Knowledge Problem

I’m off to Aberdeen, the home of the UK oil industry. Can’t wait!! I hope to find some good uisge beatha there as well; that’s water of life, or whisky in English.

Another variable in OPEC’s ability to sustain cooperation in the cartel is something they will discuss today at their meeting: the fall of the US dollar. As this story reports, the currency in which oil trades are denominated us the US dollar, so its decline is not good news for oil producers who are trying to raise revenues from the sale of oil by restricting output to raise prices. As this story says,

Continued dollar weakness another incentive for OPEC members to bust quotas, OPEC source says. In the short-term, producers can maintain their purchasing power by selling more crude. The dollar recently traded at 27 month lows against the euro and at seven month lows against the yen.

This Bloomberg News story also summarizes the OPEC meeting, and mentions how much cheating on the production quotas is occurring, as well as the motivations for it:

Rather than raise the targets, members have pumped more than promised to fight Russia, Norway and other rivals for market share.

Isn’t competition a grand, disciplining force?

One of the charming and fascinating things about British culture is the contradictory use of euphemisms for some things, and brutally frank phrasings for other things. The word “toilet” is one such contradiction — whereas we Americans say “restroom” or “ladies room”, even properly-brought-up Brits will say “excuse me, where is the toilet?” I must admit, this one grates on my ear much, much more than any other British/American English difference. So I was deeply amused yesterday when I encountered a reversal of this yesterday at Fortnum & Mason. I finally have done something I’ve wanted to do since I first studied in London in 1986 — I had a cream tea service yesterday at Fortnum’s (it was yummy, and the strawberries were fantastic, perfectly in season). I had some confusion following the waitress’s directions to the ladies room, because when I did so all I saw was a door that said “ladies and gents cloakroom”. Now, when I think cloakroom, I think coat check; but indeed at Fortnum’s, the cloakroom is the restroom is the toilet!

I noticed something yesterday (Tuesday) that is quite different from the last several visits I made here, and from when I lived here four years ago. There are many, many more cyclists on the roads, and the cyclists no longer wear face masks to filter out the particulate in the air. London’s air is still by no means pristine, as my skin indicates after just four days here, but it’s quite a bit better than it used to be. Some of that improvement is due to fleet turnover, primarily in taxicabs but also a little in buses. Some of the improvement is also due to London’s efforts to control congestion and use a fee-based system to reduce congestion in central London. I have not kept up with the developments in the congestion fee program, but I have noticed an appreciable change in air quality here.

I spent three-plus hours yesterday at the Victoria and Albert Museum, a monument to Victorian intellectual omnivorousness (and the grandeur of the Empire, of course). Most of this time I spent only in the ceramics and pottery galleries.

The evolution of ceramics uses, decoration, themes and techniques illustrates and parallels economic growth more broadly. The 12th-14th centuries were dominated by Islamic ceramics, which were largely mosque and palace decorations in very ornate, detailed geometric patterns. The dramatic colors of blue, orange/red and yellow were intense, and were the result of using costly vegetable dyes in great concentration. As with medieval cathedrals and castles in Europe, these decorations also functioned as a show of wealth. Increasingly over these two centuries these techniques showed up in home goods. Also increasingly into the 17th century, Islamic pottery showed strong use of Chinese motifs (especially as Ming dynasty pottery became so popular). The use of Chinese motifs also indicated the cross-cultural trade with China that increased up to the 17th century (but then fell off dramatically due to Chinese imperial isolationism), because the Islamic diaspora served as a crucial trade conduit between the Far East and Europe.

Spanish ceramics of the 15th-16th centuries reveal the Islamic influence of the Spanish conquest. Italian ceramics of the same period (15th-16th centuries) show many similarities — the use of strong colors from expensive dyes, decoration of cathedrals and palaces — but use largely religious themes (I believe the Koran prohibits human and landscape representations, so this difference is not that striking). The general appearance of Italian ceramics and the integration of geometric designs with human representations reflects an Islamic influence, certainly a result of cross-cultural trade and the growing trade networks of the Italian city-states. One thing I noticed yesterday is that around 1530 you start to see the Mannerist techniques of the Renaissance showing up in pottery, and the human representations become much more realistic and compelling, with more complex facial expressions.

