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October 15, 2009

Economist's View - 4 new articles

"The Chamber of Commerce Has It Backwards"

Simon Johnson:

The Chamber of Commerce Has It Backwards, by Simon Johnson: The US Chamber of Commerce is opposing the administration's proposed Consumer Financial Protection Agency, on the grounds that it would hurt small business. Their argument is that this agency will extend the dead hand of government into every small business.
For the Chamber of Commerce, government is the enemy of small business and should always and everywhere be fought to a standstill. Chamber Senior Vice President (and former Fred Thompson campaign manager) Tom Collamore sees this as "advocacy on behalf of small businesses, job creators, and entrepreneurs"...
Somewhere, the Chamber's senior leadership missed the plot. What brought on the greatest financial crisis since the 1930s? What has hurt, directly and indirectly, small business of all kinds to an unprecedented degree over the past 12 months? What is killing small and medium-sized banks at a rate not seen in nearly 80 years?
It's the behavior of the financial sector, particularly big banks and their close allies – by consistently mistreating consumers. And the letter and spirit of the regulatory regime let them get away with it. ...
The state of knowledge regarding how to persuade people to buy stuff is impressive, the degree of potential manipulation for consumer preferences is simply stunning, and the "innovations" in this area are not slowing down.
The scope for taking advantage of consumers in subtle ways, or outright duping them, is probably higher for finance than for any other sector. For fairly obvious reasons, people are more likely to misunderstand credit than, say, furniture. ...
Unscrupulous Finance has brought us down and will do it again. Those most damaged now and in the future include small and medium-sized business owners who are trying to treat customers fairly.
The Chamber of Commerce ... small business membership should wake up to the current reality and press the Chamber hard to change its position before it is too late. ... The Chamber of Commerce is arguing that unfettered finance is good for small business. They are wrong.

Another case of mixing up the difference between "free markets" and markets that behave optimally:

Markets are Not Magic, by Mark Thoma: To listen to some commentators is to believe that markets are the solution to all of our problems. Health care not working? Bring in the private sector. Need to rebuild a war-torn country? Send in the private contractors. Emergency relief after earthquakes, hurricanes, and tornadoes? Wal-Mart with a contract is the answer.

Whatever the problem, the private sector - markets and their magic - beats government every time. Or so we are told. But this is misplaced faith in markets. There is nothing special about markets per se - they can perform very badly in some circumstances. It is competitive markets that are magic, though even then we have to remember that markets have no concern whatsoever with equity, only efficiency, and sometimes equity can be an overriding concern.

In order to work their magical efficiency, markets need very special conditions to be present. There must be full information available to all participants. Product quality, locations and prices of alternative suppliers, every relevant piece of information must be known. Not quite sure if the wine is good or not? That's an information problem. Not sure if the used car has problems? Don't know where any gas stations are except the ones beside the freeway in a strange town? No way to monitor the quality of the building built in Iraq with U.S. aid? No way to be sure if consultants are worth the amount they are being paid? Information problems are common and they can cause substantial departures from the perfectly competitive, ideal outcome.

There also must be numerous buyers and sellers, enough so that no single buyer or seller's decisions can affect the market price. For example, if a firm can affect the market price by threatening to limit supply, the market does not satisfy this condition. If, as some claim, CEOs are in such short supply that they can individually negotiate their compensation, then the market is not producing an efficient outcome. Whenever there are a small number of participants on either side of the market - suppliers or demanders - this is potentially problematic.

In order for markets to work their magic, the product must be homogeneous. That is, the product or input to production sold by all firms in the market must be perfectly substitutable so that as far as the buyer is concerned, one is as good as the other. If some buyers favor one brand over another, if CEOs are perceived to have different and unique talents, if government favors one contractor over another due to political contributions, this condition does not hold. In many cases the variety may be worth the inefficiency, not many of us would want just one style and color of shirt to be available in stores, but the inefficiency is there nonetheless.

In order for markets to work their magic there must be free entry and exit. Most people understand free entry, but free exit is sometimes less evident, so let me try to give an example. Starting a blog on Blogger or TypePad is easy. Entry is a snap and you can be up and running in no time at all. It's easy to join the competition and start supplying posts. But suppose that later you decide you want to switch to, say, TypePad from Blogger (or the other way around). That is not so easy. There is no way, at least no simple and convenient way, to export all of your old posts from Blogger and import them into TypePad, a significant barrier to exit if a large number of posts must be moved. Whenever barriers exist in markets that prevent free movement into and out of the marketplace or between firms within a market (on either side - there are sometimes barriers to purchasing as well), markets will underperform.

