More on inflation, violence and identification

Chris has responded to my previous post, which he frames as a criticism of his research. I should state upfront that this does not strike me as entirely accurate, since I emphasized at various points that my concerns lay in the possible journalistic interpretation of his work. Some email correspondence between the two of us suggests that I am not alone in expressing such trepidations, but I digress. On then, to Chris’s response…

1) He begins by taking issue with my decision to focus on food prices, politely suggesting that I “may have missed” the fact that his non-discretionary index of living costs includes various other components (including rent, electricity, water, etc).

As it happens, I don’t think that I missed this at all. My reasons for focusing on food prices are quite simple. First, they provide relevant context to the real effects that I highlight in my post, i.e. agricultural shocks stemming from massive drought. This was done deliberately with the aim of illustrating the overriding message of my post: Attributing causation to any particular event is often very difficult, and we certainly have to bear real effects in the front of our minds when discussing the sources of inflation. (To reiterate, this is something that the Business Day article failed to do entirely.) Second, food prices provide an obvious segue to the other article that I discuss in my post, which concerns the role that monetary expansion had in driving up food prices and thus precipitating the Arab Spring. Such matters notwithstanding, however, I did happen to include the following passage in my original post:

To be clear, South Africans have also experienced sharp increases in the cost of amenities like electricity and water provision due to some boneheaded policy decisions and as a legacy of inefficient parastatal monopolies.

Chris may have missed that, though. (wink)

2) His second objection is that I am unfairly interpreting his research as a suggestion that food hikes are the only cause of violence. He quotes his references to “political grievances” as evidence that I haven’t read the article properly.

Again, however, this seems to be a misunderstanding of what I have written and the major point of my post. In the passage that he quotes, I'm not concerned with alternative causes of violence, but rather the underlying drivers of one particular cause, i.e. inflation. At the risk of repeating myself: To the extent that inflation does act as a trigger for social unrest and violence – and irrespective of whether that occurs alongside other factors such as political grievances or not – we need to understand what the underlying forces behind that inflation are. Any analysis that focuses only on the nominal effects of (quote unquote) “delinquent” monetary policy is simply misleading. Why? Well, because there may be very significant real price drivers occurring at the same time! This is something that the Business Day article completely failed to mention, and the same is true for The Telegraph article that I quoted in the second half of my post. I see nothing wrong with taking exception to such slipshod analysis.

3) Next issue: On my suggestion that one might baulk at the definitive description of this research as “proof” of the relationship between inflation and violence...  Well, I don’t have much to add here, since – again – this is a criticism of how the journalist chose to frame his article. “Proof” is simply too strong and simplistic a word to use given all this issues that I have raised. (Note: I see that this has happened elsewhere.)

4) The penultimate point that Chris makes in his reply extends beyond the article featured in Business Day.  I will summarize his argument as saying that the South African Reserve Bank (SARB) should abandon its focus on the headline CPI, because a) Non-discretionary inflation has been rising much faster, b) It cannot control which specific goods rise and fall in price, and c) It would better facilitate an environment of civil harmony by stabilizing the Rand against a basket of commodities.

Now, interestingly enough, subsequent to yesterday’s post I found this column that Chris has penned himself. (I’ll take it that we can safely assume away possibility of incorrect interpretation by a third party here.) He produces the below graph and proceeds to write: 

Seeing as Non-Discretionary goods price inflation has averaged well above the SARB’s price inflation target of 6% for most of the past seven years, low income groups’ standards of living are falling at a compounded rate relative to high income earners. [Emphasis mine.]

I don’t have the raw data to hand, but eye-balling the chart it doesn't seem at all obvious to me that non-discretionary goods have “averaged well above” the 6% inflation target. (Does it seem obvious to anyone else?) In fact, I’d hazard a guess that it averages a shade below the 6% mark. Certainly, the strongest statement that we can probably make about this series is that it fluctuates around that general level.

