Category Archives: Economics

Course video 3: David Ricardo on rent and on trade

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Lynne Kiesling

David Ricardo: Principles of Political Economy & Taxation from Lynne Kiesling on Vimeo.

You may know David Ricardo for his pioneering analysis of comparative advantage as the foundation of mutually beneficial specialization and trade. Ricardo’s work goes farther and deeper than that, exploring (among other things) the determinants of rent accruing to fixed inputs like land, the distribution of income among landowners and labor, and the effects of taxation. Ricardo’s excellent analyses arise from his economic context of trade blockades during the Napoleonic Wars, and the ensuing Corn Laws that Parliament passed to block the importation of inexpensive grain to compete against those politically powerful landowners.

Course video 2: Adam Smith’s Wealth of Nations

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Lynne Kiesling

Here’s the second video for my history of economic thought course: a synopsis of Adam Smith’s Inquiry Concerning the Nature and Causes of the Wealth of Nations. The video gives an overview of the entire work (except for Book III, his stage theory of history), and I hope it entices you to read some or all of it for yourself!

Adam Smith: An Inquiry Concerning the Nature and Causes of the Wealth of Nations from Lynne Kiesling on Vimeo.

Course video 1: Smith’s Theory of Moral Sentiments

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Lynne Kiesling

For the past few months I’ve been working with some talented and creative folks at Northwestern University Academic Technologies to produce some videos for use in my History of Economic Thought course. Over the next few weeks I’ll be releasing them here, and they will be available on my Vimeo page. Please distribute them widely (they have Creative Commons attribution + non-commercial licensing)! Please also leave comments, questions, suggestions, related readings, etc. so we can extend the learning environment far and wide.

Adam Smith: Theory of Moral Sentiments from Lynne Kiesling on Vimeo.

In The Theory of Moral Sentiments, Adam Smith asserts that humans have an innate interest in the fortunes of other people and desire for sympathy with others. Humans are complex individuals in Smith’s theory – rightly motivated by self-interest, but also by the innate sociability and desire for sympathy from and with others that he observed empirically. Sympathy, which Smith defined broadly as fellow-feeling with the situations (not just the emotions) of others, forms the foundation of our moral judgment.

I’m intrigued by Smith’s concept of sympathy. Smith’s model of sympathy is a process of coordination between the self and others. The Smithian sympathetic process has three essential characteristics: sympathy as a synthesis of empathy with judgment based on reason, a spectatorial/external perspective on one’s own behavior and the behavior of others, and an innate capacity for imagination that enables individuals to place themselves in the situations of others. This sympathetic process leads to coordination of expressions and actions across individuals, resulting in harmony and social order. That’s an important sense in which TMS forms the philosophical and psychological foundations of Smith’s later works, especially the Wealth of Nations.

Another subject in TMS that undergirds WON and later work in economics is Smith’s discussion of justice and beneficence. Smith argues that (commutative, or negative) justice is necessary in order to have a peaceable and productive society, while beneficence is nice but not essential. From this argument he concludes that provision for the enforcement of commutative justice is a proper role of government, an argument he will pick up in Book V of WON.

I discuss both of these subjects in the video.

Some natural gas posts worth reading

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Lynne Kiesling

Last week the EPA released a report on the extent of methane release during shale gas drilling; the results indicate that methane release is substantially smaller than previously thought. According to an article in Fuel Fix summarizing the report,

The scope of the EPA’s revision was vast. In a mid-April report on greenhouse emissions, the agency now says that tighter pollution controls instituted by the industry resulted in an average annual decrease of 41.6 million metric tons of methane emissions from 1990 through 2010, or more than 850 million metric tons overall. That’s about a 20 percent reduction from previous estimates. The agency converts the methane emissions into their equivalent in carbon dioxide, following standard scientific practice.

The EPA revisions came even though natural gas production has grown by nearly 40 percent since 1990. The industry has boomed in recent years, thanks to a stunning expansion of drilling in previously untapped areas because of the use of hydraulic fracturing, or fracking, which injects sand, water and chemicals to break apart rock and free the gas inside.

Experts on both sides of the debate say the leaks can be controlled by fixes such as better gaskets, maintenance and monitoring. Such fixes are also thought to be cost-effective, since the industry ends up with more product to sell.

This excerpt reflects my thinking on the leaks — since methane is the product they are extracting to sell and the cost of managing leaks is relatively low (but not zero), the firm has a self-disciplining incentive to reduce leaks (although not eliminate them, since the cost is not zero).

