Thursday, July 17, 2008

California's Foil Balloon Problem

A helium-modified voice is good for a laugh, but the joke is risky. Inhale too much helium from the balloon and you'll pass out. It turns out that helium balloons can black out more than just the overzealous prankster. As recent news stories point out, foil helium balloons can get caught up in power lines and cause outages. California utilities reported hundreds of balloon-related outages last year: 211 for northern California's PG&E and 478 for southern California's Edison. California Senate Bill 1499 proposes to deal with the problem by banning foil balloons and fining violators. Though foil balloons can be a problem, a bit of economic analysis suggests that the heavy-handed ban may not be the best remedy.

By increasing the odds of costly power outages, helium balloon consumption imposes external costs on society. The vast majority of electricity consumers outside of the helium balloon market may nonetheless end up incurring some costs when errant balloons make their way into nearby power lines. Since helium balloon consumption imposes external costs, the social benefit of helium balloon consumption is considerably less than the private benefit. When the social value of a good is lower than the private value, there will be an inefficiently high level of consumption in the private market.

So rather than banning the balloons altogether, the California legislature may want to consider a corrective tax. Taxing the consumption of helium balloons would force buyers to internalize the heretofore external costs that the balloons impose on everyone else. The tax would reduce both foil balloons purchased and balloon-related power outages while giving buyers and sellers an incentive to shift toward less disruptive party favors.

To analyze the issue more closely, we need to define some costs and benefits in the market for foil balloons. Because helium balloon consumption generates external costs, the marginal social benefit from a helium balloon will be less than the marginal private benefit:

Marginal Social Benefit (MSB) = Marginal Private Benefit (MPB) – External Cost

In the foil balloon market, the supply curve represents the marginal private cost (MPC) of selling balloons and the demand curve represents the marginal private benefit (MPB) of consuming balloons. The marginal social benefit (MSB) curve lies below the demand curve, since the social value of foil balloons incorporates the external costs. The socially optimal output level occurs where the marginal private cost of producing the balloons is equal to the marginal social benefit of consuming them—well below the market outcome at the intersection of our standard supply and demand curves. At points above the socially optimal output level, the marginal social benefit of the balloons will be less than the marginal cost of producing them. As a result, at least some of the current balloon consumption is inefficient.

Discussion Questions

1. According to our diagram of the hypothetical helium balloon market, what is the size of the tax necessary to achieve the socially optimal output level? Can you think of other markets where corrective taxes have been used or might be used to curb the external costs of consumption or production?

2. Is a ban more costly than a corrective tax in this case? Not all helium balloon buyers are careless with their purchase. Is the tax fair?

3. While a corrective tax has the potential to move a market closer to its social optimum, the use of government revenue from such taxes may be socially inefficient and wasteful. The correction of a market failure may simply beget government failure. Can you think of ways to prevent the government from wasting corrective tax revenues?

4. How would you go about estimating the external costs of helium balloon consumption?

5. What can you say about the price elasticity of the demand for and supply of helium balloons? Many party supply stores claim that any disruption to helium balloon sales will threaten jobs. What do you make of this?

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Monday, July 14, 2008

Deterring Suicide Bombers

So far this year, Israel has suffered two attacks at the hands of Palestinian men who resided in East Jerusalem. In the wake of the attacks, Israeli Prime Minister Ehud Olmert renewed a legislative proposal aimed at deterring would-be terrorists by punishing the families of the attackers. Punishment would include home destruction and cancelled access to Israeli social insurance programs. Eric Westervelt's NPR story offers more on the proposed law.

For the moment, let's leave aside the major issue of whether it is moral to punish people for murders committed by a dead relative. The objective of the law is clear: to provide a disincentive to suicide attacks by punishing the perpetrator's surviving family members. Should the law pass, suicide bombers would forgo not only their own lives but also, potentially, the welfare of their families. By raising the opportunity cost of a suicide attack, the supporters of the law hope to reduce the number of attacks. Recent research on the economic roots of terrorism can help us think about whether the policy will achieve its intended consequences.