Then the Dutch pottery becomes popular in the 15th-17th centuries, mirroring their growth and role as the commercial and financial juggernaut of the period. Again, Delft china shows a lot of Chinese themes, consistent with their trade and with the popularity of Ming china. Relative to the earlier Islamic, Spanish and Italian pottery, Dutch pottery is thinner and of a more consistent quality, which is the result of the increased ability to fuel hotter fires for kilns in reverberatory furnaces and clay-lined kilns to refract heat back into the kiln.

British pottery was, shall we say, rustic before the 17th century. Very utilitarian, with little emphasis on decoration and much on functionality. The heyday of British pottery comes with the entrepreneurship of Josiah Wedgewood in the mid-18th century, who harnessed the ever-increasing ability to fuel hotter and hotter fires more efficiently with coal and coke to build larger and larger kilns (that’s economies of scale for you). He also spearheaded the canal construction of the mid- to late-18th century in the British midlands, which increased transportation networks for heavy and fragile items such as pottery (and, by the way, for coal and coke coming into Staffordshire).

Wedgewood and subsequent Staffordshire potteries, such as Minton, used these transportation networks and economies of scale in production to create consistent, higher quality, diversely decorated and styled, ceramic objects and vessels in a variety of price ranges. Now families in a wider range of incomes than just the wealthy with palaces and estates could have beautifully decorated, higher quality ceramic items to increase the beauty in their everyday lives. Mass production brought higher, and higher variety, quality at affordable prices for more people.

Mass production created a backlash, of course, in the Aesthetic and pre-Raphaelite movements of the late 19th century, with its focus on artisanal pottery. Mass production potters such as Minton cleverly incorporated these motifs as they became more popular, co-opting the arts and crafts motifs for mass consumption, but also thereby increasing their popularity (to this day, even; they are by far my favorite types of ceramics, especially in their American manifestations).

How does this story mirror economic growth? Look at the time periods of the ascendancy of each society’s ceramics, the effects of cross-cultural trade on the aesthetics of a society, the effects of technological change on technique, the change in quality that provides increasing value for money for more people, and the role of entrepreneurship in creating growth and profit opportunities by serving wider and wider markets.

An interesting story on the political dynamics of OPEC from today’s (sorry, no specific link, I am reading the print version). At the upcoming meeting in Vienna, OPEC is expected to choose Alvaro Silva, Venezuela’s current energy minister, as secretary general. The current secretary general, Ali Rodriguez, is Venezuelan, and Silva will serve out the remainder of Rodriguez’s term. Hugo Chavez recalled Rodriguez after the failed coup against his regime to head PDVSA, the nationalized Venezuelan oil company.

This move is seen as a gambit to keep Venezuela from increasing its production; as I mentioned in a post last week, Venezuela shares Saudi Arabia’s need for revenue from oil sales, and in the face of lagging demand worldwide, cheating on the production qoutas and increasing production may be the best way to achieve that. OPEC seems to believe that appointing Silva will undermine Venezuela’s incentives to break with the cartel and cheat on its production quota. Silva is infamously anti-market, and opposed opening Venezuela’s oil industry to foreign capital in the 1990s.

According to this Associated Press story and this Reuters story, a California Senate investigation has found email evidence that the Los Angeles Department of Water and Power, the largest municipal utility in the country, may have engaged in some of the same trading practices that have been called “market manipulation” when performed by independent generators. The role of the munis in the California “market” is potentially quite interesting, and the California Senate committe has been looking into it for the past year. The thing that I find the most striking is the completely inconsistent treatment and rhetoric between independent generators and the munis. Public power generators, such as LADWP and BC Hydro (from British Columbia), charged some of the highest hourly prices in the California “market” in late 2000 and early 2001, selling into the ISO in peak hours when the ISO was willing to pay almost anything to keep the juice flowing. My primary interest in this is that the actions of the independent generators and the actions of the munis should be treated consistently. If we’re not going to castigate the munis for selling when the need was greatest and profiting from it, or for using arbitrage strategies that were legal (although potentially questionably ethical), then we shouldn’t castigate the independent generators. And vice versa.

