Limitations of the use of statical assumptions in regard to increasing return

Appendix H

§1. Production with increasing returns to scale (or marginal returns) creates a problem with the supply curve (sloping down?) and implies (natural) monopoly power.

§2. Marshall says it would be hard to find equilibrium if demand and supply are both sloping down. Later economists “fixed” this problem, I think, by holding scale constant in the short run (via fixed costs) and then allowing for flat or rising marginal costs. It seems that Marshall was looking at the long run, i.e., where there are no rigidities from fixed costs.

§3. Whoops! Marshall didn’t make that mistake. He discusses how rigidities are likely to affect production (scale) and thus allow for equilibrium (rising supply costs). That said, he does note that some industries with rapidly falling supply costs can result in “plunging” market prices as supply runs ahead of demand. This can happen with new technologies (e.g., cheap airlines) or trade (cheap good from China), for example.

§4. Marshall ends by arguing that declining marginal costs are unlikely in the long run for an entire industry, since demand would never exceed supply. That said, some firms in the industry might have cost advantages, and thus the opportunity to earn quasi-rents in the short run compared to firms on the margin, assuming all receive a market price.

This post is part of a series in the Marshall 2020 Project, i.e., an excuse for me to read Alfred Marshall’s Principles of Economics (1890 first edition/1920 eighth edition), which dominated economic thinking until Van Neumann and Morgenstern’s Theory of Games and Economic Behaviour (1944) and Samuelson’s Foundations of Economic Analysis (1946) pivoted economics from institutional induction to mathematical deduction.

Interesting stuff

  1. Read: A look into the work of a Mississippi River pilot
  2. Read: COVID and digital nomads
  3. Read: Surprise (not!) — lots of fraud in the PPP bailouts for small businesses
  4. Listen: All drugs should be legalized
  5. Read: What if Remote Work Didn’t Mean Working from Home?
  6. Read: The Economics of Dining as a Couple
  7. Listen: Pipe Dreams: The Urgent Global Quest to Transform the Toilet
  8. Listen: “…the challenges facing Black America go beyond racial discrimination and the threat of police violence…
  9. Read: Can plastic be “infinitely” recycled?
  10. Listen: Finally, a central banker (and economist) who makes a lot of sense

The incidence of local rates, with some suggestions as to policy

Appendix G

§1. By “rates”, Marshall means local [property] taxes. He begins by noting that taxes that cost more than they give are “onerous” whereas those that give back more than they cost (easy when they are focussed on collective goods rather than private subsidies) are “beneficial”. Since rates are local, they will attract/repel workers and citizens based on that benefit/cost calculation.

§2. A building on land will be more/less profitable over the long term (think net present value) if it fits/misses the neighbourhood’s character, and this character changes over time.

§3. Onerous rates can reduce the value of a building to those who may rent it; even beneficial rates can be bad if they deliver value far later than they are collected.

§4. It’s a good idea to have the same national tax on building values (close to my idea), whereas local rates (on building and/or land value) may need to vary with local conditions. Hopefully they are beneficial!

§5. The incidence (burden) of rates will balance out over time, but it can be onerous (or beneficial) in the short run, which will tend to affect decisions on where to live/work/build.

§6. Speculation occurs at the border between town and outlying areas (e.g., farms), i.e., where the gap between current (use) value and future (converted) value is greatest.

§7. Landlords and farmers tend to share the burdens of rates over the long term, due to lower turn over of occupation.

§8. Rates on residential property should be higher than those on commercial property because turnover is lower in the former (benefits and costs can sync over time) and competition for location is higher in the “commercial” sectors (where rent is an important part of costs/profits).

…while taxes, and especially graduated taxes on expenditure in general [e.g., VAT], present great technical difficulties to the tax collector; and further cost much more to the consumer directly and indirectly than they bring into the revenue; taxes on houses are technically simple, cheap in collection, not liable to evasion, and easy of graduation (p 661).

§9. Marshall says, again, that the costs and benefits of rates need to be balanced over the long run, to make sure that those who pay also receive the benefits from their contributions.

This post is part of a series in the Marshall 2020 Project, i.e., an excuse for me to read Alfred Marshall’s Principles of Economics (1890 first edition/1920 eighth edition), which dominated economic thinking until Van Neumann and Morgenstern’s Theory of Games and Economic Behaviour (1944) and Samuelson’s Foundations of Economic Analysis (1946) pivoted economics from institutional induction to mathematical deduction.

