Markets in all their glory

I knew I was going to enjoy The Inner Lives of Markets by Ray Fisman and Tim Sullivan when, early in the book, it mentions the use of Kakutani’s fixed point theorem in the proof of existence of general equilibrium. Not that this should put you off. All of the economics covered in this delightful book (shipping on 9 June in the UK, already shipping in the US) is described clearly and with a lovely lightness of touch.

As the book explains, “A market is just a technology, a mechanism where participants have the chance to directly affect resource allocation through an expression of their preferences.” They can be organised and run in many ways, and are varyingly effective at that principal task of allocating resources. The book begins (after an introduction featuring the famous Radford paper (pdf) on the economy of a WW2 prisoner of war camp) by explaining the elegant abstraction of general equilibrium theory and the welfare properties of markets. It goes on to the variety of ways in which the welfare properties do not hold, due to asymmetries of information, through the lens of a particular model or approach to modeling.

The first of these is Akerlof’s lemons model of second hand car sales – the adverse selection that can ultimately cause a market to collapse when sellers have more information about the product than buyers. Of course there are markets for second hand cars: devices such as warranties and nice showrooms help compensate for the information asymmetry. The book goes on to Spence’s introduction of signalling in labour and other markets.

There is a nice chapter covering auctions – including online auctions – and how these are evolving. The use of online auctions is decreasing over time; it seems the transactions costs are actually rather high, at least for most buyers. As the chapter observes, prices achieved in online auctions on sites like Ebay are about 10% lower than fixed prices for the same items, so this is rather a high transaction cost. The ‘auction discount’ across markets has grown over time from 3% in 2003 to 15% now. I liked this observation in the book about the scope for using auctions: “This lack of use [in practical applications] of the Vickrey [2nd price] auction was something of a puzzle to economists, who were captivated by the way that, in its elegant simplicity, the mechanism helped magically cure the bidders’ headaches over strategizing and over-paying.” It reminded me of a conversation with a friend who was helping test the auction one regulator had designed for a sale of spectrum licences; she said, “It was great fun. The economists assumed we wouldn’t talk to each other but of course we cheated like anything!”

The book proceeds on to digital platforms, and ends with Roth-style matching markets such as the kidney exchange – the latter a shorter version of Roth’s own excellent book, Who Gets What and Why.

One of the interesting threads through this new book is the strong defence it puts up of the integral role of maths in economics. Critics of economics often, of course, see the mathematization of the subject as one of its big flaws – how can you reduce the complexity of society to a few equations? Equally of course, this is nonsense (even though – as Paul Romer has explained – there is misuse of maths too): the humanities also use ‘models’, but with words rather than symbols – the causes of the First World War? Actor-network theory? And careful statistical inference cannot happen without representing the relationships being tested algebraically. The Inner Lives of Markets goes further, explaining that key insights in understanding and improving the way markets work came about because economists were using mathematics. Akerlof got his ‘lemons’ insight from attending a class on topology. Auction theory and market design similarly depend on sophisticated algorithms.

The  book is an ideal read to introduce students to these areas of economics, and to describe to general readers the power and usefulness of a part of economics not very visible to the public but where substantial progress has occurred during the past 10 or 20 years. (The authors’ previous book, The Org, did the same for industrial organisation.) Digital platforms for example wouldn’t exist without digital technology, but equally wouldn’t exist without the economic technology. The Inner Lives of Markets is a very nice complement to and update of one of my favourite books, John McMillan’s Reinventing the Bazaar. It is clear and readable, with lots of examples of familiar, everyday contexts. It would be terrific if the message gets out that economics is about so much more than the ups and downs of the financial market and the arcana of macroeconomics.

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More to read

It’s always a pleasure to get the new season’s catalogues from the publishers, albeit alarming to be getting Autumn listings before there has been much summer, and is it really the end of May already? First off the block, or rather through my letterbox, is the one from Princeton University Press. Up front is a book that will thrill Dave Birch: The Curse of Cash by Ken Rogoff. “The world is drowning in cash – and it is making us poorer and less safe,” starts the blurb. Eminent economists are finally coming round to Dave’s views.

