Bluematter.

Stardom sent me this clip about Seva Cafe, a restaurant operating the Radiohead business model: eat first, then pay whatever you feel like.

Instead of a warm glow, I feel depressed. Why are projects such as Seva Cafe so loved? Why is someone volunteering to do social service more respected than, say, an industrialist that creates tons and tons of consumer surplus? What is wrong with commercialism? Why do people hate prices, money, and the market mechanism itself?

One potential reason behind the markets' bad reputation is their worrying tendency to generate inequality when left unchecked. Most people, however, are not simply against free-market libertarian societies; they are suspicious of markets at the micro level, even when these operate within reach of the redistributionist arm of the state.

My feeling is that people suspect markets because the incentives of the seller are diametrically opposed to those of the buyer: the former wants the price to be high, the latter low (with the opposite going for quality); furthermore, and perhaps more crucially, the parties in the transaction are usually better off concealing information from each other, or communicating outright misleading information (seen any ads recently?). This is not a problem in the textbook model of perfect competition, but real-world markets can generate a lot of ill feeling amongst participants. Information is gold, and it's often hard work. In contrast, in a perfectly altruistic 'giving' economy, the incentives of the giver ('supplier') are fully aligned to the incentives of the receiver ('the buyer'): the former is better off the happier he makes the latter. I'm way more confident in the quality of the food my mom serves me than that of my local chinese. I feel way more comfortable with a friend that 'cares for me' than with an explicitly selfish business associate. I prefer a partner who loves me to paid-for company.

One problem with this is that altruism exists in very small amounts, and it tends to constitute a very unstable equilibrium (a few people deviating is usually enough to bring to whole edifice crumbling down). And even if that wasn't a problem and the objective was to organise an economy of angels, there is no technology that is nearly as good as markets in determining the relative value of goods. An 'altruistic' model can work - often very well - only at the most micro of levels (e.g. in the case of Seva Cafe) where the lack of information can be brushed aside and gross inefficiency can be 'subsidised' from outside the system. But it is no way to run a full-blown economy. Alas, this is not immediately obvious.

The implications of the public's mistrust of markets are profound. Simply put, it's the resource allocation equivalent of having invented the chainsaw and insisting on using your nails to cut down trees. What can be done to change public perceptions of markets?

I am [...] fat. But now my wife, who is desperate, for some reason, to keep me around for a very long time, is turning the economics of obesity on its head, agreeing to provide me financial incentives to finally drop the pounds. It is a peculiar strategy, but it's not without merit: Economists have recently shown that if you pay people enough money, they will lose significant weight.

I thought of that the other day when I was talking to Barry Nalebuff, a professor at Yale University and one the country's top game-theory economists. He has studied weight-loss incentives extensively. When I told him what my wife was paying me, he said: "It's not going to work. It's not big enough. Not even close." [...] he suggested I enter into a contract in which I agree to pay him if I don't drop some pounds. "As much as people don't like to lose money, what they really don't like to lose is their own money," he said.

In fact, some of his Yale colleagues are in the final stages of launching a business based on this very concept. They have started a company called stickK.com that will allow people to take out a contract on themselves. They pick a price. If they don't lose a certain amount of weight, they lose the money, either to a charity, friends or family. Ian Ayres, one of the company's founders, said he hopes the Web site makes money by selling advertisements and forming corporate partnerships.

"The basic idea is to let economic incentives have a chance," he said. "It's been very hard to produce successful results through traditional weight-loss methods."

Ayres took out a contract on himself with another of the company's founders. He needed to get down to 185 pounds, losing at least a pound a week or forfeiting $500 for each week he failed. Sure enough, he dropped below 185 pounds. Now if his weight goes above 185 pounds, a penalty kicks in. He has avoided more than $21,000 in potential penalties. "It's been a free way to lose weight," Ayres said.

He added, "Thousands of studies have shown that people work harder to avoid losses than to gain a similar amount."

From the Washington Post, via Greg Mankiw.

This is so good words fail me. xkcd: a webcomic of romance, sarcasm, math and language, I suggest you read all 340 scripts posted. Here's the blag.

Datacharmer posted recently on the links between charitable giving and wealth, following work by Arthur Brooks. Brooks asserts that:

Emerging evidence—crunchy statistics from real data, not the mushy self-help stuff—supports the contention that giving stimulates prosperity, for both individuals and nations. Charity, it appears, can really make you rich.

To prove this, he regresses income on giving and, to prove causality, he uses volunteering as an instrument for giving. Now for volunteering to be a valid instrument in this case, it would have to be both well correlated with giving levels (fine) and unrelated to income levels (hmmm). While divine favour is promised to those who give, I don’t think this provides us with firm evidence. The trouble is in the number of ways in which income and time spent volunteering could be related. The data on which this work was done comes from the S.C.C.B. survey and a quick look at the variables shows that income is reported at the household level, not the individual. What is often the result of household income rising above a certain level? Stay at home housewives. What do housewives do when the kids are at school (or gone for good)? Volunteer. This is just one possible link between income and volunteering. Another is raised in a comment on the previous post – poor households have to work all hours to make ends meet. As income increases and the budget constraint eases, more time is available to volunteer. I would view the results of this IV work with extreme caution.

