The Royal Canadian Mint still doesn't know what happened to $15 million in gold. Having exhausted plausible theories, like bad accounting, some now turn to more implausible heist accounts: folks dissolving gold in acid and thereby sneaking it past the metal detectors. The Mint assures us that their detectors can detect this kind of dissolved gold. But they still don't know what happened to the gold. I guess I'm not cut out for heists; last thing I'd think to do with gold is dissolve it in acid.
On folate in bread: the bootleggers and baptists story is seeming less plausible to me than that the reg is just part of some boilerplate treaty agreement on food regs, treaty language imported from elsewhere, and that nobody thought too hard about that bread is exceedingly unlikely to be traded across wide oceans. How hard would it be to strike out a line or two from a bigger treaty where there is no real trade issue though?
Update Some stories suggest the issue is flour, which would make more sense. Flour can travel by ship.
Senin, 13 Juli 2009
Minggu, 12 Juli 2009
Cross-tasman trade in bread?
One of the things that worries me least is whether or not my bread is fortified with Folic Acid. For some things, I'd go to the barricades. This seems one of the more minor regulatory impositions; however, I can imagine it being very costly for small bakeries.
What I'm puzzled about is the National government's willingness to go carry through with the prior Labour government's policy in this area. They cite cross-Tasman trade agreements with Australia. Now, I can see the case for regulatory harmonization in some areas, weighing appropriately concerns about reduced Tiebout competition, but who trades bread across the ocean?! If efficiencies of scale in bread-making were so large relative to transportation costs, I'd expect there to be one or two big bakeries serving all of New Zealand. Instead, they're everywhere! Coupland's, the big South Island bakery, doesn't seem to ship bread even up to the North Island, never mind to Australia.
Whenever I see things like this, I start thinking about Bootleggers and Baptists. This is all of course just speculation, but folic acid supplementation really seems like the kind of thing that can be done at very low per-unit costs by the very big bakeries but at much higher per-unit costs by the little guys. There are fixed costs in redoing your recipes and testing things out. So it seems a possibility for the kind of regulation designed to raise rivals' costs. So, there's the bootleggers. The Baptists, as often the case, are the public health folks demanding that somebody think about the children.
National's candidate explanation makes no discernible sense, unless there's a massive trans-Tasman trade in bread that nobody's told me about. Bread is about the least likely thing to ship across the ocean though: low value per unit weight so bad for shipping by air, and highly perishable so bad for shipping by sea. So I'd be a bit surprised if the trade regulations were the real story. Purely speculation, but might it be the case that big bakeries have already incurred the fixed costs of rejigging production lines and are keen not to see that investment sunk without it similarly being imposed on the little guys? I see no exemption in the regs for small bakers unless they want to go purely organic.
Or maybe my paranoid goggles are on again now that semester's started and I'm again teaching Public Choice.
What I'm puzzled about is the National government's willingness to go carry through with the prior Labour government's policy in this area. They cite cross-Tasman trade agreements with Australia. Now, I can see the case for regulatory harmonization in some areas, weighing appropriately concerns about reduced Tiebout competition, but who trades bread across the ocean?! If efficiencies of scale in bread-making were so large relative to transportation costs, I'd expect there to be one or two big bakeries serving all of New Zealand. Instead, they're everywhere! Coupland's, the big South Island bakery, doesn't seem to ship bread even up to the North Island, never mind to Australia.
Whenever I see things like this, I start thinking about Bootleggers and Baptists. This is all of course just speculation, but folic acid supplementation really seems like the kind of thing that can be done at very low per-unit costs by the very big bakeries but at much higher per-unit costs by the little guys. There are fixed costs in redoing your recipes and testing things out. So it seems a possibility for the kind of regulation designed to raise rivals' costs. So, there's the bootleggers. The Baptists, as often the case, are the public health folks demanding that somebody think about the children.
National's candidate explanation makes no discernible sense, unless there's a massive trans-Tasman trade in bread that nobody's told me about. Bread is about the least likely thing to ship across the ocean though: low value per unit weight so bad for shipping by air, and highly perishable so bad for shipping by sea. So I'd be a bit surprised if the trade regulations were the real story. Purely speculation, but might it be the case that big bakeries have already incurred the fixed costs of rejigging production lines and are keen not to see that investment sunk without it similarly being imposed on the little guys? I see no exemption in the regs for small bakers unless they want to go purely organic.
