Monthly Archives: April 2015

In (further) defence of the Austrians


The original freakonomist

Steve Horwitz and B.K. Marcus have written a pretty decent rebuttal of a notably poor article by Janek Wasserman about the Austrian school of economics in its modern day incarnation. But I think there’s something more to be said in the Austrian’s defence.

When you study economics what is it that you’re studying? As Israel Kirzner explained,

(L.M.) Fraser has classified definitions of economics into Type A definitions and Type B definitions. Type A definitions consider economics as investigating a particular department of affairs, while Type B definitions see it as concerned with a particular aspect of affairs in general. The specific department singled out by Type A definitions has usually been wealth or material welfare. The aspect referred to in Type B definitions is the constraint that social phenomena uniformly reveal in the necessity to reconcile numerous conflicting ends under the shadow of an inescapable scarcity of means”

The argument as to which Type is appropriate is far from settled. Ha-Joon Chang in his recent book makes a pretty unequivocal case for a Type A definition of the scope of economics. To him, ‘economics’ is something you step into when you leave your house for work in the morning, and something you step out of when you get home, hug your partner, and feed the cat the in the evening.

But, as Kirzner notes, “During the twentieth century…a transition from Type A to Type B definitions has been vigorously carried forward”. Mostly thanks to the late Gary Becker, economic notions of choice and incentives were applied to an increasing array of hitherto non-economic phenomena. Becker applied economics to families and criminals and, while some may have griped about the ‘imperialism in the social sciences‘, bestselling books now argue that economics explains everything from what makes a perfect parent and why milk cartons and soft drinks cans are the shapes they are, to how racial segregation in housing can arise.

The Austrians were at these new frontiers in economics before most. One of the Austrian school’s great works is Ludwig von Mises’ Human Action. It was a vast treatise at a time when such had been denounced by Keynes. Compared to previous works, with names like The Principles of Political Economy and Taxation (Ricardo), Principles of Political Economy (Mill), The Theory of Political Economy (Jevons) or, again, Principles of Economics (Marshall), Mises deliberately took as his field of study Human Action in its entirety. “Until the late nineteenth century political economy remained a science of the “economic” aspects of human action, a theory of wealth and selfishness” Mises wrote in 1949

“It dealt with human action only to the extent that it is actuated by what was very unsatisfactorily described as the profit motive, and it asserted that there is in addition other human action whose treatment is the task of other disciplines. The transformation of thought which the classical economists had initiated was brought to its consummation only by modern subjectivist economics, which converted the theory of market prices into a general theory of human choice.

…The general theory of choice and preference goes far beyond the horizon which encompassed the scope of economic problems as circumscribed by the economists from Cantillon, Hume, and Adam Smith down to John Stuart Mill*. It is much more than merely a theory of the “economic side” of human endeavors and of man’s striving for commodities and an improvement in his material well-being. It is the science of every kind of human action. Choosing determines all human decisions.”

Modern day armchair economists, undercover economists, economic naturalists, freakonomists and their Type B students would agree.  As Horwitz and Marcus point out, Austrian economics was not ‘made in America’, but a substantial part of the most cutting edge modern economics was made in Austria.

* You might add Chang to this list

EDIT – This post was picked up by the people at the Foundation of Economic Education

The economics of voting – or why it make sense for most people not to

One of the great things about economics is that it allows you to think clearly and logically about subjects that are usually shrouded in sentiment. When you hear “economists know the price of everything and the value of nothing”, you are hearing sentiment complaining about being told to take a back seat to logic.

Take your ‘democratic duty’ to vote. There is, of course, nothing of the kind. The many people who struggled to win the right to vote in Britain (and the United States and elsewhere) were fighting so that they could vote, not so that you had to. Indeed, in many cases voting is more trouble than it’s worth. Literally.

You might have a vote but it is not free. In terms of time and effort voting has a cost – getting registered, reading all the manifestos if you really want to do it properly, and walking to and from the polling station.

And what is the pay off – the reward times your contribution to the probability of that party winning?

