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It\’s easy to sketch a diagram showing a tradeoff between environmental protection and economic growth. But what\’s the actual empirical evidence on how much environmental protection reduces economic growth? This question turns out to be harder to answer than you might think.

As a starting point, measuring the costs of environmental protection isn\’t easy, because the ways in which firms and consumers adapt and react to environmental laws isn\’t easy to measure.  The costs and indeed the relevance of environmental protection is also relatively small for many firms, compared to many other costs and issues they face: wages and a workforce with the needed skills; the costs and reliability of suppliers; the reliability of transportation, communication, and energy infrastructure; the abilities of competitors and challenges of international markets; along with taxes, workforce and land-use regulations. When asking how even fairly substantial changes in environmental rules affect productivity, it might be hard to sort out environmental rules from the rest of these factors.

In addition, high-income countries tend to have both higher environmental standards and higher productivity levels than low-income countries, and so a simple correlation will tend to show that but enviromental standards are associated with economic productivity. But this is another case where correlation is unlikely to be causal. Instead, it\’s more likely that high-income countries find it easier to put a priority on environmental protection and to spend the necessary resources than low-income countries. In addition, stronger environmental standards for high-income countries might lead pollution-emitting production activities to be located more in low-income countries; in this case, looking at pollution just in the high-income country after an environmental rule is passed would give a misleading impression of how much it affected pollution.

Finally, there is a theory called the \”Porter hypothesis,\” named after Michael Porter at Harvard University, which cites evidence that when environmental goals are set in a strict way, but firms  are allowed flexibility in how to achieve those goals in the context of a competitive market enviroment, firms often become quite innovative–and in some cases, the innovations induced by the new environmental rules save enough money that the rules end up imposing no economic costs at all. For an early statement of the Porter hypothesis and a counterpoint, the interested reader might look up the 1995 exchange on the subject in the Fall 1995 Journal of Economic Perspectives. Michael E. Porter and Claas van der Linde make their case in \”Toward a New Conception of the Environment-Competitiveness Relationship,\” (9:4, 97-118), and Karen Palmer, Wallace E. Oates, and Paul R. Portney respond in \”Tightening Environmental Standards: The Benefit-Cost or the No-Cost Paradigm?\” (9:4, 119-132).

For a flavor of the argument, Porter and van der Linde argue that firms are often not especially knowledgeable about their internal environmental costs and benefits, and when regulation refocuses their attention, substantial gains are possible. They write (citations omitted):

In 1990, for instance, Raytheon found itself required (by the Montreal Protocol and the U.S. Clean Air Act) to eliminate ozone-depleting chlorofluorocarbons (CFCs) used for cleaning printed electronic circuit boards after the soldering process. Scientists at Raytheon initially thought that complete elimination of CFCs would be impossible. However, they eventually adopted a new semiaqueous, terpene-based cleaning agent that could be reused. The new method proved to result in an increase in average product quality, which had occasionally been compromised by the old CFC-based cleaning agent, as well as lower operating costs. It would not have been adopted in the absence of environmental regulation mandating the phase-out of CFCs. Another example is the move by the Robbins Company (a jewelry company based in Attleboro, Massachusetts) to a closed-loop, zero-discharge system for handling the water used in plating. Robbins was facing closure due to violation of its existing discharge permits. The water produced by purification through filtering and ion exchange in the new closed-loop system was 40 times cleaner than city water and led to higher-quality plating and fewer rejects. The result was enhanced competitiveness.

In contrast, Palmer, Oates, and Portney acknowledge that such cases are possible, but suggest that they are rare exceptions. They cite evidence from firm surveys done by the Bureau of Economic Analysis that suggest that offsetting gains from environment regulations are only about 2% of the costs. They write:

The major empirical evidence that they advance in support of their position is a series of case studies. With literally hundreds of thousands of firms subject to environmental regulation in the United States alone, it would be hard not to find instances where regulation has seemingly worked to a polluting firm\’s advantage. But collecting cases where this has happened in no way establishes a general presumption in favor of this outcome. It would be an easy matter for us to assemble a matching list where firms have found their costs increased and profits reduced as a result of (even enlightened) environmental regulations, not to mention cases where regulation has pushed firms over
the brink into bankruptcy. … [W]e spoke with the vice presidents or corporate directors for environmental protection at Dow, 3M, Ciba-Geigy and Monsanto—all firms mentioned by Porter and van der Linde in their discussion of innovation or process offsets. While each manager acknowledged that in certain instances a particular regulatory requirement may have cost less than had been expected, or perhaps even paid for itself, each also said quite emphatically that, on the whole, environmental regulation amounted to a significant net cost to his company. We have little doubt about the general applicability of this conclusion.

More recently, Stefan Ambec, Mark A. Cohen, Stewart Elgie, and Paul Lanoie looked at the evidence on \”The Porter Hypothesis at 20 Can Environmental Regulation Enhance Innovation and Competitiveness?\” in a 2011 working paper for Resources for the Future. Tomasz Koźluk and Vera Zipperer have now published \”Environmental policies and productivity growth: a critical review of empirical findings,\” in the OECD Journal: Economic Studies (vol. 2014: 1, pp. 1-32).