Or maybe my paranoid goggles are on again now that semester's started and I'm again teaching Public Choice.
Utility is more than health
The excellent Glen Whitman points us to an LA Times article showing that, while mice on a calorie restricted diet live longer, they also are less happy than the control group of mice kept on a full diet.
This points to a generalized problem in the public health literature. Far too many public health folks are willing to assume that health is the maximand and not utility. Consequently, they want to tax or regulate anything that's both fun and potentially damaging to health.
Update: Brad Taylor weighs in nicely.
This points to a generalized problem in the public health literature. Far too many public health folks are willing to assume that health is the maximand and not utility. Consequently, they want to tax or regulate anything that's both fun and potentially damaging to health.
Still, this is the important issue, is it not? If eating less increases your lifespan but decreases your happiness, then there’s a very real trade-off between quantity and quality of life. Which means the author’s conclusion that even people with a healthy weight “should probably be eating less” is simply unjustified -- unless we make some fairly heroic assumptions about what’s loaded into that key word “should.”Indeed. I've argued the point at length in the New Zealand Medical Journal, but especially here.
Too often, researchers couch paternalistic arguments in allegations of market failure to give the cloak of scientific efficiency to their prescriptions. Doing so is just bad economics. A more honest approach would first specify that the authors want to tell everyone how to live their lives, then present the set of Pigovean instruments as an efficient way of inducing the consumption choices they view as better than that which people would otherwise choose for themselves.
Be not ashamed of your paternalism: embrace it! But, if others disagree, don’t blame shadowy special interests for the failure of your policy prescriptions; rather, concede that most people really don’t like it when others try to tell them how to live, even if following the advice would lead to slightly longer (but less interesting) lives.
Update: Brad Taylor weighs in nicely.
Kamis, 09 Juli 2009
Rejoinder to BERL
On Monday, BERL released a statement rejecting criticism of their study. We have completed our reply, available here. Let's hit the highlights.
BERL levies three main critiques of our work. Let's take them in turn.
Reply Number One:
They say that we misinterpret their brief and consequently fault them for things that were never within their remit: specifically, that they do not include the benefits of alcohol.
It is certainly true that benefits were not within the RFP. We noted as much throughout our report, and in our executive summary. However, counting benefits as being precisely equal to zero is what allows BERL to count private costs as social costs. As BERL correctly notes at page 173 of their report:
If benefits are outside the remit, the proper approach is to consider only external costs. At minimum, BERL should have apportioned its cost tally between private and external costs. Instead, they termed all costs as social costs.
Reply Number Two
BERL notes two errors in our original document. Adrian Slack pointed these out to me at the NZAE meetings, I checked into it, and emailed him the day before he posted his rebuttal informing him that we were adjusting our costs upwards slightly to correct for this. We planned on incorporating the fix to a revised version of our paper, but once BERL's rebuttal went up, I instead quickly issued our errata here. Correcting the errors Adrian pointed out added $36 million to our measure of external costs; at the same time, we added in $197 million in excise-equivalent duties collected by the Customs Service and left out of our initial analysis. We now find net external benefits rather than costs, but would say rather that external costs roughly match external benefits.
Interestingly, in re-reading the section from BERL's source, Rayner, on the employment costs of harmful alcohol use, we also find that Rayner provides a strong argument against BERL's multiplier. Again, BERL multiplies all forgone wages by 1.87: the ratio of GDP to wages. Rayner says that total wages are an upper bound estimate of labour costs; the lower bound estimate is transitional costs in replacing a worker. BERL goes 1.87 times above their cited source's upper bound estimate.
We're reasonably pleased that a rather complicated reverse-engineering job on BERL's report resulted in objections amounting to only $36 million.
Reply Number Three
BERL argues we use assumptions with a cost-deflating bias motivated by world view.
The first striking bit of evidence against us? That we're willing to consider that maybe, just maybe, prisoners and hard core alcoholics would have labour market characteristics somewhat worse than the average Kiwi even if alcohol had never been invented. We don't assume anything here: we go to the relevant literature, find some reasonable relevant estimates of comorbidity of alcoholism and other mental health disorders and of the labour market characteristics of prisoners prior to incarceration, and adjust the figures accordingly. The adjustment has little effect on our overall figures in the grand scheme of things: it knocks about $69 million off of the total cost figures and much less than that off of the external cost figure (since most wage costs are internal). But we thought it was something that should be checked.
