Tag Archives: economics

Pill testing, placebos and illegal market efficiency

Testing illegal drugs for the active ingredient differs from testing for poisonous adulterants. Both tests have opposite effects on drug use before and after buying. After the pill has been purchased, testing reduces use, because sometimes the drug fails the test, whether correctly or not, and is discarded. Before purchase, the option to test for and avoid adulterated or inactive drugs reduces the buyer’s risk, thus increases use.

In the longer term, testing benefits the dealers of purer, more predictable and less toxic drugs, putting some suppliers of fakes out of business. Pill predictability reduces overdoses – a health effect similar to lower toxicity. If old drugs can be tested, but new ones not, then buyers experiment less and the incentive to invent new narcotics decreases.

The avoidance of poisonous adulterants is good for public health, but purer pills not necessarily so. Inactive drugs undermine consumer confidence in the illegal market, reducing use, prices and casual purchases. Trust then requires a long-running relationship with the seller, which has multiple benefits. It motivates dealers to care about the health of their loyal customers, simplifies policing and gives researchers and social workers better long-term access to the at-risk population.

One claimed benefit of party drugs is that they reduce anxiety, increase the user’s confidence and social interaction, thus improving mental health. Evidence from psychiatric medicines suggests that many such benefits are due to the placebo effect. Users are quite inaccurate in estimating the purity of ingested drugs, and factors like price and place of purchase strongly influence their perception of purity. The price per pure gram is negatively related to purity in some markets, further supporting the placebo interpretation. If inactive pills boost confidence similarly to illegal drugs, then there is a clear case for flooding the market with harmless placebos. The availability of pill tests for the active ingredient reduces this opportunity to make the illegal market inefficient. Tests for toxic adulterants, however, actually favour harmless placebos.

Easier combining of entertainment and work may explain increased income inequality

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Many low-skill jobs (guard, driver, janitor, manual labourer) permit on-the-job consumption of forms of entertainment (listening to music or news, phoning friends) that became much cheaper and more available with the introduction of new electronic devices (first small radios, then TVs, then cellphones, smartphones). Such entertainment does not reduce productivity at the abovementioned jobs much, which is why it is allowed. On the other hand, many high-skill jobs (planning, communicating, performing surgery) are difficult to combine with any entertainment, because the distraction would decrease productivity significantly. The utility of low-skill work thus increased relatively more than that of skilled jobs when electronics spread and cheapened. The higher utility made low-skill jobs relatively more attractive, so the supply of labour at these increased relatively more. This supply rise reduced the pay relative to high-skill jobs, which increased income inequality. Another way to describe this mechanism is that as the disutility of low-skill jobs fell, so did the real wage required to compensate people for this disutility.

An empirically testable implication of this theory is that jobs of any skill level that do not allow on-the-job entertainment should have seen salaries increase more than comparable jobs which can be combined with listening to music or with personal phone calls. For example, a janitor cleaning an empty building can make personal calls, but a cleaner of a mall (or other public venue) during business hours may be more restricted. Both can listen to music on their headphones, so the salaries should not have diverged when small cassette players went mainstream, but should have diverged when cellphones with headsets became cheap. Similarly, a trucker or nightwatchman has more entertainment options than a taxi driver or mall security guard, because the latter do not want to annoy customers with personal calls or loud music. A call centre operator is more restricted from audiovisual entertainment than a receptionist.

According to the above theory, the introduction of radios and cellphones should have increased the wage inequality between areas with good and bad reception, for example between remote rural and urban regions, or between underground and aboveground mining. On the other hand, the introduction of recorded music should not have increased these inequalities as much, because the availability of records is more similar across regions than radio or phone coverage.

Would a protest influence you?

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Help, a politician I don’t like is in power! I should do something about it. But what? I know! I will join a protest – this is something. Now I can feel good about myself for having done something. And post on social media how I opposed evil so effectively. I am a socially conscious, altrustic person.

On a more serious note, one way to evaluate whether a given protest could change the situation is to put yourself in the position of the target audience. If your favourite politician was in power, would this protest change your support for said politician? If you were the politician in power, would you change your policy when many opponents use this protest against it?

Even if the answer is no, a protest may still have some effect, because it may change the preferences of the swing voters. The „no” may come from deeply ideological people, whereas more open-minded folks may conform to the herd. If they see many people opposed to something, they may start to oppose it too.

On the other hand, a protest may have the opposite effect to the one intended. It may harden ideological positions and increase polarisation. If the majority is weakly in favour of a policy, then protests against it may strengthen the support of the majority for it, leading to greater turnout and more yes-votes.

