest rate it deemed appropriate on those reserves. So that’s a very important tool, and probably the most important tool that they are going to have when the moment arises.

Should the Federal Reserve have a mandate to pursue financial stability, along with full employment and a stable price level? 

The question whether there should also be a financial stability mandate is a more reasonable one to take up. Though I have to say that I find it a little surprising that people would think that there isn’t one. It’s true that the Federal Reserve Act mentions price stability, it mentions maximum employment and it doesn’t, in a similarly direct way, talk about the responsibility for financial stability. But, historically, if we ask why the Federal Reserve Act was passed at all, we know that Congress established the Fed in response to a financial crisis. From the legislative history, it’s clear that the whole point of the Federal Reserve Act was to have an institution that would act to ensure financial stability.
It’s true that when the current language of the Federal Reserve Act was drafted in the 1970s, financial stability had become a less central concern, and instead inflation and unemployment were both big problems. Still, the idea that anyone would have thought that it was somehow not the Fed’s concern is strange. I find it hard to imagine that if the Fed thinks it should do something out of a concern for financial stability, anyone would actually be able to object that this was overstepping the bounds of what Congress ever wanted it to be concerned with. ... I don’t see anything wrong with making it more explicit. It’s just that it seems to me that an amendment of the act to do this would be fixing something that isn’t really a problem.

Thursday, September 18, 2014

National Attitudes on International Trade

Americans, who are sometimes caricatured as being especially supportive of free trade, are actually among those most opposed. People from the low-income countries of the world, far from feeling oppressed by international trade, are often among its stronger supporters. The Pew Research Center has a new survey out--"Faith and Skepticism about Trade, Foreign Investment"--on the responses of people in 44 nations to questions about the effects and consequences of international trade. Here is a sampling of the evidence.

People from low-income countries The populations who are typically most in favor of free trade are those from low-income countries.

(For the record: "Advanced economies include France, Germany, Greece, Israel, Italy, Japan, South Korea, Spain, United Kingdom & the U.S. Emerging economies include Argentina, Brazil, Chile, China, Colombia, Egypt, India, Indonesia, Jordan, Lebanon, Malaysia, Mexico, Nigeria, Pakistan,
Peru, Philippines, Poland, Russia, South Africa, Thailand, Tunisia, Turkey, Ukraine, Venezuela & Vietnam. Developing economies include Bangladesh, El Salvador, Ghana, Kenya, Nicaragua, the Palestinian territories, Senegal, Tanzania & Uganda."

As the report notes: "Some of the greatest public skepticism about trade and foreign investment is found in the United States." Here are some examples. The U.S. is below other advanced economies, and far below the emerging and developing countries, in the share of the population who believes that trade creates jobs or raises wages. In the U.S., the share of people who see growing trade and business ties with other countries as good is lower than in regions across the world.

Again, this isn't just a U.S. phenomenon. In general, high-income countries across the world are more skeptical of trade than emerging and developing countries. Here's a country-by-country breakdown of the responses on whether trade with other countries helps jobs and wages.

Economists can argue all they want about the benefits and costs and trade-offs of free trade, but public opinion will play an important role in the extent to which trade can flourish.

One obvious response to these kinds of survey answers is to say something like: "Well, of course those from low-income countries are more in favor of free trade. They are the ones gaining jobs and economic growth from free trade, while high-income countries suffer."

Before swallowing this argument too quickly, it's worth remembering that some off the protesters who make the argument used to argue the exact opposite not that long ago: that is, they used to argue that international trade is a process where the high-income countries of the world are exploiting the rest of the world. Indeed, at least some of the anti-globalization protesters like to believe that they are speaking for the poor and oppressed of the world, but at least on the topic of international trade, the poor of the world seem to want more international trade, not less.

As an economist, I believe that international trade is not a zero-sum game, but through its competition and challenges and, yes, its disruptions, trade offers overall benefits for all the nations participating. I won't argue that case here: if you want to look at some of my past blog posts on international trade issues,  you can start with posts on global supply chains (here and here), the growth of trade in services, the importance of trade within regions for economic growth, shifting patterns of global trade, the "hyperglobalization" of world trade, raising U.S. exports, and finally some discussion of international trade in iPods and in apples--the fruit.

