Are we asleep?

On Wednesday I was passing through Dublin Airport on my way back to New Zealand, when I saw poster ads promising people up to 150,000 euros as a reward, if they've been responsible for introducing a new foreign company as a direct investor in Ireland. You can see how the scheme works here.

It's a clever idea, and it comes on top of an already impressive track record in attracting foreign direct investment (FDI) into Ireland. The agency involved, IDA Ireland, is widely regarded as one of the best of its kind: as one example, in the 'Achievements' bit of its website, it says that "2013 was a record year for FDI in Ireland as IDA client employment reached its highest ever level at 166,184. FDI alone created 25,000 jobs in 2012 and 2013".

And it is quality investment. As a recent report from an IBM unit says:

For most countries it is not just the number of jobs created that is of interest, but also the type of investment projects and their value to the economy. Comparing countries on what
projects are attracted, and not just the number of jobs, is therefore an increasingly important metric for gauging inward investment performance. To this end, IBM-Plant Location International has developed an FDI value indicator that assigns a value to each investment project, depending on the sector and the type of business activity. This value indicator assesses the added value and knowledge intensity of the jobs created by the investment project. Using this measure, Ireland continues to be the top performer in the world, resulting from the country’s success in attracting research and development (R&D) activities in life sciences and ICT coupled with high-value investment in financial services. 

It's left me wondering whether we are doing anything at all in New Zealand to attract inward FDI, let alone anything comparably slick or substantial or successful. Quite the contrary: I can recall people arguing against the desirability of FDI in the first place (repatriated profits would supposedly weaken the balance of payments) and some crassly populist criticism of the cost of wining and dining potential investors.

While Ireland's got some unique advantages - it's a low tax, business friendly, English speaking base within the EU -  we have our own selling points. But when's the last time you saw any recent government making a serious attempt to capitalise on them? And why aren't we getting our share of the FDI that's creating those high value added and knowledge intensive jobs?

Monopoly Power

A Monopoly is a market situation where a single firm (or individual) is the sole producer and seller of a product or service in an entire market. It is characterized through a lack of competition. As a result the monopolist has the ability to affect market prices, which often results in an inefficient outcome for society. 

Monopolies typically emerge because entry into a particular market is restricted. Those restrictions may be effects of high entrance costs, government regulations, or other impediments. Due to the lack of competition, monopolies often cause higher prices, lower outputs and sometimes even inferior quality of the provided goods or services. Thus, to see why monopolies still persist in certain industries, we need to take a closer look.

Sources of Monopoly Power

As mentioned above, monopolies derive their market power from entry barriers to their markets. Those barriers can can be divided into four groups, according to their sources: specific resources, government regulations, natural monopolies, and deliberate actions.

Specific resources

If a company (or an individual) owns a specific and unique resource, it can already act as a monopolist. Imagine you live in a small village in the middle of the desert where there is just one well to provide water. If this well is owned by one individual, he (or she) can charge a lot of money, because there is no alternative supply and water is an absolute necessity. However, this source of monopoly power is not very relevant in practice, as resources can be traded worldwide today, which makes it easier for customers to find alternatives (even for seemingly unique products).

Government regulations

In many cases monopolies arise because of government regulations. This happens whenever the government grants a firm (or institution) the right to be the sole producer and seller of a certain good or service. Given that monopolies often cause inefficiencies, this may seem a little odd. However, government regulated monopolies are established specifically because they are viewed to be in the best public interest.

Just think of copyright and patent laws. When a pharmaceutical company creates a new drug, it can apply for a patent (i.e. the right to be the sole producer and seller of this drug for a limited time). This is attractive for companies because they can generate high profits during the patent period. Hence, the firms are given an incentive to engage in research and development of pharmaceuticals, which is beneficial for society.

Natural monopolies

Sometimes it is more efficient for one producer to supply the entire market than for two or more suppliers. Natural monopolies often occur in industries with the need for large and expensive infrastructures. In those industries we often see economies of scale for the relevant output range, which means that an increase in output reduces the average cost of production for the supplier. In other words, if there is more than one supplier, the output for each of them is lower, which results in higher average production costs (per supplier). 