We all agree that no single measure of price changes is perfect. Indeed, it is precisely for this reason that we have constructed so many different indices in the hopes of getting a better sense of how “inflation” is playing out in the economy. Central banks like the SARB choose to follow a preferred metric – like the CPI – for a number of reasons, most of them very sensible. As it happens, the sheer volatility of commodities is a key reason why some CBs prefer “core” to “headline” inflation measures. Trying to conduct monetary policy in response to a simple basket of commodity prices would not only be incredibly difficult due to the inherent volatility (and the fact that the CB is more or less powerless to  stop these short-run swings), but potentially counterproductive because of the amplifying effect that it could have on consumption cycles. (For more discussion, see Matt Rognlie’s excellent posts on this subject: here, here, and here.)

5) As for his final point, that peer review is not superior to insights that bring in paying clients… Well, clearly that is not what I meant by “cracking” the problems of identifying a causal link between price increases and the uprisings in the Arab world. (Mind you, if he did accurately predict these events in advance of them happening then I certainly am impressed.) So, while I regard the profit mechanism as essential as the next economist, that has nothing to do with my concerns about getting to grips with some very obvious identification problems. That said, allow me to make a broader concluding remark: Just as no-one should suggest that peer-review is infallible, we should never confuse profitability with validity. Even psychics have been doing a roaring trade for centuries. It doesn't make them right.

Climate mitigation as a secondary benefit

But keep it quiet.

I spent some time last week with the Dutch economist, Johannes Bollen, who was visiting my university to present his research on the "co-benefits" of climate and air pollution policies. His basic argument is that you can go a long way towards meeting (global) climate goals simply by tackling (local) air pollution. In fact, his most up-to-date model suggests that rigorously addressing air pollution -- finding the optimal balance between health improvements and increased energy costs -- will get us 75 percent of the way towards the "2°C target" of the Copenhagen Accord.

Those results bear repeating: No global carbon tax or binding international treaties required. Just individual countries focused on cleaning up their own air pollution and we have already solved three-quarters of the climate problem. It sounds too good to be true and, yet, there's a growing body of evidence that points towards similar conclusions.[*]

For instance, you might remember an AER paper by Muller et al. (2011) that I mentioned a few months back. Their study made a big splash because, among other things, it showed that the price of coal-fired electricity should be several times higher than it currently is, given the adverse effects that local air pollutants (small particulates, SO2, NOx) have on human health and productivity. Again, nothing to do with climate effects; just accounting for the local health damages caused by dirty air.

It almost goes without saying that this promises to be a very important research area. The climate change narrative -- despite many excellent scientists and economists producing meticulous research -- has become bogged down by its own press and politics. We're at such an impasse that I simply can't see the necessary political will (and public buy-in?) to move us forward in any meaningful way over the next decade.

Focusing on local pollution, however, allows us to abstract from the most problematic areas of climate change; whether that is the unjustified/misplaced skepticism about the underlying science, or the longer-term uncertainties that make cost-benefit analysis of climate change mitigation difficult. From a purely economic perspective, it also frees you from the inherent problems associated with a global commons; such as competing incentives, inter-temporal conflicts, lack of enforcement, and free-rider problems. Those kinds of issues are dramatically simplified when you move from the global scale to the national scale, and narrow your time horizon.

The thing is, and while it's obviously great to kill two birds with one stone, I actually think that we should be very careful about emphasizing the climate link. Rightly or wrongly, policy geared towards tackling climate change is an extremely touchy subject. Yes, it's absurd to think that there is some grand communist plot at hand whenever someone mentions "cap-and-trade" or "carbon tax". (Also ironic when you consider that accounting for environmental damages is about putting an end to the socialized benefits that polluters enjoy at the expense of everyone else.) However, we have to acknowledge and operate within the practical confines of our world... which, more often than not, means making allowances for the irrationalities, whims and idiocies of our fellow citizens. And, yes, I'm sure the feeling is mutual.

THOUGHT FOR THE DAY: Tackling local air pollution will bring about marked improvements in human health and economic welfare, both now and in the future. We also have good reason to believe that it will go a long way towards mitigating climate problems. Unfortunately, climate change is a subject that comes with a lot of baggage. I'd prefer to see the results without bringing up the baggage.