Second, we count only as external costs of forgone labour ten percent of the total forgone wages. In this category, BERL begins by obfuscating about computers not running themselves if you're home hung-over. If you go through BERL's numbers, like we have, you'll find that the vast bulk of their forgone labour costs come from unemployment, followed by reduction in workforce through premature mortality. In the first case, BERL's argument about complementarities is a total nonsense. In the second, firms will bear transitional costs of hiring and retraining. BERL's numbers require that these costs equal the forgone worker's total wages times 1.87. Hiring costs are not 187% of annual salaries. Absenteeism, reduced productivity, and injury-related wage costs amount to about 13% of BERL's tabulated total paid labour costs. It's only in those cases where the complementarities story can start making sense as being a substantial fraction of the overall wage bill. Again, recall that BERL's cited source, Rayner, argues for a multiplier of no more than 1.0. We apply a multiplier of 1.1, and apportion the 0.1 as an external cost. Note also that even counting that ten percent as external is more than a little controversial; others question whether there can be any externality at all.
Finally, BERL asserts that alcohol reduces human capital formation. We cited some evidence to the contrary in our report; BERL cites nothing. Frankly, BERL's turning to this issue, and complementarities, smells like ex post rationalization of a dodgy multiplier. In the initial report, this is all that BERL provides to justify its multiplier:
BERL concludes by rehashing their favorite trope: world-view and rationality. Never mind that we have, ad nauseum, shown that none of our results hinge on assuming perfect information, perfect foresight, or perfect rationality. The prior link is the most exhaustive coverage, but the same issue has been covered here and here as well. And I re-iterated it at the NZEA conference with both Nana and Slack in attendance. Instead of providing any reason why the analyses above are wrong, BERL instead reiterates the perfect rationality tropes and throws in personal attacks by suggesting that we think drink driving and murder are perfectly ok. Is this really how senior economists at an established consultancy are going to defend their report?
In the same section, BERL laments our lack of citation on a claim that alcohol saves more lives than it costs.
Our full reply, linked to at the top of this post, has a few other bits of interest, including a summary of issues we have raised that BERL thus far has utterly failed to address. Do read the whole thing.
BERL levies three main critiques of our work. Let's take them in turn.
Reply Number One:
They say that we misinterpret their brief and consequently fault them for things that were never within their remit: specifically, that they do not include the benefits of alcohol.
It is certainly true that benefits were not within the RFP. We noted as much throughout our report, and in our executive summary. However, counting benefits as being precisely equal to zero is what allows BERL to count private costs as social costs. As BERL correctly notes at page 173 of their report:
When measuring the social cost of harmful AOD use, known private costs should generally be excluded…because private costs are offset by private benefits, so there is no net social costThey there cite Collins and Lapsley, their primary source, as warning against the counting of private costs. They then go on:
In the case of harmful drug use, however, individual decisions are not necessarily made on a rational basis, that is, a decision where the consumer equates their costs and benefits. We argue that the consequences of irrational consumption decisions lead to private costs that are borne by the rest of society, and hence should be included as social costs… We assume that it is irrational to drink alcohol to a harmful level and that harmful alcohol use has zero private benefit.Without that assumption, BERL could not count private costs as socially relevant. Their entire method hinges critically on that they have decided to assume zero gross benefits to drinkers of their drinking. So while benefits were outside of the RFP, they have taken a very strong position on the absence of benefits: a position without support in the economic literature. It consequently is fair game to critique BERL for counting the benefits as being equal to zero. And we do not understand how BERL can say with a straight face "we cannot accept criticism for not covering issues that were outside the project's brief" when their entire method is built on their having brought it into the project's brief.
If benefits are outside the remit, the proper approach is to consider only external costs. At minimum, BERL should have apportioned its cost tally between private and external costs. Instead, they termed all costs as social costs.
Reply Number Two
BERL notes two errors in our original document. Adrian Slack pointed these out to me at the NZAE meetings, I checked into it, and emailed him the day before he posted his rebuttal informing him that we were adjusting our costs upwards slightly to correct for this. We planned on incorporating the fix to a revised version of our paper, but once BERL's rebuttal went up, I instead quickly issued our errata here. Correcting the errors Adrian pointed out added $36 million to our measure of external costs; at the same time, we added in $197 million in excise-equivalent duties collected by the Customs Service and left out of our initial analysis. We now find net external benefits rather than costs, but would say rather that external costs roughly match external benefits.