The other half of Brook’s work concerns higher levels of giving leading to greater wealth at a national level. I find this story far more plausible. Two of the major recipients of donated funds are universities (at least in the US – in 2006, 14% of total giving went to educational organisations) and organisations working with the socially disadvantaged. It is not hard to imagine a causal chain going from increased funds into education to increased levels of human capital and to increased wealth, or from more social work to greater labour force participation and to increased wealth.

So giving to charity might not make you richer directly, but it probably will benefit your country.

An alternate view of chritable giving is here. The authors propose a view in which giving is a status seeking activity (quite possible with alumni giving in the US) and as such is an inefficient use of resources. They show that under certain conditions it would be optimal to tax charitable donations, rather than giving the usual Pigouvian subsidy. Very interesting.

WikipediaVision, a map showing Wikipedia edits in near-real time

Along those lines: FlickrVision

Ski-gliding the Eiger in the Swiss alps

Preview of the 2010 FiFa World Cup venues

If you have been to the cinema recently, you might have had the "pleasure" of seeing an anti-piracy advert featuring the cast of the (excellent) Pixar film, Ratatouille. Its main points are that pirate movies are terrible quality, have terrible sound and a terrible picture and that if you watch them, you will have a terrible time (and you run the risk of being called a ‘knock-off Nigel’). This ad is ridiculous for at least two reasons I can think of. Firstly, they’re preaching to the choir (we’re already in the cinema, they’ve already won the battle).

Secondly, the ad tells me precisely the opposite of what its makers want it to tell me. It signals to me that pirated films are actually fairly good quality and would be an enjoyable watch, not far off comparable with buying an official DVD. Why? Because if the reverse were true, if they were rubbish, then no-one would buy them (at least, not more than once). If no-one bought them, the big film companies wouldn't be worried about them and wouldn't spend bundles of cash telling me not to watch them. If something is crap, you don't need to tell me not to consume it, I will work that out all on my own, thanks.

Watching Premier League football, you frequently hear claims by away team managers that they have been short-changed by a weak/incompetent ref, more often than not concerning penalties given or not given. Are these managers ever right or are they just suffering from a confirmation bias?

While it is true that opposition teams get far fewer penalties at Old Trafford, Anfield and Stamford Bridge, it is very difficult to determine whether this represents a big-team/home team bias. Man Utd playing at home will normally have more of the play and more penalty box action than their opponents and, as such, would be expected to win more penalties.

This very clever paper seeks to provide an answer by focusing on something that is completely at the referee’s discretion, the amount of time added on at the end of a game. In the authors’ words:

Referees have discretion over the addition of extra time at the end of a soccer game to compensate for lost time due to unusual stoppages. We find that referees systematically favor home teams by shortening close games where the home team is ahead, and lengthening close games where the home team is behind. They show no such bias for games that are not close. We further find that when the rewards for winning games increase, referees change their bias accordingly.

The data is from matches in Spain's La Liga and the authors find that the relevant mechanism is the size of the home crowd. In other words, the more fans a team has at a game, the more they will be favoured by the ref. The authors see this as evidence that social pressure affects referees' decision making. However, it is unclear why this should be the case. It is unlikely that the refs have been bribed (this is Spain, not Italy) and unlikely that refs are afraid of physical harm (again, this is Spain, not Bulgaria). So where is the benefit? Are referees being influenced without realising it, or are Spanish refs all utilitarians, seeking to maximise the welfare of the largest number of people in the stadium? Suggestions in the comments section please.

Last week, The Economist wrote this about Inheritance Tax:

Taxes should be assessed on three grounds: how they affect incentives, how fair they are and how simple. Estate taxes score well on the first two, less satisfactorily on the third.

Are they right? On the first point, efficiency, the answer at the moment is that we just don’t know. The efficiency of IHT depends heavily on whether people who die rich have intentionally remained rich to pass on their wealth to their kids. If this is the case (and these parents actually care about how much their kids receive, rather than gaining utility from the act of giving itself) then IHT will distort behaviour, tending to reduce the incentives to work and save. If, however, most people who die with assets were holding them as insurance against living a lot longer, then IHT would cause next to no distortions and would be a very efficient tax. Unfortunately, it is very difficult to empirically disentangle peoples' motives, so we don't currently know which is more prevalent.

The Economist are right, however, in pointing out that IHT improves the work and savings incentives of children of the rich. Expecting to receive a huge inheritance surely can’t be good for your entrepreneurial zeal.