An example of a natural monopoly is the railway system. To provide railway services, a company needs a large infrastructure (tracks, power lines, etc.). If there are two competitors in the market, both of them need to pay the fixed costs related to this infrastructure. Hence, it is more efficient for them to merge and thereby reduce the fixed costs.

Deliberate actions

Last but not least, some companies deliberately erect barriers to entry in their markets to prevent the entrance of new competitors. However, for this to be possible, the companies need to have a certain market power beforehand. As companies grow, they automatically become more powerful, since they control a bigger share of the market. The bigger (and more powerful) a firm becomes, the more the industry is at risk of limited competition.

Effects of Monopoly Power

Since a monopolist company is the sole supplier of its industry, it faces a downward sloping demand curve (unlike firms in a competitive market). As a result, the firm has to lower the price of its good or service to increase quantity sold. Therefore, a monopolist's marginal revenue (MR) is always less than the price (P) of its good or service. This is crucial for understanding monopolist behavior. 
To give an example, imagine you are the sole supplier of ice cream in your village. To keep things simple, assume you can sell 1 cone for a price of 1$, thus your revenue will be 1$. However, if you want to sell 2 cones, you have to reduce the price to 0.90$, which will result in a marginal revenue of 0.80$ and a total revenue of 1.80$. So, even though you can sell an additional ice cream cone, you earn 0.10$ less on each unit sold, therefore marginal revenue falls. 

The fact that marginal revenue is lower than the price of the good has several implications for the profit maximizing behavior of a monopolist. Those can be illustrated in a supply and demand diagram (see illustration 1).

Illustration 1: Profit maximization of a monopolist

As we just saw, a monopolist usually faces a downward sloping demand curve (D) and a marginal revenue curve (MR) that lies below the demand curve. In fact, whenever we face a linear demand curve (e.g. y= a*x - b), the marginal revenue curve will be twice as steep (e.g. y=a*x - 2b). Though, please note that this only applies to linear curves.
To maximize profits, the monopolist will produce up to the point where marginal revenue equals marginal cost (MR = MC). This results in an output quantity of QM, and a price of PM. In contrast, in a competitive market (where MR = D), the company would produce quantity QC, for a price of PC.

Hence, monopoly output is lower than competitive output, but prices are still higher. This results in a welfare loss for society (deadweight loss) which can be quantified as the shaded triangle DWL. The deadweight loss is the reason why monopolies are often not in the best interest for society.

Government Policy towards Monopolies

To react to the inefficiencies caused by monopolies, the government has different options to chose from. The most relevant ones are the following: competition law, price regulations, nationalization, or doing nothing.

Competition law

One way to prevent monopolies from arising is through competition law. In this case, government institutions primarily control mergers and acquisitions to make sure they will not result in an impediment to the competitiveness of an industry. In addition, the institutions enact laws to prevent collusive behavior and other activities that could restrict competition.

Price regulations

Alternatively, if a monopoly already exists, the government policy can confide itself to controlling the negative effects of monopoly power. Generally, this is done by prescribing the prices the monopolists are allowed to charge. However, it is rather difficult to set those prices appropriately, which makes it difficult to successfully implement this policy in reality. 

Nationalization

A rather invasive option is the nationalization of existing monopolies. This allows the government to directly control the firm's behavior and thus minimize its negative effects on society. However, since this kind of policy is diametrically opposed to the idea of a free enterprise economy, it has become extremely rare in practice.

Remain inactive

As we have seen above, there are certain occasions where monopolies are socially desired or even encouraged by the government (e.g. patents, copyrights). Furthermore, it is possible that the inefficiencies caused by a possible intervention would be more harmful than the effects caused by the monopoly itself. In those cases the monopoly outcome is more desirable for society and the government will remain inactive and not interfere in the market.

In a nutshell

A Monopoly is a market situation where a single firm (or individual) is the sole producer and seller of a product or service in an entire market. Monopolies can arise because of specific resources, government regulations, costs of production, or deliberate actions. They are characterized through a lack of competition, which results in lower production outputs and higher prices. The government can react to monopolies by enacting competition law, imposing price regulations, nationalizing the monopolies or, if the inefficiency is acceptable (or even desirable) for society, by not doing anything at all.

