Knowledge Problem

Lynne Kiesling

I am in Glen Arbor, Michigan, attending a Liberty Fund conference on Charles Darwin. I’ll have a lot to say about it.

But for now, I refer you to the plentiful and interesting posts today at Environmental Economics. Coase, Grandfather Mountain, and an energy bill update.

Lynne Kiesling

Because that’s what it looks like to me. And to Jim Lucier of Prudential Securities, who took the words right out of my mouth on Tuesday’s Kudlow & Company. In all of the commentary and analysis that I have read, very few people believe that this bill will do anything constructive to remove obstacles to competitive electricity markets, reduce our overall energy consumption, or provide valuable direction to energy technology research. Its most noticeable provision amounts to little more than a farm subsidy under a different name. From a recent Reuters article:

To stretch America’s gasoline supplies, the leaders of a joint Senate-House conference committee racing to finish a U.S. energy bill agreed on Monday to almost double production of the motor fuel additive ethanol to 7.5 billion gallons a year by 2012. …

The ethanol compromise is larger than the 5 billion gallons approved by the U.S. House of Representatives, but smaller than the 8 billion gallons called for by the Senate.

Ethanol, derived mostly from corn, is a popular political cause in farm country, where it is regarded as a homegrown answer to oil imports and a boon to farm income.

Ethanol lobbying has paid off, as has energy industry lobbying:

Oil and utility companies such as Exxon Mobil Corp. and Southern Co. spent $367 million over the last two years pushing the U.S. Congress to pass energy legislation. For many, the money was a good investment: lawmakers are poised to pass a measure providing about $11.6 billion in taxpayer subsidies. [NOTE: if you read the whole article, I think the author misunderstands the effects of PUHCA repeal, for what it's worth.]

Increasingly, we have become resigned to the fact that legislation like this is nothing more than thinly-disguised excuses for subsidies to well-organized parties that are good at lobbying. One comment I’ve heard from folks who are knowledgeable about energy and favor competition and markets is that the most important thing about this bill is getting is passed and over with so we can get on with life. That’s hardly a ringing endorsement!

Why have we allowed ourselves to become so blasé about rent seeking? Even in as large, prosperous, and complex an economy as ours, an expenditure of $376 million on lobbying is a huge waste. And that doesn’t count the lobbying expenditure of ethanol and environmental interests. Pretty much flat-out deadweight loss, with very little creation of new value. Where’s the outrage? Are we so beaten down by the sclerotic bureaucracy of politics that we just chalk it up as essentially another tax, and then get on with our lives?

That difference between the active engagement of concentrated interests who will benefit from legislation and diffuse interests who will pay the price is at the core of Mancur Olson’s analysis of rent seeking. The Rise and Decline of Nations applies his arguments from The Logic of Collective Action to analyzing growth and decline in stable societies (i.e., not being ravaged by war or political unrest). He argues that in stable societies, decline occurs because groups organize to try to capture increasing shares of economic surplus. Sadly, this race to capture requires the expenditure of resources, which is what wasteful rent seeking is.

Note also that the appearance of decline is likely to be slow and incremental, particularly if the society is dynamic and productive in other ways. So we have to compare the drag on the economy that rent seeking produces in our stable society relative to the total surplus that we would create if we were not saddled with the wasteful expenditure of rent seeking. Since we have to compare the very-real results we experience in the presence of rent seeking with hypothetical results we don’t experience, we have a problem of “the seen and the unseen” from Bastiat. We don’t see the true benchmark against which to compare our actual state, so we don’t evaluate it properly.

Also of note: if you look at the the Google news search for recent articles on the energy bill, note how varied the headlines are. There are so many different regional dimensions to this bill, it’s amazing. Something for everyone to love and hate, although for my part I see very little of substance to love. I guess that’s how logrolling, vote trading, and pork barrel politics works. That complex set of incentives is how organized groups take advantage of our indifference.

Lynne Kiesling

While we’re on the subject of contracting and incentives in sports … Khazak cyclist Alexandre Vinokourov is leaving team T-Mobile for Spanish team Liberty-Seguros. “Vino” came in fifth in the Tour last week and third in 2003.