These papers reiterate the more-or-less standard conclusion that it\’s hard to disentangle costs of environmental protection and overall economic growth, for all the reasons given above.  They emphasize that the Porter hypothesis only holds for well-designed environmental policies: for example, policies that require firms to take specific anti-pollution actions do not offer flexibility to meet clear goals. Koźluk and Zipperer also offer some useful discussion of potential channels in which environmental protection might improve overall economic productivity. For example, when some industries have costs of cleaning up water, it may reduce costs for other industries that make use of clean water. If the revenues from a carbon tax or other pollution tax are used to reduce the marginal rates of other taxes, the economy could benefit. If environmental regulations are more likely to drive inefficient companies out of business, then more-efficient companies could benefit–leading to an overall gain in efficiency for the economy. Stricter environmental rules could encourage companies to produce better equipment for monitoring and addressing pollution, which could then give those companies an advantage in the global economy for selling such equipment.

But this is still a lot of \”ifs.\” In a December 2014 OECD working paper, Koźluk and Zipperer, together with Silvia Albrizio and Enrico Botta, offer then own attempt at addressing these questions in \”Do Environmental Policies Matter for Productivity Growth? Insights from New Cross-Country Measures of Environmental Policies\” (Economic Department Working Papers No. 1176).

They create a measure of \”environmental policy stringency\” that is based on policy measures affecting air pollution and climate issues. Their measure combines market-based and non-market-based policies. Market-based policies include taxes on carbon dioxide, nitrogen oxides, sulfur oxides, and diesel fuel, as well as trading schemes that involve incentives to use renewable energy or to save energy. Non-market policies include setting emissions standards for these emissions, along with particulate emissions, as well as government research and development spending on less-polluting energy. They have data back to the 1990s for a range of high-income countries. Here\’s one way of looking at their current results. The horizontal axis shows the stringency of their environmental policy measure for non-market instruments, while the vertical axis shows the stringency for market-based instruments (both measured on a scale from 0-6). Poland, for example, stands out as country with above-median market based standards, but below-median nonmarket standards.

The authors then compare this data on environmental rules to productivity data at the national, industry, and firm level. They summarize the results this way:

There is no empirical evidence of permanent effects of environmental policy tightening on multifactor productivity growth (MFP), positive or negative. Analysis based on a new cross-country dataset with unprecedented time-series coverage finds that all effects tend to fade away within less than five years. No lasting harm to productivity levels is found at the macroeconomic, industry or firm levels. … Most advanced industries and firms see the largest gains in productivity levels, while less productive firms are likely to see negative effects. Highly productive firms, often the largest firms in the industry, may be best suited to profit rapidly from changing conditions – seizing new market opportunities, rapidly deploying new technologies or reaping previously overseen efficiency gains. They may also find it easier to outsource or relocate production abroad. Less advanced firms may need higher investments to comply with the new regulation, exhibiting a significant temporary fall in productivity growth. Assuring a swift reallocation of capital and minimising barriers to entry are necessary conditions for the efficiency gains from environmental policy tightening to be translated into economic growth. A non-negligible part of the productivity gains is likely to come from the exit of the least-productive firms.

Of course, this study isn\’t the final word. It is focused on high-income countries, which start off with (roughly) similar kinds of environmental protection compared with many other countries in the world, and also start off with (roughly, over several decades) levels of productivity growth. But that said, the study suggests that an important reason why stricter environmental policy doesn\’t impose lasting costs on productivity is because it helps drive less efficient firms out of business and thus allows more efficient firms to expand.

A couple of months after a US national election is finished, and the Federal Elections Commission has updated its statistics on campaign contributions and the heat and energy has died down a bit, I like to check the invaluable Open Secrets website run by the Center for Responsive Politics for what actually happened with campaign spending. Here are a few things that caught my eye.

Total spending for the 2014 Congressional races looks like it will come in at about $4 billion, quite similar to the amount spent in 2012 and 2010. In the context of a high-income country with a population of nearly 320 million, this is not a large amount. As I point out in my Principles of Economics textbook (which I naturally recommend for its combination of high quality and moderate price), \”For example, consumers in the U.S. economy spend about $2 billion per year on toothpaste. In 2012, Procter and Gamble spent $4.8 billion on advertising, and General Motors spent $3.1 billion. Americans spend about $22 billion per year on pet food—three times as much as was spent on the 2012 election.\” As another comparison, Americans spend about $8 billion each year celebrating Halloween.  With the US government making decisions that involve $3.5-$4 trillion in spending and taxes, not to mention the nonmonetary effects of other laws regulatory rulings, people are going to allocate resources to try to affect those outcomes.

House

Financial activity for all House candidates, 2013-2014

Senate

Financial activity for all Senate candidates, 2013-2014

An alternative measure from Open Secrets looks at the average spending per candidate, not overall. By this measure, spending by House candidated was largely equal between Democrats and Republicans, but Democratic candidates for the Senate spent more than twice as much as Republican candidates.

Before the Great Recession, the primary tool for the Federal Reserve to conduct monetary policy was by altering the federal funds interest rate. As the recession got underway, the Fed started cutting this interest rate in August 2007 and by December 2008, it was down to almost zero percent, where it has remained. As the figure shows, the Fed consistently reduced interest rates during periods of recession (the shaded areas), but the Great Recession was the only episode during this time period where the economic contraction was so severe that the rate was taken all the way to zero.

