Conversable Economist

\”Price discrimination\” has a specific technical meaning for economists. It\’s not about sellers charging more to certain groups because of biased attitudes about gender, race/ethnicity, religion, or sexual orientation. Instead, it\’s about setting up a varying set of prices in order to charge more to those who are willing to pay more–unlike the standard situation in a plain vanilla market in which everyone pays the same price.

There are lots of examples of price discrimination. When a movie is first released, the ticket prices are typically higher in \”first-run\” theaters than when the movie arrives at \”second-run\” theaters a few months later. Books are often released first in more-expensive hard-cover editions, and later in less-expensive paperbacks. Those who aren\’t sure about going out for dinner are enticed by happy hour and early-bird specials, while those willing to pay more arrive later in the evening. There are discounts for students or senior citizens. There are volume discounts for buying a larger quantity of a good. Such arrangements often seem potentially beneficial to both buyers and sellers.

But there\’s one more kind of price discrimination called \”personalized pricing,\” in which prices would vary across individuals so that everyone would be charged as much as they were willing to pay. This seems more problematic, and a combination of big data and online retail may be bringing it our way. Ariel Ezrachi and Maurice E. Stucke write about \”The rise of behavioural discrimination,\” in the European Competition Law Review (2016, 12: 485-492; not freely available online). They also refer to an Executive Office of the President report from February 2015, \”Big Data and Differential Pricing.\” That report sets up the issue in this way:

\”Economics textbooks usually define three types of differential pricing. Personalized pricing, or first-degree price discrimination, occurs when a seller charges a different price to every buyer. Individually negotiated prices, such as those charged by a car dealer, are an example of personalized pricing. Quantity discounts, or second-degree price discrimination, occur when the per-unit price falls with the amount purchased, as with popcorn at the movie theater. Finally, third-degree price discrimination occurs when sellers charge different prices to different demographic groups, as with discounts for senior citizens.

Big data has lowered the costs of collecting customer-level information, making it easier for sellers to identify new customer segments and to target those populations with customized marketing and pricing plans. The increased availability of behavioral data has also encouraged a shift from third-degree price discrimination based on broad demographic categories towards personalized pricing. Nevertheless, differential pricing still presents several practical challenges. First, sellers must figure out what customers are willing to pay. This can be a complex problem, even for companies with lots of data and computing power. A second challenge is competition, which limits a company’s ability to raise prices, even if it knows that one customer might be willing to pay more than another. Third, companies need to prevent resale by customers seeking to exploit price differences. And finally, if a company does succeed in charging personalized prices, it must be careful not to alienate customers who may view this pricing tactic as inherently unfair. …

Ultimately, whether differential pricing helps or harms the average consumer depends on how and where it is used. In a competitive market with transparent pricing, the benefits are likely to outweigh the costs.  …  Ultimately, differential pricing seems most likely to be harmful when implemented through complex or opaque pricing schemes designed to screen out unsophisticated buyers. For example, companies may obfuscate by bundling a low product price with costly warranties or shipping fees, using “bait and switch” techniques to attract unwary customers with low advertised prices and then upselling them on different merchandise, or burying important details in the small print of complex contracts.When these tactics work, the economic intuition that differential pricing allows firms to serve more price-sensitive customers at a lower price-point may even be overturned. If price-sensitive customers also tend to be less experienced, or less knowledgeable about potential pitfalls, they might more readily accept offers that appear fine on the surface but are actually full of hidden charges. ….\”

Ezrachi and Stucke point out a number of ways in which these issues are becoming a practical reality. The collection and interconnection of big data from a wide variety of sources creates the possibility that when you shop on-line, the seller may already know quite a lot about you. They write:

\”As the volume, variety and value of personal data increases, self-learning pricing algorithms can use the data collected on you and other people to identify subgroups of like-minded, like-price-sensitive individuals, who share common biases and levels of willpower. Pricing algorithms can use data on how other people within your grouping react, to predict how you will likely react under similar circumstances. This then enables the self-learning algorithm to more accurately approximate the user\’s reservation price, observe behaviour, and adjust. The more time we spend online–chatting, surfing, and purchasing–the more times the algorithm can observe what you and others within your grouping do under various circumstances; the more experiments it can run; the more it can learn through trial and error what your group\’s reservation price is under different situations; and, the more it can recalibrate and refine (including shifting you to another group). 

\”To better train their algorithms and categorize even smaller groups of individuals, firms will need personal data. Among other things, this trend will accelerate the \”Internet of Things\”, as firms compete to collect data on consumers\’ activities at home, work, and outside. Smart appliances, cars, utensils, and watches can help firms refine their consumer profiles and gain a competitive edge. Thus in making use of our demographics, physical location (via our phones), browser and search history, friends and links on social networks, and online reviews and blog posts, firms can target us with personalised advertisements with ever increasing proficiency. Also, at the point of sale, the categorisation can help sellers approximate our price sensitivity.\”

It used to be said that when you go to a website, you are like a person with a name-tag at a convention: that is, you could be identified, but others didn\’t necessarily know much about you. But in the future, when you go to a website, certain sellers at least will already know a great deal about you. With this information, the seller will be able to customize your retail experience by manipulating the information presented about products, choices, prices, and deals in ways that makes someone with your specific characteristics more likely to buy and to pay higher prices.