Interestingly, in re-reading the section from BERL's source, Rayner, on the employment costs of harmful alcohol use, we also find that Rayner provides a strong argument against BERL's multiplier. Again, BERL multiplies all forgone wages by 1.87: the ratio of GDP to wages. Rayner says that total wages are an upper bound estimate of labour costs; the lower bound estimate is transitional costs in replacing a worker. BERL goes 1.87 times above their cited source's upper bound estimate.
We're reasonably pleased that a rather complicated reverse-engineering job on BERL's report resulted in objections amounting to only $36 million.
Reply Number Three
BERL argues we use assumptions with a cost-deflating bias motivated by world view.
The first striking bit of evidence against us? That we're willing to consider that maybe, just maybe, prisoners and hard core alcoholics would have labour market characteristics somewhat worse than the average Kiwi even if alcohol had never been invented. We don't assume anything here: we go to the relevant literature, find some reasonable relevant estimates of comorbidity of alcoholism and other mental health disorders and of the labour market characteristics of prisoners prior to incarceration, and adjust the figures accordingly. The adjustment has little effect on our overall figures in the grand scheme of things: it knocks about $69 million off of the total cost figures and much less than that off of the external cost figure (since most wage costs are internal). But we thought it was something that should be checked.
Second, we count only as external costs of forgone labour ten percent of the total forgone wages. In this category, BERL begins by obfuscating about computers not running themselves if you're home hung-over. If you go through BERL's numbers, like we have, you'll find that the vast bulk of their forgone labour costs come from unemployment, followed by reduction in workforce through premature mortality. In the first case, BERL's argument about complementarities is a total nonsense. In the second, firms will bear transitional costs of hiring and retraining. BERL's numbers require that these costs equal the forgone worker's total wages times 1.87. Hiring costs are not 187% of annual salaries. Absenteeism, reduced productivity, and injury-related wage costs amount to about 13% of BERL's tabulated total paid labour costs. It's only in those cases where the complementarities story can start making sense as being a substantial fraction of the overall wage bill. Again, recall that BERL's cited source, Rayner, argues for a multiplier of no more than 1.0. We apply a multiplier of 1.1, and apportion the 0.1 as an external cost. Note also that even counting that ten percent as external is more than a little controversial; others question whether there can be any externality at all.
Finally, BERL asserts that alcohol reduces human capital formation. We cited some evidence to the contrary in our report; BERL cites nothing. Frankly, BERL's turning to this issue, and complementarities, smells like ex post rationalization of a dodgy multiplier. In the initial report, this is all that BERL provides to justify its multiplier:
The value to society of lost output is considerably larger than lost earnings alone, for example, in addition to lost wages there is also lost profit. As such, the earnings profiles were scaled up to reflect the difference between wages and residual value added. The resulting output profiles were based on the assumption that the average GDP per FTE (BERL Forecast Database) is 1.87 times the average wage income (StatsNZ). These output profiles by age, gender and workforce status are used in the calculations below.BERL specifically viewed the 1.87 multiplier as reflecting residual value added. We went to the empirical literature, found estimates of 1.05-1.1 for value added, and applied the upper bound of that range. It seems that, in BERL's view, actually thinking to consult the empirical evidence counts as a cost-deflating downwards bias.
BERL concludes by rehashing their favorite trope: world-view and rationality. Never mind that we have, ad nauseum, shown that none of our results hinge on assuming perfect information, perfect foresight, or perfect rationality. The prior link is the most exhaustive coverage, but the same issue has been covered here and here as well. And I re-iterated it at the NZEA conference with both Nana and Slack in attendance. Instead of providing any reason why the analyses above are wrong, BERL instead reiterates the perfect rationality tropes and throws in personal attacks by suggesting that we think drink driving and murder are perfectly ok. Is this really how senior economists at an established consultancy are going to defend their report?
In the same section, BERL laments our lack of citation on a claim that alcohol saves more lives than it costs.
