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uebernietzsche"Behind the contemporary highly fashionable Schumpeterian and evolutionary economics towers Nietzsche, his Übermensch entrepreneur and his creative destruction. Nietzsche the economist here comes to us filtered through Joseph Alois Schumpeter via Werner Sombart. As opposed to Sombart, who carefully documented the influence Nietzsche had on him, Schumpeter as usual has held the cards that would have revealed the origins of his own ideas very close to his chest. However, a closer look at the intellectual climate, the general Zeitgeist, and the work of the most influential continental European economist during Schumpeter’s ‘golden period’, his own 20s, shows the overwhelming influence of Nietzsche on all three counts."

Click here to read the whole thing.

Today I held a presentation (pps, 803 kB) based on Aghion and Howitt's seminal article A Model of Growth Through Creative Destruction (Econometrica, 1992). The presentation was optimized for an online audience, i.e. you'll understand the whole model by just going through the slides. During the presentation I also mentioned Aghion's speech "Growth and Education: Gerschenkron meets Schumpeter". I blogged about it here.

PS: There is one important derivation you find neither in their 1992 article nor in their textbook Endogenous Growth Theory. Since I have written it on the blackboard during the presentation I'll replicate it here:

Expected welfare is
Given that the innovation process is Poisson with parameter λφ(n) and the stock of technology At grows geometrically we have
"Factoring out" multiplicative constants yields
and ∫e-axdx = 1/a we get

Here is a neat version of the Lemons Problem (Akerlof (1970)) taken from Jean Tirole's book The Theory of Industrial Organization (p. 108, sligthly modified):

Robinson Crusoe is the monopoly owner of a goat. Friday is the potential purchaser of the animal. The goat is characterized by s, the amount of milk it produces daily (a quality parameter). Robinson has θ1s if he keeps the goat [θ, a positive real number, is a taste parameter. Generally, all consumers prefer high quality, s, for a given price; however, a consumer with a high θ is more willing to pay to obtain high quality] and p if he sells it at price p. Friday has θ2s if he buys at a price p and p otherwise.
robfri01Assume that, for technical reasons, milk cannot be traded; only the animal can. Friday's marginal valuation for quality exceeds Robinson's: θ2 > θ1 (these parameters are known to both parties). Thus, trading is Pareto optimal regardless of s. However, trading must be voluntary. Robinson has experience with the goat and knows s perfectly. Friday knows only that s is, a priori, uniformly distributed on the interval [0,smax]. Assume further that Friday is risk-neutral (his objective function is

θ2se - p, where se is the expected quality of the goat,

conditional on its being offered for sale). Is there a price p (≤ θ1smax) at which Robinson and Friday can agree to trade? Suppose there is. Friday should then infer the following: If Robinson is willing to sell his goat at price p, the quality s must satisfy p ≥ θ1s. This means that Robinson sells if and only if s belongs to the interval [0, p/θ1]. Given that s is, a priori, uniformly distributed, the average (expected) quality of the goat given that it is offered for sale is
robfri02The average quality is biased downward by the decision to put the goat on the market (se(p) ≤ (1/2)smax for p ≤ θ1smax). This is the so-called adverse-selection or lemons problem.

Friday agrees to buy the goat if and only if his expected surplus form the transaction is positive, i.e., iff θ2se(p) ≥ p or θ2 ≥ 2θ1. If tastes do not differ too much in the sence that θ2 < 2θ1, there exists no price at which Robinson is willing to sell and Friday willing to buy. In this case the market breaks down completely. What ever s, a socially desirable transaction does not occur.robfri03The reason why the market disappears in this example is clear. Suppose that the price is high and the seller is willing to sell, but the buyer does not want to buy. The traditional way to balance the market is to lower the price to reduce excess supply. However, this mechanism may not work here. A decrease in price reduces the average quality on the market. (The fact that the good is still offered becomes, in a sense "bad news." The actual quality is endogenously given.) this may turn out to reduce demand instead of increasing it.
In general, the market may not disappear; it may only shrink because of adverse selection. This situation arises in the used-car market, where the frequency of transactions is certainly smaller than it would be were the information structure about qualities perfect (leaving aside other transaction costs). It also arises in the insurance market--high-risk consumers are more likely to wish to purchase health or life insurance.

Counteracting forces that attenuate this problem: Repeat purchases, warranties, and multidimensional contracts.

Hat tip to Christoph Weiss.