This could be done in literally dozens of ways. One example from Ezrachi and Stucky is that the first item presented in an online list of possibilities will both be a decoy designed with your characteristics in mind: it will also be higher-priced, and perhaps lacking in some features.  When you scroll down the list, you will find other items that have lower prices or more features. Compared to the decoy item, these look like good deals. A standard example in regular retailing is that many restaurants report that the second most-expensive bottle of wine and the second least-expensive bottle of wine are among their top seller, because those who want to splurge can feel they are being a little thrifty, and those who want inexpensive can feel they aren\’t being totally cheap. \”So we may have originally intended to purchase a cheaper item, but chose a more expensive item with perhaps a few more attributes, as it was relatively more attractive than the personalised decoy option.\”

Another option is \”price-steering,\” where a website makes it easier to find more expensive options. Or firms can make strategic use of complexity: \”To better discriminate, companies can take advantage of consumers\’ difficulty in processing many complex options. Companies may deliberately increase the complexity by adding price and quality parameters, with the intent to facilitate consumer
error or bias and manipulate consumer demand to their advantage. By increasing their products\’ complexity, firms can also make it difficult to appraise quality and compare products, increase the consumers\’ search and evaluation costs, and nudge consumers to rely on basic signalling that benefits the firms. Once the customer is snagged, the complexity in contract terms can increase
the customers\’ switching costs and increase the likelihood of customers retaining the personalised default option.  This enables firms to inch closer to perfect behavioural discrimination.\”

Notice that none of these strategies involve the seller actually lying. In fact, one can easily think of circumstances where these options could benefit consumers, by providing them with the selection of products and information that they actually find most attractive. But it\’s also easy to think of ways in which people can be manipulated. Ezrachi and Stucke write:

The road to near-perfect behavioural discrimination will be paved with personalised coupons and promotions: the less price-sensitive online customers may not care as much if others are getting promotional codes, coupons, and so on, as long as the list price does not increase. Online sellers will increasingly offer consumers with a lower reservation price a timely coupon-ostensibly for being a valued customer, a new customer, a returning customer, or a customer who won the discount. The coupon may appear randomly assigned, but only customers with a lower reservation price are targeted. Indeed, the price discrimination can happen on other, less salient aspects of the purchase. Retailers can offer the same price, but provide greater discounts on shipping (or faster delivery), offer complimentary customer service, or better warranty terms to attract customers with lower reservation prices, greater willpower, or more outside options.

In the brave new world of big data and online purchases. buyers really do need to be wary. And one suspects that the Federal Trade Commission and other consumer protection agencies are going to become active participants in determining what tools sellers can use.

Robert Shiller delivered the Presidential Address for the American Economic Association on the subject of \”Narrative Economics\” in Chicago on January 7, 2017. A preliminary version of the underlying paper, together with slides from the presentation, is available here.

Shiller\’s broad point was that the key distinguishing trait of human beings may be that we  organize what we know in the form of stories.  He argues:

\”Some have suggested that it is stories that most distinguish us from animals, and even that our species be called Homo narrans (Fisher 1984) or Homo narrator (Gould 1994) or Homo narrativus (Ferrand and Weil 2001) depending on whose Latin we use.  Might this be a more accurate description than Homo sapiens, i.e., wise man? Or might we say \”narrative is intelligence\” (Lo, 2007), with all of its limitations? It is more flattering to think of ourselves as Homo sapiens, but not necessarily more accurate.\”

Shiller goes on to make a case that narratives play a role in economic activity: for example, the way people act during the steep recession of 1920-21 and the Great Depression, as well as in the Great Recession and the most recent election. To me, one of his themes is that economist should seek to bring the narratives of these times that economic actors were telling themselves into their actual analysis by applying epidemiology models to examine actual spread of narratives, rather than bewailing narratives as a sort of unfair complication for the purity of our economic models.

Near the start, Shiller offers the Laffer Curve as an example of a narrative that had some lasting force. For those not familiar with the story, here\’s how Shiller tells it (footnotes omitted):

Let us consider as an example the narrative epidemic associated with the Laffer curve, a diagram created by economist Arthur Laffer … The story of the Laffer curve did not go viral in 1974, the reputed date when Laffer first introduced it. Its contagion is explained by a literary innovation that was first published in a 1978 article in National Affairs by Jude Wanniski, an editorial writer for the Wall Street Journal. Wanniski wrote the colorful story about Laffer sharing a steak dinner at the Two Continents [restaurant] in Washington D.C. in 1974 with top White House powers Dick Cheney [at the time, a Deputy Assistant to President Ford, later to be Vice President] and Donald Rumsfeld (at the time Chief of Staff to President Ford, later to be Secretary of Defense]. Laffer drew his curve on a napkin at the restaurant table.  When news about the \”curve drawn on a napkin\” came out, with Wanniski\’s help, the story surprisingly went viral, so much that it is now commemorated. A napkin with the Laffer curve can be seen at the National Museum of American History … 

Why did this story go viral? Laffer himself said after the Wanniski story exploded that he himself could not remember the event, which had taken place four years earlier. But Wanniski was a journalist who sensed that he had the elements of a good story. The key idea as Wanniski presented it is, indeed, punchy: At a zero-percent tax rate, the government collects no revenue. At a 100% tax rate the government would also collect no revenue, because people will not work if all the income is taken. Between the two extremes, the curve, relating tax revenue to tax rate, must have an inverted U shape. …

Here is a notion of economic efficiency easy enough for anyone to understand. Wanniski suggested, without any data, that we are on the inefficient side of the Laffer curve. Laffer\’s genius was in narratives, not data collection. The drawing of the Laffer curve seems to suggest that cutting tax rates would produce a huge windfall in national  income. To most quantitatively-inclined people unfamiliar with economics, this explanation of economic inefficiency was a striking concept, contagious enough to go viral, even though economists, even though economists protested that we are not actually on the inefficient side of the Laffer Curve (Mirowski 1982). It is apparently impossible to capture why it is doubtful that we are on the inefficient side of the Laffer curve in so punch a manner that it has the ability to stifle the epidemic. Years later Laffer did refer broadly to the apparent effects of historic tax cuts (Laffer 2004); but in 1978 the narrative dominated. To tell the story really well one must set the scene at the fancy restaurant, with powerful Washington people and the napkin.