UPDATE: The British Medical Journal gets in on the action here.

[*] I haven't scrutinized Johannes' model in enough detail to proclaim his results as gospel truth. That being said, seeing his presentation and having talked through the underlying methodology certainly makes me confident that he has carefully covered his bases. I'll try to keep tabs on how his working paper develops or is revised over the coming months.

Links - Market Design edition

Regular readers[*] will know that a favourite theme of this blog is thinking about how -- and where -- markets function "optimally", versus cases where some form of intervention/regulation might be preferable. In that tinkering spirit...

1) The Boston Globe has a profile on Harvard's Alvin Roth, who specialises in optimising market design in a variety of sectors. Apart from his dedication to solving real-life problems, about the most interesting aspect of Roth's work is that he focuses on recreating market processes in precisely the industries where markets seem out of place, or even "repugnant" (e.g. organ donors). Much of this involves dealing with goods that are intrinsically hard to evaluate in monetary terms. [HT: Michael Giberson. I'd recommend a visit to Roth's Market Design blog as well.]

Reading the article, I was immediately reminded of the literature on "intrinsic motivation" and "moral crowding out", which highlight the pitfalls of trying to replace moral contracts with monetary incentives. The most famous example of this is probably the study of late parent arrivals at day-care centres in Haifa, which went up after monetary fines were introduced. In other words, the introduction of fines had the exact opposite effect of what was intended. Parents no longer felt bad about making a teacher stay late looking after their kids, since they were incurring a fine in return... A "fair" trade in their eyes.

2) Rob Stavins on the design options for cap-and-trade versus the alternatives. This is an older post, but one that is well worth revisiting for anyone interested in the options regarding climate policy and, as per usual, Stavins gives a really good breakdown of the key issues. To be honest, I've been meaning to write a brief summary on the differences between cap-and-trade and carbon taxes for a while (pros, cons, etc)... But this post (and others by Stavins) are a great place to start if you want to understand the basic arguments for and against the different climate policy instruments.

3) Daniel Kuehn is frustrated by the asymmetries in the public choice discourse. In particular, he takes issue with the assumption that being interested in market failure somehow makes you oblivious to government failure. I've trod a similar line here before and strongly agree that this is a false dichotomy.[**] However, and while I believe that Daniel is referring more to the armchair proponents of the public choice school than anything else, I would still note that the leading public choice figures themselves generally offer a far more nuanced and considered view of the market-vs-government debate. (E.g. See the paper by James Buchanan that I mention towards the bottom of this post. Some more thoughts on the matter here.)

Daniel quotes a segment from George Akerlof's seminal paper on information asymmetry, A Market For Lemons, which points to a careful arbitration between government intervention and private solutions:

It should be perceived that in these markets social and private returns differ, and therefore, in some cases, government intervention may increase the welfare of all parties. Or private institutions may arise to take advantage of the potential increase in welfare which can accrue to all parties. By nature, however, these institutions are nonatomistic, and therefore concentrations of power - with ill consequence of their own - can develop.

I replied in kind in the comments section by quoting the closing paragraph of Ronald Coase's 1960 essay, The Problem of Social Cost, in which he established the underpinnings for his eponymous theory on bargaining rights and (environmental) externalities:

It would clearly be desirable if the only actions performed were those in which what was gained was worth more than what was lost. But in choosing between social arrangements within the context of which individual decisions are made, we have to bear in mind that a change in the existing system which will lead to an improvement in some decisions may well lead to a worsening of others. Furthermore we have to take into account the costs involved in operating the various social arrangements (whether it be the working of a market or of a government department), as well as the costs involved in moving to a new system. In devising and choosing between social arrangements we should have regard for the total effect. This, above all, is the change in approach which I, am advocating.

So, ya... Call me crazy, but that's two Nobel Prize laureates -- whose respective theories can and have been twisted by completely opposing factions -- essentially coming down on the same side of the issue.

[*] Both of us... Hi Mom. Other readers might be interested in the "regulation" or "externalities" taglines.
[**] I imagine that some might think me slightly schizophrenic to strongly criticize overbearing government in some posts on this blog and then complain about a lack of decent regulatory frameworks in others. However, I'm very much a horses-for-courses man. My basic premise is that markets work fantastically well by themselves most of the time... But it's the exceptions that make life interesting. 