Abstract: After presenting casual evidence of the difference between economists and the rest of the population, I review the survey and experimental evidence on this topic during the last 20 years. I then ask whether these results are applicable to real world situations. To consider this, examples of referenda results in Switzerland are presented where the citizens decided against recommendations of most economists. What is particular in economic theory that causes these differences in convictions? Explanations can point to aspects of positive economic theory and to normative convictions of economists. I conclude with consequences that economists might draw.

Here [free version] is the paper.

almarEconometrica: After the publication of the first volume of his “Cours” in 1907, Professor Colson became acquainted with the work of Alfred Marshall, and was much struck by the identity of their methods... In his letter, he asked whether Marshall was a mathematician who had turned economist, or was, like Colson himself, an economist who had merely found it useful to introduce certain mathematical formulae into his analysis. Marshall answered in the highly interesting letter which follows <>:

Balliol Croft, 6 Madingley Road, Cambridge

I write in English, because I start tomorrow for South Tyrol, and must finish some writing before I start: and I write slowly in French. Briefly—I read Mill’s Political Economy in 1866 or ‘7, while I was teaching advanced mathematics: and, as I thought much more easily in mathematics at that time than in English, I tried to translate him into mathematics before forming an opinion as to the validity of his work. I found much amiss in his analysis, and especially in two matters. He did not seem to have assimilated the notion of gradual growth by imperceptible increments; and he did not seem to have a sufficient responsibility—I know I am speaking to a mathematician—for keeping the number of his equations equal to the number of his variables, neither more nor less. Since then I have found similar matters not quite to my taste in the economic work of nearly all those who have had no definite scientific training.
At that time and for long after I knew very little of the realities of economic life. But I worked at what I regard as the central problem of distribution and exchange. Before 1871 when Jevons’ very important Theory of Political Economy appeared, I had worked out the whole skeleton of my present system in mathematics though not in English. My mathematical Note XXI concentrated my notions: but the greater part of the earlier notes and especially Notes XIV-XX were evolved in substance about the same time. These contained the substance of my doctrine of Substitution; though I did not make use of that term till long after.
As I have said in my original Preface, I owed much to the mental discipline afforded by Cournot; but the one book which really guided me was written by a landowner, who had very slight knowledge of mathematics, and indeed occasionally talked great nonsense in them.
It was von Thünen*, as you already know.
In 1877 I married; found myself committed to writing a cheap popular book, which was necessarily superficial, and which I loathed. After a few years I became very ill, and expected not to be able to write anything considerable. So I took out the diagrammatic appendices which I had written for my book on International Trade; and decided to edit them, showing their uses, and above all their limitations: after that was done I expected to depart this life. But I slowly recovered. And so the purely analytical work in Book V of my Principles, with a part of Book III, were the kernel from which my volume expanded backwards and forwards to its present shape. The Austrian School is on lines somewhat similar to a part of mine. But I knew nothing of Carl Menger till my own ideas were nearly in full shape: and Böhm Bawerk and Wieser were at that time at school, or students at the University.
Unfortunately, the French translation of my Principles Vol. I was partly published before I received an unexpected call for a new edition which appeared in 1907.
The Preface to that indicates the nature of the changes made in it, and in my plans generally. Age is beginning to tell on me; and I resigned my Professorship a year ago, in order that I might make more progress with National Industries and International Trade, which I am writing slowly.
The Austrians, and especially Böhm Bawerk, annoy me (though there is much in their work which I admire) by pretending to have revolutionized the bases of economics; whereas nearly all their doctrines appear to me to have been latent in the writings of the “classical” economists. Also they offend against my mathematical instincts: though I have now ceased to use the mathematical language easily.

Yours very truly.........

I know well your Transports; and have often recommended it. But I do not know, alas!, your Cours; and now I have no more any pupils.
I send a Memorandum that may interest you.

Source: Alfred Marshall, the Mathematician, As Seen by Himself, Econometrica, Vol. 1, No. 2. (Apr., 1933), pp. 221-222.

* @German speaking people: see also Johann Heinrich von Thünen, Econometrica, Vol. 2, No. 1. (Jan., 1934), pp. 1-12.

Varying Views of the Corporate Tax [1]

In 1962, Professor Arnold Harberger produced a seminal article on the incidence of the corporate income tax. The article did more than analyze the corpo­rate tax; it showed the importance of going beyond narrow partial equilibrium analysis in looking at the effects of taxation.