Start with the reward. If one party offers huge benefits (not necessarily in a welfare state or social security sense) the reward for voting will be increased. Conversely, if another party promises unimaginable hardship, the cost of not voting rises.

But now consider your contribution to the probability of that party winning. One person has one vote, but how many elections have ever come down to that one vote? None. That one person, even in a tight race, would have made no difference to the outcome by staying home or going for coffee instead of voting.

To give you a concrete example, I live in a constituency which is bound to be won by the Silver Party but I want the Gold Party to win. I incur the cost of voting but with no expectation of a pay off. Why would I do that? I suppose I could think of myself as making a contribution to the national, aggregate total for the Gold Party, but does it really make much difference if they get 10,768,594 votes as opposed to 10,768,593?

Is this not the fallacy of composition? The erroneous idea that what makes sense for me makes sense for everyone which would lead to nobody voting, apparently a sub-optimal outcome?

Well no, not really, because everybody is not me. If you live in a marginal constituency where your vote carries a higher probability of contributing to your favoured party winning, it might make perfect sense for you to incur the cost of voting and, so, you would. And margins, as economists have known much longer than political scientists, are where decisions are made.

Who gets what?


Worth every penny

“If, therefore, the choice were to be made between Communism with all its chances, and the present state of society with all its sufferings and injustices; if the institution of private property necessarily carried with it as a consequence, that the produce of labour should be apportioned as we now see it, almost in an inverse ratio to the labour—the largest portions to those who have never worked at all, the next largest to those whose work is almost nominal, and so in a descending scale, the remuneration dwindling as the work grows harder and more disagreeable, until the most fatiguing and exhausting bodily labour cannot count with certainty on being able to earn even the necessaries of life; if this or Communism were the alternative, all the difficulties, great or small, of Communism would be but as dust in the balance.”John Stuart Mill, 1848

It is one of the oldest fallacies in economics that reward is or ought to be linked to effort. Indeed, as well as appearing in works by august economists like John Stuart Mill it has been solemnised as ‘the Protestant work ethic’ – a fair days ways work for a fair days pay. The attitude persists. Many people think it outrageous that Christiano Ronaldo earns €18,200,000 a year for kicking a football around a couple of times a week while people are fishing cigarette butts out of nightclub urinals for minimum wage.

But, as the generation of economists after Mill realised, reward is linked to productivity. If buckets of water sell for £1 each then someone who can run 100 buckets a day from a tap and drive them to the market in a van will make 10 times more with a fraction of the effort than someone who has to walk to a well and carry by hand 10 buckets day to the market.

This is one of the reasons wages are higher in developed countries than developing ones. There is plenty of effort going on in poor countries but very little capital (like the tap or the car) to augment its productivity and productivity is what counts.

More accurately in modern economies reward is linked to an employers estimation of the workers (likely) productivity. Real Madrid pay Christiano Ronaldo his €18,200,000 a year because they think he will add at least that amount to their profits. People want to watch a team with Ronaldo in, they want to wear shirts with his name on them and they are willing to pay for that. They are willing to pay something or more than they would otherwise to do so.

For a concrete example, consider Real Madrid shirts with ‘RONALDO’ on the back.

1 – Adidas have a bunch of white cloth and thread which they could sell for, say, £1 a sq yard.

2 – They build a factory in Pakistan, buy a bunch of sewing machines and hire a local worker to sew these into plain white T shirts which they can sell for £2 each. The workers sewing and Adidas’ factory and machine have, between them, added £1 of value.

3 – Next they ask the worker to sew an Adidas badge on the shirt. Now it can be sold for £10. Adidas, via their brand, have added £8 of value. You might say that it was the worker who added the value as they did the sewing. But, in fact, only a fraction was added by the worker. To see how true that is consider how much value would have been added if, for the same effort, the worker had sewn ‘JIMMY SAVILE’, ‘MICHAEL VICK’, or ‘GHI PUINNJNULJ’ on the back of a shirt. It wasn’t the worker’s sewing but what they sewed that added the value.

4 – Now they ask the worker to sew ‘RONALDO’ on the back of the shirts. Now they can be sold for £50. Christiano Ronaldo has added £40 of value.