I am leaving tomorrow for London and Aberdeen, to give presentations at the Institute of Economic Affairs and the annual meetings of the International Association of Energy Economics. I am leaving town at the right time, as my Cubs continue to be depressing (although at least Alou’s hitting is coming along, he just hit a single and is 2 for 4 today) and the first heat wave of the summer is coming this weekend. The paper I am presenting at the IAEE meetings is a version of this comment that I submitted to FERC in April in their market structure and design comment period, which I also mentioned below in my GAO post. I’m going to try to post commentaries on some of the papers, since it is an energy conference, as well as some observations as I travel around one of my favorite places on the planet.

Leave it to my eloquent former colleague Virginia Postrel to pick up on an extremely good analysis of the economics of antitrust law by Paul Joskow. I read this article on the plane to San Francisco last Friday, and it was one of the most compelling arguments I’ve seen yet for why actions, institutions and market structures that might look anti-competitive could really be outcomes of market processes. If you don’t take into account transaction costs, you miss them. It’s a great article. Virginia’s column on it is also far, far better than any summary I could write; go read it and enjoy.

Following up on an article in Monday’s Wall Street Journal (subscription required), I’ve been reading up on Irbis Enterprises. Irbis, which means “snow leopard” in Mongolian, is an organization attempting to align the incentives of nomadic herders in Mongolia with not killing snow leopards to sell their coats. As the WSJ article says,

Irbis … marries two causes — wildlife conservation and poverty reduction — that are often at odds … [T]he snow leopard … shares its home with people who have no option but to rely on the land for survival.

Here’s how it works: Irbis trains nomadic herders in crafts using local materials. Herders sign a contract with Irbis stating that they will not kill snow leopards, and they keep the proceeds from the international sales of the items they make. Irbis pays each family a 20 percent bonus if no snow leopards are killed in their area, and if a snow leopard is killed, then all families in the area lose that bonus. This summary of Irbis’ methods lays out the conservation contract and the bonus arrangement. Also, almost all of the individuals working with Irbis (and by association with the International Snow Leopard Trust) are indigenous Mongolians.

OK, how do the economics of this setup align incentives for human well-being with snow leopard conservation? First, Irbis is focusing on creating trust and relationships through developing local institutions, using local people and local knowledge. These informal institutions are the foundation of successful, ongoing commercial relations and trade. Second, the concept of a contract as a binding agreement between Irbis and the herders to trade skill acquisition and profits from crafts for profits from killing snow leopards creates an institution of visible commitment. Third, the payment of a bonus contingent on the actions of a larger group of families, and the potential loss of future profits from the cheating of any one family, decentralizes enforcement of this contract and creates a strong social norm within groups of herders to avoid killing snow leopards. Thus enforcement is cheaper and more effective because it relies on local personal relationships coupled with a potential real economic loss if any one of them cheats.

This set of institutions illustrates many, many of the lessons we learn from game theory. First, repeat the interactions to increase the possibility of cooperation to achieve mutually beneficial outcomes. Furthermore, exploit the already-existing repeated interactions among herding families that travel in groups together to increase the possibility of cooperation at lower enforcement costs. Second, find some way to make commitment credible, as Irbis is doing with their conservation contract and their trust-building activities. Third, use diffuse local knowledge to customize the institution to fit local culture and norms.

There are about 1,000 snow leopards in Mongolia, and none have been killed in the areas where Irbis has signed contracts with herders. Herder consumption of flour and rice has increased. Irbis is planning on expanding the program, which is quite young, into more of the snow leopard’s range. This is very, very cool. Now if we could achieve this kind of institutional success with tiger (my favorite charismatic megafauna!) conservation and human well-being! This PERC policy analysis by Michael ‘t Sas-Rolfes illustrates only too painfully the incentive problems in wild tiger conservation, and how international treaties to end tiger poaching have little actual effect. The Hornocker Wildlife Institute sponsors and performs extensive conservation and habitat research on Siberian tigers, and you can sponsor individual wild tigers, but their program does not address the core incentive problems in tiger poaching in the way that the Irbis approach addresses the incentive problems in snow leopard killing.