The early Harberger work suggested that the corporate tax was borne by the owners of all capi­tal, not just corporate capital. Harberger assumed a closed economy with a fixed total capital stock. The capital could be allocated either to the corporate or to the non-corporate sectors, which were assumed to produce somewhat different goods and services. If a corporate tax were imposed, raising the tax rate above that of the non-corporate sector, capital would migrate to the non-corporate sector. Gross returns would rise in the corporate sector and fall in the non-corporate sector to equalize after-tax yields between the sectors. Thus, a por­tion of the corporate tax would be shifted to non-corporate capital. There would also be an effi­ciency (dead weight) loss that would make the burden greater than the amount of the tax itself.

In later work, Professor Harberger changed his assumption that the economy is closed and con­cluded that the corporate tax is borne largely by domestic labor, at least in the case of a small open economy that has little impact on the world rate of return.
Putting a tax on the income from corporate capital would simply lead to adjustments whereby less capital would be at work in that country [Image: Effect of Tax on Desired Capital Stock]. Where would the capital go? It would go abroad…. In realizing that the presence of the tax implies that significantly less capital will be combining with the same amount of total labor (in the small developing country), it should come as no surprise that the equilibrium wage has to be lower [Image: A Smaller Stock of Capital reduces Wages]. But there is an additional and more critical reason (above and beyond simple capital labor-substitution) why labor’s wage must fall: the need to compete with the ROW [rest of the world] in the production of manufactures (corporate tradables). The tax is a wedge that has been inserted into the pre-existing cost structure. The prices of corporate tradable products cannot go up because they are set in the world marketplace; the net-of-tax return to capital cannot go down (except transitorily), because capital will not be content to earn less here (in the small developing country) than abroad. Some element of cost has to be squeezed in order to fit the new tax wedge into a cost structure with a rigid product price at one end and a rigid net-of-tax rate of return to capital on the other. The only soft point in this cost structure is wages. If they do not yield, the country may simply stop producing corporate tradables. Or, if the country continues to produce such goods, then wages must have yielded—by just enough to absorb the extra taxes that have to be paid….[40]
Harberger goes on to point out that the United States is a large country, not a small one, so the exit of U.S. capital would somewhat depress the rate of return to capital in the world, which would some­what mitigate the capital flight and reduce the share of the tax burden passed on to U.S. labor. Nonetheless, he estimates that U.S. labor would still have to bear seven-eighths of the corporate tax (ibid.). Harberger assumes an unchanged world capital stock, i.e., that the world stock of capital does not fall to restore after-tax returns to the levels they enjoyed before the imposition of the U.S. tax. If one instead adds the assumption that the world capital stock is elastic over time with respect to the rate of return, then even this modest offset to the impact of the U.S. corpo­rate tax on U.S. labor would vanish.

Harberger reiterated his analysis in a recent interview in the IMF Survey conducted by Prakesh Loungani.
Loungani: The effects of some economic policies are better understood thanks to your academic contributions. You did path-breaking work on whether capital or labor bears the burden of the corporate income tax.

Harberger: There are interesting developments to report on that front. In the closed-economy case that I analyzed in the 1960s, the natural result is that capital bears the burden of the tax and can easily bear more than the full burden. But my students and I have now analyzed the open-economy case, which is more applicable to today’s global economy. The result in this case is that labor bears the burden and can easily bear more than the full burden.

Loungani: That’s quite a flip. Why does it happen?

Harberger: Think of the so-called “tradable goods” sector of an open economy, the sector that produces goods that are traded on a world market. The prices of these goods are determined in the world market. And, with an open economy, the rate of return to capital is largely determined in the world market, because capital can flow from country to country in search of the highest return. Now the government gets in there and tries to impose a corporation income tax on capital. Well, who bears the burden? Capital can move across national boundaries to try to escape the tax. So it’s labor, the factor of production that can’t easily escape national boundaries, that ends up bearing the burden of the tax.
In this analysis, part of the fixed quantity of U.S. capital relocates abroad, and domestic labor suffers a loss in income and therefore bears the entire cor­porate tax, plus a dead weight loss. One could go two steps further ... click here to continue reading. I highly recommend reading the whole article ([1] Tax Incidence, Tax Burden, and Tax Shifting: Who Really Pays the Tax?, Stephen J. Entin)

related items:
Taxation by Louis Kaplow (via Marginal Revolution)