But the Great Recession ended in June 2009. The recovery, unpleasantly sluggish though it has been, has now been underway for more than five years. As we start 2015, an obvious question is when the Fed will raise interest rates. Eric Rosengren of the Federal Reserve Bank of Boston offers some insight about how the Fed is viewing this question based on comparing current economic conditions with the two previous times that the Fed acted to raise the federal funds interest rate in a substantial way: that is, the rises in February 1994 and in June 2004.

First, the November 2014 unemployment rate was 5.8%.  In June 2004, the Fed tightened when the unemployment rate was 5.6%. In February 1994, the Fed tightened with the unemployment rate was 6.6%. Notice that in both cases, the Fed acted to raise interest rates at a time when the unemployment rate was still falling–not waiting until the unemployment rate had bottomed out. The underlying argument here is that it makes sense to raise interest rates when the economy has a reasonable degree of forward momentum.

What about inflation? The measure of inflation used here is based on the personal consumption expenditure index, which the Fed uses instead of the better-known Consumer Price Indes. The previous two tightenings happened when the inflation rate was about 2%, maybe just a bit  higher. The current inflation rate is closer to 1.5%. The lack of inflationary pressure means that the Fed can feel itself under less pressure to raise interest rates.

What about economic growth? The 1990-91 recession ended in March 1991, so the tightening was a bit less than three years later, when growth had rebounded for a quarter to a 4% rate, and been re-established at rates above 2% per year. The 2000-2001 recession ended in November 2001, and the tightening came less than three years later, again after growth had rebounded to hit 4% for at least a quarter or two. In the aftermath of the Great Recession, growth has not rebounded as quickly. However, the most recent GDP data suggest that the economy was growing at 4% or faster in the second and third quarter of 2014.

Rosengren presented these slides at the meetings of the Allied Social Sciences in Boston on January 3. The panelists in the meeting didn\’t try to reach any specific consensus on the subject, but it\’s fair to say that several of them expect the Fed to raise interst rates later in 2015, but perhaps later in the year rather than earlier.

Why wait? Part of the reason is to make sure that the preliminary figures showing more rapid GDP growth in the second and third quarter of 2014 hold up as they are revised. More broadly, given the sluggish pace of the recovery so far, and the continued low rates of inflation, there seems to be more reason to worry about raising rates too soon than there is about waiting a few more months.

However, one sometimes hears a worry that the Fed should beware of raising interest rates because it might hurt the stock market. This didn\’t happen the last two times the Fed raised interest rates. Remember that the Fed seeks to raise rates at a time when the economy has solid forward momentum. Remember also that people investing in stocks are looking ahead at what is likely to happen, and investors have been well aware for some time that the Fed was likely to raise rates in 2015. The February 1994 and June 2004 rises in the federal funds rate left the stock market with more room to rise, and the same could well hold true this time.

There has also been concern that policies of ultra-low interest rates run a risk of creating other distortions in financial markets, as investors search for more lucrative returns. As one example, I wrote about potential issues in the leveraged loans sector a few months ago. Other concerns are discussed here, here, and here. Lower interest rates also create winners and losers: they obviously help borrowers, like the federal government, corporations that borrrow, and housing market, but they hurt those who planned on receiving higher interest payments, including pension funds, insurance companies, and older Americans.

In the depths and turmoil of the Great Recession, the Fed was correct to pull out all the stops, cut the federal funds interest rate to near-zero, assure that credit was available across financial markets, and use quantitative easing. The Fed closed down its organizations for emergency lending by 2011. It has started a slow process of reversing quantitative easing in October 2014. Steps toward raising the federal funds interest rate above zero seem likely to follow later in 2015.

Most Americans see themselves as \”middle class.\” But in most low-income countries, \”middle class\” is more likely to describe an aspiration than a sense of belonging. As a result, the economic, sociological, and political role of the \”middle class\” can be quite different across high-income and low-income countries.

At least, this is the case made by Alexandre Dormeier Freire in a boxed commentary appearing in the Global Wage Report 2014-2015, from the International Labour Organization. Friere writes (citations omitted):

In developed economies, many people define themselves as middle class, and so the idea represents a shared sense of how most people in a society live. In emerging and developing economies, being middle class is typically more of an aspiration, representing how most people would like to live.

Economists sometimes represent the middle class as an average class located in an interval of 75 per cent to 125 per cent of the median income. But most authors agree that great heterogeneity characterizes the middle class. Consequently, notions such as lower middle class, upper middle class and even old vs new middle class have appeared, conveying a certain difficulty in providing an accurate and precise definition. When it comes to emerging and developing economies, authors are confronted with the difficulty of applying a notion that is linked to the Western context. Ravallion simply considers that “someone is middle class if that person would not be considered poor in any developing country, implying a lower bound of $9 a day.”

From an economic point of view, the middle class is considered the driver of modern consumption societies. From a sociological perspective, the formation of a social class includes other factors: a specific economic position (possibly creating conflicts of interest with other social classes) and a consciousness of having similar conditions. Today in Western societies, relatively high levels of consumption of goods and services define, or are a major attribute of, the middle class. Some identify this increasing consumption as consumerism and argue that this profoundly changes traditional social relations within the middle class because people tend to be more individualistic than class-oriented, and social relations are driven by more hedonistic and individualistic patterns. In this view, both factors contribute to the erosion of the class identity in all societies. In emerging and developing economies, such consumption is still perceived more as a privilege of the upper middle class than as a unifying social force, as in Western-based societies.