The ‘result’ that “alcohol saves many more lives than it takes” is an assertion that requires evidence. And the idea that addiction has rational foundations clearly indicates a model view of a consumer that would be at variance with others' views, including those of some economists. Such a value judgement would not have been appropriate for an independent study such as ours.On that point, as noted in our report (at page 37), we're drawing again on one of BERL's preferred sources, Collins and Lapsley, who at page 38 of their report (Table 11) present figures from Chikritzhs, Stockwell et al (2002) finding that across all categories of drinking, alcohol saved about 2363 lives in Australia in 1998; even among high-risk drinkers, where total lives lost outweigh total lives saved, 557 individuals were estimated to have had their lives saved. If there's any citation issue here, it's that we should have noted that Collins and Lapsley here were citing the work of Chikritzhs et al.
Our full reply, linked to at the top of this post, has a few other bits of interest, including a summary of issues we have raised that BERL thus far has utterly failed to address. Do read the whole thing.
The murderer's utility
Paul Walker nicely summarizes the David Friedman argument on the law and economics of counting the criminal's utility.
I agree with his analysis entirely when I'm wearing my economist's hat. When doing economics, as economists, we have to set the moral questions to one side. Wertfreiheit.
Now, if the conclusion of a serious study found that murderers' enjoyment of crime were greater than the cost imposed on victims, in other words that allowing murder is Kaldor-Hicks efficient, I'd then take off my economist's hat and put on my amateur moral philosopher's hat and say that murder should nevertheless be illegal because it infringes the victim's rights and because, as amateur moral philosopher, I really don't mind discounting the utility of rights-violators all the way down to zero. But I would be taking off my economist's hat when doing so. If economics gives us the efficiency-based case against murder, as I rather expect it would, so much the better. But if it doesn't, it's far better to present the economics straight up, and then present the value judgments separately, than to pervert the economic analysis by doing things like, oh, declaring at the outset that the murderer gets no utility and that a total discounting of the murderer's utility is consistent with good economic practice.
Aside: wertfreiheit is one of my favorite economics words. Methodenstreit is another. I may currently be engaging in methodenstreit with BERL over wertfreiheit. I like that. Is it strange that I always hear the Sepultura lyrics as "War of Methodology" rather than "War for Territory"?
I agree with his analysis entirely when I'm wearing my economist's hat. When doing economics, as economists, we have to set the moral questions to one side. Wertfreiheit.
Now, if the conclusion of a serious study found that murderers' enjoyment of crime were greater than the cost imposed on victims, in other words that allowing murder is Kaldor-Hicks efficient, I'd then take off my economist's hat and put on my amateur moral philosopher's hat and say that murder should nevertheless be illegal because it infringes the victim's rights and because, as amateur moral philosopher, I really don't mind discounting the utility of rights-violators all the way down to zero. But I would be taking off my economist's hat when doing so. If economics gives us the efficiency-based case against murder, as I rather expect it would, so much the better. But if it doesn't, it's far better to present the economics straight up, and then present the value judgments separately, than to pervert the economic analysis by doing things like, oh, declaring at the outset that the murderer gets no utility and that a total discounting of the murderer's utility is consistent with good economic practice.
Aside: wertfreiheit is one of my favorite economics words. Methodenstreit is another. I may currently be engaging in methodenstreit with BERL over wertfreiheit. I like that. Is it strange that I always hear the Sepultura lyrics as "War of Methodology" rather than "War for Territory"?
Zombies and Epiphenomenalism
NCIB ROFL gives a nice daily roundup of amusing articles published in the PubMed database. Highlights include medical articles on optimal methods for extracting the zipper-entrapped penis an ergonomics article on the force required to drag sheep over various surfaces.
Perhaps there's no equivalent in the humanities because it would be too easy. Here's the latest from Dialogue, a Canadian philosophy journal. Andrew Bailey's work on Zombies and Epiphenomenalism. doi:10.1017/S0012217309090076
I had a look because of the intriguing title, but the article goes into some interesting work on theory of mind. I was unaware that the metaphysical possibility of zombies had been raised as a counterexample against physicalist theories of mind. Bailey concludes:
Perhaps there's no equivalent in the humanities because it would be too easy. Here's the latest from Dialogue, a Canadian philosophy journal. Andrew Bailey's work on Zombies and Epiphenomenalism. doi:10.1017/S0012217309090076
ABSTRACT: This paper examines the relationship between the claim that zombies are logically/metaphysically possible and the position that phenomenal consciousness is epiphenomenal. It is often taken that the former entails the latter, and that therefore any implausibility in the notion of conscious epiphenomenalism calls into question the genuine possibility of zombies. Four ways in which the zombist might respond are examined, and I argue that two — those most commonly encountered — are inadequate, but the others — one of which is rarely formulated and the other new — are more forceful. The upshot, nevertheless, is that the zombist may indeed face an unwelcome commitment to conscious epiphenomenalism.If there actually are zombies, an unwelcome commitment to conscious epiphenomenalism is the least of our worries.