Here an image of what mus be one of history\’s best-known napkins from the National Museum of American History, which reports that the exhibit was \”made\” on September 14, 1974, and measures 38.1 cm x 38.1 cm x .3175 cm, and was a gift from Patricia Koyce Wanniski:

Did Laffer really pull out a pen and start writing on a cloth napkin at a fancy restaurant, so that Jude Wanniski could take the napkin away with him? The website of the Laffer Center at the Pacific Research Institute describes it this way:

\”As to Wanniski’s recollection of the story, Dr. Laffer has said that he cannot remember the details, but he does recall that the restaurant where they ate used cloth napkins and his mother had taught him not to desecrate nice things. He notes, however, that it could well be true because he used the so-called Laffer Curve all the time in classroom lectures and to anyone else who would listen.\” 

In the mid-1980s, when I was working as an editorial writer for the San Jose Mercury News in California, I interviewed Laffer when he was running for a US Senate seat.  He was energy personified and talked a blue streak, and I can easily imagine him writing on cloth napkins in a restaurant. When remembering the event 40 years later in 2014, Dick Cheney said:

It was late afternoon, sort of the-end-of-the-day kind of thing. As I recall, it was a round table. I remember a white tablecloth and white linen napkins because that’s what [Laffer] drew the curve on. It was just one of those events that stuck in my mind, because it’s not every day you see somebody whip out a Sharpie and mark up the cloth napkin at the dinner table. I remember it well, because I can’t recall anybody else drawing on a cloth napkin.

The point of Shiller\’s talk is that while a homo sapiens discussion of the empirical evidence behind the Laffer curve can be interesting in its own way, understanding the political and cultural impulse behind tax-cutting from the late 1970s up to the present requires genuine intellectual opennees to a homo narrativus explanation–that is, an understanding of what narratives have force at certain times, how such narratives come into being, why the narratives are powerful, and how the narratives affect various forms of economic behavior.

My own sense is that homo sapiens can be a slippery character in drawing conclusions. Homo sapiens likes to protest that all conclusions come from a dispassionate consideration of the evidence. But again and again, you will observe that when a certain homo sapiens agrees with the main thrust of a certain narrative, the supposedly dispassionate consideration of evidence involves compiling every factoid and theory in support, as well as denigrating those who believe otherwise as liars and fools; conversely, when a different homo sapiens disagrees with the main thrust of certain narrative, the supposedly dispassionate consideration of the evidence involves compiling every factoid and theory in opposition, and again denigrating those who believe otherwise as liars and fools. Homo sapiens often brandishes facts and theories as a nearly transparent cover for the homo narrativus within.

When you are thinking about investing in a mutual fund , here\’s an impolite but seemingly relevant question to ask: How wealthy were the parents of the manager of the fund?  Oleg Chuprinin and Denis Sosyura raise this question in \”Family Descent as a Signal of Managerial Quality: Evidence from Mutual Funds\” (August 2016, NBER Working Paper No. 22517). The paper is not freely available online, but Jay Fitzgerald offers a short accessible overview in the December 2016 NBER Digest. As Fitzgerald writes:

\”This study relies on hand-collected data from individual U.S. Census records on the wealth and income of managers\’ parents. The researchers also identified and verified fund managers via Morningstar, Nelson\’s Directory of Investment Managers, and LexisNexis Public Records. They ultimately identified hundreds of fund managers, most born in the mid-1940s, whose parents\’ Census records were in the public domain. They then examined the performance of hundreds of actively managed mutual funds focused on U.S. equities between the years 1975 and 2012.

\”The researchers find that mutual fund managers from wealthier backgrounds delivered `significantly weaker performance than managers descending from less wealthy families.\’ Managers from families in the top quintile of wealth underperformed managers in the bottom quintile by over one percent per year on a risk-adjusted basis.\” 

Here\’s a figure to illustrate the findings. The results show monthly returns in \”basis points,\” which means that 20 is actually .2%. Fund managers whose parents came from the highest wealth quintile performed the worst, while fund managers whose parents came from the lowest wealth quintile performed the best.

What\’s going on here? It seems unlikely that skill levels are distributed in this way across families. Instead, the plausible explanation offered by the authors is that it\’s a lot easier for people from high-wealth families to become fund managers, and a lot harder for people from low-wealth families to do so. Because those who start in low-wealth families face more barriers in becoming a fund manager, only the most very highly suited and skilled actually work their way into such a job. Fitzgerald notes some other differences, too:

\”Indeed, in tracking career trajectories of mutual fund managers, they find that the promotions of managers from well-to-do families are less sensitive to their performance. In other words, managers who are born rich are more likely to be promoted for reasons unrelated to performance. In contrast, those born into poor families are fewer in number and are promoted only if they outperform. They also find that fund managers from less-affluent families who do make it into top ranks are more active on their job: they are more likely to trade and deviate from the market, whereas those born rich are more likely to follow benchmark indexes.\” 