The way we live now

Today's release of the September quarter Consumer Price Index incorporated the latest three-year review (pdf) of spending patterns, and some other changes, notably using technology to capture the prices of many consumer electronic goods. Instead of Stats people visiting physical stores or browsing electronic retailers' websites, info will now be gathered from retail transaction data collected by market research firm GfK.

It's another fine example of how using data collected for one purpose can be cleverly used by Stats for another - something that Stats has become quite adept at (and from casual observation, rather better at than many other national statistical agencies). In this case, it's a rich data set: "The data includes price and quantity information, as well as information about the characteristics of individual products. This allows us to use sophisticated methods to measure price change". In areas like electronic goods, where the grunt of the microchip or the amount of RAM or the quality of graphics is changing all the time, it can be quite hard to figure out how much of an apparent price rise is down to quality changes in the goods being bought. A laptop might have gone up 10% in price, but could well be effectively cheaper if you're actually getting 20% more performance. With this rich data Stats can figure out the trade-offs.

The other interesting thing in the new improved CPI is the list of items being dropped from the CPI shopping basket. Here it is: it's an interesting squint at the way we live now. The common theme is how new technology is making once ubiquitous products obsolete, with smart phones and tablets in particular dealing to a variety of other products.

What's gone into the basket? Pets, mainly - not because we've all suddenly decided in the past three years to become petowners when we weren't before, but because Stats used to reckon that it couldn't get a good price series for puppies and kittens, and now it reckons it can. Here's the full list.

We're apparently drinking more cider (excellent), using ferries more (good), but grabbing an UP&GO or similar as we rush out the door (not my ideal breakfast, though Sanitarium say it's "a nutritious liquid breakfast range that's designed for people who live life on the go" and that "Not only does UP&GO taste great, it's also good for you", so what do I know). And then there's that damned post-Canterbury-quake nuisance, having to hire someone to get you an accurate fix on rebuild costs for your house insurance.

So it's another interesting peek into changing lifestyles. Stats has been doing this for just over 100 years now, and it's fascinating to look at the patterns. If you've never seen it, head over to '100 years of CPI', and in particular the link there to '100 years of CPI - Basket change', which is an "Interactive basket visualisation showing when selected goods and services were added or removed from the CPI". It's almost a complete social history in itself.

In food, for example, saveloys came into the basket in the drear 1970s (1974) but we progressively got our culinary act together, with fancier cheese (1988), avocado, courgettes, capsicums, fresh pasta (all 1999), and hummus and free-range eggs (2008), which is also when saveloys got ejected from the basket. And if you want a bit of "I don't know whether to laugh or to cry" reminiscing - press the 'Really?' button, where you'll see the rise and fall of the tinned herring, the waterbed, and, most poignantly of all, the Buzzy Bee toy.

Good news from charter schools

Radio New Zealand told me this morning that, according to copies of Education Review Office reports RNZ had been shown, two of the early group of charter schools have been found to be doing well ('Big ticks for charter schools').

I'm delighted to hear it. Charter schools have the potential to address what is one of our main educational challenges: the long tail of underachievers in our public schools. To be clear: our educational performance on average is pretty good, and we score well on international comparisons like the PISA ones. But there's a large group at the bottom who struggle. For one reason or another, the standard state school isn't working for them.

What's encouraging about the experience overseas is that the main positive impact of charter schools tends to be the improved performance of precisely those groups who struggle most in the traditional schools. Here's what the big (many would say definitive) study of charter schools in the US had to say (executive summary here, pdf):

Looking back to the demographics of the charter school sector in the 27 states, charter school enrollment has expanded among students in poverty, black students, and Hispanic students. These are precisely the students that, on average, find better outcomes in charter schools. These findings lend support to the education and social policies that focus on education as the mechanism to improve life chances for historically underserved students. Charter schools are especially beneficial learning environments for these students (p18)

Enrollment and persistence in charter schools is especially helpful for some students, particularly students in poverty, black students, and English language learners all of whom post significantly higher learning gains in both reading and math. Hispanic students are on par with their TPS [traditional public school] peers in both reading and math. For students with multiple designations (such as being black and in poverty), the impacts of charter schooling are especially positive and noteworthy (pp23-4)

It's interesting to see that on these early ERO findings the same thing is happening here. RNZ quoted the ERO report on Vanguard Military School as finding that "A significant proportion of students have not experienced success in their previous schools. At this school they are responding positively to adults' high expectations".