IHT does fare better on the second point, equity, as it is paid exclusively by the rich. Only 6% of estates pay it and the fact that this will rise slightly over the next few years indicates simply that more people are becoming rich (it doesn't matter whether this is from a property boom or from anything else). On the downside, the many loopholes allow the very rich to avoid paying any IHT, leaving the rising middle classes to shoulder the burden. There is also Tim Worstall’s argument that rich kids are an equalising force in themselves, through their profligate spending habits. Overall, IHT does seem to promote a more equal society, based on merit rather than fortune (and would do a better job with a lower threshold than £600k).

On the third point, simplicity, the UK's tax is actually a better option in many ways than a pure inheritance tax (the option favoured by The Economist - along with the crazy French idea of varying the rate according to the closeness of blood ties between bequester and inheritor). While taxing inheritances directly would be far more equitable and would encourage the spreading of bequests, it would be an administrative nightmare compared to the relatively simple single probate system currently in force. It would also create a whole new raft of avoidance possibilities. A better option for the UK would be to simplify the current regime and cut out many of the loopholes currently exploited by the rich, especially the use of trusts.

I am out of town for a week with limited access to the internet, and a fine economist and good friend has agreed to guestblog here at Bluematter. while I am away. Most of you are not my mom, but I thought I'd let you know anyways.

Chris Dillow links to this very clever paper (free access):

We provide a test for statistical discrimination or "rational" stereotyping in environments in which agents learn over time. Our application is to the labor market. If profit maximizing firms have limited information about the general productivity of new workers, they may choose to use easily observable characteristics such as years of education to "statistically discriminate" among workers. As firms acquire more information about a worker, pay will become more dependent on actual productivity and less dependent on easily observable characteristics or credentials that predict productivity.

When you start out on a job, employers have to make do with easily available information about you (years of education, race, etc). As the employer observes individual productivity first-hand, however, this information becomes obsolete. So, if employers are fully rational and internalise the additional information efficiently, education and other easily observable characteristics should become increasingly weaker predictors of wages. The way they test for this is by utilising additional variables for characteristics that are not easily observable but are correlated with productivity:

Consider a wage equation that contains both the interaction between experience and a hard-to-observe variable that is positively related to productivity and the interaction between experience and a variable that firms can easily observe, such as years of education. We show that the wage coefficient on the unobservable productivity variable should rise with time in the labor market and the wage coefficient on education should fall. We investigate this proposition using panel data on education, the AFQT test, father’s education, and wages for young men and their siblings from NLSY. [...] Our results support the hypothesis of statistical discrimination.

So far, so good. But the authors also go on to test for discrimination on the basis or race; econometric specification issues aside, their results are worrying:

We use a similar methodology to investigate whether employers statistically discriminate on the basis of race. If our model is taken literally, the small race differentials for new workers and the spread in the race gap with experience is most consistent with the view that race is negatively correlated with productivity and the productivity gap becomes reflected in wages as fims acquire additional information that can legally be used to differentiate among workers. We wish to stress however, that other factors are probably as or more important in differences between whites and blacks in wage profiles, and race differences in human capital accumulation accounts for at least part of our findings.

Xenophon, Works on Socrates:

I once heard him discuss the subject of estate management (in Greek: οικονομία, economics) in the following manner.
“Tell me, Critobulus, is estate management the name of a branch of knowledge, like medicine, smithing and carpentry?” “I think so,” replied Critobulus.[...]

“But what do we mean now by an estate? [5] Is it the same thing as a house, or is all property that one possesses outside the house also part of the estate?”
“Well, I think that even if the property is situated in different cities, everything a man possesses is part of his estate.”
[6] “Do not some men possess enemies?”
“Of course; some in fact possess many.”
“Shall we include their enemies in their possessions?”
“It would be ridiculous, surely, if one actually received a salary for increasing the number of a man's enemies!”
[7] “Because, you know, we supposed a man's estate to be the same as his property.”
“To be sure--meaning thereby the good things that he possesses. No, of course I don't call any bad thing that he may possess property.”
“You seem to use the word property of whatever is profitable to its owner.”
“Certainly; but what is harmful I regard as loss rather than wealth.”[...]

[10] “That is to say, the same things are wealth and not wealth, according as one understands or does not understand how to use them. A flute, for example, is wealth to one who is competent to play it, but to an incompetent person it is no better than useless stones.”
“True--unless he sells it.”
[11] “We now see that to persons who don't understand its use, a flute is wealth if they sell it, but not wealth if they keep it instead of selling.”
“Yes, Socrates, and our argument runs consistently, since we have said that what is profitable is wealth. For a flute, if not put up for sale, is not wealth, because it is useless: if put up for sale it becomes wealth.”

Through a few vias originating at The Visible Hand in Economics and a post entitled Was Jesus an early applied economist?

Google trends on economics: (1) Seasonality (2) Negative trend (3) Top source: Pakistan

The worlds top 5 smallest countries

Are you tone-deaf?

Death, and more death

Simulating the life of bugs

Who owns who in the motor industry

Via Social Science Statistics. The Dilbert blog is, of course, by far the best economics blog amongst nominally-non-economics blogs out there.

...looks like Japan!


Via Marginal Revolution.