Cafe Hayek

"A Clean and Snappy Place!"

McDonald's makes the world a cleaner place.  So concludes Wharton's Adrian E. Tschoegl in his 2007 paper "McDonald's -- Much Maligned, But an Engine of Economic Development."  Here's the relevant passage (from page 12):

McDonald’s emphasis on cleanliness, including or especially in restrooms, has led its competitors to upgrade their facilities.  Before the first McDonald’s opened up in 1975, restrooms in Hong Kong’s restaurants were notoriously dirty (Watson 1997).  Over time, competitors felt compelled to meet McDonald’s cleanliness standards.  The same thing appears to be occurring in China (Watson 2000).  In Korea, McDonald’s introduced the practice of lining up in an orderly fashion to order food; traditional practice was simply to crowd the counter, with success in ordering accruing to the most aggressive (Watson 2000).  In the Philippines, Jollibee mimics McDonald's clean and well-lighted look.

Here's yet another small way that capitalism makes humans' environment safer and more pleasant.

Green Is As Green Does

Today's edition of the Wall Street Journal contains several excellent letters on the alleged desirability of using government to promote "green" technologies.  Here are the first three of these letters:

Fred Krupp's op-ed "Climate Change Opportunity" (April 8) overlooks what most climate change skeptics are skeptical of: government's ability to effectively regulate the economy. If there is a way to make money from alternative energy sources, the market will find it. There is no need for bureaucrats to lead the way. Government regulations at best distort the market to benefit politically favorable (read "green") industries, and at worst create unintended consequences that increase the cost of energy and energy innovation. Congress doesn't need to act in order for energy efficiencies to be realized by business; it needs to stay out of the way.

David Smith
Boston

In Europe, consumers pay up to $9 a gallon for gasoline, in part because European Union governments tax gasoline at rates of $2 to $3 a gallon and more. What most people don't realize is that gasoline taxes are implicit carbon taxes. Taxing gasoline at $1 a gallon is roughly equivalent to taxing the carbon dioxide emissions from gasoline at $100 per ton. So, European motorists are paying carbon dioxide penalties of $300 or more per ton. That's about six times higher than the maximum estimated carbon permit price under the Warner-Lieberman cap-and-trade proposal.

Yet where in Europe is the miracle fuel to replace petroleum? Where are all the zero-emission vehicles? Europe is not one mile closer than we are to achieving a "beyond petroleum" transport system. In fact, from 1990 to 2004, EU transport sector carbon dioxide emissions increased by almost 26%.

Mr. Krupp and other cap-and-trade advocates ignore the main lesson of the failed Synfuels program of the 1970s, memorably expressed by MIT's Thomas Lee, Ben Ball Jr. and Richard Tabors: "If a technology is commercially viable, then government support is not needed, and if a technology is not commercially viable, no amount of government support will make it so."

Marlo Lewis
Senior Fellow
Competitive Enterprise Institute
Washington

The Environmental Defense Fund's president says he is simply trying to lower the cost of adapting to climate change. I'm suspicious. When environmentalists wanted to save the spotted owl, they told us that economic costs should not be a factor in that decision. When they wanted to save salmon by demolishing dams, they told us that cost should not be an issue. When they wanted to protect Alaskan wilderness, they said that energy costs should not be considered. Now, suddenly, they are all about saving us money. Either they have changed the way they think about the environment, or they want to control how I live my life, using any argument. That's handy.

Bill Conerly
Chairman
Cascade Policy Institute
Lake Oswego, Ore

Feedback, knowledge and the division of labor

Arnold Kling over at EconLog tells the poignant story of worrying about his father's health care. Anyone who has had a loved one in the hospital can relate. There are a lot of smart and caring people involved in the treatment, yet no one is overseeing the process and noting the interactions between this specialist and that one. No one is watching the heart rate zealously. The overworked nurse under pressure from another patient fails to note something crucial on the chart. Lots of cooks but no one's in charge. Usually a family member has to play that role, a family member who more often than not doesn't have the time for the full-time assignment and more than often not doesn't have the expertise other than to ask a lot of questions.

Economists talk about the power of specialization and the division of labor. Economists talk about how well things can work when no one's in charge. In the hospital though, it appears not to work as well as it might. Lauren in the comments to Arnold's post asks the right questions:

For which kinds of economic entities does division of labor break down? Why is it that sometimes having no one individual in charge is the economic ideal that is coordinated by the invisible hand, and other times not?