To flesh this out a bit, results from a Pew Foundation survey back in 2012 showed how Americans categorized themselves. Notice that only 7% of Americans identify themselves as \”lower class\” and only 2% as \”upper class.\” Apparently, the \”middle class\” includes 91% of the U.S. population.

How does this differ for lower-income countries? In its Global Employment Report 2013, the ILO categorizes the population of low-income countries by the fairly standard measures of \”extremely poor,\” which consumption of less than $1.25 per person per day; \”moderately poor,\” from $1.25 to $2 per day; near-poor, from $2 to $4 per day; \”middle class,\” between $4 and $13 per day; and \”above middle class,\” which is above $13 per day in consumption. By this standard, the \”middle class\” in the developing world is on the rise, but is not yet more than half the population.

The ILO report sums up the patterns this way:

As the total share of poor and near poor workers gradually fell, an estimated 41.6 per cent of the developing world’s workers were attaining the middle and upper-middle-classes in 2011. This is a remarkable development given that in 2001, less than 23 per cent of the developing world’s workforce was middle-class versus 53.7 per cent living in poverty. The decade from 2001 to 2011 saw rapid growth in middle-class employment, with an increase of nearly 401 million middle-class workers (above US$4 and below US$13) and an additional increase of 186 million workers above the US$13 a day line. Current ILO projections indicate that the number of workers in the middle-class and above in the developing world could grow by an additional 390 million by 2017, with the share of middle-class workers rising to 51.9 per cent.

It may be a fool\’s mission to try to generate a shared idea of \”middle class\” that reaches across the experience of the U.S., other high-income countries, and also low-income countries around the world. The growth of income inequality in the U.S. and other high-income countries may be eroding the shared sense of \”we\’re almost all middle class,\” at the the same time that growth in emerging economies is moving toward a situation where a majority fall within at least some definition of teh middle class.

But in a rough-and-ready way, I think the key factor in defining the middle class may be a sense of whether your life typically involves living from week-to-week or month-to-month relying on a regular paycheck. For example, I think that the reason many objectively low-income people in the U.S. view themselves as \”middle class\” is that they are working for livilng. Similarly, high-income people in the U.S. view themselves as \”middle class\” because they have bought into a world of high expenses, and thus they also feel an ongoing pressure that they are working to pay their regular expenses.  In low-income countries, the key step that often moves people up to the \”middle class\” is a regular job with a paycheck, as opposed to holding a series of ad hoc, temporary, and subsistence jobs.

Freire makes the interesting suggestion that the \”middle class\” shares a consumerist mindset, which offers both a kind of shared social identity, support for a set of political institutions, and a functional basis for ongoing economic growth. In low-income economies, building support for institutions, laws, and infrastructure that allow the middle class to grow and flourish may be a delicate political business when the middle class is a minority. But as the middle class moves toward becoming a majority, I wonder if building building support for these institutions, laws, and infrastructure may become easier.

Obviously, the middle class in lower-income developing countries will not equal the buying power of the middle class in high-income countries any time soon. But that said, the new middle class in low-income countries will in many ways have much more in common with the middle class around the world than did the \”absolutely poor\” living on less than $1.25 per day.  A certain kind of shared globa consumerism–bolstered by cheap computing power, cellphones, brand names, news, movies music, and the Internet–may be on its way.

Full disclosure: I was an outside reader of the ILO Global Wage Report 2014-15 last summer, and received a modest honorarium for commenting on a draft of the report.

In the quiet shadow of New Year\’s Day, it seems useful to offer some thematic reflections on what I\’m seeking to accomplish with this blog. For example, at the end of my first year in blogging in 2011, I tried to describe my overall approach:

[M]y goal is not to rehash the topic-du-jour of the blogosphere one more time, with my own dose of snarky. Instead, I\’m aware that sitting at my desk as managing editor of the Journal of Economic Perspectives gives me an eclectic reading list, and I\’m trying to pass along some thoughts and insights that readers who don\’t have such peculiar jobs might not otherwise see. 

\’Tis the season of re-gifting, and so I make bold to pass along this list of 16 of the most popular posts of 2014 at this website, at least one from each month, in reverse chronological order. Of course, I encourage you to spend your holidays surfing the Conversable Economist archives; after all, unless your personal interests are perfectly aligned with pageview popularity (and isn\’t that a frightening thought?), you are likely to find other posts of interest, too.

Focusing Behavioral Economics on Development Professionals (December 10, 2014)

Automation and Job Loss: The Fears of 1964 (December 1, 2014)

Why Experts Buy Generic (November 12, 2014)

The economy of a country and its potentinal for future growth is based on  the skill levels of all workers, not just on those who attend the best colleges and universities. The U.S. has been underperforming in education for decades, and the international statistics show it. Here are a few of the many figures that caught my eye from Education at a Glance 2014: OECD Indicators.

This figures compares the percentage of those with a tertiary education comparing 25-34 year-olds to the education level of 55-64 year-olds. The black squares show the older group; the blue triangles show the younger group; and the light blue bars show which countries have been expanding education in a way that the younger generation is well ahead of its elders. One wouldn\’t expect the U.S. to have the highest level of gains, given that other countries had much lower levels of those with a higher education several decades ago–and thus greater potential for gains. Still, it\’s a little shocking to see that the U.S. shows almost no intergenerational gain in education levels, and is second from the bottom in such gains. Tou can also see by the position of the blue triangles that the U.S. is just barely above the OECD average for tertiary education in its 25-34 age group.