I had a look because of the intriguing title, but the article goes into some interesting work on theory of mind. I was unaware that the metaphysical possibility of zombies had been raised as a counterexample against physicalist theories of mind. Bailey concludes:
Finally, however, to the degree that the notion of causal gaps (or causal agents that are neither physical nor phenomenal) can be made plausible, it might be possible for the zombist to evade even this commitment and sever the link between the zombie hypothesis and phenomenal epiphenomenalism entirely.I'll have to ask the philosophers at the staff club to fill me in on the zombie wars.
This last move will be attractive to — perhaps even necessary for — the zombist, given the widespread wariness that exists, among physicalists and anti-physicalists alike, about phenomenal epiphenomenalism. Yet it has as yet been little explored, and remains highly speculative. Perhaps this is the front on which the next battle of the “zombie wars” is to be fought.
Rabu, 08 Juli 2009
A word after the final word on rationality
Eric has generously given me co-blogger status on Offsetting Behaviour so I can weigh in on the subject of irrational consumers and one’s world view.
The background for this was the session of the NZAE meetings last week when the BERL report on the costs of alcohol was presented. There we heard again the suggestion the question of whether the costs drinkers impose on themselves should be included as costs in a cost-benefit calculation is simply a matter of one’s “world view”. That is, the suggestion is that if you believe that consumers are the best judges of their own well-being then, by definition, any costs consumers impose on themselves are offset by equal or greater benefits and so can be excluded, but if you believe that some consumers make decisions that they will come to regret, these consumers incur non-offset costs that should be included.
Now, my world view is for the most part closer to the first than the second, although I don’t hold dogmatically to this view. That is, I believe that although consumers can and do make mistakes, they mostly are better judges of their own well being than are government officials, or at least are entitled from a personal-liberty perspective to make their own mistakes. Call that “world view 1”. But for the purposes of discussion, let us assume “world view 2”, which is the empirical and ethical assumption that people can make mistakes that can and should be averted by government policy. The question I want to address is how, or indeed if, that world view can be incorporated into cost benefit analysis (or just cost analysis).
It is probably useful to review first just what cost-benefit analysis is. Cost-benefit analysis is one of many approaches to answering two valuation questions: How can we compare bundles of different goods for a single individual to get a sense of whether alternative policies would make that individual better or worse off? and, How do we make comparisons across individuals to decide whether a policy that makes some consumers better off and some worse off is socially desirable?
Cost-benefit analysis is an approach that tries to make as much use as possible of the information contained in prices and individual decisions. For an economist with world view 1, the first valuation question is relatively easy: A rational consumer will consume a good up to the point where the marginal benefit equals the price, and so the price represents the value to that consumer. For goods traded in markets, this gives us a quick and easy way of observing that value. For goods that are not so traded, we ask the conceptual question: How much money would the consumer be prepared to pay to have one outcome compared to another? This can be hard to measure, but at least is conceptually clear. But what if you have world view 2? In this case, you cannot assume that price represents value at the margin, and so have to start making subjective assessments about the value the consumer would place on a good were he not making irrational decisions. That in itself is not a fatal problem. As with the example of non-traded goods above, we need to make subjective decisions all the time in cost-benefit analysis. But what does a dollar measure of cost and benefits mean for an irrational consumer in world view 2? For a drinker who consumes a later-to-be-regretted excess, we can only ask the conceptual question of how much he would, in principle, be willing to spend to reduce the amount he had drunk (i.e. a dollar measure of the costs his excess drinking imposes on himself) if dollars have some meaning as a measure of value for that consumer. If an irrational consumer would choose to spend additional income on things other than alcohol that would make him worse off, then, income is not a measure of value for that consumer at all. It would seem that to use dollar values to calculate the costs of alcohol that irrational drinkers impose on themselves, you can’t adopt world view 2; rather, you need something like world view 1.5—that consumers who are not fully rational in their decisions over the consumption of alcohol and drugs are fully rational for all other allocations. Only with this near-rationality are we able to continue to assume that there is useful value information contained in prices.