From an economic viewpoint, marching on the street with signs, chanting slogans or commenting on social media has no direct impact on politicians or most voters. The exception is those who are stuck in a traffic jam when a protest closes a street. Rational agents should not pay attention to protests which do not affect them (such activism is „cheap talk” in economic jargon, or at best „money burning”).

Real people may be swayed by the opinion of a large crowd. However, a form of protest that has an objective impact on people’s lives is likely to influence people more, because it affects them via both the opinion of the crowd and the direct impact. Both the belief shift and the hardening of the opposition are probably greater.

There are many illegal means of directly affecting the population, but also some legal forms of protest with objective impact. Economic protest is boycotting certain countries, firms or goods, refusing to work for the regime, and moving elsewhere („voting with one’s feet”), and is usually legal. The objective impact is that if enough intelligent and hardworking people shift their spending and taxpaying elsewhere, then the regime will be in fiscal trouble. If this does not change the policy of the leadership, then at least the lack of money will make the program harder to carry out.

There is a larger personal cost for economic protest than for cheap talk. One has to give up certain goods, or pay more, or experience the hassle of moving residence. This is why most people who threaten to boycott a firm or leave a country do not end up doing so. The threats are just another form of cheap talk, which can be posted on social media to impress other cheap talkers.

On backpackers and low-spending tourists

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Countries encourage tourism to make money. The same goes for local governments, tourism industry associations and tour firms. Some places provide options for low-spending tourists like backpackers, despite not making much money from them. These options may be cheap campsites, backpacker hostels, allowing hitchhiking and work-travel visas. At first sight, any positive revenue from poorer tourists would justify welcoming them. This simple revenue calculation, however, neglects the substitution effect and dynamic demand.

Substitution means that if cheaper travel options are available, then some tourists who would have spent more in the absence of these options now spend less. For example, a person who would stay in a hotel if there was no other accommodation, stays in a backpacker hostel instead. On the other hand, if all options are expensive, then the poorest tourists do not come at all. There is a tradeoff between the number of tourists and the average tourist’s spending. If introducing cheaper options leads to many tourists switching to these, but does not attract many additional low-spending people, then creating these cheaper options reduces total profit.

Dynamic demand means that a person who has toured a particular location once changes his or her likelihood of going there in the future. For example, having seen a tourist site, a person does not visit it again. Or someone going on vacation and liking the location starts going there year after year. If a region encourages young, low-income people to visit as backpackers, then it may increase or decrease future visits by these people when they are older and wealthier. In particular, if people do not tour the same location again (and spend more when older), then encouraging them to visit when young reduces the total profit from them over their lifetime.

The fact that some regions welcome backpackers has several possible explanations. There may not be much substitution, or a visit may increase future visits. The tourism industry may not have thought this through and may be reducing their own profit inadvertently. Or the government may have other objectives than taxes from the tourism industry. For example, allowing people from other countries to visit cheaply may make these people friendly to the host country, which may yield some nonmonetary benefit in international relations.

Measuring a person’s contribution to society

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Sometimes it is debated whether one profession or person contributes more to society than another, for example whether a scientist is more valuable than a doctor. There are many dimensions to any job. One could compare the small and probabilistic contribution to many people’s lives that a scientist makes to the large and visible influence of a doctor to a few patients’ wellbeing. These debates can to some extent be avoided, because a simple measure of a person’s contribution to society is their income. It is an imperfect measure, as are all measures, but it is an easily obtained baseline from which to start. If the people compared are numerous, un-cartelized and employed by numerous competitive employers, then their pay equals their marginal productivity, as explained in introductory economics.

People are usually employed by one firm at a time, and full-time non-overtime work is the most common, so the employers can be thought of as buying one “full-time unit” of labour from each worker. The marginal productivity equals the total productivity in the case where only one or zero units can be supplied. So the salary equals the total productivity at work.

Income from savings in a competitive capital market equals the value provided to the borrower of those savings. If the savings are to some extent inherited or obtained from gifts, then the interest income is to that extent due to someone else’s past productivity. Then income is greater than the contribution to society.

Other reasons why income may be a biased measure are negative externalities (criminal income measures harm to others), positive externalities (scientists help future generations, but don’t get paid for it), market power (teachers, police, social workers employed by monopsonist government get paid less than their value), transaction costs (changing a job is a hassle for the employer and the employee alike) and incomplete information (hard to measure job performance, so good workers underpaid and bad overpaid on average). In short, all the market failures covered in introductory economics.