The study is interesting to me on both conceptual and practical grounds. On conceptual grounds, it\’s difficult to measure the extent of favoritism to those from more-wealthy families, or equivalently, the extent of bias against those from less-wealthy families. After all, those who come from families with greater wealth may often have an advantage because their families were in a better position to invest in their human capital, or else because of social favoritism, and it\’s not easy to find data that will distinguish between the two. But in the example of mutual funds, the measure of job performance is very simple–it\’s just the return on the fund. So if those from high-wealth families don\’t (on average) measure up as managers of mutual funds, it certainly smacks of favoritism toward them

On practical grounds, there\’s no particular reason to believe that the underlying takeaway from the paper applies only to mutual funds. When those who face  higher barriers to success manage to overcome those barriers in any occupation, it may often be a sign that their competence level is not just high, but exceptionally high.

A lot of the US discussion about international trade seems to assume that we can simultaneously discourage the importers and encourage the exporters. But this belief assumes, implicitly, that importers and exporters are different firms. If the US firms that import have a lot of overlap with firms that also export, then if you impose costs on these firms by hindering their imports, you will also make it harder for them to export.

In fact, the main US importers do have a lot of overlap with the main US exporters. J. Bradford Jensen offers a useful figure in a blog post at the Peterson Institute for International Economics,: \”Importers are Exporters: Tariffs Would Hurt Our Most Competitive Firms.\” For example, out of the 2,000 US firms that are in the top 1% of exporters, 36% are also in the top 1% of importers; conversely, of the 1,300 US firms that are in the top 1% of importers, 53% are also in the top 1% of exporters.

The figure emerges from ongoing work by Andrew B. Bernard, J. Bradford Jensen, Stephen J. Redding, and Peter K. Schott. For a recent example, see their working paper \”Global Firms,\” available as National Bureau of Economic Research Working Paper #22727 (October 2016). Or for an earlier overview of this work, the same four authors wrote \”Firms in International Trade,\” which appears in the Summer 2007 issue of the Journal of Economic Perspectives.  As they note in the NBER working paper:

\”Research in international trade has changed dramatically over the last twenty years, as attention has shifted from countries and industries towards the firms actually engaged in international trade. … [M]uch of international trade is dominated by a few “global firms,” which participate in the international economy along multiple margins and account for substantial shares of aggregate trade.\” 

Jensen explains further in the PIIE blog post:

\”First, it is costly for firms to start importing and exporting—effort and investments are required to start doing each. This implies that only the most productive firms will engage in importing or exporting. Once a firm starts importing, it reduces the firm’s costs and thus makes it possible to export. Similarly, exporting increases a firm’s revenue and this makes it possible for the firm to import. These two aspects of firm behavior are intertwined and both would be damaged by higher tariff costs.

\”In a world with these types of interdependent firm decisions, small decreases in trade costs (such as reductions in tariffs) can have magnified effects on trade flows, as they induce firms to serve more markets, export more products to each market, export more of each product, source intermediate inputs from more countries, and import more of each intermediate input from each source country. But the process can work in reverse. Hence, policies to restrict imports, such as tariffs, that are intended to help a nation’s firms can end up hurting its most successful producers, for whom importing is part and parcel of exporting and a central pillar of their overall business strategy.\”

Engels offers several interrelated counterarguments. One is that the Malthusian arguments offers capitalists a rationalization for treating the poor as a \”surplus population\” and that \”nothing should be done for them except to make their dying of starvation as easy as possible.\” Engels calls this \”the immorality of the economist brought to its highest pitch.\” Instead, Engels argues that there is not a problem of surplus population, but instead a problem of \”surplus wealth, surplus capital and surplus landed property.\”  Instead, Engels argues that workers produce a surplus. He writes that \”every adult produces more than he himself can consume, that children are like trees which give superabundant returns on the outlays invested in them …\” In Engels\’s view, if all the interests of capital and labor are fused together, so that workers can share in what they have produced, \”overpopulation\” will not occur.

Finally, Engels argues that the Malthusian argument neglects the power of science to increase argues production. He writes: \”[T]here still remains a third element which, admittedly, never means anything to the economist – science – whose progress is as unlimited and at least as rapid as that of population. … [S]cience advances in proportion to the knowledge bequeathed to it by the previous generation, and thus under the most ordinary conditions also in a geometrical progression. And what is impossible to science?\” It made me smile a bit to contemplate Engels offering a defense of rising output driven by technological progress (and apparently no need for market-based incentives to raise output) as a central part of his challenge to Malthus.

Here\’s an excerpt from Engels\’s 1844 essay, in which he includes a number of pleasantly snarky comments about economists in general:

Malthus, the originator of this doctrine, maintains that population is always pressing on the means of subsistence; that as soon as production increases, population increases in the same proportion; and that the inherent tendency of the population to multiply in excess of the available means of subsistence is the root of all misery and all vice. For, when there are too many people, they have to be disposed of in one way or another: either they must be killed by violence or they must starve. But when this has happened, there is once more a gap which other multipliers of the population immediately start to fill up once more: and so the old misery begins all over again. …  The implications of this line of thought are that since it is precisely the poor who are the surplus, nothing should be done for them except to make their dying of starvation as easy as possible, and to convince them that it cannot be helped and that there is no other salvation for their whole class than keeping propagation down to the absolute minimum. Or if this proves impossible, then it is after all better to establish a state institution for the painless killing of the children of the poor .. whereby each working-class family would be allowed to have two and a half children, any excess being painlessly killed. Charity is to be considered a crime, since it supports the augmentation of the surplus population. Indeed, it will be very advantageous to declare poverty a crime and to turn poor-houses into prisons, as has already happened in England as a result of the new “liberal” Poor Law.
Am I to go on any longer elaborating this vile, infamous theory, this hideous blasphemy against nature and mankind? Am I to pursue its consequences any further? Here at last we have the immorality of the economist brought to its highest pitch. What are all the wars and horrors of the monopoly system compared with this theory! … 

