A wasteful Christmas

As noted by Chris Berg, the Australia Institute has rolled out its annual reminder of Joel Waldfogel’s almost 20-year old observation about the wastefulness of Christmas giving. As the gift giver has less than complete knowledge of the preferences of the recipient, the recipient tends to value the gift at less than the amount that the giver paid. The disparity in value represents a deadweight loss.

As for most of the annual responses to the Australia Institute’s release (with a special mention for Steven Kirchner’s 2009 comparison of Christmas gift giving with government spending), Berg suggests that such spending may not be wasteful. Christmas gifts signal to loved ones the strength of the relationship. To the giver, the money is not wasted. Further, the narrow definition of efficiency fails to capture benefits such as the effect of the gift on the strength of the relationship.

While I consider Berg’s analysis to be on the mark, I would not characterise the situation as one without “waste”. In fact, waste can be a vital element of the signal. For a signal to be reliable, there should a cost to the signaller. Otherwise, the signal may be faked. If gifts had no cost, people would give them to a far wider set of recipients, destroying the value of the signal to the receiver as to who cares about them. Receivers of the signal would then start to ignore the signals as they can’t tell the good from the bad. This makes gift giving useless to the signaller and destroys their incentive to make the signal in the first place.

This scenario creates an incentive for the giver to increase the cost (including price, inconvenience, degree of thought) of the gift to a size that cheaters will not match it. This might result in continually increasing gift size as givers seek to make sure that the gift is large enough.

Given the above, it is worth asking whether gifts are the most efficient way to make this signal or whether there is a way for all parties to agree to restrain the costs that they will incur. On the first point, the evidence of continued gift giving would suggest that the givers consider this an efficient way for them to signal. However, this is an indicator of private efficiency and it may not be the socially optimal method.

On the second point of restraint, one possibility could be  along the lines of Robert Frank’s suggestion of progressive consumption taxation. If the government taxed consumption at a progressively higher rate, there would be less incentive to engage in competitive conspicuous consumption or gift giving. However, we then end up back where we started. As Kirchner asked, if we put this money into the hands of government result in the purchase of goods with an even lower value to the recipients? Personally, I would rather trust my loved ones.

Benefits from immigration

With immigration again a hot political topic, Ross Gittins has waded into the debate, with his latest contribution seeking to skewer the economic argument for high immigration. Gittins referred to the Productivity Commission’s 2006 report into immigration which found that a 50% increase in skilled immigration could boost GDP by 4 per cent after 20 years. The Commission also predicted that real income would increase marginally, with all the income gains accruing to the new migrants.

Two points are worth mentioning. The first is his suggestion that there is a lack of evidence for scale effects in the provision of public goods. If twice as many people use a road, there is benefit in spreading the cost across that greater number. Alternatively, the larger number of people may make that road viable to build. However, there is a more important scale effect that we need consider, that of the extent of the market. As said by Adam Smith:

As it is the power of exchanging that gives occasion to the division of labour, so the extent of this division must always be limited by the extent of that power, or, in other words, by the extent of the market.

It is on this basis that trade has created so much wealth. Picture the basket of goods that we would be able to buy if there was no movement of goods across borders.  Immigration, through enlargement of the  market and the provision of labour, has similar effects. With many services reliant on the location of labour and consumers, and there still being many obstacles to trade, free movement of people allows increased opportunity for specialisation and gains from trade.

The second point concerns the huge gains to the immigrants who come to Australia. The Productivity Commission’s found that most of the income increase goes to the new immigrants. How should we value the chance for an immigrant to come to Australia and take advantage of opportunities not present in their home country? It must count for something. Of all of the methods tried to raise the wellbeing of the world’s poor, migration to a developed country is still the most sure-fire bet.

Climate change and peak oil

Beliefs come in clusters. If someone believes in action on climate change, they are more likely to support unions, gay marriage and progressive taxation. To me, one strange pair of beliefs is that on peak oil and climate change.

Take this quote by the Australia Institute in Running on Empty? The Peak Oil Debate: As a result of peak oil, “skyrocketing oil prices are likely to result in severe disruption to economies, with central banks raising interest rates to slow runaway inflation, people out of work, famine, hunger and serious civil unrest.” This is a common perspective held by those concerned by peak oil. Yet many of the same people will advocate strong carbon emission cuts and suggest we can do it in a way that creates jobs and is good for the economy. Why can we make a huge reduction in fossil fuel use by choice, yet not navigate an externally imposed constraint?