Tort law is no panacea for the environment

Looking over the comments section of an old post, I realised that I had yet to make good on a promise to "flesh out my scepticism regarding the ability of tort law to meaningfully contribute to climate change action" (or, alternatively, expose it as a sham). Essentially, a friend of mine with strong anarcho-capitalist leanings had suggested that the climate impasse could - and should - be resolved through the private courts rather than any type of government regulation that seeks to create, for example, a carbon price via cap-and-trade or carbon taxes. I have just left my response underneath his comment as to why I regard this stance to be wholly unworkable in practice. I invite you to look over my points and see whether you agree or not. (The summary version: Non-representation of future claimants, and the complete impracticability of claimants to adequately and fairly engage separate carbon producers from all over the world; and vice versa).

Anyway, moving beyond the specific case of climate change, this is leads me to the consideration of tort law as a means of addressing environmental ills, generally. Indeed, I would say it is very much related to something that's central to my specialisation: The role of markets (underpinned by legal institutions like tort law) versus the role of governmental regulation in dealing with environmental problems. Before continuing, let me first say that my usual position on economic matters is fairly uncontroversial in that I regard markets as vastly superior to any supervening government force. Freedom to choose, responsibility for our own actions, etc, etc...

However, as an environmental and resource economist, I am constantly brought up against cases where markets don't work particularly well, or, alternatively, no market exists to deal with the provision of certain goods. That is the nature of our specialisation; we have to consider externalities, fuzzy property rights, environmental public goods, and other market "failures". Even with these imperfections, I am inclined to heed the words of one of my university professors who said something to the effect of: "Always consider other options before getting involved in environmental policy, because outside actions have the potential to stuff things up proper make matters even worse".

Having said that, there are still undoubtedly many cases where government intervention and regulation has led to improvements in environmental outcomes and natural resource management. Further, it's no coincidence that such instances often invoke market mechanisms, thereby simulating artificial scarcity and conferring property rights. This ultimately creates the right set of incentives for people to act in a profitable way to address environmental issues.[*] I can name many, many examples... From the rejuvenation of previously endangered fisheries, to the reduction of acid rain.

Even if we ignore such successes, I find it curious that certain libertarians continue to hold an unshakeable belief in the efficiency of tort law to resolve all environmental ills in an otherwise unregulated market. Regulation, on the other hand, is seen as nothing more than unworkable nonsense cobbled up by a lumbering coalition of bureaucratic imbeciles and self-serving politicians. This position seems to not only understate the transaction costs and asymmetries of information and financial power in a real-world market system, but also thoroughly oversells the efficiency of our legal systems. So, in addition to the points that I tried to highlight specifically with regards to climate change, here are some additional factors that I believe limit the effectiveness of tort law when it comes to addressing environmental problems on a more general scale:

First and foremost, litigation takes a very long time and can be hideously expensive... especially when there is money and power involved. It's easy to cite a number of high-profile environmental and health incidents that illustrate this. Exxon took 20 years to pay out after the Valdez oil spill off Prince William Sound. Officials from Union Carbide were still embroiled in criminal proceedings upon the 25th anniversary of the Bhopal Gas Disaster in India (although the company had made an out-of court settlement in 1989). More recently, Chevron has vowed to overturn a landmark $8.6bn fine imposed by a court in Ecuador in a case that has already been running for 18 years. Because of these factors, there is an inherent bias towards groups with money and legal clout. Legal disputes are hardly ever a fair fight between equals; it's about who brings the best lawyers to the party and who can confidently front the costs for the entire (possible) duration of a trial.