As contracting and team dynamics go, cycling teams are a fascinating subject for study. Vino is leaving T-Mobile because he wants to win the Tour, but T-Mobile is Jan Ullrich’s team and is likely to continue to be so for the next couple of years. Cycling teams in the Tour cannot simultaneously support two contenders; given the complex institutional structure of the Tour, the dominant strategy for a team that wants to have an overall winner is to ride in support of one contender (note that not all teams share that objective function, but may want to maximize stage wins, or green jersey/polka dot jersey wins).

There was some speculation of Vino joining Team Discovery Channel, but now my money’s on George Hincapie as the Discovery contender for 2006.

Lynne Kiesling

For new institutional economists, the NHL is a multi-dimensional laboratory right now. The six-year labor agreement signed last Friday, including team-level salary caps and revenue sharing, has spurred a flurry of contract buyouts. The Yahoo Sports NHL news archive since Saturday has been full of stories of teams buying out contracts of their star players. The Flyers have bought out John LeClair and Tony Amonte, the Red Wings have put Derian Hatcher, Darren McCarty, and Ray Whitney on waivers that could lead to contract buyouts, and so on.

If I had Vincent Lecavalier, I’d want to keep him too (and I mean that in many ways, he’s a great hockey player and he’s easy on the eyes!). But now the Lightning and other teams who might compete for his services have to come up with non-salary dimensions of the transaction.

In other words, the contract changes, the imposition of new contraints and the relaxation of others, are inducing a realignment of costs, personnel, etc. The parties have agreed to a contract that addresses a particular set of strategic actions that they think the other side could take during the term of the contract; in so doing, though, they have induced a realignment process for both owners and players. This is institutional change in action. Of course, complete contracting is impossible, so over the next six years I’ll be interested to see what opportunities evolve for opportunistic behavior on the part of both parties.

Another dimension in which the NHL is a NIE laboratory is in their proposed rule changes. The rules are primarily meant to increase the flow of the play (good), and continue to erode the strong benefits of the neutral zone trap defense, with an ultimate goal of making the game more television friendly. Some of the rules with the most interesting incentive effects are

• Offensive zones will be bigger, the neutral zone will be smaller, and the end zones behind the goal line will be smaller.
• The center line doesn’t count in a two-line pass.
• Offensive players can “tag up” on the blue line if they precede the puck into the zone and not be offsides.
• Goaltenders will have smaller pads and cannot play the puck behind the goal line in the corners.
• When a player instigates a fight in the last 5 minutes, he gets an automatic 5-minute penalty and one-game suspension. Suspension doubles with each additional incident.
• When a player instigates a fight in the last 5 minutes, the Coach is fined $10,000. Fine doubles with each additional incident.
• Ties will be decided by a shootout after a 5-minute overtime, and the losing team still wins a point.

My thoughts on the incentive changes and their likely results: I’ll be interested to see how changing the proportion of the ice that’s neutral will affect flow. I’ve always thought that the larger Olympic ice produced better flow, and it may be that the reason is larger offensive zones, but I don’t know what the proportions of neutral to offensive are in Olympic ice. It’s an interesting change to consider.

I’ve always thought that the mandatory helmet rule created enormous moral hazard and elevated the brutality of the physical side of the game. Given that we seem to be stuck with the mandatory helmet rule, the suspension/Coach fine combo sends a pretty strong signal that coaches must not condone fighting at the end of the game. But what about the other 55 minutes? Will it be business as usual? This also does nothing to address the mid-ice from-behind Scott Stevens specialty cross check, which I think is barbaric and should be subject to this kind of suspension and fine combination.

The interesting thing to me about this suspension/Coach fine combination is that it works to change the coach’s incentives in addition to the player’s incentives. I wonder what the league thinks the revenue effects will be of this rule; sadly, lots of people like the end-of-game fighting in hockey (and just fighting in general). At the margin, will this reduce the attendance of fans with these preferences? I hope not. Maybe it will have a civilizing influence on them …

I pretty much agree with the likely outcomes that Colby Cosh outlined; I also like the way he said that the rule changes are “complex, mutually interacting systems.” (my kinda language!) He nails the idea that the neutral zone trap is now not going to be as valuable. I particularly endorse his comments on the goalie rules:

The removal of the red line should renew some of the intense play in the corners we’ve lost as goalies have become quarterbacks. I didn’t object to the spectacle of free-ranging goalies like Marty Turco on its own merits; I’m open to tactical change in the game, and there are probably conservative NHL fans still learning to cope with the “new” rule that lets goaltenders fall down to make saves. What made goalie quarterbacking absurd was the degree to which they were coddled by the officials. The old rule was that the goalie was fair game for a hit if he left the crease (just as a quarterback can be sacked), and that would have kept goaltender adventuring in check just as well, but apparently it’s not an option. Since the modern goalie seems unwilling to grow a pair, we have little choice but to confine him to his stupid little trapezoid. (But N.B.: this rule change will bring a few more good pure puckstoppers into the league, since puckhandling will no longer be a make-or-break skill for young goalies.)