Now, it can reasonably be argued that addictive substances are quite different from other goods, and so a world view that assumes rationality except in that narrow sphere might be perfectly sensible. So let’s now consider the other valuation question, and ask whether adding up dollar costs across individuals makes sense with less-than-fully-rational consumers. With fully rational consumers, the idea of adding up dollar costs and benefits rests on the practical idea that dollars (unlike some subjective measure of well-being like “utility”) can be transferred between consumers, and on an ethical notion called the compensation principle. This says that a policy can be justified if, in principle, the consumers who gain from the policy could make a monetary compensation to those who lose in such a way that everyone is made better off by the policy. When, for example, Sir Geoffrey Palmer quotes “the headline figures in the Berl report of $5.296 billion in social costs of alcohol (and drugs), versus the alcohol excise tax take of $795 million, as a basis for his preferred policy option of significantly raising excise taxes to cover the shortfall”, he is invoking the compensation principle.
To illustrate, consider the situation of a rational drinker facing a price of $10 per drink, and imposing an external cost of $10 per drink on other people. Further imagine that demand is highly insensitive to price, but this is not known to the policy maker. In this case, we could put a $10 dollar tax per drink on the alcohol. Tax revenue would now equal $10 times the number of drinks purchased, which would exactly equal the external costs. We would now know that the benefit to the consumer was in fact greater than the external costs imposed, shown by the fact that the consumer is willing to pay the price of $20. If demand were sensitive to price, there would be some reduction in alcohol consumption—a reduction in those drinks for which the gross benefit to the drinker were less than the resource plus external cost of the drink, exactly what we would like according to the compensation principle.
In contrast, consider the same situation of an irrational drinker with price-insensitive demand who faces a price of $10 per drink but receives no benefit at all from the alcohol. This drinker is also imposing a cost of $10 per drink on society ($10 of resources used to make the drink with no offsetting benefits to the drinker), but that cost is entirely borne by himself. We could place a tax of $10 per drink on this drinker, but all that would do is increase the costs to the drinker by the same amount that it provided compensation to “society”. The story does not change significantly if demand is price sensitive. In this fanciful example, the appropriate tax would be the one that pushed the price of a drink so high that the drinker would reduce his consumption to zero (since he receives no benefit from the drink). That is, the appropriate tax would be one derived from his (irrational) demand curve for alcohol, not from any calculation of the dollar value of the costs he imposes on himself.
Contrary to Sir Geoffrey’s statement above, therefore, a comparison of the dollar value of the social costs of alcohol to the value of tax revenue received makes no sense if the social costs include costs imposed on himself by the drinker.
In short, the point here is that one is free to take a world view that people are sometimes not fully rational or informed, and to devise paternalistic policies based on that world view. But don’t use a false precision of dollar values, and don't use the technical apparatus of a valuation technique that depends on an assumption of rationality for its internal consistency.
The background for this was the session of the NZAE meetings last week when the BERL report on the costs of alcohol was presented. There we heard again the suggestion the question of whether the costs drinkers impose on themselves should be included as costs in a cost-benefit calculation is simply a matter of one’s “world view”. That is, the suggestion is that if you believe that consumers are the best judges of their own well-being then, by definition, any costs consumers impose on themselves are offset by equal or greater benefits and so can be excluded, but if you believe that some consumers make decisions that they will come to regret, these consumers incur non-offset costs that should be included.
Now, my world view is for the most part closer to the first than the second, although I don’t hold dogmatically to this view. That is, I believe that although consumers can and do make mistakes, they mostly are better judges of their own well being than are government officials, or at least are entitled from a personal-liberty perspective to make their own mistakes. Call that “world view 1”. But for the purposes of discussion, let us assume “world view 2”, which is the empirical and ethical assumption that people can make mistakes that can and should be averted by government policy. The question I want to address is how, or indeed if, that world view can be incorporated into cost benefit analysis (or just cost analysis).
It is probably useful to review first just what cost-benefit analysis is. Cost-benefit analysis is one of many approaches to answering two valuation questions: How can we compare bundles of different goods for a single individual to get a sense of whether alternative policies would make that individual better or worse off? and, How do we make comparisons across individuals to decide whether a policy that makes some consumers better off and some worse off is socially desirable?