A quick retort to these kinds of figures is to point out that perhaps higher education in some other countries is of lower quality, and so it doesn\’t mean as much to have a tertiary degree. Well, maybe that\’s part of the dynamic here. But those who are starting to lag behind always complain about the unfairness of what is being measured, don\’t they?

How about at the high school level? Here are upper secondary graduation rates across countries. The U.S. ranks below the OECD average.

The sunk cost fallacy appears in every introductory economics course. Rational behavior suggests that people should realize that they can\’t change the past. The amount of money or time or energy that has already been spent on some project is a \”sunk costs,\” and it should be irrelevant to whether you keep going with the project. When making a choice, you should look only to the future costs and benefits of your actions.

Many people find it hard to disregard sunk costs. There are the romantic relationships that have been lukewarm or worse for a long time, with no likely prospect of change, but where one or both people can\’t break up because they\’ve been together for so long. There are the investors whose stock portfolio or house has lost value, but who doesn\’t sell because if they just keep holding on, they can pretend that those losses haven\’t yet happened. There are large projects in business and government where a lot has been spent in the past, and so the project must be continued into the future–even though its prospects appear grim. Indeed, the sunk cost fallacy is sometimes called the \”Concorde effect,\” after the supersonic jet where development and construction went on long after it was clear that the project was not economically viable.

Some evidence suggests that children and animals may be better at avoiding the sunk cost fallacy than adults. At some level, this makes sense. After all, children and animals may be less likely than adult humans to become ego-involved and locked down into what happened in the past, and thus more likely only to look forward. But I\’ll also admit that, at some level, this theory also sounds a bit ridiculous to me. How does one test whether children and in particular animals take sunk costs into account?  The classic discussion of the evidence here here seems to be a 1999 paper by Hal R. Arkes and Peter Ayton called \”The Sunk Cost and Concorde Effects: Are Humans Less Rational Than Lower Animals?\” It appeared in a 1999 issue of Psychological Bulletin, published by the American Psychological Association (125:5, pp. 591-600). The journal isn\’t freely available on-line, but many readers will have access through a library.

As one example, here\’s a discussion from Arkes and Ayton of a study looking at whether female albino mice take sunk costs into account, or focus only on the future.

A prototypical study … tested the litter defense behavior of female albino mice. On the 8th day of a mother\’s lactation period, a male intruder was introduced to four different groups of mother mice and their litters. Each litter of the first group had been culled at birth to four pups. Each litter of the second group had been culled at birth to eight pups. In the third group, the litters had been culled at birth to eight pups, but four additional pups had been removed 3 to 4 hr before the intruder was introduced. The fourth group was identical to the third except that the removed pups had been returned to the litter after only a 10-min absence.

The logic of the Maestripieri and Alleva (1991) study is straightforward. If each mother attended to past investment, then those litters that had eight pups during the prior 8 days should be defended most vigorously, as opposed to those litters that had only four pups. After all, having cared for eight pups represents a larger past investment than having cared for only four. On the other hand, if each mother attended to future costs and benefits, then those litters that had eight pups at the time of testing should be defended most vigorously, as opposed to those litters that had only four pups. The results were that the mothers with eight pups at the time of testing defended their litters more vigorously than did the mothers with four pups at the time of testing. The two groups of mothers with four pups did not differ in their level of aggression toward the intruder, even though one group of mothers had invested twice the energy in raising the young because they initially had to care for litters of eight pups. Thus, the magnitude of expected benefits, not the amount of prior maternal investment, determined the mothers\’ defensive behavior.

Arkes and Ayton also discuss a number of other animal studies: the behavior of a kind of fish called a convict cichlids (Cichlasoma nigrofasciatum); a study about how female digger wasps provide dead katydids for their larva to consume; the nest defense behavior of savannah sparrow; and others. They discuss alternative interpretations of these studies, but argue that the results generally support the claim that animals don\’t take sunk costs into account.

What about studies of children?  They discuss a 1997 study that tested children in the age groups 5-6, 809 and 11-12 with this question:

Imagine you are at a fairground with your parents. Your mother gives you a 50 pence coin, and your father gives you a one pound coin.After walking around for a while you decide to use the 50 pence cointo buy a ticket for the merry-go-round. [But then you discover that you have lost your ticket./But then you discover that you\’ve lost the 50 pence coin so you can\’t use it to buy a ticket for the merry-go-round.] Would you use the one pound coin to buy a new ticket? Half the children in each of the three age groups received one of the two sentences inside the brackets.  … [For the older children, when] the money was lost, the majority of the respondents decided to buy a ticket. On the other hand, when the ticket was lost, the majority decided not to buy another ticket. This difference was absent in the youngest children. Note that it is not the case that the youngest children were responding randomly. They showed a definite preference for purchasing a new ticket whether the money or the ticket had been lost. Like the animals that appear to be immune to the Concorde fallacy, young children seemed to be less susceptible than older children to this variant of the sunk cost effect.