One answer is that maybe it works better in the hospital than it looks. Would we really want our parents in the hospital to be treated by a generalist? There are enormous amounts of knowledge and technology being brought to bear in curing people in a modern hospital.

But it clearly could be so much better than it is. We want the benefits of specialization without the costs, the same way we get them in other areas of our lives. What we want is someone to coordinate the process, someone other than ourselves to look out for the hammer-nail problem. All the specialists I've known are people with a hammer. Everything looks like a nail. The surgeon wants to cut. The oncologist want to give chemo. Beside the interaction problem, you want to make sure you don't have a specialist blinded by too much specific knowledge who fails to see the bigger picture

So why do we need someone in charge in the hospital but not in the graphite industry? In the graphite industry, there are plenty of pencils, tennis rackets and fishing rods and the dozens (thousands?) of products that use graphite. We don't need a graphite czar to make sure there's enough graphite to go around. All the specialists that contribute to those products don't get out of control. Their interactions don't get ignored. As Hayek pointed out, the knowledge gets coordinated without a coordinator. Why does it work there but not in the hospital?

The simple answer is that the price system and profit motive interact in the graphite industry causing the whole thing to work smoothly without it being anyone's intention. The prices and the profit motive lead to feedback and accountability. There are a whole bunch of people with the incentive and the information to make the system work well.

The simple answer is right. But it cannot explain why other organizations work well without prices and profits. Within a firm and within a family, resources and decisions get made without prices and often without profits. The answer (as Coase understood and as Lauren notes in her comment) is that in these organizations, the savings in transaction costs overcomes the loss of feedback and information benefits from using prices. But there are still incentives. There still is a residual claimant who bears the costs of failure and the benefits of success—the boss or the parent. Love motivates the parent. Bonuses and keeping your job motivate the boss.

So why doesn't a hospital work better? The answer I think, is that the level of specialization in medicine has emerged from a process that has very few incentives to make sure that the level of specialization is as productive as it should be. There are very few informational feedback loops. Very little accountability. Sure, if a surgeon leaves a scalpel in your chest cavity and sews you back up, the surgeon bears a cost. And as a result, it doesn't happen very often. But the kind of errors that Arnold worries about, the kind of errors that I've worried about with my Dad in the hospital (and the kind I've seen made) are the ones that have little or no consequence to anyone other than the patient.

These errors are built into the system. When a drug leads to unexpected side effects because the right questions weren't asked, when an opportunity for a safer treatment is missed, when an aggressive treatment for one illness weakens the immune system and leads to other problems, who can you blame? Who bears a cost other than the patient?

You can blame the hospital of course, whatever that means, but the costs to the human beings who work in the hospital are small. There are no feedback loops within the hospital to reward generalists who look for the costs of specializations. And the reason there are not is because the patient is not the customer. The patient is not paying the bill. The financial incentives that do exist are coming from Medicare and Medicaid and the insurance companies. The normal feedback loops that protect the customer from error and greed and simple stupidity are missing. In a way, it's amazing it works as well as it does. It works as well as it does presumably because most doctors and nurses do care about the lives in their hands. But it's imperfect and could be much better.

And because there isn't a residual claimant within the hospital, it is left to the wife or the husband or the parent or the child of the patient to represent the patient's interests in the face of the decentralized incentives presented by the hospital and its specialists. Ironically, the monitoring and feedback comes from the family, another organization that is usually not using monetary incentives to improve performance. But the love works pretty well.

But the patient who is unrepresented for whatever reason, who must rely on the system itself to keep an eye on the treatment regimen is at a greater risk than the patient whose wife is a doctor or better yet, a loving doctor or better yet, a loving doctor who is at her husband's side 24/7 until he comes home safely.

It's a flawed system that will stay that way until the incentives change. In the meanwhile, my heart and prayers go out to Arnold and his Dad and to anyone with a loved one at a distance going through a medical challenge.

Privatize It

Here's a letter appearing in today's New York Times; it's written by Alphonso Jackson, Secretary of Housing and Urban Development:

Re “B Is for Bailout, C Is for ...” (editorial, Sept. 10):

When is the definition of a bailout not a definition of a bailout? When your editorial defines the term.

Our efforts to help homeowners in trouble through the Federal Housing Administration are financed by insurance premiums that borrowers themselves pay. This is not a bailout, nor a handout.

The new FHASecure product is designed for homeowners who were steered into exotic mortgages they couldn’t afford when their original rates doubled or tripled.