But what I will say is that in the next few decades, the most rapid growth in the global economy is going to be happening in emerging market economies from China and east Asia, to India and south Asia, to Latin America, eastern Europe, and even Africa. Trade between these countries is going to expand as well, driven in part by political agreements but driven even more by economic opportunities, and by the falling costs of transporting value between countries--whether that value travels by container shipments and airplanes, or by way of information and communications technology. The U.S. and other high-income countries do not control this process. The practical and non-ideological question is whether the U.S. and other high-income countries find ways to hook up their economies to the growth engines of the world economy, so that their workers and standard of living can benefit from that growth, or whether that opportunity is fumbled and missed.

Wednesday, September 17, 2014

Empathy for the Poor: A Meditation

The U.S. Census Bureau has just published its annual report with estimates of the U.S. poverty rate, which was 14.5% in 2013, down a touch from 15.0% in 2012. It's easy to have sympathy for those with low incomes. But for many of us, myself included, true empathy with the one-seventh or so of Americans who are below the  poverty line is more difficult. It can be difficult to avoid falling into easy and ill-informed moralizing that if those with low incomes just managed their food budget a little better, or saved a little bit of money, worked a few more hours, or avoided taking out that high-interest loan, then their economic lives could be more stable and their longer-term prospects improved.

When I find myself sucked into a discussion of how the poor live their lives, I think of the comments of George Orwell in his underappreciated 1937 book, The Road to Wigan Pier, which details the lives of the poor and working poor in northern industrial areas of Britain like Lancashire and Yorkshire during the Depression. Orwell, of course, was writing from a leftist and socialist perspective, deeply sympathetic to the poor. Bur Orwell is also painfully honest about his reactions and views. At one point Orwell laments that the poor make such rotten choices about food--but then he also points out how unsatisfactory it feels to patronizingly tell those with low incomes how to spend what little they have. Here's Orwell: 
English working people everywhere, so far as I know, refuse brown bread; it is usually impossible to buy whole-meal bread in a working-class district. They sometimes give the reason that brown bread is 'dirty'. I suspect the real reason is that in the past brown bread has been confused with black bread, which is traditionally associated with Popery and wooden shoes. (They have plenty of Popery and wooden shoes in Lancashire. A pity they haven't the black bread as well!) But the English palate, especially the working-class palate, now rejects good food almost automatically. The number of people who prefer tinned peas and tinned fish to real peas and real fish must be increasing every year, and plenty of people who could afford real milk in their tea would much sooner have tinned milk--even that dreadful tinned milk which is made of sugar and corn-flour and has UNFIT FOR BABIES on the tin in huge letters. In some districts efforts are now being made to teach the unemployed more about food-values and more about the intelligent spending of money. When you hear of a thing like this you feel yourself torn both ways. I have heard a Communist speaker on the platform grow very angry about it. In London, he said, parties of Society dames now have the cheek to walk into East End houses and give shopping-lessons to the wives of the unemployed. He gave this as an instance of the mentality of the English governing class. First you condemn a family to live on thirty shillings a week, and then you have the damned impertinence to tell them how they are to spend their money. He was quite right--I agree heartily. Yet all the same it is a pity that, merely for the lack of a proper tradition, people should pour muck like tinned milk down their throats and not even know that it is inferior to the product of the cow. 
In another passage, Orwell discusses how the poor are living by a "fish and chip standard" where cheap luxuries, gambling on lotteries and sports, and electronic pleasures are making life bearable even for those who lack jobs or a realistic chance of economic progress.