Arkes and Ayrton cite some other evidence, not directly related to the sunk cost fallacy, that in some cases young children may act more in accordance with strict rationality than older children or adults, because adults are prone to more complicated strategies, while children don\’t overthink the situation. Here\’s a discussion of another study with younger and older children:

The participants ranged in age from 3.6 years to 18 years. Each of them faced a panel containing a horizontal row of three knobs, above which was a signal light and below which was a delivery mechanism for marbles. On each of 80 trials, participants were told to press one of the three knobs. Correct presses would be followed by the delivery of a marble. For all participants, pulling one particular knob was followed by reinforcement, but at a 33% rate for some persons and at a 66% rate for others. … A participant was deemed to be a \”maximizer\” if the correct knob was pulled on at least 18 of the last 20 trials. … [T]he youngest children were more likely to be maximizers than were the participants of any other age. Weir (1964) attempted to explain these surprising results:
\”It is likely that the 3- and 5-year olds are drawn to the payoff button on the basis of a simple reinforcement notion only. . .. Older subjects . . . employ complex strategies. . . . It is interesting to note that . . . the belief that there is a complex solution actually results in fewer choices of the most frequently reinforced alternative …  The older participants were `too smart for their own good.\’\”

The exact reasons why people pay attention to sunk costs are not clear. One hypothesis is that people or organizations just don\’t like admitting error. Another hypothesis is that when disregarding sunk costs feels wasteful in some way, and people don\’t like to waste. Yet another hypothesis is that in many aspects of life, there is a positive correlation between past efforts and future payoffs, and so giving up on a project with large sunk costs feels like it is also giving up on future payoffs.

As noted earlier, I\’m not confident about interpreting some of the evidence about animals and young children as a strong demonstration that they do ignore sunk costs. But I\’m always looking for a lively way to explain basic economics concept to students. Explaining some of the evidence that animals and small childen may be better able to disregard sunk costs–appropriately hedged with caveats– couuld help some students remember the concept of sunk costs more clearly.

A shadow hangs over the possibilities for commercializing outer space: What are the property rights? Say that a company launched a rocket to the asteroid belt and managed to bring back tons of rare minerals to earth. Would the company \”own\” those minerals?  Every explanation of the basic principles of economics includes a riff on the importance of property rights. After all, if people can\’t hold property, then the incentives to work or save or invest are vitiated. In \”Celestial Anarchy: A Threat to Outer Space Commerce?\” Alexander W. Salter and Peter T. Leeson explore the issue of property rights in space. Here\’s how they set up the argument (citations omitted):

Economists have long highlighted the necessity of private property rights for thriving commercial activity. … Celestial anarchy thus appears to pose a serious obstacle to flourishing outer space commerce. But what if private parties sidestepped the problem posed by sovereigns’ inability to support celestial property rights by enforcing such rights privately—that is., without reliance on any government? ….[I]t is widely believed that a purely private celestial property rights regime is not possible. This article argues that conventional wisdom is wrong. Celestial anarchy is genuine, but the ostensible problem it poses for the development of outer space commerce is not. Private property rights can and do survive without the endorsement or involvement of any sovereign entity. This suggests that private parties can, if given the chance, enforce property rights in outer space. …  Economic theory demonstrates how private individuals can enforce property rights without reliance on government. And economic reality demonstrates how they in fact do so. There’s nothing special about this theory or its manifestations in practice that would limit it to terrestrial property rights.

How might a system of property rights work?  Salter and Leeson offer some examples from international trade. First, an example from history:

In the ninth and tenth centuries a professional class of merchants emerged across Europe. These merchants confronted the central obstacle of international anarchy pointed to above: the absence of a supranational sovereign that could protect international traders’ property rights, enabling the growth of international commerce. … In response to such obstacles to international commerce, medieval merchants resolved international commercial disputes privately on the basis of merchant-developed law in private, merchant-developed courts. This system of self-enforcing property rights is called the
medieval lex mercatoria (law merchant).

They argue that this system of law functioned because of the “discipline of continuous dealings,” which basically means that it\’s not worth defying the private law in any given case, because by doing so, you would lose the ability to be protected by the private law in all future cases. They write: \”Since the gain from defecting is a onetime gain but the gains lost from defecting even once are forever, if parties don’t discount the future excessively, they earn more by always cooperating than by ever defecting. Property rights are self-enforcing.\”

Trade disputes in modern times are also often handled by private arbitrators. Salter and Leeson explain (again, citations omitted):

Given the difficulties, and for many years the impossibility, of using national sovereigns to enforce international commercial disputes, contemporary international traders rely on private international arbitration associations instead. Indeed, at least 90 percent of modern international commercial contracts contain clauses stipulating the resolution of contractual disputes via private arbitration. The sums of money at stake in these private courts are enormous. For example, in 2001 roughly 1,500 parties from 115 countries used the arbitration services of the International Chamber of Commerce (ICC), the largest of such organizations, in property conflicts that ranged in value from $50 to $1 billion. Over 60 percent of these disputes were for amounts between $1 million and $1 billion. 

Over time, international treaties now mean that national governments have agreed to enforce the decisions of these private panels: \”In 1958 the first multinational treaty aimed at facilitating the enforcement of private international arbitral decisions in the national courts of sovereigns emerged: the United Nations New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. Since then, many, though not all, countries have signed the New York Convention (NYC).\”

Their bottom line is that it is not necessary to have a government that rules outer space in order to have a recognized legal system for dispute resolution in outer space. They write:

Perhaps commercial space pioneers would use already-existing arbitration associations, such as the ICC, in order to enforce celestial property rights. Or perhaps a body of private outer space law—informed at its core by familiar precedents relating to nuisance, damages, liability, and so on—might progress to the point that space-specific arbitration agencies, employing their own experts in space law, would serve as the primary dispute resolution mechanism and process by which precedent is set. Alternatively, the first space pioneers might have a voluntary convention in which their representatives form a kind of outer space “social contract,” thereby setting the rules for original appropriation of unowned resources, property rights enforcement, and the proper bounds of behavior between parties when one party’s behavior imposes uncompensated burdens on others.