There are some ways to reconcile these beliefs. Peak oil may result in a shift to coal, with a higher emissions profile (although, peak coal is now on the agenda). Others consider it a matter of planning – we can deal with each if we plan. But for a 40 per cent per cent emissions cut by 2020, supporters of such cuts tell us that the solutions are largely on the table. Why are they not available for when we reach peak oil?

Having said that, the converse combination of beliefs is more difficult to reconcile. Many people who believe in the power of  markets will argue that when the oil supply peaks, prices will adjust, substitutes will emerge and like the end of the stone age or the bronze age, we will not stop using oil because we run out. Yet many of these same people will decry the potential carnage to the economy if government takes measures to reduce emissions. Why cannot the market adapt to these regulatory responses in the same way as a natural shortfall or absence? If government restricts offshore exploration (without implying that this is the best policy response), is the long-term effect any different to there being no new offshore oilfields to discover?

Again there is some possible reconciliation. The current price could be argued to already contain all relevant information about supply. Government may be clumsy and overly restrictive in its response to climate change. But would an alternative policy response be to advocate a climate change policy that creates the right incentives in the least restrictive way? There are few who take that position (as I blogged before).

As for my perspective, with the right price on carbon and room to innovate within that price, a shift to a low-carbon economy will not be painful, particularly if revenue from carbon replaced other taxes. With peak oil, a high oil price is no different from a tax on carbon. There is some unpredictability in the price of oil (in the same way that price would vary under a cap-and-trade regime), but within the constraint, there will be innovation and a move to whatever form the new energy regime will take.

I will add a final proviso, however, that my perspective relates to the effect of these issues in the developed world. Short term oil price shocks and constraints on carbon intensive energy use may play out very differently in a developing country. The right response in that case is a much more difficult question.

Fitness spreading

One of the issues at the core of my research is the speed of human evolution, particularly over the last 10,000 years. There are several potential arguments to suggest that the speed of human evolution is increasing, such as a larger population (creating a larger source of mutations) and the huge changes in environment that humans have experienced.

One of the obstacles to this argument is the largely monogamous nature of marriages, especially in more recent times and developed countries. If each man pairs with a single woman, and there are roughly equal numbers of each, inability to pair will no longer be a significant evolutionary factor. However, it is possible to argue that sexual selection can play a role even if there is pure monogamy (i.e. assuming no infidelity or serial monogamy).

Suppose that males and females can each be ranked in order of fitness – that is, their probability of surviving to adulthood. When it is time to match, the highest fitness male and female will pair off. The second highest ranked of each sex would like to pair with the highest ranked of the opposite sex, but given the highest ranked is already paired off, the two second highest ranked settle for each other. This continues down the rankings until the lowest ranked of each sex pair.

Now consider the offspring of these pairs. The offspring from the highest ranked pair will have the highest fitness. In fact, if you wanted to produce an offspring of the highest possible fitness, you would pair these two individuals. Similarly, if you aimed to produce the lowest possible fitness offspring, you would have done so by matching the lowest ranked pair.

The net result of this process is that the offspring in the population will have the largest possible range of fitness. Fitness matching concentrates harmful mutations in low fitness babies. With this large range of fitness, natural selection is faster, with the lowest fitness offspring least likely to survive and helpful genes concentrated in the high fitness offspring.

The result of this fitness spreading process is that sexual selection provides a platform for natural selection to have an increasing effect. Even in a perfectly monogamous society, sexual selection can still be a force.

The evolution of technology

In Kevin Kelly’s recent appearance on Econtalk, he talked about his new book What Technology Wants. I have not read the book but some of Kelly’s statements about human evolution are worth comment.

Kelly notes that, to a degree, humans created our own humanity. Kelly talked about how humans are the first domesticated animal, in that we used our minds to domesticate ourselves. While we are a continuation of the primate line, we have added with our minds things other primates don’t have. For example, by inventing cooking, humans effectively developed an external stomach to digest food that we were not normally able to digest. This additional nutrition changed the size of our teeth, the shape of our jaw and the enzymes in our stomachs. When humans domesticated livestock, we developed lactose tolerance. As a result, we are self-created – both the creator and the created.