Interesting stuff

  1. Listen: Daniel Kahneman on Why Our Judgment is Flawed — and What to Do About It
  2. Watch: “Chinatown” architecture in the West is not authentic. Instead, it’s aimed at avoiding discrimination.
  3. Read: What is the Dutch obsession with pavement cafes all about?
  4. Listen: If you treat discussions and debates like a soldier (“defend the position!”) rather than a scout (“what’s interesting over here?”), then you are likely to feel right but be wrong over the long term.
  5. Read: Monopoly was invented to demonstrate the evils of capitalism
  6. Read: Reusable plastic shopping bags are actually making the problem worse
  7. Read: The bad science behind “wash hands and keep distance but ignore masks”
  8. Read: Internet 1.0 was freedom and exploration. Internet 2.0 was exploitation via algorithms. Internet 3.0 will put everything behind paywalls.
  9. Listen: The weird origins of Daylight “Savings” Time and other time trivia
  10. Read: How the Personal Computer Broke the Human Body: “What Zuboff observed was that as intellectual engagement with the work went down, the necessity of concentration and attention went up. What the computer did was make the work so routine, so boring, so mindless, clerical workers had to physically exert themselves to be able to focus on what they were even doing. This transition, from work being about the application of knowledge to work being about the application of attention, turned out to have profound physical and psychological impact on the clerical workers themselves.”

H/T to PB


Appendix F

In this very short appendix, Marshall explains how the exchange rate in a barter economy (e.g., apples for nuts) will be somewhat arbitrary compared to prices in an economy using money.

In a barter economy, each side has a willingness to trade based on the marginal utilities (MU), since (assuming one has nuts to trade for apples) MU is rising as their stock of nuts is falling, and MU is falling as their stick of apples is rising. In a monetary economy, prices are more stable because (it is assumed) the stocks of both apples and nuts are “unlimited” because apple traders can use cash to buy anything, not just nuts.

This post is part of a series in the Marshall 2020 Project, i.e., an excuse for me to read Alfred Marshall’s Principles of Economics (1890 first edition/1920 eighth edition), which dominated economic thinking until Van Neumann and Morgenstern’s Theory of Games and Economic Behaviour (1944) and Samuelson’s Foundations of Economic Analysis (1946) pivoted economics from institutional induction to mathematical deduction.

Interesting stuff

  1. Read: Predictable shenanigans with carbon offsets in California“Mark Trexler, a former offsets developer who worked in earlier U.S. and European carbon markets, said the board should have anticipated the perverse incentives created by its program. “When people write offset rules, they always ignore the fact that there are 1,000 smart people next door that will try to game them,” he said. Since the board set up a system that “incentivizes people to find the areas that are high-density, or high-carbon, that’s what they’re going to do.””
  2. Listen: The birth of techno in Berlin
  3. Watch: In this 1983 video, Grandmaster flash explains how to mix records. History!
  4. Read: It’s not a ‘labor shortage.’ It’s a massive reassessment of work in America
  5. Listen: (Negative) carbon credits are getting more attention, but can they work?
  6. Watch: Tracking down the other 99% of plastics that are NOT floating in the middle of the ocean
  7. Read: Finally! “Indigenous leaders launch $2.1 billion class-action lawsuits against Canada over lack of drinking water
  8. Read: Are dentists making money on unnecessary procedures? Sadly, yes.
  9. Read: Louisiana’s refineries, chemical plants and other polluting locations are typically located in areas where freed slaves lived — areas that are still predominately Black. Coincidence? No, systemic racism.
  10. Read: Social Justice Groupthink: Liberalism and science, Pluckrose and Lindsay remind us, are “systems—not just neat little theories—because they are self-skeptical rather than self-certain . . . They are self-correcting.” Enlightenment empiricism encourages us to critique our own beliefs and modify them, however reluctantly we may do so. “People in liberal systems are free to believe anything they wish, and they’re free to argue for anything they want, but to claim that such beliefs are knowledge and demand they be respected as such is another matter.” Social Justice dogma, which demands uncritical adherence, is the opposite of liberal, although the political right has muddied the waters for years by grouping us all into a collective rubric of “liberal,” “the left” or “radical.”

H/T to BZ

Escape the income trap, live well

Kaattje writes*

As with many Latin American countries, Ecuador has failed to progress after reaching middle-income status decades ago. Low productivity growth and a failure to move up the “value chain” are typical features of the ‘middle-income-trap’. As with other countries with natural resources, Ecuador’s growth-strategy relies on extracting and exporting raw materials (mainly petroleum but also bananas and coffee) rather than on diversifying production. GDP-growth depends on high prices for primary commodities, leaving the economy vulnerable to price-volatility. The norm of low-skilled and low-value added activities limits job creation and overall labour-productivity.