Cost-benefit analysis is an approach that tries to make as much use as possible of the information contained in prices and individual decisions. For an economist with world view 1, the first valuation question is relatively easy: A rational consumer will consume a good up to the point where the marginal benefit equals the price, and so the price represents the value to that consumer. For goods traded in markets, this gives us a quick and easy way of observing that value. For goods that are not so traded, we ask the conceptual question: How much money would the consumer be prepared to pay to have one outcome compared to another? This can be hard to measure, but at least is conceptually clear. But what if you have world view 2? In this case, you cannot assume that price represents value at the margin, and so have to start making subjective assessments about the value the consumer would place on a good were he not making irrational decisions. That in itself is not a fatal problem. As with the example of non-traded goods above, we need to make subjective decisions all the time in cost-benefit analysis. But what does a dollar measure of cost and benefits mean for an irrational consumer in world view 2? For a drinker who consumes a later-to-be-regretted excess, we can only ask the conceptual question of how much he would, in principle, be willing to spend to reduce the amount he had drunk (i.e. a dollar measure of the costs his excess drinking imposes on himself) if dollars have some meaning as a measure of value for that consumer. If an irrational consumer would choose to spend additional income on things other than alcohol that would make him worse off, then, income is not a measure of value for that consumer at all. It would seem that to use dollar values to calculate the costs of alcohol that irrational drinkers impose on themselves, you can’t adopt world view 2; rather, you need something like world view 1.5—that consumers who are not fully rational in their decisions over the consumption of alcohol and drugs are fully rational for all other allocations. Only with this near-rationality are we able to continue to assume that there is useful value information contained in prices.
Now, it can reasonably be argued that addictive substances are quite different from other goods, and so a world view that assumes rationality except in that narrow sphere might be perfectly sensible. So let’s now consider the other valuation question, and ask whether adding up dollar costs across individuals makes sense with less-than-fully-rational consumers. With fully rational consumers, the idea of adding up dollar costs and benefits rests on the practical idea that dollars (unlike some subjective measure of well-being like “utility”) can be transferred between consumers, and on an ethical notion called the compensation principle. This says that a policy can be justified if, in principle, the consumers who gain from the policy could make a monetary compensation to those who lose in such a way that everyone is made better off by the policy. When, for example, Sir Geoffrey Palmer quotes “the headline figures in the Berl report of $5.296 billion in social costs of alcohol (and drugs), versus the alcohol excise tax take of $795 million, as a basis for his preferred policy option of significantly raising excise taxes to cover the shortfall”, he is invoking the compensation principle.
To illustrate, consider the situation of a rational drinker facing a price of $10 per drink, and imposing an external cost of $10 per drink on other people. Further imagine that demand is highly insensitive to price, but this is not known to the policy maker. In this case, we could put a $10 dollar tax per drink on the alcohol. Tax revenue would now equal $10 times the number of drinks purchased, which would exactly equal the external costs. We would now know that the benefit to the consumer was in fact greater than the external costs imposed, shown by the fact that the consumer is willing to pay the price of $20. If demand were sensitive to price, there would be some reduction in alcohol consumption—a reduction in those drinks for which the gross benefit to the drinker were less than the resource plus external cost of the drink, exactly what we would like according to the compensation principle.
In contrast, consider the same situation of an irrational drinker with price-insensitive demand who faces a price of $10 per drink but receives no benefit at all from the alcohol. This drinker is also imposing a cost of $10 per drink on society ($10 of resources used to make the drink with no offsetting benefits to the drinker), but that cost is entirely borne by himself. We could place a tax of $10 per drink on this drinker, but all that would do is increase the costs to the drinker by the same amount that it provided compensation to “society”. The story does not change significantly if demand is price sensitive. In this fanciful example, the appropriate tax would be the one that pushed the price of a drink so high that the drinker would reduce his consumption to zero (since he receives no benefit from the drink). That is, the appropriate tax would be one derived from his (irrational) demand curve for alcohol, not from any calculation of the dollar value of the costs he imposes on himself.
Contrary to Sir Geoffrey’s statement above, therefore, a comparison of the dollar value of the social costs of alcohol to the value of tax revenue received makes no sense if the social costs include costs imposed on himself by the drinker.
In short, the point here is that one is free to take a world view that people are sometimes not fully rational or informed, and to devise paternalistic policies based on that world view. But don’t use a false precision of dollar values, and don't use the technical apparatus of a valuation technique that depends on an assumption of rationality for its internal consistency.
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