These are pretty fair indications of how inefficient legal systems can be, with endless recourse to stalling and appeals. Indeed, (good) regulation is often aimed at circumventing inefficient and protracted tort processes such as the ones that I have highlighted. In other words, it helps to reduce transaction costs to a minimum.[**]

To be sure, unchecked government meddling in production and industrial processes can have - and has had - very damaging consequences to both human beings and our environment. For instance, the Indian Government had a heavy hand in the Bhopal Plant and may be as liable as anybody for the tragedy that ensued. However, I don't see that as particularly relevant to the sheer length of the subsequent court case. Moreover, if regulation is dangerous because it affords power to supposedly disinterested third parties, would judges and juries not be susceptible to this influence too? Or, more simply, could they not also be subject to making the same bad decisions that stand to affect both current and future outcomes through the rule of legal precedent?

This leads me to another weakness underpinning our legal system: It lacks the very mechanism that makes markets work so efficiently. That is, there is no comparable profit-loss mechanism that leads self-interested parties to drive a continual improvement of the system. This idea was succinctly captured in a recent paper by Nobel Laureate James Buchanan: The Limits of Market Efficiency. As a pioneering figure in public choice theory, Buchanan did as much as anyone to highlight the fallibility of government authorities in being effective regulators. In this paper, however, he sets to balance the scales by showing that a) markets "work" only under certain legislative frameworks, and b) these frameworks are themselves devoid of forces that would make them inherently optimal. Here's a snippet:

Consider[...] the differences between the spontaneous emergence of a body of law, a set of rules, and the allocation of valued resources in the market process. In the latter, [...]opportunities for securing differential private rents and avoiding differential negative rents are open and available to prospective entrepreneurs-arbitrageurs, whose behavior, in itself, becomes part of the correction that efficiency conditions require. Contrast this process with application to law. Suppose that a law, rule, or convention emerges and exists, one that is recognized, even if by all participants, to be less enhancing to their well-being than a readily imagined alternative. The opportunity cannot, however, be exploited by single entrepreneurs-artibrageurs because of the nonpartitionability of law, as such. There is nothing comparable to the profit-loss dynamic of the market that will insure any continuing thrust toward more desirable outcomes. 

To conclude, I think that scepticism of government is absolutely justified in many cases, as I have tried to indicate at the beginning of this post and in a number of my previous posts. If there are market imperfections, it doesn't necessarily follow that government involvement will adequately address them. Indeed, it could exacerbate the situation and, frankly, it’s ridiculous to pretend otherwise. Where possible, I absolutely support community/individual management of resources above that of the State, just I support individual responsibility in many economic aspects. I also think that tort law can play an important role in controlling for localised environmental externalities. However, as per my reasons above, I disagree that regulations are inherently inefficient in comparison to a purely market-based system underpinned by tort law. Again, the danger is in applying blanket rules to complex situations that require evaluation on an individual basis.

THOUGHT FOR THE DAY: There is no silver bullet solution to solving our many, and often complex, environmental problems. Those that see tort law as some kind of panacea overlook the very real inefficiencies present in such a system. Consequently, torts remain very useful tools alongside regulatory measures for addressing environmental issues, but I don't believe that they can succeed by, or in of, themselves.

UPDATE: I completely forgot to talk about something that I'd originally meant to include in this discussion; the role that risk plays in limiting the effectiveness of pure market transactions. In particular, how different risk premiums are exacerbated by asymmetries of information, and how this can make it preferable to have some unilateral rule in place that guarantees us a minimum standard of protection from risk, which we cannot otherwise control for. This is very important in the context of justice administered ex post versus ex ante. As I wrote here:

[...] I much prefer driving in a country where standardised driver licenses and road-worthiness tests for vehicles offers me some insurance against risk-prone drivers. There's no way I control for who shares a highway with me, but at least I am reassured that their cars (say nothing of the drivers themselves) are expected to meet certain minimum standards. 

And, of course, I would suggest that "justice" administered ex post is, in many cases, a straggling third best; especially when it comes to more dramatic outcomes like severe injury and death. Don't get me wrong; there's plenty bad regulation out there... But I'd prefer (regulatory?) prevention than (courtroom?) "cure" when the latter involves putting a monetary value on matters that are inherently beyond valuation.