If Malthus had not considered the matter so one-sidedly, he could not have failed to see that surplus population or labour-power is invariably tied up with surplus wealth, surplus capital and surplus landed property. The population is only too large where the productive power as a whole is too large. The condition of every over-populated country, particularly England, since the time when Malthus wrote, makes this abundantly clear. These were the facts which Malthus ought to have considered in their totality, and whose consideration was bound to have led to the correct conclusion. Instead, he selected one fact, gave no consideration to the others, and therefore arrived at his crazy conclusion.

The second error he committed was to confuse means of subsistence with [means of] employment. That population is always pressing on the means of employment – that the number of people produced depends on the number of people who can be employed – in short, that the production of labour-power has been regulated so far by the law of competition and is therefore also exposed to periodic crises and fluctuations – this is a fact whose establishment constitutes Malthus’ merit. But the means of employment are not the means of subsistence. Only in their end-result are the means of employment increased by the increase in machine-power and capital. The means of subsistence increase as soon as productive power increases even slightly. Here a new contradiction in economics comes to light. The economist’s “demand” is not the real demand; his “consumption” is an artificial consumption. For the economist, only that person really demands, only that person is a real consumer, who has an equivalent to offer for what he receives. But if it is a fact that every adult produces more than he himself can consume, that children are like trees which give superabundant returns on the outlays invested in them – and these certainly are facts, are they not? – then it must be assumed that each worker ought to be able to produce far more than he needs and that the community, therefore, ought to be very glad to provide him with everything he needs; one must consider a large family to be a very welcome gift for the community. But the economist, with his crude outlook, knows no other equivalent than that which is paid to him in tangible ready cash. He is so firmly set in his antitheses that the most striking facts are of as little concern to him as the most scientific principles.

We destroy the contradiction simply by transcending it. With the fusion of the interests now opposed to each other there disappears the contradiction between excess population here and excess wealth there; there disappears the miraculous fact (more miraculous than all the miracles of all the religions put together) that a nation has to starve from sheer wealth and plenty; and there disappears the crazy assertion that the earth lacks the power to feed men. …

At the same time, the Malthusian theory has certainly been a necessary point of transition which has taken us an immense step further. Thanks to this theory, as to economics as a whole, our attention has been drawn to the productive power of the earth and of mankind; and after overcoming this economic despair we have been made for ever secure against the fear of overpopulation. We derive from it the most powerful economic arguments for a social transformation. … Through this theory we have come to know the deepest degradation of mankind, their dependence on the conditions of competition. It has shown us how in the last instance private property has turned man into a commodity whose production and destruction also depend solely on demand; how the system of competition has thus slaughtered, and daily continues to slaughter, millions of men. All this we have seen, and all this drives us to the abolition of this degradation of mankind through the abolition of private property, competition and the opposing interests.

Yet, so as to deprive the universal fear of overpopulation of any possible basis, let us once more return to the relationship of productive power to population. Malthus establishes a formula on which he bases his entire system: population is said to increase in a geometrical progression – 1+2+4+8+16+32, etc.; the productive power of the land in an arithmetical progression – 1+2+3+4+5+6. The difference is obvious, is terrifying; but is it correct? Where has it been proved that the productivity of the land increases in an arithmetical progression? The extent of land is limited. All right! The labour-power to be employed on this land-surface increases with population. Even if we assume that the increase in yield due to increase in labour does not always rise in proportion to the labour, there still remains a third element which, admittedly, never means anything to the economist – science – whose progress is as unlimited and at least as rapid as that of population. What progress does the agriculture of this century owe to chemistry alone – indeed, to two men alone, Sir Humphry Davy and Justus Liebig! But science increases at least as much as population. The latter increases in proportion to the size of the previous generation, science advances in proportion to the knowledge bequeathed to it by the previous generation, and thus under the most ordinary conditions also in a geometrical progression. And what is impossible to science? But it is absurd to talk of over-population so long as “there is ‘enough waste land in the valley of the Mississippi for the whole population of Europe to be transplanted there”; so long as no more than one-third of the earth can be considered cultivated, and so long as the production of this third itself can be raised sixfold and more by the application of improvements already known.

Every now and again, I\’ll post a cartoon suitable for tacking up on a bulletin board, or blending into an economics lecture. Here\’s a useful reminder from Honest Abraham Lincoln himself for 2017. Thanks to all readers who take a few minutes out of their day, now and then, to spend time looking at quotations from the Internet on this site.

This particular image is from cheezburger.com, but versions of it are all over the web.  I like this version because of the glasses. And yes, you can find message boards and social media where people plaintively ask something like: \”Is this really true?\”

A more fluid labor market is socially valuable, because it helps unemployment rates stay lower and offers broader opportunity. Also, employers who know that employees have decent and readily available outside options have better incentive to treat employees well. But most economists recognize that labor markets are full of \”frictions,\” which is a catch-all term for the costs involved in making connections between willing workers and willing employers. (Indeed, the 2010 Nobel Prize in economics went to Peter A. Diamond, Dale T. Mortensen and Christopher A. Pissarides \”for their analysis of markets with search frictions\”.) There\’s an old rule of thumb that one should expect a month of job search for every $10,000 you would like to earn, and even though that specific number is probably an unreliable guess, the comment makes the point that the time and information costs involved in finding a new job can be high. One of the very practical barriers for a lot of unemployed workers is a lack of information about available jobs, and a lack of experience in how to find the relevant information.