Just what you'd expect when you get a variety of options, where students have more opportunity to match up what they want with a school that provides it. As usual, greater choice, more competition and more innovation work, and they work most for those who had least choice previously - typically those on the outer, for one reason or another.

Neither of these two schools, by the way, would have worked for me or my wife or our kids - Vanguard, according to an earlier report by RNZ, has gone for "the ethos and training methodology of the military", and South Auckland Middle School for "project-based learning based on Christian philosophy and values". But then there are lots of people who'd have hated the school I did well at (and others did well there too, if they were either academic or rugby-playing - the rest, not so much).

And that's the whole point. Students need to be able to access the approach that best suits them. Vanguard and South Auckland are just the ticket for some kids who would otherwise have floundered.
More choice is an excellent idea: we shouldn't be lumbered with markets in important areas like education and health, where there are limited "one size fits all" options on offer, and especially when the losers from limited choice are towards the bottom of the social and economic ladder.

Money, Money, Money

For many people, money is equal to bills and coins. However, even though this is not wrong, it is only one part of the equation. Generally speaking, money is a set of assets that is commonly used and accepted as payment for goods and services in an economy. This suggests that anything can be considered money, as long as it fulfills certain criteria (i.e. as long as it is generally accepted).

To really understand what money is, we must therefore look at the relevant functions it performs within the economy. To keep things simple, we will focus on the three most important ones here: money as a medium of exchange, a store of value, and a unit of account.

1) Medium of exchange

Money can be used in exchange for goods and services. This reduces transaction costs by a huge margin, because people no longer need to barter. In other words, you can just walk into a store and buy a pair of jeans (or whatever you need) in exchange for your money. This only works as long as the seller is confident, that he will be able to use the currency he receives to buy goods or services of equal value later on.

2) Store of value

Money can serve as a store of value. That means, it can be used to transfer buying power into the future. If you sell your car for instance, you can keep the money for a while and use it to buy a new car later in the future. For that reason money needs to be durable and must not lose its value over time. 
Please note that this may not be perfectly accurate in reality, as money can actually lose some of its value due to inflation. However we consider this effect negligible for now (but we will cover it later).

3) Unit of account

Money is also a measure of economic value. Every good you can buy in a shopping center has a price tag on it. Thanks to that we can easily compare the value of completely different goods. To give an example, you may want to buy some ice cream for 2$ and a shirt for 20$. By comparing the prices you know that the ice cream is worth about 1/10 of a shirt. Using money as a unit of account is very convenient because it allows us to compare virtually everything. 

In a nutshell:

Money is a set of assets that is generally used and accepted as a medium of exchange for goods and services in an economy. Apart from its function as a medium of exchange, money also serves as a store of value and a unit of account. Everything that fulfills these three functions can be considered money.

Do we need some JOLTS?

...JOLTS being the Job Openings and Labor Turnover Summary that the American Bureau of Labor Statistics (BLS) publishes every month. You can find the text of the latest one here and it's on FRED (the St Louis Fed's economic database) if you'd like to download the data or create some graphs of your own.

Right now, the financial markets and the mainstream media have been heavily focussed on the big statistic that the BLS publishes - the monthly jobs report - and that's fair enough. So have I, in one of my day jobs as a tracker of the main macroeconomies.

But as I've got to know it a bit better I've found the JOLTS data actually gives you a much better feel for what's going on in the US labour market than the big headline jobs and unemployment numbers, and I'm beginning to think we could do with the same insight into what's going on in our own economy.