Trade since the war has had to adjust itself to meet the demands of underpaid, underfed people, with the result that a luxury is nowadays almost always cheaper than a necessity. One pair of plain solid shoes costs as much as two ultra-smart pairs. For the price of one square meal you can get two pounds of cheap sweets. You can't get much meat for threepence, but you can get a lot of fish-and-chips. Milk costs threepence a pint and even 'mild' beer costs fourpence, but aspirins are seven a penny and you can wring forty cups of tea out of a quarter-pound packet. And above all there is gambling, the cheapest of all luxuries. Even people on the verge of starvation can buy a few days' hope ('Something to live for', as they call it) by having a penny on a sweepstake. Organized gambling has now risen almost to the status of a major industry. Consider, for instance, a phenomenon like the Football Pools, with a turnover of about six million pounds a year, almost all of it from the pockets of working-class people. I happened to be in Yorkshire when Hitler re-occupied the Rhineland. Hitler, Locarno, Fascism, and the threat of war aroused hardly a flicker of interest locally, but the decision of the Football Association to stop publishing their fixtures in advance (this was an attempt to quell the Football Pools) flung all Yorkshire into a storm of fury.
And then there is the queer spectacle of modern electrical science showering miracles upon people with empty bellies. You may shiver all night for lack of bedclothes, but in the morning you can go to the public library and read the news that has been telegraphed for your benefit from San Francisco and Singapore. Twenty million people are underfed but literally everyone in England has access to a radio. What we have lost in food we have gained in electricity. Whole sections of the working class who have been plundered of all they really need are being compensated, in part, by cheap luxuries which mitigate the surface of life.
Do you consider all this desirable? No, I don't. But it may be that the psychological adjustment which the working class are visibly making is the best they could make in the circumstances. They have neither turned revolutionary nor lost their self-respect; merely they have kept their tempers and settled down to make the best of things on a fish-and-chip standard. . . . Of course the post-war development of cheap luxuries has been a very fortunate thing for our rulers. It is quite likely that fish-and-chips, art-silk stockings, tinned salmon, cut-price chocolate (five two-ounce bars for sixpence), the movies, the radio, strong tea, and the Football Pools have between them averted revolution. Therefore we are sometimes told that the whole thing is an astute manoeuvre by the governing class--a sort of 'bread and circuses' business--to hold the unemployed down. What I have seen of our governing class does not convince me that they have that much intelligence. The thing has happened, but by an unconscious process--the quite natural interaction between the manufacturer's need for a market and the need of half-starved people for cheap palliatives.
In modern times, we have Americanized the "fish and chips standard" into "burger and fries," but the notion of the poor living through sports and pop culture, mediated through electronic devices, still has an uncomfortably contemporary ring.

In some ways, the issue of empathizing with the poor comes down to this: Is some of the seemingly dysfunctional behavior associated with poverty (say, low savings, poor diet, or certain kinds of risk-taking behavior) a result of poverty, or is it a reason why people ended up in poverty. An accumulating body of evidence suggests that being confronted with poverty leads to characteristic psychological reactions that can make it hard to escape from poverty.

For example, Johannes Haushofer and Ernst Fehr review the evidence "On the psychology of poverty" in the Science magazine issue of May 23, 2014 (pp. 862-867). After considering a range of evidence about the effects of poverty from both developed and developing countries, they write: "The evidence indicates that poverty causes stress and negative affective states which in turn may lead to
short-sighted and risk-averse decision-making, possibly by limiting attention and favoring habitual behaviors at the expense of goal-directed ones. Together, these relationships may constitute a feedback loop that contributes to the perpetuation of poverty."

Sendhil Mullainathan, along with various co-authors, has been pursing a research agenda which holds that the poor, who by definition are confronted by financial scarcity, are led by their poverty to act in ways just like the rest of us when we are confronted by a scarcity. In a 2013 interview, Mullainathan said:
You can get some people to sympathize with the poor, but to empathize is actually very hard, because most people are not poor. I realized that scarcity gives you a thread. You can understand some behaviors of your own that you experience under scarcity, and you can almost follow that thread and say, "I can at least imagine what that scarcity must be like if it were really unrelenting." This allows you to almost project yourself more into people’s shoes, and therefore to gain a richer understanding of a world which many of us don't otherwise have access to.
Mullainathan has carried out some interesting structured games in which some players turn out to be comparatively rich while others are comparative poor. The games are hypothetical settings, of course. But intriguingly, those who turn out to be poor in the game become much more willing to borrow at unfavorable conditions--even though it makes them worse off in the long run.

For my own part, my life often feels as if I am perpetually experiencing a shortage of time. Somehow, the tasks of life get done. But why can't I do a better job of working especially  hard for a few months or a year, and then getting well ahead of my work? Surely, it would be a more relaxed and  pleasant life if I didn't live from one deadline to the next?!? But I usually fail at saving up time and getting ahead in this way--just as those who are confronted with a shortage of income often fail to try extra-hard to save for a time, to ease what is otherwise an ongoing financial crunch. If you compare my own behavior in living deadline to deadline under a shortage of time, and the behavior of a low-income person in living check to check with a shortage of income, some of the patterns look much the same.