Charles B. Blankart writes: When I was a student of economics in the early 60ies the prevailing view on public finance was relatively simple: Public revenues were regarded as separated from public expenditures, and public expenditures were dominated by three fundamental pillars:
  • Wagner’s law* of increasing government expenditures as a share of GNP,
  • Brecht’s law of higher per capita expenditures of larger cities, and
  • Popitz‘ law of increasing government centralization
For me as a student public finance appeared as well structured discipline, predictable in the exams and therefore with a small risk factor, but with little intellectual attractiveness. That this doctrine was not the full truth became evident for me when I have read, some years later, James M. Buchanan’s Public Finances (1965). Therein I have found an alternative view of these "iron laws", as can be seen, e.g., from his remarks on Wagner’s law:
"...many historical and institutional reasons may be adduced to explain why the economy has become increasingly collectivized, especially over the past quarter century. But a more fundamental examination may be helpful; institutions are themselves patterns formed by individual decisions, and there are no immutable historical laws." (p. 50)
popitzIn the mid seventies I accepted an invitation to the Center for Study of Public Choice in Blacksburg where Wagner’s law was in full discussion as an outflow of the previous seminar of the Center’s members on this topic and where the publication of the book Budgets and Bureaucrats to be edited by T. E. Borcherding (1977) was approaching. With these discussions, the first pillar of my former doctrine has got a theoretical foundation. For the two other pillars, Brecht’s law and Popitz‘ law, I have found a more theoretical basis in the writings of W. J. Baumol (1967) and W. E. Oates (1972).

Nevertheless Popitz‘ law of increasing government centralization still remained somewhat in the shadow of scholarly interests. This has induced me to collect some historical material and to interprete it with the tools of economics. I shall not develop a theoretical model, but simply present an economic view of a historical episode. Click here to read his story.

*see The curious attraction of Wagner's law (of increasing state activity)

Adam Smith refers to monopoly as a "...great enemy to good management", and to competition as the medium for "...new divisions of labour, and new improvements of art, which never otherwise would have been thought of" Hayek claims that "It is only through the process of competition that the facts will be discovered." Cournot, after whom Cournot competition is named, finds that "the result of competition is to lower the price." If increasing social welfare or well-being is an objective, then we should have some notion of which market structure is the most desirable. In this essay (short), I will examine the market structure of monopoly and its associated costs, concentrating on the theory of X-Efficiency.
Great article. BTW, did you know that Leibenstein attributed his choice of the term 'X' for X-efficiency to Tolstoy's reference in War and Peace: 'Two armies may be identical in every observable respect - manpower, armaments, cavalry, provisions - yet one army, in possession of an intangible 'X-factor,' will soundly defeat the other ...' (Part XIV, II)? In case you like to dig deeper, go on and read Harvey Leibenstein as a Pioneer of Our Time (The Economic Journal). Here (AER) is Leibenstein's original 1966 article.

mancurI've just stumbled across a short article about Mancur Olson and his work. Here is Kenneth Arrow on Olson. He had some simple, profound ideas on democracies, and the problems specific to tyrannical and anarchical regimes as well. Mancur died on this date in 1998.

Addendum: Here is Tyler Cowen on Olson.

The interpretation of the evolution of modern industrialism has been utterly vitiated by the anticapitalistic bias of governments and professedly prolabor writers and historians. The rise in real wage rates, the shortening of hours of work, the elimination of child labor, and the restriction of the labor of women, it is asserted, were the result of the interference of governments and labor unions and the pressure of public opinion aroused by humanitarian authors... The incorrectness of this interpretation is obvious... It is not labor legislation and labor-union pressure that have shortened hours of work and withdrawn married women and children from the factories; it is capitalism, which has made the wage earner so prosperous that he is able to buy more leisure time for himself and his dependents. The nineteenth century's labor legislation by and large achieved nothing more than to provide a legal ratification for changes which the interplay of the market factors had brought about previously. As far as it sometimes went ahead of industrial evolution, the quick advance in wealth soon made things right again. As far as the allegedly prolabor laws decreed measures which were not merely the ratification of changes already effected or the anticipation of changes to be expected in the immediate future, they hurt the material interests of the workers.
The term "social gains" is utterly misleading. If the law forces workers who would prefer to work forty-eight hours a week not to give more than forty hours of work, or if it forces employers to incur certain expenses for the benefit of employees, it does not favor workers at the expense of employers. Whatever the provisions of a social security law may be, their incidence ultimately burdens the employee, not the employer. They affect the amount of take-home wages; if they raise the price the employer has to pay for a unit of performance above the potential market rate, they create institutional unemployment. Social security does not enjoin upon the employers the obligation to expend more in buying labor. It imposes upon the wage earners a restriction concerning the spending of their total income. It curtails the worker's freedom to arrange his household according to his own decisions.

Ludwig von Mises, Human Action, Part 4, Chapter XXI.7

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