In a post on the EPA report, Walter Russell Mead remarks that

Companies are developing more sophisticated leak detection systems, and unlike many other environmental problems (like, say, power plants’ greenhouse gas emissions), there is a market incentive to prevent these leaks without any sort of green interventionist policy. Every unit of methane released into the atmosphere during drilling is lost profit.

But that’s not stopping misguided greens like Bill McKibben from bemoaning the news. McKibben took this opportunity to stress the need to transition away from fossil-fuels altogether, rather than appreciating the fact that we’re extracting one of the cleanest fossil-fuels more efficiently and with much less environmental impact than ever before. McKibben’s blinders are firmly in place; we’re unlikely to see a revision to a post of his earlier this month in which he suggested that methane leakage might make natural gas worse for the environment than coal.

I’ve never found McKibben’s arguments compelling, and now I realize why: his advocacy for dramatic, fast changes does not reflect how real people in real-world, complex decisions make changes in their behavior. McKibben fails to think at the margin. He does not acknowledge that the long transition to cleaner fuels is already in process. Long transitions are typical in technological change; think about how long it took to transition from water power to steam power — 60 years! McKibben’s argument for sudden, dramatic change does not reflect economic thinking.

Happy birthday Hayek!

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Lynne Kiesling

Today’s Hayek’s birthday, a worthwhile landmark for reflection on his work and why it’s important to read. I assign “The Use of Knowledge in Society” in every class I teach, and I recommend it if you haven’t yet read it. Here Hayek argues that the fundamental economic problem societies face is not the allocation of a given set of resources based on a given set of preferences and technical capabilities; instead, the coordination of decisions and actions among interacting individual agents with diffuse private knowledge and plans forms the basis of economic activity. The diffuse and private nature of knowledge hampers such plan coordination, but out of human interaction, institutions emerge that enable decentralized coordination. Prices and market processes compose an institution for coordination in the face of the knowledge problem. Moreover, Hayek argued, knowledge transcends “scientific” information, there is no given and uniform set or distribution of data, and such information fails to capture all knowledge relevant to both static and dynamic decision-making and coordination.

Hayek’s substantial insight in this work, one that has become largely incorporated into mainstream economics, is that the price system operating through market processes is an effective, parsimonious (but not perfect) means of generating, signaling, and aggregating such knowledge. Prices cannot convey all individual knowledge pertinent to a particular economic decision, but they do serve as knowledge surrogates by communicating some private knowledge (Horwitz 2004). Coordination of individual actions and plans emerges as a beneficial consequence of the price system; thus the price system and market processes enable emergent, or unplanned, order.

Hayek characterized the fundamental economic problem not as the static allocation of scarce resources among uses by omniscient agents, but rather as the coordination of actions and plans among dispersed agents with diffuse private knowledge. In his statement that “… the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form, but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess” (p. 519), Hayek draws on the earlier arguments of the socialist calculation debate and of his (1937) work. The “man on the spot” (p. 524) has subjective, private knowledge of “the particular circumstances of time and place” (p. 522), and that knowledge is among the decision-relevant data that cannot be aggregated except through a decentralized system of prices and a market process of exchange to determine those prices. Prices economize on the communication and interpretation of knowledge among dispersed agents.

How do individuals learn the plans of others? How do we learn when we are wrong and take action accordingly? Prices and market processes provide feedback channels. Feedback loops, learning, adaptation to a changing environment and changing actions and plans of others, interdependence of agents and their actions in a complex system, and how prices and markets serve as feedback loops making a complex system adaptive – all are important implications of Hayek’s argument. Prices provide profit opportunities and realized profits, and those realized profits serve as feedback that can spur the discovery of new products, services, business models, or other ways to create value through economic activity. Alert entrepreneurs see these opportunities, learn from observed and realized feedback, and adapt their plans accordingly. Prices enable “error detection and correction within the market” (Boettke 1998, p. 135). Markets are processes for social learning and provide feedback channels for entrepreneurial alertness.

This post is drawn from my article, “Knowledge Problem” (SSRN link), which is included in the forthcoming Oxford Handbook of Austrian Economics (Peter Boettke and Chris Coyne, eds.).

Planet Money’s t-shirt project

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Lynne Kiesling

Are you a fan of Leonard Read’s I, Pencil (see video above)? Hayek’s argument the “The Use of Knowledge in Society” about how prices coordinate the decisions of anonymous individuals with diffuse private knowledge? Adam Smith’s tale of the making of a woollen coat? Pietra Nivoli’s book on the global travels of a t-shirt?