Active labor market policies are a government attempt to reduce these costs. In a December 2016 Issue Brief, the Council of Economic Advisers discusses the subject of \”Active Labor Market Policies: Theory and Evidence for What Works.\”  The CEA defines active labor market policies as \”policies that promote participation in the labor force and help workers match to employment opportunities. These programs include employment services, job search assistance, job training programs, and employment subsidies. But the empirical evidence also finds that not all approaches to supporting employment and earnings are equally successful, with some programs having substantial benefits relative to their costs while others do not.\”

As I have pointed out here before, US spending on active labor market policies (as a share of GDP) is considerably less than most other high-income countries. Here\’s a figure from the CEA:

Moreover, even this low US level has been on a generally downward trend for several decades:

Of course, the hard-headed question is whether active labor market policies work–and whether some work better than others. The CEA report cites an array of evidence on this point (for readability, the quotations that follow omit citations and footnotes).

On offering job search assistance and requiring participation from those receiving government benefits: \”While job search assistance leads to faster employment, there is little evidence that it affects wages. Job search programs may also yield other benefits. When job search is required of recipients of unemployment insurance (UI), research shows that reemployment assistance typically saves the government several hundred dollars per participant in UI benefits by reducing time to reemployment …\”

On offering job training for various groups: \”Job training programs focusing on economically disadvantaged adults, typically those with low earnings or levels of education, consistently yield significant positive effects on employment outcomes. Recent evidence comes from evaluations of WIA [Workforce Investment Act] training programs for disadvantaged adults …  these training programs increased quarterly earnings between $500 and $800 (in the range of 10 to 25 percent increases) for workers by three years after receiving training, in addition to positive employment effects. … Sectoral training, one specific type of training program that focuses on training workers for jobs in particular industries and which typically develops and implements training programs in partnership with employers, is an especially promising avenue for disadvantaged workers. … In one successful example of training leading to positive results for mid-career workers … when dislocated workers obtain training in the form of community college coursework, the equivalent of one academic year of courses translates into increases in long-term earnings of between seven and ten percent. They also find that these effects are more pronounced when coursework is concentrated on quantitative courses.\”

On employment subsidies for hiring workers: \”While effective at encouraging employment, an important consideration for employment subsidies is that they be designed and administered in ways that mitigate two potential drawbacks: The first is that some portion of their value may be captured by firms who would have hired such workers in any event. A second is that targeted employer-based subsidies may lead to stigmatization of the targeted group among potential employers.\” I\’ve written before on \”What Do We Know about Subsidized Employment Programs?\” (April 25, 2016), and noted that there are a couple of large-scale studies underway that should provide fuller evidence here.

Just to be clear, not all the evidence on active labor market policies is positive. The design and context of active labor market policies matters. But in my reading, the evidence is certainly strong enough to support additional large-scale experimentation with these policies, which can be designed in a way to facilitate a later evaluation of the results.

Finally, I\’ll add that the main focus of the CEA report is on US-based evidence about active labor policies, but an array of international evidence is also available. For a literature review, interested readers might begin with a literature review paper by David Card, Jochen Kluve and Andrea Weber What Works? A Meta Analysis of Recent Active Labor Market Program Evaluations,\” published by the German Institute for the Study of Labor (IZA Discussion Paper No. 9236, July 2015).

In the year 301, Diocletian, who was Emperor of the Roman Empire, enacted widespread price ceilings for many good. How did that work out One canonical source for a discussion of what happened at that  time is an essay by Roland G. Kent,  \”The Edict of Diocletian Fixing Maximum Prices,\” which appeared in 1920  in the University of Pennsylvania Law Review (69: pp. 35-47). It\’s available at various places on the web, like JSTOR and here). The heart of the article is to offer a translation of the Diocletian Edict. Here, I\’ll just offer some of Kent\’s description of what happened. He writes:

In the year 284 A. D., Diocletian (as we now know the Dalmatian soldier of lowly origin) was by his soldiers proclaimed Augustus or Emperor of the Roman Empire, stretching from the Atlantic Ocean to Mesopotamia. … In these and the following years the prices of commodities of all sorts and the wages of laborers reached unprecedented heights. In the year 301, consequently, Diocletian felt obliged to issue an Edict fixing maximum prices for practically all articles and services. Of this Edict we know but little from literary sources; but as it was published in inscriptional form throughout the countries to which it applied, we have the actual text recorded in stone. …

After providing a translation of the edict, which as one might expect is heavy on expressions of piety and condemnations of avarice and greed, Kent summarizes it in this way:

The provisions of the Edict are, in simple language, that maximum prices are set for articles of trade and for services, and that these are not to operate in such a way as to raise prices where the current level of prices is lower; that traders shall not buy in localities where prices are low and transport and sell the goods elsewhere at the maximum price; that the penalty for the violation of the law is death, and that leniency is not to be expected in return for a conciliatory attitude in court; further, that the same penalty applies to him who purchases at an illegally high price, and to him who hoards goods and refuses to put them on the market at legal price. After the preamble come the price lists arranged in schedules.