In the US, for example, in the most recent month there were some 4.6 million hires, offset by some 4.4 million 'separations', for a net employment gain around the 200K mark. 'Separations' were made up of 2.5 million 'quits' (people who voluntarily leave their jobs), 1.6 million layoffs and discharges (involuntary moves), and 0.4 million 'other' (retirements, deaths, disability etc). And yes, the numbers don't add up exactly, because of rounding, but that's the internal logic of the numbers. What the media mostly report - the net 200K gain - is actually the net resultant of giant (by comparison) gross flows, as I mentioned before in commenting on an excellent graphic display of some of these trends.

Looking at separations, here's the layoffs and discharges component. The shaded areas are recessions. There are always large numbers of layoffs, in good times and bad, because the US labour markets tend to be very flexible, but they're now way down on where they were during the worst of the GFC. Indeed they're down to the levels typically seen in pretty good times.

And here's what has been happening to quits. As you can see, quits drop sharply in tougher times: people are less prepared to risk leaving what they've got, plus there are fewer opportunities to move to. Interestingly, from this perspective, the US labour market hasn't yet got back to its buoyant pre-GFC level of quits.

And that's not because the opportunities aren't there. As the graph below shows, the number of job openings (red line) has actually just climbed back to its pre-GFC level. Actual hires, though (blue line), haven't quite got back there.

Overall, you'd say that this adds up to a positive picture. The haemorrhaging of layoffs has dropped to relatively low levels, and the number of job openings (which I'd take as the most forward-looking indicator in all of this) is back up at a robust level, though there seems to be some residual caution on both the employer (hires) and employee (quits) sides of the market. You don't get anything like the same degree of insight from the monthly new jobs number, or the monthly unemployment rate.

I think there's a good case for having the same sort of insight into our own labour market. I'm pretty sure that we don't have these American-style gross statistics (I did have a quick re-look at the Quarterly Employment and Household Labour Force surveys, and couldn't find them, but if I'm wrong, no doubt someone will put me right).

Yes, we know (say) what the total number of filled jobs was each quarter, so we know what the change in jobs was from one quarter to the next. But we don't know if a 10,000 increase in jobs was down to 10,000 hires, no quits, no sackings, or 100,000 hires, 60,000 quits and 30,000 layoffs. And I'm not sure you can make a good enough fist of either tracking the economic cycle or devising labour market policy without some clearer sighting of those gross flows.

We're even more in the dark on job openings (in US terminology) or vacancies (ours). That's not to knock MBIE's vacancies index (latest reading shown below), which is a useful macroeconomic indicator in its own right. But it's an index, of the main online job ads only, and not the sort of 'ask the employers directly' numbers the US collects.

I'm just about the last person who'd wish an extra or unnecessary burden on Stats - I've been up close and personal with them for a long time, and I know the pressures on resources - but I'm starting to think we could do with better tracking of the dynamics of our labour market. And we could probably do it cheaper than the Americans do, as we're more adept at re-using 'administrative data' (like the IRD's) that's been collected already for other reasons (the Americans use a separate standalone survey).

As it happens, it looks as if Stats think so, too. I dug out Stats' list of the important Tier 1 statistics (background here, list itself here as a pdf). 'Job and worker turnover' is listed as a currently produced Tier 1 statistic, though I'm not sure the 'turnover' part is comprehensive and I reckon this could usefully be expanded on JOLTS lines. MBIE's vacancies index was recently made a Tier 1 statistic, but is not yet anything like a full headcount of job openings. And layoffs, unfortunately, is on the long finger: 'redundancies' is at the research stage, with no decision thus far on how often the data might be collected, or when the exercise might start.

In sum, we know that the JOLTS data give us much better understanding of the US economy; we can be pretty sure they'd do the same for us if we had their equivalents; and we've agreed that they should be on the Tier 1 list. Maybe time to get on with it?

Positive Externalities vs. Negative Externalities

Externalities are often defined as the positive or negative consequences of economic activities on unrelated third parties. Since the causers are not directly affected by those externalities, they will not take them into account. As a result, the social cost (or benefit) of these activities is different from their individual cost (or benefit), which leads to a market failure.

There are different types of externalities. The definition above already suggests that they can be either positive or negative. Additionally, there is another (and maybe less familiar) distinction which should be made here: Both positive and negative externalities can arise on the productionor on the consumption side.