To qualify for the product, borrowers must have a strong credit history and have made on-time mortgage payments before their loans suddenly reset. We also require that they be capable of repaying: no “no-doc” or “liar loans” here.

The premiums that F.H.A.-backed homeowners pay go directly into our insurance fund, which allows us to be self-sustaining. This ensures that borrowers, not the government, remain responsible for the loans they sign.

Alphonso Jackson
Secretary, Department of Housing and Urban Development

I strongly suspect that there are costs that Mr. Jackson overlooks, but let me grant him the benefit of the doubt.  If he's correct -- if the Federal Housing Administration truly is self-sustaining -- it can be privatized.  If it were privatized, its customers would continue to be served.

Stossel on Moore

John Stossel of ABC News is a seasoned reporter with a keen nose for the facts.  In this op-ed in today's Wall Street Journal, Stossel reveals some important facts that Michael Moore missed in the docu-ganda movie "Sicko."

Here are some key passages from Stossel's excellent essay:

Mr. Moore claims that because private insurance companies are driven by profit, they will always deny care to deserving patients. For this reason, he argues, profit-making health-insurance companies should be abolished, our health- care dollars turned over to the government, and the U.S. should institute a health-care system like the ones in Canada, Britain or France. But does Mr. Moore think, even for a second, that any of the government systems he touts in his movie would have provided a bone-marrow transplant to Ms. Pierce's husband? Fat chance.

When government is in charge of health care, the result is not that everyone gets access to experimental treatments, but that people get less of the care that is absolutely necessary. At any given time, just under a million Canadians are on waiting lists to receive care, and one in eight British patients must wait more than a year for hospital treatment. Canadian Karen Jepp, who gave birth to quadruplets last month, had to fly to Montana for the delivery: neonatal units in her own country had no room.

Rationing in Britain is so severe that one hospital recently tried saving money by not changing bed-sheets between patients. Instead of washing sheets, the staff was encouraged to just turn them over, British papers report. The wait for an appointment with a dentist is so long that people are using pliers to pull out their own rotting teeth.

Patients in countries with government-run health care can't get timely access to many basic medical treatments, never mind experimental treatments. That's why, if you suffer from cancer, you're better off in the U.S., which is home to the newest treatments and where patients have access to the best diagnostic equipment. People diagnosed with cancer in America have a better chance of living a full life than people in countries with socialized systems. Among women diagnosed with breast cancer, only one-quarter die in the U.S., compared to one-third in France and nearly half in the United Kingdom.

Mr. Moore thinks that profit is the enemy and government is the answer. The opposite is true. Profit is what has created the amazing scientific innovations that the U.S. offers to the world. If government takes over, innovation slows, health care is rationed, and spending is controlled by politicians more influenced by the sob story of the moment than by medical science.

And be sure to watch Stossel's special on health care, to be aired this Friday on ABC, at 10:00pm EDT.

Frank Talk on Status

In response to this review by Daniel Gross of Robert Frank's latest book, I sent the following letter to the New York Times Book Review:

Reviewer Daniel Gross should have asked harder questions about Robert Frank's argument that higher taxes on "the rich" will moderate individuals' quest for status ("Thy Neighbor's Stash," August 5). Monetary wealth and the material goodies it buys are hardly the only source of status.  Consider, for example, Prof. Frank's faculty position at Cornell University.  He earned this position in large part through his hard work.  By his own thesis, then, he inadvertently caused other scholars to work unnecessarily hard in their quest to win high status Ivy-League appointments -- a quest that for the vast majority of us futile.

Higher taxes on the rich will do nothing to create more Ivy League faculty positions, more mansions with stunning views of the Pacific ocean, a greater number of the world's most beautiful women or most eligible bachelors, or most of the other things that confer and signal high status for those who possess them. Frankly, it is naive to suppose that muting competition in markets will mute humans' competition for status.

Indeed, given that humans are quite status-conscious, a social system in which we seek status chiefly through earning money provides what is likely the best available outlet for this proclivity -- namely, competition within private-property-based markets.  Not only does it result in new and greater quantities of goods and services for others, but it sure beats the hell out of violence and even politicking as a means of challenging others for status.

Sam Walton or Bono?

Michael Strong argues that Wal-Mart is one of the world's great forces for alleviating poverty.  He's correct.

Cowen, Gates, Boudreaux, and Regressive Taxation

Each of Tyler Cowen's New York Times columns is worth a careful read.  But today's column is one of his best (in my opinion).  He covers a lot of ground on the income-inequality debate, and covers it skillfully.