The Salter and Leeson argument is usefully mind-expanding about the potential for private property rights. But as they point out at the end of the article, their argument is essentially one of economics, not of politics. I can easily imagine the kind of regime that they describe as useful for thinking about issues that arise between those who are operating in outer space, applying to the times when they are operating in outer space.

But the first time resources or other resources from outer space are brought to Earth in sufficient quantities to be worth a lot of money, or to move prices of minerals in Earth-markets, I suspect that any agreements reached by those who were travelling in outer space will come under Earthly political challenge. Denmark recently announced that it was challenging Russia and Canada for control over the territory that includes the North Pole, and the United States and Greenland also have ongoing claims in Arctic waters. I suspect that nations will try to assert jurisdiction over outer space, too.

Charles Dickens wrote what has become one of the iconic stories of Christmas day and Christmas spirit in \”A Christmas Carol.\” But of course, the experiences of Ebenezer Scrooge are a story, not a piece of reporting. Yesterday, I offered an article by Charles Dickens about his views of \”masters\” and \”hands\” during a textile strike, written for the weekly journal Household Words that Dickens edited from 1850 to 1859. Here\’s another piece from Dickens from the journal from the issue of January 26, 1856, with his first-person reporting on \”A Nightly Scene in London.\” Poverty in high-income countries is no longer as ghastly as in Victorian England, but for those who take the time to see it, it for our own time and place, surely it is ghastly enough.

Economists might also take note of Dickens\’s comment on the reactions to poverty by \”the unreasonable disciples of a reasonable school, demented disciples who push arithmetic and political economy beyond all bounds of sense.\” He writes: \”I know that the unreasonable disciples of a reasonable school, demented disciples who push arithmetic and political economy beyond all bounds of sense (not to speak of such a weakness as humanity), and hold them to be all-sufficient for every case, can easily prove that such things ought to be, and that no man has any business to mind them. Without disparaging those indispensable sciences in their sanity, I utterly renounce and abominate them in their insanity …\” Here\’s Dickens:

A NIGHTLY SCENE IN LONDON

On the fifth of last November, I, the Conductor of this journal, accompanied by a friend well-known to the public, accidentally strayed into Whitechapel. It was a miserable evening; very dark, very muddy, and raining hard.

There are many woful sights in that part of London, and it has been well-known to me in most of its aspects for many years. We  had forgotten the mud and rain in slowly walking along and looking about us, when we found ourselves, at eight o\’clock, before the Workhouse.

Crouched against the wall of the Workhouse, in the dark street, on the muddy pavement-stones, with the rain raining upon them, were five bundles of rags. They were motionless, and had no resemblance to the human form. Five great beehives, covered with rags— five dead bodies taken out of graves, tied neck and heels, and covered with rags— would have looked like those five bundles upon which the rain rained down in the public street.

\”What is this! \” said my companion. \”What is this!\”

\”Some miserable people shut out of the Casual Ward, I think,\” said I.

We had stopped before the five ragged mounds, and were quite rooted to the spot by their horrible appearance. Five awful  Sphinxes by the wayside, crying to every passer-by, \” Stop and guess! What is to be the end of a state of society that leaves us here!\”

As we stood looking at them, a decent working-man, having the appearance of a stone-mason, touched me on the shoulder.

\”This is an awful sight, sir,\” said he, \”in a Christian country!\”

\”GOD knows it is, my friend,\” said I.

\”I have often seen it much worse than this, as I have been going home from my work. I have counted fifteen, twenty, five-and-twenty, many a time. It\’s a shocking thing to see.\”

\”A shocking thing, indeed,\” said I and my companion together. The man lingered near
us a little while, wished us good-night, and went on.

We should have felt it brutal in us who had a better chance of being heard than the working-man, to leave the thing as it was, so we knocked at the Workhouse Gate. I undertook to be spokesman. The moment the  gate was opened by an old pauper, I went in, followed close by my companion. I lost no
time in passing the old porter, for I saw in his watery eye a disposition to shut us out.

\”Be so good as to give that card to the master of the Workhouse, and say I shall be glad to speak to him for a moment.\”

We were in a kind of covered gateway, and the old porter went across it with the card. Before he had got to a door on our left, a man in a cloak and hat bounced out of it very sharply, as if he were in the nightly habit of being bullied and of returning the compliment.

\”Now, gentlemen,\” said he in a loud voice, \”what do you want here?\”

\”First,\” said I, \” will you do me the favor to look at that card in your hand. Perhaps you may know my name.\”

\”Yes,\” says he, looking at it. \” I know this name.\”

\”Good. I only want to ask you a plain question in a civil manner, and there is not the least occasion for either of us to be angry. It would be very foolish in me to blame you, and I don\’t blame you. I may
find fault with the system you administer, but pray understand that I know you are here to do a duty pointed out to you, and that I have no doubt you do it. Now, I hope you won\’t object to tell me what I want to know.\”

\”No,\” said he, quite mollified, and very reasonable, \” not at all. What is it ?\”

\”Do you know that there are five wretched creatures outside?\”

\”I haven\’t seen them, but I dare say there are.\”

\”Do you doubt that there are?\”

\”No, not at all. There might be many more.\”

\’\’Are they men? Or women?\”

\”Women, I suppose. Very likely one or two of them were there last night, and the night before last.\”

\”There all night, do you mean?\”

\”Very likely.\”

My companion and I looked at one another, and the master of the Workhouse added quickly, \” Why, Lord bless my soul, what am I to do? What can I do ? The place is full. The place is always full—every night. I must give the preference to women with children, mustn\’t I? You wouldn\’t have me not do that?\”

\”Surely not,\” said I. \”It is a very humane principle, and quite right; and I am glad to hear of it. Don\’t forget that I don\’t blame you.\”

\”Well!\” said he. And subdued himself again.