In a 2003 research paper, Alan Krueger and Jitka Maleckova found that participation in terrorism is unrelated, and possibly even positively related, to a person's income and education. As Daniel Lerner pointed out in a study of Middle East extremism in the 1950s, would-be terrorists are not so much have-nots as they are want-mores. In a more recent article in The American, Krueger cites Claude Berrebi's research on the characteristics of Palestinian terrorists from the West Bank and Gaza Strip:

"[Berrebi] compared suicide bombers to the whole male population aged 16 to 50 and found that the suicide bombers were less than half as likely to come from families that were below the poverty line. In addition, almost 60 percent of the suicide bombers had more than a high school education, compared with less than 15 percent of the general population."

Apparently, better-educated terrorists are more likely to be committed to their organization's goals and also more likely to have the financial means to participate actively. After all, a person needs some level of income security to have pursuits beyond basic subsistence.

Krueger and Maleckova also cite some anecdotal evidence suggesting that terrorist groups attempt to recruit somewhat educated suicide bombers. Nasra Hassan, a UN relief worker, interviewed 250 Palestinians militants and their associates between 1996 and 1999:

"A planner for Islamic Jihad explained to Ms. Hassan that his group scrutinizes the motives of a potential bomber to be sure that the individual is committed to carrying out the task. Apparently, the groups generally reject for suicide bombing missions 'those who are under eighteen, who are the sole wage earners in their families, or who are married and have family responsibilities.'"

The evidence presented by Krueger and Maleckova casts doubt on the effectiveness of the Israeli Prime Minister's proposal. The threat to families isn't much of a threat to a terrorist with minimal or zero family responsibilities. The law may not present much of a threat to terrorists with families either. If the suicide bombers tend to be a bit more educated and financially stable than their peers, they will probably develop a contingency plan that softens the punitive blow to their families. Similarly, terror groups may alter their tactics in response to the law, perhaps offering some sort of compensation to the families of suicide bombers as a recruitment incentive.

Discussion Questions

1. Economic analysis allows us to answer "what if?" questions, such as "What would happen to the number of suicide attacks if the Israeli government punished the families of suicide bombers?" Economics is not so great for dealing with "what should?" questions; but as citizens, we still have to tackle them. What should the Israeli legislature do about Olmert's calls to punish the families of suicide bombers?

2. In Krueger's article from The American, he suggests using "demand-side" policies to reduce the number of terrorist attacks. In the "market" for terrorists, the demanders are terrorist groups hoping to employ the services of suicide bombers. According to Krueger, what types of policies might suppress the demand for terrorists? Can you think of ways for Israel and its allies, like the United States, to go about attacking the financial resources of terror groups?

3. Krueger points out that we're unlikely to find many would-be terrorists among the illiterate and destitute. What does he say about the notion that "the elite become terrorists because they are outraged by the economic conditions of their countrymen?"

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Monday, July 07, 2008

Oil Prices and Expectations

Harvard economist Martin Feldstein's latest opinion piece in the Wall Street Journal argues that we can implement policies today that will impact the current price of oil. Current oil production responds to expectations about the future, Feldstein explains. Any significant change in expectations about the future price of oil will have an immediate impact on the current supply of oil. Broadly speaking, the expected price of oil changes for one of two reasons:

1. Changes in expectations about the growth of oil demand; and
2. Changes in expectations about the growth of oil supply.

How might changes in expected oil demand lead to higher current prices? As Feldstein points out, "when oil producers concluded that the demand for oil in China and some other countries will grow more rapidly in future years than they had previously expected, they inferred that the future price of oil would be higher than they had previously believed." If oil producers expect higher future prices for oil, they will curb production today (leave some oil in the ground) in hopes of extracting it at higher prices in the future. On the graph, the current supply of oil shifts to the left, to S1, causing the current price of oil to rise to P1 and the current quantity of oil to decline.

How might changes in expected oil supply lead to higher current prices? Again, from the editorial: "[C]redible reports about the future decline of oil production in Russia and in Mexico implied a higher future global price of oil." If producers expect oil supply growth to weaken in the future, the expected future price of oil rises, and oil producers leave some oil in the ground today in order to extract it at higher future prices. Once again, we'd expect the supply curve for oil to shift to the left, causing the price of oil to rise (to P1) and the quantity of oil to decline.

An increase in expected oil supply or a decrease in expected oil demand would lead to lower current oil prices. If oil producers think that future cars will be much more fuel-efficient than previously believed, they'd expect relatively weak growth in oil demand, and correspondingly lower future prices. In this case, producers respond by pumping more oil today in an effort to avoid lower future prices. Similarly, as Feldstein points out, "increasing the expected future supply of oil would also reduce today's price."