In the following paragraphs we will look at the different types of externalities in more detail.

Positive externalities

Economic activities that have positive effects on unrelated third parties are considered positive externalities. As we learned above, they may be present in the form of production or consumption externalities.

Positive production externalities are positive effects that originate during the production process of an economic actor. An example of this could be an orchard placed next to a beehive. In this situation both the farmer and the beekeeper benefit from each other, even though neither of them has considered the other one's needs in his decision-making.

Positive production externality

This can be illustrated by comparing social cost and social benefit based on a supply and demand diagram. In this case, individual demand (D) is equal to social benefit (SB) since there are no externalities on the consumption side. However social cost (SC) is lower than individual supply (S) because there is an external benefit (EB) that is not included in the individual supply curve. As a result the market equilibrium (E*) is different from the optimal market situation (O*) and there is an undersupply of both orchards and beehives.

Positive consumption externalities are positive effects on third parties that originate from the consumption of a good or service. A possible example could be your neighbor’s flower garden. She most likely cultivates the plants solely for her own pleasure, yet you can still enjoy the beauty of the flowers whenever you walk by.

Positive consumption externality

Again, this can be illustrated by comparing social cost and social benefit. In this case however, the individual demand curve (D) lies below the social benefit curve (SB) because the external benefit (the beauty of the flowers) is not included in the neighbor's demand curve. The social cost (SC) on the other hand is equal to the individual supply (S) because there are no externalities on the production side. Like in the first illustration the market equilibrium (E*) is different from the optimal market situation (O*) and as a result there is an undersupply of flowers. What is different from the previous illustration though, the optimal price (p2) in this example is higher than the equilibrium price (p1).

Generally speaking, for positive externalities the overall benefit to society is higher than the one that is taken into account by the actors during their decision-making process. This results in an undersupply of beneficial products (or activities) for society. In order to correct these market failures it is important to know whether the externality arises from the production or the consumption side, since this affects the desired optimal market equilibrium. 

Negative externalities

Analogous to the previous paragraphs, negative externalities are economic activities that have negative effects on unrelated third parties. They can be divided further into production and consumption externalities.

Negative production externalities are negative effects that originate during the production process of an economic actor. The most common example of this kind of externality is the pollution caused by a firm during the production of their goods. Pollution affects the entire population, however as long as companies are not held accountable for their activities, they have no incentive to reduce their economic impact (since that would be more expensive).

Negative production externality

To illustrate this, we shall compare social cost and social benefit again. Similar to the positive externality example, individual demand (D) represents social benefit (SB). The social cost curve (SC) in this case however is higher than the individual supply curve (S) because of the external cost (EC) that is not included in the firms supply decision. As a result the market equilibrium (E*) is different from the optimal market situation (O*) and there is an oversupply of harmful behavior. In this example the optimal price of the good (p2) is higher than its actual market price (p1).

Negative consumption externalities are negative effects that arise during the consumption of a good or service. To give an example, we can revisit your neighbor. If she likes to play loud music in the middle of the night, a negative externality on your part could be sleep deprivation. Once again, she may not take this into account since the consequences do not directly affect her.

Negative consumption externality

In this case, the individual demand curve (D) lies above the social benefit curve (SB) because of the external cost (your sleep deprivation) that is not included in the neighbor's demand curve. The social cost curve (SC) on the other hand is equal to the individual supply (S), because there are no externalities on the production side. Again, the market equilibrium (E*) is different from the optimal market situation (O*) and as a result there is an oversupply of loud music. In this example the optimal price of the good (p2) is lower than its actual market price (p1).

The major characteristic here is, that without any regulatory influence, neither the firm nor your neighbor will take the negative effects of their activities into account. They are not directly affected by the consequences and will thus produce more than in an efficient market (where externalities are taken into consideration). This results in an excess supply of harmful behavior.

In a nutshell

Externalities are the consequences of economic activities on unrelated third parties. They can arise on the production or on the consumption side and can be either positive or negative. In all cases however, they will result in market failures that can only be avoided by imposing some kind of regulation to internalize the externalities.