Many other enticing titles listed. Philipp Ther’s Europe Since 1989. The Nobel Factor by Avner Offer and Gabriel Soderberg (how the creation of the prize in 1969 changed economics). The Euro and the Battle of Ideas by Marcus Brunnermeier, Harold James and Jean-Pierre Landau. The Power of Networks by Christopher Brinton and Mung Chiang. The Age of Risk by Emily Nacol. There’s a textbook I read in proof, Ethan Bueno de Mesquita’s Political Economy for Public Policy, a terrific synthesis of welfare economics and political economy considerations. All these and more. From just one publisher. And I made the mistake of going into a bookshop with a spare half hour yesterday.

I was also intrigued by The Princeton Field Guide to Dinosaurs by Gregory Paul. A field guide: do dinosaurs really roam New Jersey?

Update: how could I have missed on a first read through a new book by Joel Mokyr, A Culture of Growth: The Origins of the Modern Economy. A must-read for me.

Taxing the Rich (how to)

Do you want to raise more taxes from rich people, dear Reader? I thought so. Then a read of Taxing the Rich: A History of Fiscal Fairness in the United States and Europe by Kenneth Scheve and David Stasavage is illuminating.

Apart from anything else, the historical data on top tax rates is fascinating. There have really only been two big moves in top income (and inheritance) tax rates: up, a lot, from the 1920s to around 1950; down, by half of a lot, mainly in the 1980s but drifting down subsequently. It is also interesting to note the contrast between the US/UK top marginal rates and the rest of the developed world – about 40% vs about 60%. As in so many areas, the fact that data and economic research are heavily US-centric has a distorting effect on economic policy debates elsewhere. Extraordinarily, the burden of total taxation on the highest income bracket in the UK reached 90.7% during the second world war (compared to 19.1% for the bottom group). Talk about progressive.

The book discusses the forces driving the trends in taxation of the rich. The authors’ main point is that war has been the principal driver, with the sense of fairness the result of the calls the state made on citizens at those times. It was at times when the government demanded immense sacrifices from the majority of the population that the effective social contract ensured the wealthy paid: “War mobilization changed beliefs about tax fairness. It created an opportunity for new and compelling compensatory arguments that increased support for taxing the rich.” In other words, while the arguments for taxing the rich have always relied on fairness, the notion of fairness has changed at different times. The book demonstrates that as wars created opportunities for profit for capitalists, thanks to wartime production, the demand they should shoulder more of the tax burden gained great traction.

The book challenges the previous consensus that the consensus in favour of strongly redistributive taxation, to compensate for the sacrifice of ordinary people, lasted for any length of time after world war two. And to the extent there was, it anyway steadily crumbled. The book agrees that globalization, and a new emphasis on incentives for economic growth, played a part in reducing tax rates on the rich as the 20th century wore on. But they argue that a more important factor was the weakening of the kind of compenstory arguments that had been available in wartime. “Different compensatory arguments can be made today, but they have a smaller impact. In today’s debates about progressive taxation, observers often fail to appreciate this fact.”

The book reports a representative survey of over 2000 Americans showing that the top marginal tax rate they select is in fact below today’s rate of 39.6%. There appears to be little support from this for higher taxation. To put it another way, Americans don’t see why Silicon Valley should be taxed because Wall Street was bailed out – although they oppose the bailout. The lesson is: ‘fairness’ is not an abstract concept. You have to find a fairness argument with traction, and the compensatory arguments being used by the left today do not have that. Looking back to the 19th century, before the era of global war provided a strong compensatory argument, the principles that enabled increases in taxes on the rich concerned equal treatment for all within the tax system: as existing taxes were raised on land, new mercantile fortunes were untaxed. So taxation was extended in its coverage. The authors suggest looking to the thickets of exemptions and special privileges rather than the headline-grabbing top marginal rates. Interestingly, this is something Jo Maugham emphasised this week. Maybe he had read this very interesting book. David Stasavage also spoke at this recent LSE Conference on inequality.