Here are his concluding paragraphs:

The broader philosophical question is why we should worry about inequality — of any kind — much at all. Life is not a race against fellow human beings, and we should discourage people from treating it as such. Many of the rich have made the mistake of viewing their lives as a game of relative status. So why should economists promote this same zero-sum worldview? Yes, there are corporate scandals, but it remains the case that most American wealth today is produced rather than taken from other people.

What matters most is how well people are doing in absolute terms. We should continue to improve opportunities for lower-income people, but inequality as a major and chronic American problem has been overstated.

.....

Earlier in this same column, Tyler notes that

Happiness, possibly the most relevant variable for a study of inequality, is also the hardest to measure. Nonetheless, inequality of happiness is usually less marked than inequality of income, at least in wealthy societies. A man earning $500,000 a year is not usually 10 times as happy as a man earning $50,000 a year. The $50,000 earner still enjoys most of the conveniences of the modern world. Even if more money makes people happier, it appears to do so at a declining rate, which places a natural check on the inequality of happiness.

Although I share Arnold Kling's skepticism of "happiness studies," the general point of the above reported finding is compelling.  Indeed, that same point is the one that has long led many people to argue for "progressive" income taxation.  It's the idea that an extra dollar of income to someone earning $500,000 annually is "worth less" to that high-income earner than is an extra dollar of income earned by someone earning $50,000 annually.

It's never been clear to me, though, why this fact (if it be a fact -- as I suspect it, generally, to be) -- was ever taken to support so unambiguously a case for "progressive" taxation of incomes.  First is the point Tyler makes: if an extra dollar of income in Bill Gates's pocket means less to Bill Gates than would mean to me, then the genuine economic difference between Gates's position and my position is less than it appears if monetary incomes or wealth is taken to be a precise and full measure of economic well-being.  While "redistributing" this dollar from Gates to Boudreaux might still increase "happiness" equality between Gates and myself, the alleged need for such "redistribution" in the first place is less pressing.

Second, given that Bill Gates almost surely has a greater talent for contributing to the happiness of humankind than I have, it's especially important that he continue to confront keen incentives to continue contributing to that happiness.  Precisely because an extra dollar in Gates's wallet means less to him the more dollars he earns, he needs to earn ever-more dollars per year in order to keep keen his incentives to innovate and produce and sweat the details of satisfying consumer demands.

While I do not support regressive income taxation, a theoretical case can be made in favor of it -- a case that has at least as much cogency and economic merit as does the case for "progressive" taxation of incomes.

The System Is the Solution

Here's my latest column in the Pittsburgh Tribune-Review.  In it, I argue that people's propensities -- as uncovered by behavioral economics -- to behave "irrationally" from time to time do not mean that the market will fail to perform well.

The Capitalist Peace

In the forthcoming January 2007 issue of the American Journal of Political Science, Columbia University political scientist Erik Gartzke has a gem of an article.  Its title is  "The Capitalist Peace."  (It isn't yet available on-line.)  In this paper, Gartzke refines the argument that he presented in the Economic Freedom of the World: 2005 Annual Report, co-authored with James Gwartney and Robert Lawson.

Here's the abstract from Gartzke's forthcoming paper:

It is widely accepted that democracies are less conflict prone, if only with other democracies. Debate persists, however, about the causes underlying liberal peace. This paper offers a contrarian account based on liberal political economy. Economic development, free markets, and similar interstate interests all anticipate a lessening of militarized disputes or wars. This paper shows that this “capitalist peace” subsumes the effect of regime type in standard statistical tests of the democratic peace.

Business as Family

In a recent post I mentioned an insight of Hayek's from The Fatal Conceit.  Here's the quote:

Part of our present difficulty is that we must constantly adjust our lives, our thoughts and our emotions, in order to live simultaneously within the different kinds of orders according to different rules.  If we were to apply the unmodified, uncurbed, rules of the micro-cosmos (i.e. of the small band or troop, or of, say, our families) to the macro-cosmos (our wider civilisation), as our instincts and sentimental yearnings often make us wish to do, we would destroy it.  Yet if we were always to apply the rules of the extended order to our more intimate groupings, we would crush them.  So we must learn to live in two sorts of world at once.

