Pigou vs Coase, as refereed by Demsetz

This is a good summary of the Pigou vs. Coase debate on externalities. I have one comment: That the author should have brought Hayek into the picture. After all, the piece was published in 1996. What follows is a kind of executive summary.

Demsetz sees the debate on externality as one between two ideals: An ideal state (with perfect information) and an ideal market (also with perfect information and zero transaction cost). Taken to the limit, both models do not generally produce identical solutions. It is well known that the initial distribution of wealth and income affects market outcomes. Change that distribution and the economy rests somewhere else. With Pigovian state intervention, one also needs to factor in the initial distribution of wealth and income as a determinant of political process. Still, it is reasonable to imagine that both models arrive at the same end-point if they started with the same initial conditions.

Demsetz then concludes, based only on theoretical considerations, that the choice between the two models is one determined by preferences for freedom and the final (and/or initial) distribution of incomes and wealth.

Once we depart from the ideal to actual governments and markets, the choice between the two solutions would then have to take into account how much information there is (available) in the competing models, and how well they would reduce transaction cost. Here, Hayek would pronounce in favor of Coase, if only because Hayek believes that the market is more capable of ‘discovering’ such phenomena as efficient technologies and consumer preferences. Transaction cost can be seen as another form of externality, so we start to run the risk of arriving at a proverbial slippery slope.

Nonetheless, Demsetz is essentially right. Transaction cost is not at the kernel of Coase; and neither did Pigou ignore transaction cost. What was being debated was who should have the property rights to the externality, a question that economists usually avoid but one that Coase faced head on.

Progress and income inequality in PH

A recent Pew Research Center piece  has data on income inequality for various countries and the world.

The distribution of income in PH is as follows for 2011: 14% poor; 72% low-income; 14% middle to upper middle; and 0.2% high-income.

The global percentages are: 15% poor; 56% low-income; 22% middle to upper middle; and 7% high-income.

What might be concluded? We aren’t exactly poor, but we are predominantly low-income. That means the middle and high income groups are a minority of only 14%.

The economic challenge to those who claim they have a better mousetrap is whether they can reduce the low-income group to the global average of about 50%, raise the middle group to 30+%, while lowering the poor to 10% or below. Doable, but not easy, over the next decade.

Some (maybe strange) economics questions

 

1. Can economics say anything about unforeseeable (uninsurable) disasters? I’m thinking about the idea that a butterfly moving its wings can cause a global tsunami.

2. Will robots cause permanent unemployment? Rephrase this question. In ancient history, the nobility didn’t do the work because they had vassals and slaves. Were the nobles unemployed? Was that a bad thing? Is employment/underemployment/unemployment an issue of quality of life?

3. What exactly is poverty? If stray dogs are poor, and pet dogs are rich, is it good policy to control the population of stray dogs? Or is it better policy to have feeding stations for stray dogs? Or is it an even better policy to mandate that those who have pet dogs also feed the poor and hungry humans nearby? After all, we seem to always say that humans have rights that animals don’t.

EC 23 Mid-term Exam

Hints:

Be sure you understand the three methods of solving a system of N linear equations: by ‘brute force’ or substitution; by finding the inverse of the matrix of coefficients; and by using determinants as per Cramer’s Rule.  Because the exam has limited time, you should go through the examples in the textbooks, and practice how to find the solution.

The exam question sheets should not be turned in with your blue books.  The questions are useful for class discussion, so please bring them with you for the class meetings after the exam.

Relax.  It’s only math.  It’s only economics.  It’s not the beginning or the end of the world.

 

Philippines vs China

WHY WE WON

It seems that we can boil down the legal conclusion of the arbitral ruling as based on only two key questions.

One, what is an island? A rock is not an island. So there. Even if China builds up a rock, it still cannot become an island. It may be a feeler island, but still that’s not an island in the legal contemplation of international law. UNCLOS says that artificial islands are not properly islands. (Otherwise, any oil rig can claim to be an island!)

And there’s the economics of islands. Under UNCLOS (Art. 121(3)), only natural formations that can sustain economic life on its own, can have maritime zones, such as an Exclusive Economic Zone (EEZ).

Two, what is an archipelagic state? It is one composed of many islands. PH is archipelagic. China is not. It appears that China conceded its status as a coastal (non-archipelagic) state when it signed the UNCLOS because the UNCLOS classifies countries in only two ways — archipelagic or coastal. The Tribunal ruling, in para. 573, categorically restates that China is a coastal state.

The answers to these two questions determine the EEZ, which is 200 miles from the coastline of a non-archipelagic state; and 200 miles from the archipelagic baseline of an archipelagic state. The baseline is a point-to-point boundary that encompasses or includes the islands of an archipelagic state.

An outlying island in the South China Sea, even if it could be claimed as territory of China, cannot result in an expanded EEZ based on archipelagic baselines because China is not an archipelagic state. (Consider the following related question: Can the US consider the waters between Hawaii and Los Angeles as “internal waters” using the archipelagic baseline approach? The answer is in the negative because, like China, the US is not an archipelago.)

The EEZ of an outlying island is 200 miles around that island because such an island is treated like any other land territory (Art. 121(2)). The EEZ cannot extend beyond the 200 miles (beyond this, there would be continental shelf (something else) or open international waters (high seas)). And an EEZ could be delimited if competing EEZ’s from other nearby states exist.

The ruling states that the disputed territories are not at all islands, and therefore cannot provide China an EEZ. Practically all the major disputed territories are inside the EEZ of the Philippines because it is an archipelagic state. Therefore, even ‘rocks’ can be useful to the Philippines, if they are located within the EEZ based on the archipelagic baselines of the Philippines. These useful rocks include Scarborough Shoal, Second Thomas Shoal, Johnson Reef, McKennan Reef, Hughes Reef, and Mischief Reef. Some of the disputed rocks are outsize the EEZ of the Philippines.

An important caveat is that territory and sovereignty are matters of international law not subject to the UNCLOS. Nonetheless, disputes relating to the EEZ are pointedly the subject of the UNCLOS.

WHY IT MATTERS

EEZ means maritime zones (not necessarily territory in the usual ‘conquest’ or ‘historic’ sense) that we can, under international law and UNCLOS, consider as usable only by us. We can, by negotiation, lease or allow others to use the EEZ, but the extent to which the Philippine Executive can do this is governed by the 1987 Constitution.

NB: The map of PH EEZ is from Wikipedia.

PH EEZ Screen Shot 2016-07-14 at 2.07.29 PM

 

Undistributed Middle Redux

How does the fallacy of the undistributed middle (FUM) arise in economics?

FUM can be exemplified as: The queen has a poodle; I have a poodle; I am queen.

This can be rewritten as: If I am queen, I have a poodle; since indeed I have a poodle, then I am queen.

FUM then boils down to hypothesizing that P implies Q, and then claiming that P is true because Q is true.

This restates what we ought to know from logic – that FUM is a formal (syllogistic) error. This error, when expressed in terms of P and Q, is that of not ruling out all the other possibilities that can produce Q.

In economics, we can think of P as the unseen but ‘true’ model, which has an implication Q. If we gather statistics to show that Q is true, can we proclaim hallelujah that P is true? No, because this would be exactly just another FUM! And yet we find that this thought process using FUM underlies many an article in economics journals (to EC 23 students: gentle reminder that this is a HW assignment).

Karl Popper would now stir from his grave, and say that humans never learn. (Does that mean that Karl was at least part alien?)

FUM is no fun.