Discussion Questions

1. Although Feldstein points out that a significant increase in expectations about the future supply of oil would put downward pressure on today's price of oil, he does not explicitly endorse a policy of drilling in currently protected areas of the United States. The crucial question is whether or not future drilling in currently protected areas would have a large enough impact on worldwide oil supply to trigger production changes today. What do you think?

2. There's much discussion in the news about how to develop alternative sources of energy that would reduce the future demand for oil. What are some policies that would reduce the future demand for oil and oil-derived products, like gasoline? Would government commitment to these types of policies be credible enough to lower expectations of future oil prices?

3. Not all economists agree with Feldstein about the ability of current energy policies to impact current oil prices. Many (though not necessarily most) believe that there is very little the government can do to achieve lower oil prices in the next few months or years. Why might this be the case?

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Tuesday, July 01, 2008

Sacking Mugabe

The path to growth remains elusive for many of the world's economies. Prescribing effective growth policies is exceedingly difficult. The unique features in each of the world's economies defy formulaic approaches to growth—it's not necessarily clear that Japan's path will work for Cambodia. Economic history offers a bit more clarity when it comes to what won't work. Of the more recent episodes of economic collapse, Zimbabwe's is perhaps the starkest. The Mugabe regime's mismanagement of the Zimbabwean economy reads like a step-by-step guide to economic ruin.

In 2000, Zimbabwe's autocratic ruler, Robert Mugabe, implemented a clumsy and often violent land redistribution program. Mugabe forcefully seized white-owned farmland and gave it to black farmers unfamiliar with commercial farming practices. The absence of any cooperative knowledge transfer between white and black farmers led to a precipitous fall in agricultural output. The failure of the agricultural sector caused a severe contraction in overall economic output, creating massive unemployment. The collapsing economy sapped Mugabe's regime of the tax revenues necessary to pay soldiers and finance government outlays. An autocrat's reign is only as secure as his army is brutal—hungry, underpaid soldiers aren't much for intimidating political opponents or scaring the populace into submission. To maintain his government's outlays, Mugabe turned to borrowing. Of course, the loans would eventually need to be repaid. Lacking the tax base to repay the loans, the government resorted to the capstone of many economic disasters: printing money.

The results were predictable: hyperinflation reached roughly 4 million percent per year as of June 2008. At these levels of inflation, even the most mundane daily transactions involve considerable uncertainty and frustration. Mugabe's response to the hyperinflation that he himself initiated could not have been worse. The government imposed price ceilings, threatening to jail shop owners if they charged more than the official price. The price ceilings led to massive shortages of necessities like bread and milk. Many firms shut down production, escalating an already high unemployment rate.

You don't have to be an economist to recognize the first step to improving Zimbabwe’s economy: get rid of Mugabe. But removing Mugabe from power is easier said than done. Opposition presidential candidate Morgan Tsvangirai gave it an impressive go during this year's elections, but widespread violence against opposition supporters caused Tsvangirai to withdraw from the presidential run-off. At this point, Mugabe remains president.

Discussion Questions

1. Mugabe is 84 years old—why doesn't he just step down? Charlayne Hunter-Gault's article in The Root suggests that Mugabe has strong incentives to maintain his grip on power given the fate of other overthrown tyrants. Hunter-Gault raises an interesting dilemma for freedom-lovers all over the world: we want to get rid of brutal dictators, but the dictators may do everything they can to retain power precisely because they fear what we'll do to them once they're out of office. Should we offer Mugabe amnesty just to get him to step down?

2. In a recent Wall Street Journal editorial, former World Bank president and U.S. Deputy Secretary of Defense Paul Wolfowitz suggests a way to pressure Mugabe out of office. Wolfowitz calls on the international community to very publicly declare promises of aid and debt relief for Zimbabwe under the condition that Mugabe is removed from office. Do you think this strategy would succeed?

3. Mugabe's land redistribution program was catastrophic for Zimbabwe's economy, but as this NPR story points out, several neighboring countries attempted to benefit from the displacement of white farmers in Zimbabwe. How could the Zimbabwean government have balanced the goals of efficiency of the farming sector and equity for the black population that suffered a history of oppression by a ruling white minority?

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