Sure, there are plenty of counterexamples of low-income people who manage their resources extremely well, under the pressure of limited income. And there are plenty  of counterexamples of busy people who manage to work ahead of their deadlines on a consistent basis. But perhaps the central theme of economics is the necessity of making choices as best we can under conditions of scarcity. For many of the modern poor, Orwell's summary of their position in life still rings true. One could look across swathes of modern America and still write: "Whole sections of the working class who have been plundered of all they really need are being compensated, in part, by cheap luxuries which mitigate the surface of life." It is a failure of basic human empathy to blame the poor for behaviors that offer a way of mitigating the surface of difficult life circumstances.

Tuesday, September 16, 2014

How the Free Rider Idea Evolved

In social science parlance, a "free rider" is someone who benefits from a collectively provided good but does not make an appropriate contribution to the provision of that good. A homely example might be the family that shows up each year empty-handed at the big reunion, planning just to eat what all the other families provides. In an introductory economics class, the idea of a free rider often arises the discussion of public goods, referring to the idea that self-interest can lead people to a wish to benefit from collective--often government--goods and services, without contributing an appropriate share. Of course, if many people behave in this way, collective action can become difficult to sustain.

The meaning of "free rider" has evolved over time, until terminologysort of popped up in the economics literature. Philippe Fontaine explores earlier and current uses of  "Free Riding" in  the September 2014 issue of the  Journal of the History of Economic Thought (v. 36, pp 359-376). The journal isn't freely available on-line, but many readers will have access through library subscriptions.

Fontaine discusses two main uses of "free rider" in economics leading up to the 1960s: one in the context of securities practices and the other in the context of labor unions.

The use of "free rider" in the context of securities practices seemed to involve situations where there was an expectation that established institutional participants in financial markets had a responsibility to act in certain ways, and that holding back in an attempt to increase profits was acting like a "free rider. Fontaine offers examples going back to the 1930s, but here's one example from the 1960s which involves about a case where in an initial public offering, certain securities dealers who had been allocated shares would hold back shares from the public, and then plan to sell them later at a higher price. Here's Fontaine (citations omitted):
The NASD [National Association of Securities Dealers] likewise prohibited the practice of free riding “hot issues.” Here, professionals who had withheld shares from the public at the initial public offering were castigated for selling them with a significant profit in the trading market afterwards. From the mid-1960s, free riding was used to describe “the practice of purchasing during distribution and selling after a subsequent rise in price in the aftermarket.” Though not illegal, this practice was forbidden by the NASD because the broker-dealer was not supposed to enjoy “an unfair advantage from his position as a distributor of securities.” ... For its proponents, regulation of the securities market was justified by the need to defend the interests of the public against unfair practices and free riding in particular, while, for its adversaries, this regulation appeared as an obstacle to access a supposedly open market.
Discussions of labor unions in the 1940s and 1950s often referred to the "free riders" who wanted to receive union wages and benefits without paying union dues. Fontaine again:
"Discussing the Taft–Hartley Act, the former president of the American Economic Association and authority on labor issues, Sumner H. Slichter (1949, p. 2), wrote that the “‘free-rider’ is a well-known problem of the American union.” That problem referred to the “reluctance of workers to pay union dues after their immediate demands have been met.” Among the characteristics of the American trade unions, the institutionalist economist saw “reliance upon the closed shop or the union shop,” which he defined as “devices partly to deal with the problem of the ‘free-rider’” (p. 5).  In an issue of the Annals of the American Academy of Political and Social Science devoted to discussing labor in the American economy, even Senator Robert A. Taft (1951, p. 196), Republican of Ohio, who wrote the Taft–Hartley Act of 1947 as a result of his conviction that the Wagner Act was too favorable to the labor unions, conceded that a “limited type of compulsory membership contract is a complete answer to the ‘freerider’ argument so often advanced to support the need for a closed shop.”
When did the free rider terminology jump from being specific to a financial or a labor union context, and become a general term widely used by economists? The answer here turns out to be trickier than one might expect.