Christiano Ronaldo gets a lot of money because he adds a lot of value.

We can also see why ‘wicked’ capitalists get money for little apparent effort. Think back to our water makers. If a capitalist builds a tap and a car which now enables the second person to bring 100 buckets of water a day to market without all that walking and carrying, that capitalist has added £90 of value.

Is this ‘fair’? I’m an economist, not a philosopher. But plenty of people must think it was fair or it wouldn’t happen. You often hear football fans complain that the prices of tickets or replica shirts is a disgraceful rip off – then they hand their money over for a ticket or shirt. At the moment they hand over £80 for a match ticket or £50 for a shirt they are signalling that they would rather have the ticket/shirt than the £80/£50. Quite simply, it is worth more to them. Which action reveals their true preference; The complaining, which is free to do, or the buying, which costs money?

The ‘epidemic’ of zero hour contracts

Well, I did warn you.

Today Ed Miliband promised that a future Labour government would end the “epidemic of zero-hours contracts” which are “undermining hard work, undermining living standards, undermining family life” in Britain. But the Office of National Statistics, workers on zero hours contracts account for 2.3% of the workforce. Is that really an ‘epidemic’?

I’ll admit, I wouldn’t want to be on a zero hours contract (though it might have been useful when I was studying). You might not want to be on a zero hours contract. But, surely, what matters is whether the people on zero hours contracts want to be on them?

In 2013 the Chartered Institute of Personnel and Development produced a study of zero hours contracted workers. It found that

  • “Almost half of zero-hours contract workers (47%) report they are satisfied with having no minimum contracted hours, with 27% saying they are dissatisfied and almost a quarter (23%) neither satisfied nor dissatisfied.”
  • “Almost two-thirds of employers surveyed that use zero-hours contracts (61%) report that zerohours staff are not contractually obliged to accept work and are free to turn it down. However, 15% of employers say zero-hours staff are contractually required to be available for work, and a further 17% report that in some circumstances zerohours contract staff are expected to be available for work.”
  • “In all, 80% say they are never penalised for not being available for work, a further 17% say they are sometimes penalised and 3% say they are always penalised if they are not available.”
  • “Most zero-hours contract workers (52%) don’t want to work more hours than they typically receive in an average week. However, 38% say they would like to work more hours, with 10% undecided.”
  • “About a third of employers that employ zero-hours workers say they have a contractual provision or policy outlining their approach to arranging work with zero-hours workers or cancelling work that had been offered. However, about four in ten employers say they don’t have such provisions or policies and a quarter say they don’t know.”
  • “In all, 46% of zero-hours contract workers say they either receive no notice at all (40%) or they find out at the start of a shift that work is no longer available (6%).”
  • “Six in ten zero-hours workers report they are allowed to work for another employer when their primary employer has no work available. A further 15% say they are able to sometimes. Just 9% say they are never able to work for another employer and a sizeable 17% don’t know.”
  • “Almost two-thirds (64%) of employers who use zero-hours workers report that hourly rates for these staff are about the same as an employee doing the same role on a permanent contract. Nearly a fifth (18%) report that hourly rates for zero-hours staff are higher than permanent employees. Around one in ten employers report (11%) that they are lower.”

So, a mixed picture. Or maybe that doesn’t matter. Maybe whether people like them or not is immaterial to whether the government permits them or not. That’s a political question and this is an economics blog.

So, take a look at the chart below


Source: OECD

Unemployment has been one of the relative British economic success stories in recent years. And, in large part, this is down to its relative labour market flexibility – the ease with which workers can be hired and fired, in other words. Indeed, as the graph below shows, countries with less regulation of temporary employment see more employment.


Source: OECD

But maybe those unemployed Greeks and Spaniards are, actually, better off than British workers on zero hour contracts? Actually, the evidence shows that it’s better to have a temporary job than no job.

It’s early days in the campaign so there will be more of this stuff, no doubt, from all parties. But it would be a mistake to let a part of a labour market which has weathered recession remarkably well fall victim to political posturing.