The new dimensions for goaltender equipment correct a recent, egregious, and entirely objectionable change in the game, and are the most thoroughly unimpeachable rule alteration adopted by the NHL governors. … Call me a crazed romantic, but I want to see the freakin’ glove save come back into hockey.

Amen, brother! And thanks for the Wiki and Hayek discussion link.

Eric McErlain also has some analysis and links to others.

My economic bottom line: I think many of these changes are meant to make the game more television-friendly for casual fans, a beast that the league has been wrestling for two decades. If the television-friendliness strategy pays off, then there will be more profit (or, to be technically correct, vertical rents) to be divided among the players, the teams, and the league.

Lynne Kiesling

Although an avowed long-time hockey fan, I have kept silent on the topic of the NHL lockout and the loss of the 2004-2005 season. Why? Disgust. I thought, and continue to think, that all parties acquitted themselves poorly. The owners and the league made strategic errors in estimating the value of broadcast rights to broadcasters, so held out for more than they should have for several years. They behaved similarly toward the players. The player’s union, in my opinion, has a long history of doing a bad job of representing the interests of the players, largely because I think they take too antagonistic a “stick it to the owners” stance. The players let the union organizers make too many clutch decisions. The result? Loss of a year’s play, a year’s value to fans, a year’s profit to owners, a year’s wages to players.

Except, that is, for the players who played in Europe. Sure, they played for less than they would have gotten paid in the NHL, but they were not in the best bargaining position by the time the opportunities arose. I think the contestability provided by the European leagues was beneficial for bringing Friday’s labor agreement into being, because it moved the threat points of the players in two ways. It gave players a credible alternative to NHL play; however, it did so at a lower wage and a lower quality of league play. So I think the bargaining range for the players compressed some and moved to the left.

I’m excited because my peeps won the draft lottery and are positioned to draft 17-year-old phenom Sidney Crosby. The USA Today argues that Crosby might be the PR goodwill that the NHL needs right now:

The 88-year-old NHL needs something special about now. The league’s 30 teams are hoping the 2.2 million fans who attended games during the 2003-04 season will come back to the rink. With ESPN not exercising its $60 million option to show games this season, hockey is the only one of the big-five pro sports without a cable TV partner in the USA.

I think Gary Bettman should hang his head in shame. If he were CEO of a publicly-held corporation and not the Commissioner of a sports league, he would have had to resign at least in the past year if not earlier. How can the league have so grossly mismanaged both its labor relations and its broadcast relations? ‘Splain me this, Gary: why should I come back to the rink? Why should I even bother to turn on the TV?

If the volume of postings to hockey blogs in the past week is any indication, there’s interest there, latent now because of the past two years of miscalculations and mismanagement. But hockey is likely to remain a niche sport, so don’t be greedy and overreaching in negotiating a new broadcast contract. Negotiate a contract that gives the broadcaster good incentives to show hockey frequently, instead of, say, showing World’s Strongest Man 2000 over and over and over… Even better than treating ESPN/ABC as having market power, how about allowing a local/cable bidding consortium? For example, Fox Sports and local Fox affiliates could put in a bid to broadcast local team games on the local affiliate, but also make several games a week available on Fox Sports. But Bettman is going to have to exercise more leadership than he might be capable of, to get consensus among the owners on a more accessible broadcast strategy.

This idea actually stems from my biggest pet peeve about local vs. cable broadcasting and the rights that the owners exercise. I refuse to attend Chicago Black Hawks games because I do not want owner Bill Wirtz to earn a penny from my business. First, Wirtz owns a wholesale liquor distributor (Judge & Dolph), and Wirtz is a classic rent seeker who has consistently lobbied Illinois and Wisconsin legislatures to reduce the abilities of retailers to shift their business among distributors. Second, Wirtz refuses to allow home games to be televised, even if they are sold out. What kind of antiquated mindset actually thinks that watching a game on TV and going to a live game are substitutes? At the margin am I more likely to buy tickets because I know I won’t be able to watch the game? Certainly not. At the margin am I less likely to buy tickets if I am able to watch the game? Perhaps, but the effect is small, and is probably small for most people. Why he continues to think that this is a profitable strategy is beyond me.