In a conceptual sense, the free rider arguments entered mainstream economics as a result of the work of Mancur Olson's classic 1965 book The Logic of Collective Action. However, the terminology of "free rider" is only found once in that book, referring to the labor market context. But there is an intriguing use of the "free rider" terminology in a speech given by James Buchanan, "What Should Economists Do?,” originally given as the Presidential Address to the Southern Economic Association in November 1963, and published in the January 1964 issue of the Southern Economic Journal (30:3, 213-222). Buchanan said:

Suppose that the local swamp requires draining to eliminate or reduce mosquito breeding. Let us postulate that no single citizen in the community has sufficient incentive to finance the costs of this essentially indivisible operation. Defined in the narrow, orthodox way, the "market" fails: bilateral behavior of buyers and sellers does not remove the nuisance. ... This is, however, surely an overly restricted concept of market behavior. If the market institutions, defined so narrowly, will not work, they will not meet individual objectives. Individual citizens will be led, because of the same propensity, to search voluntarily for more inclusive trading or exchange arrangements. A more complex institution may emerge to drain the swamp. The task of an economist includes the study of all such cooperative trading arrangements which become merely extensions of markets as more restrictively defined. 
I have not got out of all the difficulties yet, however. You may ask: "Will it really be to the interest of any single citizen to contribute to the voluntary program of mosquito control? How is the "free rider" problem to be handled? This spectre of the "free rider," found in many shapes and forms in the literature of modern public finance theory, must be carefully examined. ... There may be cases where the expected benefits of the draining are not sufficiently high to warrant the emergence of some voluntary cooperative arrangement. And, in addition, the known or predicted presence of free riders may inhibit the cooperation of individuals who would otherwise contribute. ... Hence, the "market," even in its most extended sense, may be said to "fail." What recourse is left for the individual in this case? It is surely that of transferring, again voluntarily, at least at some ultimate constitutional level, activities of the swamp-clearing sort to the community as a collective unit, with decisions delegated to specifically designated rules for making choices, and these decisions coercively enforced once they are made. Therefore, in the most general sense (perhaps too general for most of you to accept), the approach to economics that I am advancing extends to cover the emergence of a political constitution. 
As Fontaine notes, "Buchanan maintained that the “‘free rider’ problem” could be “found in many shapes and forms in the literature of modern public finance theory. That was true, indeed, but the phrase free rider problem was no part of public finance language. No mention was made of the free-rider problem or free riding in [Buchanan's book] The Calculus of Consent of 1962." However, Buchanan had read pre-publication drafts of Olson's Logic of Collective Action, which explores the dynamics of what came to be called free riders in detail, and Buchanan apparently brought the term over from its earlier applications to labor unions and securities regulation.

As in Buchanan's explanation, it is straightforward to use the idea of a "free rider" as a justification for why people form governments and give them legal power to collect taxes. But the notion of the free rider developed a little further in the 1960s, in a way with less clear justifications for government. Olson explained near the start of the Logic for Collective Action, "[A]ny group or organization, large or small, works for some collective benefit that by its very nature will benefit all of the members of the group in question. Though all of the members of the group therefore have a common interest in obtaining this collective benefit, they have no common interest in paying the cost of providing that collective good. Each would prefer that the others pay the entire cost, and ordinarily would get any benefit provided whether he had borne part of the cost or not."

But Olson, Buchanan, and others argues that the free rider dynamic was quite different in large and small organizations. Fontaine explains the dynamic in this way:
[T]he free-rider problem was above all a theoretical construct, the logical basis of which rested on group size. The main difference between small- and large-number settings was that, in the former, individuals might see their action as exerting some influence on others and their lack of contribution as making a difference, which might cause them to contribute. In the large-number settings, by contrast, the individual believed that others would compensate for his or her lack of contribution—hence, free riding. In other words, the problems posed by free riding had little to do with the weakening of moral norms and they could not, therefore, be solved by simply urging people to improve; rather, they betrayed the increasing permeation of society by self-interest—taken as a rule for behavior—as a result of social change and, in particular, the increase in group size. If free riding was a rational response to certain circumstances, then it was for policy makers to help change the environment in such as way as to make it less conducive to such behavior and for social scientists to convince them that they knew what ought to be done.