Escaping the middle-income trap requires structural change. Resources and labour must be reallocated in ways that diversify the productive matrix and upgrade production. Plummeting petroleum-demand in recent years, falling commodity-prices, as well as Ecuador’s sub-soil reserves being inherently finite increase the pressure to diversify the economy. The government’s current industrial policy, however, continues to focus on extractive practices, expanding oil-extraction and investing in large-scale mining. This view does not contribute to development and conflicts with the state’s constitutional commitment to ‘Buen Vivir’, or striving for social  well-being while preserving nature and harmony among citizens who are treated equally. Such conceptualizations, originating in indigenous communities, create a demand for escaping the middle-income trap without causing substantial environmental damage.

Sustainable tourism has emerged as an alternative to extractive activities. Eco-tourism can contribute to Ecuador’s economic diversification while respecting its ‘Buen Vivir’ goals. Ecuador is home to 17 different ecosystems and the most diverse biological hotspot of the western hemisphere.

The eco-tourism experience depends on the degree of environmental protection, as future revenue depends on avoiding natural depletion. One challenge is the subjective understanding of ‘green’ tourism, which leads to self-regulated notions of environmental stewardship and raises questions on “greenwashed” experiences.

Three objectives must be balanced to minimize tourism’s potential costs to sustainable welfare: nature conservation, local participation, and economic feasibility. Past experiences in Latin America have shown the importance of using ecotourism revenues to maintain the natural resource base and the importance of host-community empowerment. Local definition and management of eco-tourism allows communities to turn their natural and cultural heritage into an economic asset while also ensuring its protection. Costa Rica‘s experience is helpful: the country advanced to one of the leading eco-tourism destinations worldwide on its way out of the middle-income trap, coming from an export-profile similar to Ecuador’s. Past eco-tourism stories also highlight how the effective advancement of sustainable well-being means balancing among (sometimes competing) economic, environmental and social interests.

Bottom Line: After being stuck in the middle-income-trap for over 60 years, it is time for Ecuador to move past its dependency on resource-extraction, to focus on sustainable development under ‘Buen Vivir.’

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Dutch education, debt & sustainability

Haydar writes*

In the Netherlands, the government subsidizes education. Historically, students had to pay fees, but they were much lower than actual costs. In addition, students at university received a stipend to make sure that everyone, especially students from lower income families, could participate. In 2012, this system changed. Stipends were replaced by loans, which can scare potential students away.

The choice of participating in higher education depends on financial pressure, future earnings, educational demands, value placed on higher education and personal characteristics (Metcalf, 2005). Metcalf shows that higher fees mean more debt and longer enrollment, both of which reduce students’ satisfaction with higher education.

The 2012 reform had one element aimed at a particular group. The previous policy gave an additional grant to students from low-income families, and the reform increased that supplement, thereby increasing in the difference between students with and without the supplement. Students not living with their parents received €14.000 less while students living with their parents received an extra €1.500, leading to a total difference of €15.500 (Bolhaar, Kuijpers, Zumbuehl, 2020).

The 2012 reform led to more debt for Dutch students (see figure) due to an increase in the price of education but also changes in student behavior. Some students borrowed more money and worked less. Other students worked the same but borrowed more. Why this happened is not clear, but the effects of this loan system can be devastating as students graduate with more debt. For students who will earn more, extra debt may not be a problem, but that debt will be a burden on those whose earnings do not rise as fast as their debt (Bolhaar, Kuijpers, Zumbuehl, 2020; Scheer, Visser, 2020) .

The bright side of this reform is that the university enrolment did not change but is the extra debt sustainable?

Bottom Line: The 2012 reform has led to more debt for more Dutch students. Students do not seem to mind this system, but their increasing debt may not sustainable. Should the reform remain as it is or is a “reform to the reform” necessary?

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Germany’s stubborn coal industry

Paula writes*

It was with relief and a good dose of surprise that the news was heard in January: Germany will achieve its targeted emission limits for 2020. Although this previously seemed out of reach, the COVID-19 pandemic allowed emissions to be reduced by 42.3%. But this is not enough. It has been long known that coal must be phased out to mitigate climate change and meet the 2015 Paris promise of keeping global warming below 2 degrees.

Germany is the largest producer of coal in Europe (see image). The energy sector constituted the largest share of CO2 emissions in 2018, with 34% of energy gained through coal in 2017. In 2020, the government announced the coal phase-out by 2038. It will be driven by increasing CO2 prices and state-ordered shutdowns of coal-fired powerplants.