How did the Diocletian Edict work out? Kent wrote:

\”Before passing to the text of the Edict, we might consider briefly its working; the available material, in fact, permits only a brief treatment. The writer De Mortibus Persecutorum, in the seventh chapter, says, \”He (Diocletian) likewise, when by his varied unreasonable tax-levies he caused an immeasurable rise in prices, tried to regulate the prices of merchandise. Then much blood was shed over trifling and cheap articles; through fear, wares were withheld from market, and the rise in prices became much worse, until after the death of many men the law was through very necessity rescinded.\”  In other words, the price limits set in the Edict were not observed by the traders, in spite of the death penalty provided in the statute for its violation; would-be purchasers, finding that the prices were above the legal limit, formed mobs and wrecked the offending traders\’ establishments, incidentally killing the traders, though the goods were after all of but trifling values; the other traders, rather than sell at prices which would bankrupt them, hoarded their goods against the day when the restrictions should be removed, and the resulting scarcity of wares actually offered for sale caused an even greater increase in prices, so that what trading went on was at illegal prices, and therefore performed clandestinely.

\”Ultimately the Edict was of necessity rescinded; how long it remained in force is unknown. But Diocletian is known to have abdicated the imperial power in 305, four years after the promulgation of the Edict; the cause assigned was ill-health resulting from the strain and burden of government. It would not be going very far from likelihood to assume that the failure of the Edict to restore business stability was a considerable factor in his poor health and abdication, and that the Edict was rescinded very soon after his abdication, if not indeed before. It remained law, therefore, not much if at all over four years.\”

As anyone with a smattering of economics–or just knowledge about human nature–might expect, it\’s highly unlikely that a sudden and unprecedented upsurge in greed and avarice circa 300 AD caused the rapid price rises. Instead, the more likely causes stem from high spending to finance the courts of the time, which in turn was financed by a currency (the denarius) in which the amount of silver was continually being reduced and which Diocletian turned to copper. As the value of the currency fell, prices increased–and the short-lived Diocletian Edict was the result.

Douglas Clement has an \”Interview with Gita Gopinath\” in The Region, published by the Federal Reserve Bank of Minneapolis (December 20, 2016). As the subheading says, the main topics include
the \”dollar’s unique status, crises & productivity, and policy spillover to emerging markets.\” Here are a couple of comments that caught my eye:

On the role of the fluctuations in the US dollar exchange rate in inflation and output: 

\”What we have known for a while is that the dollar has a unique role in international trade since most of trade invoicing is done in dollars. More recent research shows that these dollar prices tend to be sticky—that is, these dollar prices are far more stable than exchange rates. For non-U.S. economies, therefore, a depreciation of their currency relative to the dollar leads to almost a one-to-one increase in the price of imported goods in their own currency and, therefore, the pressures on inflation are high. On the other hand, because dollar prices of traded goods are relatively stable, the inflationary pressures on the U.S. economy are weak.

\”This, of course, begs the question, why do most exporters rely on dollar pricing? There are a couple of explanations. Firstly, as world trade has become more competitive, firms that wish to preserve their market shares prefer to keep their prices stable relative to their competitors’. If your competitors price in dollars and keep these prices sticky, this gives the firm an incentive to also price in dollars. … Secondly, most exporters also use imported inputs for their production. If these inputs are priced in dollars that are relatively stable, then the exporters’ cost of production is relatively stable in dollar terms and, consequently, they prefer to price in dollars. … Outside of the U.S., most nations are far more exposed to inflation driven by exchange rate fluctuations. What this also points to is that from most countries’ perspective, the exchange rate that matters is the value of their currency relative to the dollar. …

\”A weaker dollar has very little effect on inflation in the U.S., has an expansionary effect on exports and has a negligible effect on imports. On the other hand, a weaker rupee is highly inflationary for India, has a significant impact on its imports and has a negligible impact on exports. This expectation that a weaker currency for a non-U.S. economy is good for a country’s exports does not line up with the facts. … What it basically means is that central bankers in developing countries have to respond pretty aggressively to exchange rate depreciations.\”

Using fiscal policy as a substitute for exchange rate policy: 

\”So what we analyzed in our paper is a set of fiscal instruments that would deliver the same outcomes as a currency devaluation. This idea goes back to Keynes, as you said, who proposed import tariffs and export subsidies as a substitute for currency devaluation. Given the illegality of using tariffs of this nature, we instead explored the role of value-added taxes and payroll subsidies or, more specifically, raising value-added taxes and cutting payroll taxes. What we found, surprisingly, is that this form of intervention did extremely well in mimicking the outcomes of a currency devaluation, not approximately but exactly.

\”The mechanism works as follows. When a country raises its value-added tax, foreign exporters selling to the country increase their prices, making them less competitive. Domestic firms that sell locally also face the high value-added taxes, but because these prices are slow to adjust and because the government provides them with a payroll tax cut, their prices do not rise as much. That makes them more competitive in the same way that an exchange rate devaluation would. Moreover, a fiscal devaluation has the same effect on inflation and the same effect on redistribution as an exchange rate devaluation.

\”In terms of policy traction, France did implement a partial fiscal devaluation. They cut payroll taxes but did not raise value-added taxes, despite the announcement that they would. So they went only halfway there. Despite the virtues, there are political challenges to implementing a large fiscal devaluation. Countries live through a 10 percent exchange rate depreciation without immense anxiety, but if you raise value-added taxes by 10 percent, that would be very salient and likely politically infeasible.
But the broader point we made was that there are instruments other than exchange rate devaluations that a country can use to gain trade competitiveness.\”

The New England states experimented with price controls starting in 1777, and the results were very much what an introductory economic textbook would predict. (Indeed, I offer a much-shortened version of this example in my own Principles of Economics textbook. A fourth edition will be out next fall, and of course I encourage anyone teaching the intro course to take a look.)