Thus, free riding offers a broad explanation for why government needs power of compulsory taxation and regulation. But when smaller political groups that we call "special interests" organize themselves, free riding also explains why those groups would like to receive benefits of collective action, through the actions of government compulsion without paying appropriate costs. Conversely, when a group becomes large--like the size of a country or government--there will be irreconcilable divisions of opinion within the large group: for example, producers of goods and services like high prices and predictability, while and consumers of goods and services like low prices and ever-changing variety. In contemplating the problems of collective action and free-riding, Olson later wrote: "[T]here is no fully satisfactory intellectual framework or theory for the analysis of society-wide social problems.”

Monday, September 15, 2014

European Union: Functionalism and the Ratchet Effect

The euro and the European unification project have reached a difficult point. As Luigi Guiso,
Paola Sapienza, and Luigi Zingales write: "Europe seems trapped in catch-22: there is no
desire to go backward, no interest in going forward, but it is economically unsustainable to stay
still." They discuss these issues in "Monnet’s Error?" presented as part of the Fall 2014 conference of the Brookings Papers on Economic Activity.

For non-EU readers, Monnet is Jean Monnet, a French diplomat who was one of the leaders of the movement toward European Union. Monnet died in 1979, but back in the early 1950s, he was President of the European Coal and Steel Community, the first forerunners of what eventually grew into the modern European Union.

Monnet was "functionalist," who saw each step toward cross-European communication--whether the step was actually a success or not!--as a step toward something eventually resembling a United States of Europe. Here's how Guiso, Sapienza, and Zingales describe the political dynamic:
The functionalist view, advanced by Jean Monnet, assumes that moving some policy functions to the supranational level will create pressure for more integration through both positive feedback loops (as voters realize the benefits of integrating some functions and will want to integrate more) and negative ones (as partial integration leads to inconsistencies that force further integration). In the functionalists’ view integration is the result of a democratic process, but the product of an enlightened elite’s effort. In its desire to push forward the European agenda, this √©lite accept to make unsustainable integration steps, in the hope that future crises will force further integration. In the words of Padoa-Schioppa (2004, p. 14), a passionate Europe-supporter who espoused this theory, “[T]he road toward the single currency looks like a chain reaction in which each step resolved a preexisting contradiction and generated a new one that in turn required a further step forward. ... In the words of Romano Prodi, one of these founding fathers, "I am sure the euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible to propose that now. But some day there will be a crisis and new instruments will be created."
As Guiso, Sapienza, and Zingales note, the "functionalist approach implicitly assumes that there is no risk of a backlash." The past history of the EU project, along with the present experience of the euro, raise questions about whether Monnet's functionalist ratchet may be hitting its limits.

The authors point out that a number of the later entrants to the European Union joined even though only a minority supported the step in  public opinion polls: for example, "United Kingdom (36%) and Denmark (46%) joined with only a minority supporting the EU. So did Greece (42%), Sweden (40%), and Austria (42%)." In addition, each significant move to greater European unification has made the European project less popular over time: "While EU membership has strong support in most of the EU-15, this support dropped every time the European project made a step forward and never recovered. Rightly or wrongly, the Eurozone crisis has contributed to further erode this support, albeit the drop appears more related to the terrible economic conditions and, thus,
potentially more reversible. Today a majority of Europeans think that the EU is going in the wrong direction. They do not want it to go further, but overall they do not want it to go backward either,
with all the countries (except Italy) having a pro Euro majority."

On one side, Monnet's functionalist ratchet effect has clearly worked. On the other side, it may be hitting some political and economic limits:
On the one hand, Monnet’s chain reaction theory seems to have worked. In spite of limited support in some countries, European integration has moved forward and has become almost irreversible. On the other hand, the strategy has worked so far at the cost of jeopardizing the future sustainability. The key word is “almost.” Europe and the euro are not irreversible, they are simply very costly to revert. As long as the political dissension is not large enough, Monnet’s chain reaction theory delivered the desired outcome, albeit in a very non-democratic way. The risk of a dramatic reversal, however, is real. The European project could probably survive a United Kingdom’s exit, but it would not survive the exit of a country from the euro, especially if that exit is not so costly as everybody anticipates. The risk is that a collapse of the euro might bring also the collapse of many European institutions, like the free movement of capital, people and goods. In other words, as all chain reactions, also Monnet’s one has an hidden cost: the risk of a meltdown.
For some earlier posts on the economics of the euro-zone, see "A Euro Narrative" (August 15, 2013) and "Will We Look Back on the Euro as a Mistake?" (February 28, 2014).