UPDATE 2: In an older blog post, Tyler Cowen points to an AER paper by Susan Rose-Ackerman, Regulation and the Law of Torts, which strongly supports the basic arguments I have made above. Speaking of Marginal Revolution bloggers, Alex Tabarrok co-authored this book a few years ago on the inefficiencies prevalent in the US tort system.

UPDATE 3: A follow-up, of sorts, here.
___

[*] Daniel Kuehn has a really good series of posts in this regard, under the collective heading of calculation verses incentive problems.
[**] Two points additional bear mentioning. First, in all of the above cases claimants were afforded a fraction of the recompense that they were initially promised due, in large part, to the principles of corporate limited liability. In this matter, I am in essentially in agreement with the proponents of tort law that a system of limited liability encourages unduly risky behaviour. To get an idea of my views on limited versus strict liability, please see here. Second, I have seen tort proponents argue that transaction costs are subsidised by government in the case of regulation and therefore of equal weight to transaction costs incurred when markets are left to their own devices. This is a non sequitur. To use a simple example, if government bans the use of lead in petrol unilaterally then transaction costs have essentially been reduced to a minimum. Alternatively, think about how impossible it would be to track down the former owner of each and every plastic bag that happens to blow into your property versus government simply adding a tax to each bag that makes people utilise them in a far more effective and environmentally friendly way.

"Our climate isn't the only green concern"

UPDATE: The forest sell-off has been shelved following a massive public outcry.

That's the title of a short article by Michael McCarthy, the environmental editor of The Independent, in which he discusses the apparent flip-flopping of the new UK government on the sale of public forests. In of itself, this is a very interesting issue because it highlights some the practical problems of privatising "public" land. Being of a market persuasion myself, I have nothing much in principal against private ownership of these resources. Indeed, the success of private game parks all over the world gives us an indication of how well that kind of model can work, often in conjunction (and competition) with state-owned parks, to better preserve our natural heritage.

Of course, the UK's forests are perceived quite differently to game parks. They are, I would argue, probably much closer to, say, beaches in the public mindset. For various reasons, public beaches have become institutionalised as places that we like to enjoy in commons. Perhaps people even like the illusion of them being free to everyone regardless of the fact that tax money is what ultimately supports their maintenance. Having said that, there reasons why this system isn't an inherently inefficient; most notably transaction costs and the problems of exclusion. (E.g. It could be much easier for us to make a single payment to one authority that manages these assets on our behalf than to pay a new owner every time you enter a new park or beach. Further, in the absence of unsightly fencing, it is problematic to police who comes in and out, and who has paid for entrance in the first place). At any rate, I think it's fair to say that many public beaches are both well-run and well-policed.

The major point of McCarthy's article that I want to get to, however, is imbedded in his subject line. He gets down to it in the last two paragraphs:

[T]his Government has conflated "the environment" with climate change; the rest is forgotten (at least at the highest level). It was actually in the specific context of global warming policy that Mr Cameron made his "greenest ever" pledge. He saw, rightly, that saving the climate is of overwhelming importance; but he failed to see that there are other green issues, such as the care of the natural world, which are also immensely important and which the public may deem crucial. 

To be fair, being blinded to everything else by climate change is not the fault of this Government only; some of the traditional green pressure groups have followed suit, and Jonathon Porritt, doyen of green activists, pointed out in an angry blog last week how little most of them have done to combat the attack on nature conservation. But the Government will have to wake up to its mistake, or its pledge to be the greenest ever will turn out to be the biggest hostage to fortune of its time in office.

I wholeheartedly agree with this position. As I've written previously:

"I do worry that important non-climate-related research is being sidelined by this overwhelming debate on AGW [Anthropogenic Global Warming]. Clearly, there are some very important scientific and environmental questions unrelated to climate change that deserve research funding as well. Moreover, its really frustrating to see people trying to lump everything under the climate umbrella or ascribe strong climate causation when there isn't any."

THOUGHT FOR THE DAY: Climate change is a hugely important issue for anyone concerned about the environment, say nothing of human welfare. But shoehorning any and every environmental problem into a climate change story does nobody favours. It distracts focus from other genuine environmental issues and only serves to undermine the legitimacy of the climate change movement in the process.