The story is told by William R. Staples in the Annals of the Town of Providence, From its First Settlement to the Organization of the City Government in June 1832,  published in 1843, and available via the magic of Google Books (for example, here). The passages quoted here run from pp. 271-277,  Staples describes the background of the price control legislation in this way.

\”In January 1777, a convention of deputies from the New-England States met in Providence, to state the prices of goods and labor. … Congress and the states too, had thus carried on the war by issuing bills of credit,  The issues of these were regulated by the wants of army and navy. They constituted the currency the country. Every successive issue of them, tended to depreciate their value, as it necessarily increased the amount, and consequently rendered day of payment more distant and less certain. This depreciation of the currency produced an increase in the prices of all the necessaries of life, and this convention was called to regulate these prices. 

\”They met, and after some deliberation, agreed upon certain prices to be paid and received for labor and almost every necessary article. The General Assembly of this state being in session, at same time, the convention reported to them immediately passed an act with the following popular title. \”An act to prevent monopolies and oppression, by excessive and unreasonable prices, for many of the necessaries and conveniences of life, and for preventing engrossers, and for the better supply of our troops in the army, with such necessaries may be wanted. This act embodied and adopted the report of the convention, and added other articles to it, so that it included almost every article, called necessary or convenient, from a bushel of wheat down to a quart of milk. He who bought or for a higher rate, was to \”be accounted oppressive, an enemy to his country, and guilty of a breach of this act,\” and to be subject to a fine.\” 

\”The General Assembly were not unanimously in favor of this act There were some who saw how futile must be every attempt to fix the prices of articles, when the currency in which they were to be paid for was constantly depreciating in value, or in fact had no fixed value.\”

What effects did these price controls have? The following June, the town of Providence was sending representatives to the Rhode Island General Assembly. The town adopted a report with instructions for what its representatives should do and say. Staples reproduces these instructions, which started by telling the representatives to try to get better payment and support for the troops and their families. They argued that the costs of these supplies should be paid for by a \”general tax\” on the citizens, and once that tax was in effect, it would then be possible to repeal of the price control laws. Here is part of their description of the problems caused by the price controls:

As soon as adequate provision shall be made for supplying our troops, in the abovesaid, or any other equitable mode, you are instructed and directed to move for and exert your best endeavors to obtain, an immediate and total repeal of the late act of this state regulating prices, &c. …  

Because, we find by experience, that the subject of said act is so intricate, variable, and complicated, that it cannot be and remain any term of time equitable, and hath a tendency to frustrate and defeat its own purposes. It was made to cheapen the articles of life, but it has in fact raised their prices, by producing an artificial, and in some articles a real, scarcity. It was made to unite us in good agreement respecting prices, but hath produced animosity and ill will between town and country and between buyers and sellers, in general. It was made to bring us to some equitable standard of honesty, and make fair dealers; but hath produced a sharping set of mushroom pedlers, who adulterate their commodities, and take every advantage to evade the force of the act, by the most pitiful evasions, quibbles and lies. It was made to give credit to our currency; but hath done it much injury; it tends to introduce bartering, and makes a currency of almost every thing, but money, and; 

Because, by experience, we, as well as the inhabitants of the other states, find it almost impossible to execute such acts, at least without a degree of rigor and severity heretofore unknown in these free states; and, while it remains in its present situation, it tends only to weaken government, and bring all laws into contempt, and even if it could be executed, it would operate as a very heavy and unreasonable tax upon the sellers, who are generally the enterprising and the industrious: It would prevent foreigners from shipping goods to our coasts, and cause our own merchants to order theirs to the southern states, and, in general, discourage foreign trade, in carrying on which, the risk is great and very uncertain and variable, according to circumstances, from time to time, and therefore not accurately computable three years before hand. It would also tend to discourage agriculture and manufactures among ourselves, as the prospect of some extraordinary gain generally excites men to extraordinary exertions in all the different branches of business.

It hath a tendency to exclude from our markets every thing extraordinary in its kind, and of course, to prevent all improvement; to discourage industrious laborers, by allowing the indolent the same wages;  for the scarcity of laborers will find employment for all, as the scarcity of goods will bring nearly all qualities up to the prices of the first rate, by which means, articles of inferior quality will be sold dearer to the poor, than what they would be afforded at if those of the first rate quality should be sold higher.

It would multiply oaths and lawsuits, otherwise needless, and prove a strong temptation to perjury and knavery of every kind, and in some cases put a man to needless expense in the disposal of his own property. It would render a man\’s house and stores liable to be opened and searched in a manner most ignominious and unworthy of a freeman, and deprive him of the privilege of complaining of it, under the penalty of ten pounds. It would promote suspicion and jealousies in neighborhoods, and a meddling with other folks\’ goods and business, ruinous to the peace and good order of society. …

This has been our case, and if the whole money only measure the whole property a proportionable part of the money ought to measure the same proportionable part of the property, and neither more or less, for either would be injustice. Therefore, stipulating prices below this proportion, is as real injustice, as raising them above it, and this proportion is so nice a point, that nothing but the wants of mankind, can accurately hit upon it. Trade, when left free from fetters and embarrassments, will of itself settle down nicely to this proportion, and keep to it closer, than any force whatever can bring it.