The italics are in the original.  But why is it destructive to treat the wider extended order, the world of the marketplace in the same way that we treat our brothers and sisters, our husbands and wives.  Why is it destructive of civilisation (a very bold claim) to ask businesses to share their profits in good times or to treat workers with more compassion than the profit motive alone provides?  Yes, the profit motive when combined with competition encourages businesses to treat its workers and customers well, but wouldn't it be better for those businesses to go beyond profits and treat workers and customers even better?  Surely, the world would be a better place if businesses paid workers more than the market wage, offering health insurance to employees even when the employees would be willing to work for lower wages and fewer benefits.  Surely it is better to be George Bailey than Mr. Potter.

Yet Hayek says no.  Why?  I don't think Hayek addresses the question posed in quite this way (at least in The Fatal Conceit) so I'm going to post on this topic from time to time as a way of working out my own thoughts on the matter.

Here is one answer.  Suppose you have a 6:30 AM flight to visit a dying friend.  If you miss the flight, you will miss the chance to say goodbye to your friend.  You don't have a car.  Here are four ways to get to the airport:

1.  Your brother who lives around the corner will get up early with you and take you.
2.  A limo service will drive you.
3.  A local charity that provides rides for people without cars will take you.
4.  A stranger you met yesterday who heard your story and feels sorry for you will take you.

As you go to bed the night before the flight, which way gives you the most confidence that your ride will indeed show up in time to get you there?

I have ranked them in the order that would give me the most confidence, but then again, I have a very reliable brother.  You might rank the order a little differently.  But think of two and three.  Would you rank them the way I did?  Would you rather rely on someone who is motivated  by money or by love?  In one sense, it's a silly question.  Surely, there is room for both.  But let's make it stark.  Would you rather depend on someone to pick you up who only cares about the money or someone who refuses money and only wants to do it for the privilege of helping others?  Love would be great, but there's not that much love to go around.  (HT: Dennis Robertson—I'll post his quote later) My brother, I think, does love me, and I could rely on him.  But the charity doesn't love me in the same way.  It may claim to.  But it is not the same.  There are saints in the world, but they are very scarce.

Okay, says the skeptic.  But couldn't you ask a business to act a little bit like a charity?  But what is the meaning of this?  What does it mean?  Who would decide when to give a particularly indigent customer a price break or to give an employee whose child is ill, a larger holiday bonus than merited by the employees performance alone?  Is it better instead to allow private individuals give to such people rather than asking businesses?  What happens when we allow well-intentioned motives to change the role of prices and profits in the extended order.

This is something economists have written little about.  I hope to write more on this in the future.  But let me close with two examples of that sentimental yearning that Hayek mentions.

Two nights ago, I was in New Jersey for a night and stayed at a Howard Johnson hotel.  At the front desk as we checked in was a sign:

WE LOVE PETS

However, they are not allowed at this Howard Johnson out of courtesy to all our guests.

We love pets?  Who is this "we" that loves pets?  The stakeholders of the Howard Johnson "community"?  HoJo bans pets because they're costly.  They can damage carpets and furniture and imposing those costs on all guests in the form of higher prices would lower HoJo's profits.  Those higher prices and lower profits would indeed be bad for the other guests.  But this direct, baldfaced way of putting it does not communicate well to the average person.  So instead, the rational business decision is cloaked in a lie: We Love Pets.  Nonsense.  There is no "we" and if there were, there is no love.  The sign exploits my sentimental desire to think that Howard and I are engaged in something other than a commercial transaction.

My father tells me that in his town of Huntsville, Alabama, one local bank advertises with billboards that say "We Want To Be Your Friend."  But we don't want our bank to be our friend.  We have friends for that.  We want our bank to take care of our money and serve us promptly.  We'd prefer smiling bank tellers to rude ones.  But that is not friendship.  Here is what I wrote on a similar topic elsewhere:

Surprisingly, relying on strangers beats relying on friends. We don’t have enough of the latter if we want to enjoy the standard of living with all of its              material and nonmaterial satisfactions. Relying on friends or relying only on our family would lower our standard of living back to the level of subsistence. Self-sufficiency is the road to poverty.

Relying on strangers also frees up our friends to specialize in being friends and     do what friends do best. I don’t want to buy a shoulder to cry on from the low-cost seller behind a counter. I want friends and families to give that out of love. But my friends and family have more time for comfort and delight                  because the extended order of human cooperation out in the marketplace means I’m not expecting them to sew my clothes or forge a car for me.

             

 

Hayek was right.  Mingling our family behaviors with our market behaviors is deeply appealing and deeply troubling.