The list goes on and on. In order for markets to work their magic, there can be no externalities, no public goods, no false market signals, no moral hazard, no principle agent problems, and, importantly, property rights must be well-defined (and I probably missed a few). In general, the incentives that the market provides must be consistent with perfect competition, or nearly so in practical applications. When the incentives present in the marketplace are inconsistent with a competitive outcome, there is no reason to expect the private sector to be efficient.

Markets don't work just because we get out of the way. When government contracts are moved to the private sector without ensuring the proper incentives are in place, there will be problems - waste, inefficiency, higher prices than needed, etc. There is nothing special about markets that guarantees that managers or owners of companies will have an incentive to use public funds in a way that maximizes the public rather than their own personal interests. It is only when market incentives direct choices to coincide with the public interest that the two sets of interests are aligned.

If there is no competition, or insufficient competition in the provision of government services by private sector firms, there is no reason to expect the market to deliver an efficient outcome, an outcome free of waste and inefficiency. Why would we think that giving a private sector firm a monopoly in the provision of a public service would yield an efficient outcome? If the projects are of sufficient scale, or require specialized knowledge so that only one or a few private sector firms are large enough or specialized enough to do the job, why would we expect an ideal outcome just because the private sector is involved? If cronyism limits the participants in the marketplace, why would we expect an outcome that maximizes the public interest?

There is nothing inherent in markets that guarantees a desirable outcome. A market can be a monopoly, a market can be perfectly competitive, a market can be lots of things. Markets with bad incentives produce bad outcomes, markets with good incentives do better.

I believe in markets as much as anyone. But the expression free markets is often misinterpreted to mean that unregulated markets are all that is required for markets to work their wonders and achieve efficient outcomes. But unregulated is not enough, there are many, many other conditions that must be present. Deregulation or privatization may even move the outcome further from the ideal competitive benchmark rather than closer to it, it depends upon the characteristics of the market in question.

For government goods and services, when incentives consistent with a competitive outcome are present, we should get government out of the way and privatize, and there are lots of circumstances where this will be appropriate. There is no reason at all for the government to produce its own pencils and pens, buying them from the private sector is more efficient so long as the bids are competitive.

When competitive conditions are not met but can be regulated, the regulations should be put in place and the private sector left to do its thing (e.g. mandating that sellers disclose problems with a house to prevent asymmetric information or mandating that government funded projects be subject to competitive bidding and monitoring to ensure contract terms are met). There's no reason for government to do anything except ensure that the incentives to motivate competitive behavior are in place and enforced.

But rampant privatization based upon some misguided notion that markets are always best, privatization that does not proceed by first ensuring that market incentives are consistent with the public interest, doesn't do us any good. There are lots of free market advocates out there and I am with them so long as we understand that free does not mean the absence of government intervention, regulation, or oversight, even libertarians agree that governments must intervene to ensure basics like private property rights. Free means that the conditions for perfect competition are approximated as much as possible and sometimes that means the presence - rather than the absence - of government is required.

[Update: I should have added that perhaps the Chamber fully understands the difference between free markets and competitive markets, and simply wants to preserve the "freedom" to take advantage of customers.]


"Finding a Job Right Now is Extremely Difficult"

The ratio of the number of unemployed to the number of job openings suggests that the current weakness in labor markets is likely to persist:

A look at another job market number, Macroblog: ...At the end of August there were estimated to be fewer than 2.4 million job openings, equal to only 1.8 percent of the total filled and unfilled positions—a new record low. This is an especially significant issue given the large number of people who are looking for work. The ratio of the number of unemployed to the number of job openings was greater than 6 in August. In contrast, that ratio was under 1.5 in 2007 and previously peaked at 2.8 in mid-2003, suggesting that finding a job right now is extremely difficult...

Unemp-to-openings

The quit rate moved back down to its record low of 1.3 percent, as relatively few people want to leave a job voluntarily in the face of such a weak labor market. At the same time, the rate of involuntary separations moved up from 1.6 percent to 1.8 percent, not far below the peak of 1.9 percent in April.

The low probability of finding a job has also caused the average amount of time spent unemployed to rise substantially. ...

Labor markets need more help.


Can Better Logistics Ease Harsh Labor Market Conditions in Developing Countires?