My first thought on Kelly’s observations is around the idea of us evolving a trait such as lactose tolerance. The way it happens is that those with the lactose tolerance gene have higher fitness than those without and so, their descendants come to form a larger part of the population. So, when “we” domesticated milk producing animals, it was the end of the genetic line for many humans.

My second thought is a more substantive criticism. Through sexual selection, many animals are both the creator and created. Choice by peahens created the peacock’s tail. Choice by female bower birds has led male bower birds to evolve a preference for constructing elaborate bowers. Taking a human example, Geoffrey Miller argues that female choice shaped the human brain in the first place. To isolate humans as special in being both the creator and created is to ignore an important evolutionary force.

On a speculative note, Kelly is drawing a long bow when using evolution as part of the argument that technology is progressive. Evolution is not uni-directional and while there is a general tendency towards complexity (when compared to the earliest life forms), there is no law pushing it in one direction. I will need to read the book before unequivocally accusing Kelly of misusing the evolution analogy but if he were to do so, he certainly would not be alone – just read Matt Ridley’s The Rational Optimist: How Prosperity Evolves.

Post-crisis economics

Over the weekend I listened to the three-part Lionel Robbins Memorial Lectures 2010, this year given by Lord Adair Turner.

Lord Turner gives a fantastic and balanced critique of the practice of economics and its use in public policy and regulation of the financial sector. Most refreshingly, he does not end his critique with a demand to regulate and restrict, but rather lays out a range of considerations in setting policy and which arguments he considers should be given most weight. Compared to the caricature of modern markets given by Raj Patel (that I also listened to in the last week), it was a nuanced, thoughtful presentation.

A few of the features that have stuck in my mind:

1) Lord Turner used Roger Bootles distinction between creative and distributive activities in the economy, with creative referring to activities that create welfare and distributive simply transferring welfare (divorce lawyers being the classic case of distributive activity). The question arises of how much financial activity is on the distributive side of the ledger.

2) Turner questioned the benefit from increasingly “perfect” markets. For example, does  the improved price discovery from algorithmic trading (that may trade in fractions of a second) increase welfare much beyond that delivered by share markets now, with trades occurring each minute? He considered that there must be diminishing marginal returns to such activities.

3) Zero growth is not possible in a free society without increasing voluntary employment. If people are free to increase the efficiency and manner in which they conduct activities, there will inevitably be surplus resources.

4) A strong thread through the presentation was the questions of relative versus absolute wealth. As positional goods are only available to those with relatively higher incomes, relative position affects welfare. Considerations such as this mean that inequality cannot be dismissed as a policy consideration.

Coal and the industrial revolution

In a recent discussion as part of the Cato Unbound series, Matt Ridley suggested that we shouldn’t forget the Materialist explanation for the industrial revolution. The difference between the British and other bursts of economic activity, such as that of Ancient Greece, is that the British event did not peter out. The reason for that, says Ridley, is coal.

On one hand, this explanation feels like a Jared Diamond style geographic explanation, although in a more modern era. However, I am not convinced that the availability of coal is a unique enough circumstance to explain why the industrial revolution happened when and where it did. Why did the industrial revolution not occur during the Roman occupation of Britain,? Coal is also plentiful in China, with Marco Polo reporting to astonished European audiences on the flammable black rocks used by the Chinese. Why did coal not propel technologically advanced China into an industrial age? There are  also many readily accessible coal deposits in North America (although in the North American case, the Diamond geographic argument  and the need to reach a level of technology necessary to exploit the resource appears convincing).

I agree with Ridley’s point that coal contributed to the wealth and pace of the industrial revolution. However, given that the United Kingdom is not unique in having accessible coal deposits, acknowledging the role of coal  does not answer the interesting question of why the industrial revolution occurred where and when it did. To tie coal into that question, why did the British people reach a degree of technological advancement and industry that they were able to use resources like coal to propel themselves and the rest of the world into an industrial age?

Company charity part II

I have a couple of follow on thoughts from yesterday’s post on large companies being pressured to donate to charity.