\”What I want to ask you,\” I went on, \” is whether you know anything against those five miserable beings outside?\”

\”Don\’t know anything about them,\” said he, with a wave of his arm.

\”I ask, for this reason: that we mean to give them a trifle to get a lodging— if they are not shelterless because they are thieves for instance.—You don\’t know them to be thieves ?\”

\”I don\’t know anything about them,\” he repeated emphatically.

\”That is to say, they are shut out, solely because the Ward is full?\”

\”Because the Ward is full.\”

\”And if they got in, they would only have a roof for the night and a bit of bread in the morning, I suppose?\”

\”That\’s all. You\’ll use your own discretion about what you give them. Only understand that I don\’t know anything about them beyond what I have told you.\”

\”Just so. I wanted to know no more. You have answered my question civilly and readily, and I am much obliged to you. I have nothing to say against you, but quite the contrary. Good night!\”

\”Good night, gentlemen!\” And out we came again.

We went to the ragged bundle nearest to the Workhouse-door, and I touched it. No movement replying, I gently shook it. The rags began to be slowly stirred within, and by little and little a head was unshrouded. The head of a young woman of three or four and twenty, as I should judge; gaunt with want, and foul with dirt; but not naturally ugly.

\”Tell us,\” said I, stooping down. \”Why are you lying here?\”

\”Because I can\’t get into the Workhouse.\”

She spoke in a faint dull way, and had no curiosity or interest left. She looked dreamily at the black sky and the falling rain, but never looked at me or my companion.

\”Were you here last night?\”

\”Yes, All last night. And the night afore too.\”

\”Do you know any of these others?\”

\”I know her next but one. She was here last night, and she told me she come out of Essex. I don\’t know no more of her.\”

\”You were here all last night, but you have not been here all day?\”

\”No. Not all day.\”

\”Where have you been all day?\”

\”About the streets.\”

\’\’What have you had to eat?\”

\”Nothing.\”

\”Come!\” said I. \”Think a little. You are tired and have been asleep, and don\’t quite consider what you are saying to us. You have had something to eat to-day. Come! Think of it!\”

\”No I haven\’t. Nothing but such bits as I could pick up about the market. Why, look at me!\”

She bared her neck, and I covered it up again.

\”If you had a shilling to get some supper and a lodging, should you know where to get it?\”

\”Yes. I could do that.\”

\”For GOD\’S sake get it then!\”

I put the money into her hand, and she feebly rose up and went away. She never thanked me, never looked at me— melted away into the miserable night, in the strangest manner I ever saw. I have seen many strange things, but not one that has left a deeper impression on my memory than the dull impassive way in which that worn-out heap of misery took that piece of money, and was lost.

One by one I spoke to all the five. In every one, interest and curiosity were as extinct as in the first. They were all dull and languid. No one made any sort of profession or complaint; no one cared to look at me; no one thanked me. When I came to the third, I suppose she saw that my companion
and I glanced, with a new horror upon us, at the two last, who had dropped against each other in their sleep, and were lying like broken images. She said, she believed they were young sisters. These were the only words that were originated among the five.

And now let me close this terrible account with a redeeming and beautiful trait of the poorest of the poor. When we came out of the Workhouse, we had gone across the road to a public house, finding ourselves without silver, to get change for a sovereign. I held the money in my hand while I was speaking to the five apparitions. Our being so engaged, attracted the attention of many people of the very poor sort usual to that place; as we leaned over the mounds of rags, they eagerly leaned over us to see and hear; what I had in my hand, and what I said, and what I did, must have been plain to nearly all the concourse. When the last of the five had got up and faded away, the spectators opened to let us pass; and not one of them, by word, or look, or gesture, begged of us.

Many of the observant faces were quick enough to know that it would have been a relief to us to have got rid of the rest of the money with any hope of doing good with it. But, there was a feeling among them all, that their necessities were not to be placed by the side of such a spectacle; and they opened a
way for us in profound silence, and let us go.

My companion wrote to me, next day, that the five ragged bundles had been upon his bed all night. I debated how to add our testimony to that of many other persons who from time to time are impelled to write to the newspapers, by having come upon some shameful and shocking sight of this description. I resolved to write in these pages an exact account of what we had seen, but to
wait until after Christmas, in order that there might be no heat or haste. I know that the unreasonable disciples of a reasonable school, demented disciples who push arithmetic and political economy beyond all bounds of sense (not to speak of such a weakness as humanity), and hold them to be all-
sufficient for every case, can easily prove that such things ought to be, and that no man has
any business to mind them. Without disparaging those indispensable sciences in their sanity, I utterly renounce and abominate them in their insanity; and I address people with a respect for the spirit of the New Testament, who do mind such things, and who think them infamous in our streets.