If the income difference is large and the quantitative effect of the market failures is similar (neither person is a criminal, both work for employers whose competitive situations are alike, little inheritance), then the productivity difference is likely to be in the same direction as the salary difference. If the salary difference is small and the jobs are otherwise similar, the contribution to society is likely similar, so ranking their productivity is not that important. Comparison of people whose labour markets have different failures to a different extent is difficult.

Local and organic food is wasteful

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The easiest measure of any good’s environmental impact is its price. It is not a perfect measure. Subsidies for the inputs of a product can lower its price below more environmentally friendly alternatives that are not favoured by the government. Taxes, market power, externalities and incomplete information can similarly distort relative prices, as introductory economics courses explain. However, absent additional data, a more expensive good likely requires more resources and causes more environmental damage. Remembering this saves time on debating whether local non-organic is better than non-local organic fair trade, etc.

Local and organic are marketing terms, one suggesting helping local farmers and a lower environmental impact from transport, the other claiming health benefits and a lower environmental impact from fertilizers. Organic food may use less of some category of chemicals, but this must have a tradeoff in lower yield (more land used per unit produced) or greater use of some other input, because its higher price shows more resource use overall. From the (limited) research I have read, there is no difference in the health effects of organic and non-organic food. To measure this difference, a selection bias must be taken into account – the people using organic are more health-conscious, so may be healthier to start with. On the other hand, those buying organic and local may be more manipulable, which has unknown health effects. Local food may use less resources for transport, but its higher price shows it uses more resources in total. One resource is the more expensive labour of rich countries (the people providing this labour consume more, thus have a greater environmental impact).

If one wants to help “local farmers” (usually large agribusinesses, not the family farms their lobbying suggests), one can give them money directly. No need to buy their goods, just make them a bank transfer and then buy whichever product is the least wasteful.

There are economies of scale in farming, so the more efficient large agricultural companies tend to outcompete family farms. The greater efficiency is also more environmentally friendly: more production for the same resources, or the same production with less. Helping the small farms avoid takeover is bad for the environment.

Fair trade and sustainable sourcing may be good things, if the rules for obtaining this classification are reasonable and enforced. But who buying fair trade or sustainable has actually checked what the meaning behind the labels is (the “fine print”), or verified with independent auditors whether the nice-sounding principles are put into practice? When a term is used in marketing, I suspect business as usual behind it.

Economics to guide materials science

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There are too many possible materials to test them all, or even simulate by computer. Materials scientists theorize what combinations of elements are likely to yield the desired properties, but still there are too many possibilities. One way to narrow the choice is to use economics.

If the goal of developing a material is to change the world or make money, the benefit of the invention must exceed the cost. The benefit comes from the improved characteristics of the material relative to existing alternatives. What the market is willing to pay for an improvement depends on its size. There may be a theoretical maximum for a property, or its historical rate of increase may be used to forecast the likely improvement. Once an approximate willingness to pay for a unit of the candidate invented material is known, this can be compared with its estimated cost.

Financial firms dealing in commodity futures forecast the prices of chemical elements over the likely commercialization time horizon. Only materials using a combination of elements that is cheap enough are commercially promising. Cheap enough means that the improved material must cost less per unit than the market is willing to pay for it. An expensive element can be used, but only in appropriately tiny quantity. The requirement that the bundle of elements cost less than some bound cuts down on the number of combinations that are worth testing. Similarly, the manufacturing method must be cheap enough, so some methods may be ignored.

The basic cost-benefit analysis is a simple idea, though the benefit estimation may be complicated in practice. Probably the companies producing various materials are already taking the potential cost and benefit of an innovation into account in their R&D, but academic materials scientists perhaps not. If the goal is to advance fundamental science and satisfy one’s curiosity, then the cost of the material may not be an issue. But for the world to use the material, it must be cheap enough.

A practical recommendation is for an application-oriented lab to put up a periodic table with the prices of the elements added. A spreadsheet with the prices of commodities can be used to calculate the cost of a candidate combination for a new material. Testing the candidates should proceed in the order of decreasing “profit” (benefit minus cost of the material). This profit is not necessarily the same as commercial profit, because the benefit may include its whole contribution to society, not just the revenue to the producer.