Then you may be interested in Planet Money’s new t-shirt Kickstarter project:

Almost every single t-shirt out there — from the cheesiest vacation tank top to the fanciest boutique designer tee — is the result of a complicated global odyssey. We will take you on that odyssey and document the route our t-shirt took to your back. We’ll meet the people who grow the cotton, spin the yarn, and cut and sew the fabric. We’ll ride on the cargo ships that bring our t-shirt from factories in Bangladesh and Colombia to ports in the US. And we’ll examine the crazy tangle of international regulations which govern the t-shirt trade the whole way.

Planet Money does some of the best economic journalism, and the participatory nature of bringing this story into being is itself an example of the kind of value-creating interconnectedness that underlies economic exchange.

 

Nest and technology-service bundling

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Lynne Kiesling

nest-rush-hour-alert

Nest’s recent business developments are refreshing and promising. Building on the popularity of its elegant and easy-to-use learning thermostat in its first couple of years, Nest is introducing new Nest-enabled services to automate changes in settings and energy use in the home. Called Rush Hour Rewards and Seasonal Savings, Nest claims:

Rush Hour Rewards could help you earn anywhere from $20-$60 this summer—it takes advantage of energy company incentives that pay you to use less energy when everyone else is using more. Seasonal Savings takes everything Nest has learned about you and automatically fine-tunes Nest’s schedule to save energy, without sacrificing comfort. Field trials have been impressive: Nest owners have used 5-10% less heating and cooling with Seasonal Savings and 80% said they’d keep their tuned-up schedules after Seasonal Savings ended.

The ever-incisive Katie Fehrenbacher calls their move a bundling of its “smart thermostat with data-driven services“, which sounds about right to me.

Behind these new services is the cloud-based big data algorithms that are the secret sauce of Nest, and which Nest has now named Auto-Tune. Now that Nest has gotten hundreds of thousands of thermostats out there in the market, and has done two years of field trials, it has been able to collect a large amount of data about how customers use and react to temperature and cooling changes. Nest uses this data about behavioral changes to inform its services and how its algorithms work.

She also remarks on something I noticed — in its marketing of its new services Nest assiduously avoids the phrase “demand response”, instead saying “New features save energy & make money. Automatically.” Once you get beyond the elegant interface, the thoughtful network and device connectivity, and the “secret sauce” algorithms, Rush Hour Rewards is little more than standard, administered, regulator-approved direct load control. But Nest’s elegance, marketing, and social-media-savvy outreach may make it more widespread and appealing than any number of regulator-approved bill inserts about AC cyling have over the decades.

In a very good Wired story on Nest Energy Services, Steven Levy analogizes between the technology-digital service bundle in energy and in music; quoting Nest CEO Tony Faddell, Levy notes that:

This pivot is in the best tradition of companies like Apple and even Amazon, whose hardware devices have evolved to become front ends for services like iTunes or Amazon Prime Instant Movies. Explaining how this model works in the thermostat world, Fadell compares power utilities to record labels. Just as Apple provided services to help customers link with the labels to get music, Nest is building digital services to help customers save money. Unlike the case with record labels, however, Nest isn’t eroding the utility business model, but fulfilling a long-term need–getting customers to change their behavior during periods of energy scarcity.

“Until now, if utilities wanted customers to change their behavior to use less electricity at those time, they instituted what was called unilateral demand response—they wouldn’t automate the process, they’d turn off the air-conditioning whenever they wanted. It was like DRM during the iPod days—where companies like Sony said, ‘I am the guardian, and I’m going to tell you what to do’.”

Faddell (and Levy and Fehrenbacher) articulates the value potential of technology-service bundles to automate energy consumption decisions in ways that save energy and money without reducing comfort. While the guts of their services are still direct load control and are not dynamic in any way that would make meaningful use of such a potentially transactive technology, I do think it’s a promising evolution beyond the monolithic, administrative, regulatory demand response approach.

OPEC: Threat or menace…?

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Michael Giberson

… or a clumsy cartel causing excessive volatility in world oil prices, or maybe none of the above. Earlier this week the Cato Institute hosted a discussion of a recent report by Andrew Morriss and Roger Meiners, “Competition in World Oil Markets: A Meta-Analysis and Review.” Panelists included Morriss, FedEx chairman Frederick Smith, and SMU economist James L. Smith. Jerry Taylor coordinated the program.