Coda: From a U.S. policy perspective, the most recent application of the functionalist view is probably the Patient Protection and Affordable Care Act that President Obama signed into law in 2010. Even those who supported the law four years ago are quick to acknowledge that it has all sorts of flaws and shortcomings, which of course is why the Obama administration has delayed or redefined so many substantial provisions over time. But to many supporters, the details of the law seem less relevant than the belief that a functionalist political ratchet is now in effect: that is, any successes of the law will be a reason to continue the law, and any shortcomings of the law will be an additional reason for federal intervention in the health care industry to address those shortcomings. For example, President Obama has spoken supportively of a single-payer health care system over time, but has also discussed the transitional difficulties that could arise from moving in that direction too rapidly.  Many opponents of course dislike the substance of the law, but my guess is that many opponents would not be so concerned over, say, state-level health insurance exchanges aimed at providing insurance to the uninsured, if they didn't fear that it was part of a ratchet effect for future federal control over the health care industry.  Similarly, my sense is that many of the arguments over the appropriate military stance for the United States in the Middle East are less about what immediate steps should be taken, but instead about either the hope by some, or the fear by others, that those immediate steps will lead to a ratchet effect of additional military steps in the future.

Friday, September 12, 2014

Numbers, Fertility, and Life Expectancy for the Human Race

Each year the Department of Economic and Social Affairs at the United Nations publishes a "Concise Report on the World Population Situation."  The 2014 report is a chance for a quick check on the numbers, fertility, of the human race. As a starting point, here are global population projections through 2050. The high-fertility estimate is when women have on average a half-child more, and the low-fertility estimate is when women have on average a half-child less.

As your eye shows, the rate of increase in population is slowing a bit over time. Here's a figure breaking down the average population growth rates for the world and by by region. For the world, population growth rates are projected to fall from 2% in 1970 to 0.5% by 2050. For Europe, population growth rates are at zero percent now, and slated to fall lower. A number of other regions are headed that way as well, with population growth in Africa the clear outlier. The report notes: "[T]the annual increase in that populationhas been declining since the late 1960s. By 2050, it is expected that the world’s population will be growing by 49 million people per year, more than half of whom will live in the least developed countries. Currently, of the 82 million people added to the world’s population every year, 54 per cent are in Asia and 33 per cent in Africa. By 2050, however, more than 80 per cent of the global increase will take place in Africa, with only 12 per cent in Asia." 

These lower rates of population growth are reflected in lower fertility rates. Back in 1970, only Europe and Northern America had fewer than three births per woman. Now the world average is less than  three births per woman, although Africa's rate remains higher. Still, Africa's birthrate per woman roughly matches where Latin America and Asia were in the late 1970s, and fertility rates can in some cases shift quite rapidly.

People are living longer. For the world as a whole, life expectancies are up from less than 60 years in 1970 to about 70 years now. The disparity in life expectancies is much smaller than the disparity in incomes. A person in a high-income country may have 10 or 20 times as much income as someone in a low-income country, but they don't live 10 or 20 times longer.

Indeed, much of the remaining disparity in life expectancy happens not in old age, but among children. For the world as a while, about one child in every five died before reaching the age of 5 back in the 1950s. Now, only about one child in 20 dies before reaching the age of five. Even in Africa, the under-5 infant mortality rate has dropped to what the world average was as recently as the early 1980s.

 These figures are all telling us something about how the typical or common life experience of a member of the human race is changing over time. In many countries of the world, population may move to different locations, but population is growing by little or nothing. Nuclear families are smaller. Women are spending less time pregnant, but when children are born, the parents are far less likely to face the tragedy of an early death (which of course could make such tragedies feel even more painful when they do occur). With longer life expectancies and smaller families, a giant family reunion in modern times is less likely to have a few older people and a swarm of children than the equivalent event a few decades ago. Instead, the attendees at that giant family reunion may be distributed fairly evenly across four generations. In these and other ways, our fundamental feelings about what seems usual and common in our families and communities is fundamentally different from previous generations of the human race.