Wirtz’s troglodyte broadcast rights strategy, rather than being profit maximizing, contributes substantially to the continuation of hockey as a niche sport.

[end of rant]

Lynne Kiesling

I’ve mentioned before (here and here) that my hometown of Pittsburgh has an abysmal record of using eminent domain to achieve top-down, centralized urban planning goals, with disastrous results. Poor neighborhoods destroyed, a desolate and soulless downtown, and a languishing area downtown around Fifth Ave. and Forbes Ave. that the city has been trying to develop in its control-and-manage way for years. The city tried to use eminent domain to condemn properties for the Fifth and Forbes development, but one of the Institute for Justice’s best successes was in defeating that exercise of eminent domain for economic development.

Friday’s Pittsburgh Tribune-Review had a column by Jonathan Potts arguing that the city should abandon its central planning ways and see how vibrant development can be when it’s done organically:

The city’s plan has been doomed from the start because it is based on a false assumption — that the best way to rejuvenate the shopping corridor is to turn it over to a single developer who would proceed from a comprehensive plan drawn up by the city and its planners.

American cities have been following this top-down blueprint for 50 years and always with the same abysmal results. Truly vibrant urban neighborhoods develop organically, with minimal interference from government and according to the needs of those who live and work there. Yet thanks to Pittsburgh officials, Downtown’s commercial district continues to decay, its vacant storefronts attracting no one save graffiti artists and vagrants.

He goes on to discuss how downtown property owners, not politically connected suburban developers, are the ones with the best local knowledge to know how to turn buildings into attractive and appealing housing.

Thanks to Pittsblog for the link.

Lynne Kiesling

Glen Whitman’s got a nice post discussing utilitarianism, Coase, Layard, and the implications of Will Wilkinson’s recent evisceration of Layard’s utilitarian interventionist arguments about status and well being. When I first read Will’s post, my initial reaction was “yikes, I hope I never get on Will’s wrong side!” Will cleverly applies Coasian analysis to conclude that if you want to retain a utilitarian, consequentialist approach to status inequality, the least-cost avoider principle from Coase’s “Nature of Social Cost” implies that in some cases the least-cost alternative may be for you to change your preferences. In other words, if you are envious, get over it. Glen writes:

This reasoning opens a mighty interesting can of worms (and I mean that in a good way). In the traditional Coasean approach, preferences of agents are taken as given, and the only question is whose actions can reduce harm at lowest cost (keeping in mind that all harm is relative to the parties’ preferences). But if actions can change preferences, it follows that changing preferences may in some instances be the least-cost means of reducing harm. This is true even for less exotic forms of externality than Layard’s status-externality. Take the airport noise externality. Maybe the least costly solution is for people to start enjoying the sight and sound of airplanes. Or consider the visual externality created by a factory that obscures the view of a nearby mountain. Perhaps the least costly solution is for people to stop caring so much about natural scenery and learn, Rand-like, to appreciate the man-made beauty of mortar, block, and glass decorated with thousands of electric lights.

This is an intriguing line of thought, and one that is going to be a challenge for mainstream economic theory to address. Our models routinely assume preferences are fixed and given, not malleable. It’s a simplifying assumption to enable the math to go through (you need the stationarity, coupled with some other mathematical assumptions, to prove existence of equilibria). But if you relax that assumption, how does it change your results? Clearly you can’t do the same mathematical analysis, so it’s hard to compare results. It’s even hard to show that changing your preferences is the least-cost alternative in a given situation, except as an ex post revealed preference inference.

So while I think Will is right, and Glen is too, I struggle to see how we can make this idea analytically useful.

Lynne Kiesling

In his post inquiring why we organize our kids so much, I like the way Tyler Cowen put his hypothesis 3:

Suburban sprawl is a tax on spontaneity. And as more kids get trapped into planned networks, it becomes harder to go it alone.

I think there’s some validity to that hypothesis. I never lived in a subdivision until I was 14, though, so I may be biased. But I loved the freedom of outdoor exploration, although I did complain at the time because as an only child, it also meant that I had to learn how to entertain myself in the great outdoors much of the time.