Firstly, I was probably a bit flippant in describing the target donation rate as 0%. If charitable donations are what the shareholders want, so be it. However, the shareholders should make that choice, not external pressure groups. Further, the majority of shareholders should not make that choice for the others. If they want donations made, it should be from their share of the profit. This takes us to the simplest solution of giving the money to the shareholders to let them do with it at they see fit.

My second thought is about the level of funding that will go to these charities. If the company does not pay the 1% of profits to charity, the shareholders are unlikely to give all of their 1% larger dividend to charity. On a direct basis, donations to charity are likely to go down. But what of the indirect effects? Do corporate donations crowd out individual philanthropy? I suppose that is an empirical question, but I would expect that there would be some crowding out.

Perth’s Channel 7 runs a charity drive called Telethon each year which raises money for Princess Margaret Hospital for Children. The drive consists of 24 hours of entertainment during which people phone in to pledge cash support. This year the drive opened with Prime Minister Julia Gillard donating $1.5 million on behalf of the Federal Government (several layers of irony there). That donation was quickly followed by a series of companies with their cheques (very cheap advertising time for them). That start certainly reduced the incentive for me to pick up the phone to give $10 or $20.

Also on the crowding out theme, this afternoon I listened to a podcast in which Steven Johnson, author of Where Good Ideas Come From, mentioned Kickstart, an organisation that links entrepreneurs with capital. While the focus of these types of organisations is typically poverty alleviation, Johnson used the example of a band needing funding to, say, record an album. He commented that this was a different dynamic to the artist seeking government grants. It would be disappointing to crowd out these types of innovative approaches to entrepreneurship.

Company charity

The Daily Telegraph has had a go at Australia’s top 20 companies for not donating enough to charity. According to their analysis, the largest 20  Australian companies donated only 0.85 per cent of their profits to charity in 2009-10, with ANZ donating only 0.21 per cent. This is less than the 1 per cent deemed adequate by “social experts”.

I propose a different target: 0 per cent. Those profits belong to the shareholders and ideally, should be in their hands to decide if and how they will donate. These companies have an area of expertise and that is making profit by providing goods and services that people want. They should focus on that.

If these companies are interested in being a good corporate citizen, I’d prefer that they spent their time looking at their own operations and impacts rather than buying public standing through their charitable giving. I am sure that Woodside is better at preventing oil spills than selecting a suitable charity to help the homeless (or as often is the case in Perth, selecting the local theatre or music company to fund).

Having said that, in the same way that Milton Friedman did not want to condemn the cloaking of self-interested activities as “corporate responsibility”, I am not going to condemn any company that does give to charity. Charitable giving may buy customer support and reputation, which have value in themselves. Staff may prefer working for such an organisation. However, the meeting of arbitrary targets set by self-appointed social experts is simply a transfer from shareholders. I would prefer that those shareholders be left to make that decision for themselves.

Better school performance leads to more children

An article by Anna Goodman and Ilona Koupil in last month’s Evolution and Human Behavior found a link between school performance and number of children and grandchildren (in Sweden 1915-1929). This effect, as might be expected, held in males only. The number of children was linked almost entirely to whether the male married, with marriage largely a function of socioeconomic position. As most males married (around 90%), the effect of schooling performance on number of children was largely evidenced in those males at the bottom of the distribution.

One observation made by Goodman and Koupil was that as marriage prospects were largely mediated by socioeconomic position, there was little evidence of selection for cognitive abilities per se. It could be interpreted as a cold hearted conclusion. While money and social position are clearly going to have influence, what of the effort put into conversation, humour and other displays of intelligence. Are they all for nought?

For the group in this particular study, it might be  reasonable conclusion. However, given the differences are only at the low end of the school performance distribution, we might be seeing a threshold effect, whereby women are not interested in marrying someone below a certain standard. It reminds me of some of Bernard Salt‘s work, whereby an eligible man is defined as someone not married, straight, not in jail and earning over $50,000 a year. They are not even in consideration.

From a selection point of view, the elimination of individuals at the bottom of the distribution has somewhat different consequences to different reproductive success across the full spectrum of performance. I am going to dig some more into the data over the next few days to get a feel for what the change in distribution might look like over time.