Of the group of panelists, I think it is J. Smith that has the best handle on the evidence — which unfortunately is all over the map. Yes you can find evidence that OPEC has manipulated oil prices and contributes to instability, but your can find comparable evidence suggesting OPEC has had no real effect. My preferred view is that Saudi Arabia has had an ability to swing prices up or down a bit at the margin–they being the one country willing to maintain excess productive capacity and manage it with an eye to long-run price levels. On J. Smith’s discussion of the evidence, perhaps I should become more agnostic on the matter.

If you, too, have an opinion about the effect of OPEC on world oil markets, then you ought to listen to the program and consider whether your view is well supported by detailed studies of the issue.

ADDED: Mentioned in the discussion is James Smith’s Journal of Economic Perspectives article, “World Oil: Market or Mayhem?“, available free online.

Gasoline retailer getting gouged by New Jersey Attorney General?

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Michael Giberson

Last week the New Jersey Office of the Attorney General announced settlement of two of the 24 post-Sandy price gouging cases the state has pursued. Shiv Shivam Inc., doing business as Lukoil in Piscataway agreed to pay $20,000 to the state; C.S. George & Sons, Inc., doing business as George’s Gulf Station in Clifton agreed to pay $26,000. Neither gasoline retailer admitted fault. One detail about the payments to the state struck me as odd.

Here are two paragraphs from the Shiv Shivam Final Consent Judgment:

 Defendant has agreed to pay a settlement amount of Twenty Thousand and 00/100 Dollars ($20,000.00) (“Settlement Payment”) within thirty (30) days from the Effective Date.

The Settlement Payment is comprised of Six Thousand Six Hundred Sixty-One and 76/100 Dollars ($6,661.76) in civil penalties, pursuant to N.J.S.A. 56:8-13, as well as Five Thousand Four Hundred and Three and 99/100 Dollars ($5,403.99) in reimbursement of Plaintiff’s attorneys’ fees and Seven Thousand and Nine Hundred and Thirty-Four and 25/100 Dollars ($7,934.25) in reimbursement of Plaintiff’s investigative costs, pursuant to N.J.S.A 56:8-11 and N.J.S.A. 56:8-19.

The comparable paragraphs from the C.S. George & Sons settlement are similar except paying $26,000 overall, divided as $20,489.50 for civil penalties; $5,062.50 for reimbursement of Plaintiff’s attorneys’ fees; and $448.00 for reimbursement of Plaintiff’s investigative costs.

Notice Shiv Shivram is charged almost $8,000 in Plaintiff’s investigative costs, while C.S. George & Sons is charged less than $450 for similar services. Do you wonder whether it actually cost the Office of the Attorney General nearly eighteen times as much to investigate the one case as the other?

Is the New Jersey Attorney General taking advantage of the gasoline retailer’s duress at being targeted by the state to collect unconscionably excessive investigative costs?

Department stores as economically transformative

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Lynne Kiesling

Recently Virginia Postrel used the US (PBS) premiere of “Mr. Selfridge” to highlight the underappreciated social and economic role of the department store. As she notes,

Yet like railroads and telegraphs, the department stores of the late 19th and early 20th century were socially and economically transformative institutions. They pioneered innovations ranging from inventory control and installment credit to ventilation systems, electric lighting and steel construction, along with new merchandising and advertising techniques. They brought together goods from all over the world and lit up city streets with their window displays. They significantly changed the role of women, giving them new career opportunities and respectable places to meet in public. They popularized bicycles, cosmetics, ready-to-wear clothing and electrical appliances. They even invented the ladies’ room.

Decrying consumption or denigrating shopping undervalues the transformative aspects of department stores that Virginia (and “Mr. Selfridge”) emphasize. Even in cities, pre-industrial production and sales of consumer goods were artisanal, and goods generally were expensive relative to incomes. Consistent quality mass production changed that relationship, made more goods widely available while increasing widespread prosperity. The department store arises from that combination of increased average incomes, decreased average cost, and increased quantity and variety of consumer goods.

It’s a wonderful essay. Do read the whole thing.

And it also gives me a chance to reprise my little shout out from 2004 to my favorite commercial pioneer, Josiah Wedgwood, who pioneered the use of showrooms to sell porcelain goods, the distribution of catalogs, and other innovations that revolutionized the pre-department store retail landscape.