Moreover, it has recently become obvious that even from a purely economic point of view, the coal industry is ceasing to be profitable. This is mostly due to negative externalities caused by extensive greenhouse gas emissions. As CO2 emissions have been quantified and monetized by the EU’s Emission Trade System (ETS), production costs of coal energy will steadily increase. Additionally, the increasing competitiveness of renewable energies has resulted in lower electricity prices and hence decreasing market share for coal. Lignite mining will be economically unprofitable by 2030.

To compensate for possible financial losses of the industry, the government will pay more than 4 billion euros to two of the biggest energy firms, RWE and LEAG. However, this amount appears to be €1.9 billion more than the firms realistically need to finance the transition. Moreover, despite the grim outlooks for the industry, RWE – the biggest producer of CO2 in Europe – is still deforesting areas and relocating villages to expand coal powerplants. This brings up the question of the role and interests of big energy firms in the coal-phase out.

According to economic theory, inefficient firms should be eliminated under perfect competition as new firms enter the market and compete for profits in the long run. Thereby, resources are allocated to the most efficient producers. This theory does not hold in Germany, where the energy market has an oligopolistic structure, allowing big firms to keep producing despite cost disadvantages. One source of such imperfect competition can be lobbying and bribe-paying. A major lobbyist against the coal phase-out has been the “Wirtschaftsrat” (an association representing the interests of 12.000 businesses) – known for its proximity to the CDU, which is in the ruling coalition. More specifically, RWE’s close relationship to CDU politicians has given the company significant political influence, such as in the commission on energy-policy.

The interests of big energy firms run against the public interest when it comes to Germany’s coal phase-out. Firms want to avoid losses and stranded assets by producing as long as possible. The “public interest” does not automatically mean pursuing sustainability goals, but it does mean allocating resources (including labor) to future-proof industries, reducing emissions, promoting ‘clean’ energies, and facilitating job transitions.

Bottom Line: The market power of Germany’s big energy firms allows them to sustain inefficient production against the public interest.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Corruption in crisis management

Laura writes*

In 2015, Nepal was struck by a 7.8 magnitude earthquake followed by a 7.3 magnitude aftershock, resulting in over 9,000 casualties and almost 22,000 injured people (BBC, 2015). Entire villages were decimated, 2.8 million people were displaced, and 4.2 million people were in urgent need of medical assistance (WHO, 2015).

Source: BBC, 2015

The international community responded immediately by sending in rescue teams, necessary materials, and various forms of humanitarian and financial aid (MSF, 2015). Although this aid helped the Nepali community tremendously, not all resources reached the intended target groups. Why?

Primarily because of corruption.

Corruption – the ‘abuse of public office for private gain’ (Schleifer & Vishny, 2003) – is a notorious problem in development aid and affects resource allocation greatly. According to Ban Ki-Moon, the former Secretary General of the United Nations, corruption absorbs a baffling 30% of all development assistance that never makes it to its final destination (UN News, 2012), and there is increasing evidence of a strong statistical correlation between corruption and a loss of life in earthquakes (Messick, 2015).

In Nepal, corruption hampered post-earthquake aid allocation in a number of ways, which are important to examine to avoid the further loss of resources. First, corruption diverted aid away from target groups into private pockets. This is a principal-agent problem, as is exemplified by volunteer staff who reported that Nepali government officials required bribes and a share of the resources to allow the inflow of earthquake resources from India (Francis, 2015) . In addition, the Nepali government tried to “wrest control of relief” by demanding that all aid allocation should flow through the Prime Minister’s Disaster Relief Fund, which centralized aid funds and made it easier for bribes to be extracted (Francis, 2015).

Second, the presence of corruption disincentivized international donors from providing humanitarian or financial aid in future crises (Francis, 2015). For example, Britain’s International Development Committee announced large budget cuts to their development program to combat corruption in Nepal and in other earthquake-stricken countries to penalize the governments for it (Griffin, 2021). Consequently, it not only hampers short-term allocation of aid, but long-term trust in the government to allocate the aid.

Although the international community knows that corruption takes place and that it hinders development aid from reaching those in need, it still has long ways to go in identifying where and how it inhibits aid allocation. This is a strong reason to conduct case studies of corruption in post-crisis management, such as in Nepal.

Bottom Line: Corruption disrupts development aid from reaching those in need. To avoid a further loss of resources, the international community needs a better understanding of the origins and mechanisms of corruption.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).