This argues that better workflow logistics can be an effective means of alleviating harsh working conditions:

Saving labor, by Peter Dizikes, MIT News Office: The existence of harsh labor conditions in factories around the world is a pressing moral issue. But to improve those conditions, we should regard it as a logistical issue, too.
Consider the case of ABC, a giant clothing manufacturer whose products are made in more than 30 countries, and the subject of a new study led by Richard Locke ... of the MIT Sloan School of Management. After being accused of poor labor practices in the early 1990s, Locke notes, ABC became a leader among corporations in addressing labor conditions. The firm adopted a code of conduct for all factories providing it with goods, including those owned and run by local suppliers. ABC developed a system to monitor labor conditions, and hired a large compliance staff to enforce its policies world-wide.
And yet for all of its efforts, just 24 percent of the roughly 200 factories in ABC's global supply chain met its own labor standards in 2006, as Locke and some colleagues reveal in a recently published paper based on a study of the firm's own audit data and practices. Garment workers at plants supplying ABC in the Dominican Republic were exposed to noxious chemicals and forced to work in overheated conditions, according to Locke and his co-authors; as they detail it, other laborers, from Honduras to India, were asked to work overtime shifts in excess of ABC's own established limits.
The traditional system of setting labor standards and attempting to enforce them, through periodic checks by corporate compliance officers, has not worked well enough, Locke and his colleagues conclude. ... "My original view was that the compliance system could make conditions better, if it were just better-designed or better-funded," says Locke. "In the process of research, I realized that just checking on factories and threatening them doesn't work." In this view, multinational firms cannot just diagnose factory problems and expect them to vanish, but must take the lead in changing them. ...
Basic policing of factories has "yet to deliver on its promise of sustained improvement in labor rights," the authors say, while by contrast, factory monitors who take a problem-solving approach, have created "sustained improvements in working conditions and labor rights" around the world.
The authors were able to conduct the study because ABC (a pseudonym chosen to protect its identity) allowed them to study its data on labor conditions, and granted the researchers access to numerous factories where ABC's suppliers actually make its clothes.
While evaluating the firm, Locke, Amengual, and Mangla saw with their own eyes evidence that a pragmatic, trouble-shooting mode of enforcement has rapid effects. To solve the problems of exposure to fumes overheating in the Dominican Republic, for instance, compliance officers suggested moving the relevant equipment to the edge of the building space. Ventilation improved and the problem diminished significantly.
To help the factory in Honduras, ABC persuaded its management to re-orient its machinery and workers' schedules, to better handle the short-term "rapid replenishment" orders that had led to excess overtime. The improved logistics cost the factory little financially and let it comply with ABC's standards. The MIT researchers found a similar result at a factory supplying ABC in Bangalore, India, where better workflow logistics also eliminated an overtime problem.
"We know from years of research that when you implement certain kinds of systems in the advanced industrial countries, you get better results," says Locke. But the managers of factories supplying ABC, he notes, often lack "real training or understanding of production techniques and high-performance systems."
Labor-rights advocates applaud Locke's ideas. "People have looked to codes and auditing as a way to force accountability," says Chris Jochnick, director of Private Sector Development at Oxfam America. "But Rick was one of the first people to see that the way improvement happens is probably a lot more nuanced. His work is a valuable way of looking at the problem."
As Locke notes, this logistics-based approach to factory violations is just one piece of a still larger problem; the demands global brands put on local factories must be addressed as well. And as he readily acknowledges, some practical solutions could be expensive for factories, making managers reluctant to implement them. In those cases, a hard-line approach may yet be useful. "Sometimes you do need a bit of a threat," he says. "It's that blend that seems to matter." ...
Later this month, Locke will host a conference of executives both from non-governmental organizations and athletic-wear firms — including Nike, Adidas, New Balance, Puma and Asics — to discuss ways to use this problem-solving approach. ...

Firms must have the desire to set a code of conduct that they are serious about enforcing (as opposed to using the code to gain positive publicity with no real intent of forcing firms to comply), and they must also have the means to enforce compliance. This focuses on the ability to enforce or induce compliance, but the incentive to establish the code and then make a serious attempt to change things when suppliers are in violation of the rules is another important aspect of the problem.

In a competitive marketplace where buyers do not consider the labor market conditions of suppliers when purchasing a good, and where there are no regulations preventing firms from transacting with suppliers who are in violation of minimal standards (something that would be difficult to monitor), firms will have no incentive beyond their own moral values to enforce labor market standards.

I'm sympathetic to the argument that low wage jobs in many developing countries provide opportunities that wouldn't exist otherwise, but there are bounds that shouldn't be crossed.


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