 

Economic thought and its idiosyncracies

This weekend my reading was Economic Thought: A Brief History by Heinz Kurz. It really is brief, just 183 pages, starting with the Ancient Greeks and ending with behavioural economics and RCTs. So it sets out the broadest outlines of economics, with a strong bias towards macroeconomics and thinking about economic systems. Marxism is covered – indeed, gets a whole chapter of 14 pages – but industrial organisation is absent save for a bit of Schumpeter and a bit of new institutional economics.

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Within its self-imposed limitations of space and selectivity, the book does a decent job in outlining the key features of, say, classical thought and the marginalist turn – for example, Kurz emphasises the introduction of the emphasis on the flow of commodities produced each year in classical thinking. I learned a few new names: Hermann Heinrich Gossen, anyone? I hadn’t heard of him before, but learn here that he introduced the earliest version of marginal utility theory. I thought the discussion of utility theory is particularly good. Kurz writes:

“Compared with cardinal utility theory, ordinal utility theory – with its rejection of interpersonal comparisons – dramatically privileges the individual relative to society. In this perspective, the individual, one might say, is in principle attributed a right to veto public decisions that affetc his or her (subjective) well-being … As a consequence, economic policy seems unable to improve social situations. Since every policy alternative has some gainers and som losers, how could one ever judge the gains of the former against the losses of the latter, if interpersonal utility comparisons are prohibited?”

Very clear. There are a couple of other points where Kurz highlights interesting and deep methodological issues – another one, for instance, critiques Heckher-Ohlin-Samuelson in terms of its assumption of a single homogeneous ‘quantity of capital’. And in a short section on economic geography, there’s the point that in a constant returns to scale world assumed by so much of economics (including productivity accounting), “economic activity will be evenly distributed across a homogeneous plain, carried out by autarkic units of production and consumption.”

So, some nice insights. I did find myself wondering what audience the author had in mind as he wrote. He tries to explain some concepts – indifference curves, Keynesian aggregate demand, Hicks-Kaldor compensation and Skitovsky’s rebuttal – in a couple of pages at most. Economists reading this book wouldn’t need the explainers. Normal people reading it will find these far too condensed and impenetrable. As one of the former group, I’d have traded off the attempts at explanation of basic concepts for some more of Kurz’s critique of the ideas he is covering. Still, this would be a useful book for students just starting to get into the history of thought – one step beyond The Worldly Philosophers, and a prelude to a bigger book like Saadmo’s excellent Economics Evolving.

 

The health of the publishing industry

Yesterday the Publisher’s Association put out the press release on its 2015 figures  with the headline ‘Strong Year for UK publishing industry.’ Total revenues increased by 1.3% (or about £100m) to £4.4bn. With inflation around zero last year, this is a real terms increase. The release highlighted the increase in physical book sales (and particular non-fiction – but I don’t know if this category includes the depressing proliferation of adult colouring books); and the first recorded decrease in digital sales.

You have to buy the statistics, so I’ve only done a few sums on the figures in the press release. This is not helped by the fact that the author of the release was a bit hazy about the difference between millions and billions, so there was a bit of guesswork involved. Revenues from physical book sales were up 0.4% to £2.76bn (an increase of around £12m). Revenues from digital sales were down 1.6% to £554m. Interestingly, then, physical sales continue to be much larger in scale.

And what about the gap? There is a line stating: “2015 was a great year for learned journals sales and demonstrates the strength of academic publishers in driving new innovative business models that contribute towards maintaining the UK’s position as a hub of global research excellence.” Piecing together the figures, it looks like a 5% (or approx £50m) increase to £1.1bn in sales of academic journals.

Export sales were down slightly – the rest of Europe accounts for 35% of the UK industry’s sales. As far as I can tell, the export figures are included in the above three categories (physical, digital, academic journals).

So all in all, yes a good year, pleasing for those of us devoted to physical books. But most pleasing of all to the publishers of academic journals (and not so good for taxpayers and students who fund the library purchases).