Empirical project ideas with econjobmarket and AEAweb JOE

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The websites econjobmarket.org and AEAweb JOE are centralized job finding sites for economics PhDs. These have databases of application materials of thousands of job candidates, and the interviews many of them got. The subsequent jobs and publications of the job candidates are listed on the web. There are many empirical projects that can be done with this data, for example how certain keywords in recommendation letters predict the job that a candidate gets, or how the CV at the time of job application predicts future performance. One comparison that has been done in the sciences (http://www.ncbi.nlm.nih.gov/pmc/articles/PMC2572075/) is how recommendations of male and female candidates differ, i.e. what words are frequently used for one gender that are not used for the other. It is likely that economics recommendation letters contain similar biases.
The professors of top universities who have access to the databases of the job market websites have an advantage in hiring. They can predict which candidates perform well in the future and offer jobs to those. The employers without access to the databases are left with less promising candidates.

Smarter people have a comparative advantage in theory

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Theory research requires figuring out the result and how to prove it, and then writing these down. Empirical research requires the same, plus running the experiment or analyzing the data in order to prove the result. This requires relatively more time and less insight. If the production function of empirics requires in its input mix more time per unit of insight than the production function of theory, then smarter people have a comparative advantage in theory. They are endowed with more insight, but everyone has the same amount of time.
The amounts of theory and empirical research produced per unit of insight need not be related in any way for the above comparative advantage result.
Based on comparative advantage, I should switch to empirical research 🙂
Some empirical research methods are quite simple, but modern theory requires complicated math. Due to this, empirical research requires more time per unit of methods knowledge in its input mix. People with a stronger methodological background (better education) thus have a comparative advantage in theory. This suggests graduates of universities with more (advanced) coursework should be more likely to do theory.

Lobbying for free insurance

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In many countries, farmers have managed to obtain free insurance from the government – if there is a bad harvest (due to drought, flood or anything else), the government compensates the farmers using tax revenue. On the other hand, if the harvest is unusually bountiful, the farmers do not pay a windfall tax to the government (which would reduce the tax bill of other people or provide more public services). There is thus no premium for the insurance that the rest of society provides to agribusiness.
A thought experiment: the insurance for the agricultural industry is bought from some insurance company who has to pay the farmers if the harvest is bad. The premiums paid to the insurer are taken from the general tax revenues each year. If the insurance company just breaks even (perhaps due to enough competition between insurers, profits are driven to zero), then the movement of money is the same as in the case of “free” insurance by the government.
Agribusiness has managed to pump some money out of other taxpayers with the free insurance. Their success is explained by the classic lobbying theory: if the benefits of lobbying go to a small group, each member of which gets a large sum, then each member of that group has an incentive to put in the effort and money for influencing politicians. If the cost of lobbying is borne by a large group (say the taxpayers), each member of which only pays a small amount, then members of the paying group do not find it worthwhile to make the effort to counterlobby. The savings are too small to be worth the time and money.
If some politician tries to reduce the subsidy to farmers, they are targeted with intense negative publicity. The agricultural industry claims itself to be necessary for “food security” or “feeding the people”. Nevermind that large amounts of food are currently shipped worldwide. Only the import barriers to foreign-produced food are keeping it out of the domestic market. And food security – who takes a country by blockading it into submission these days? A force large enough to surround the country and cut off food import is large enough to take it by storm, which is considerably quicker. Food security really means preventing the rise of food prices. But this is a financial problem and has a financial solution – insurance against a price rise.
If reducing the farming subsidy does not work, a similar effect can be achieved by providing the same subsidy to everyone and raising taxes. Only the administrative costs are higher than in the case of reducing the subsidy. Other industries could argue that they are affected by the weather or other “national emergencies” and deserve compensation from the government. For example, rainy weather reduces ice cream sales and tourism revenues, so the ice cream sellers and the tourism industry could lobby for the same free insurance as the farmers get. If the world price of some natural resource falls, the miners of that could claim an event beyond their control is threatening them with bankruptcy and ask the government for help. If the tastes of the public change so that some form of entertainment is no longer profitable (theatre, opera, classical music), the providers of that can claim to be important for preserving the national culture and the very civilization itself and ask for taxpayer support… wait, that already happens. It is described in the Yes, Minister and Yes, Prime Minister books.
Of course in reality, the subsidies differ across industries, depending on their lobbying prowess. But if the subsidies were proportional to the tax payments of their receivers, they would neatly cancel with the extra taxes levied to finance them. So the government could abolish subsidies by enlarging the set of receivers to include everyone.
By providing free or subsidized insurance, the government is crowding out private insurance – why insure and pay premiums if the government compensates the loss without premiums? This is especially a problem for risks that are common to many voters. For example, a flood is likely to affect the whole neighbourhood, not just one house. In case of flood damage, the people in the neighbourhood can jointly lobby for the declaration of a disaster zone and a public subsidy for rebuilding. So no need to buy flood insurance. With very few buyers, insurance companies stop offering the product.