EclectEcon

and most other places, for that matter. Mis-pricing of water. From the NYTimes (reg req'd), courtesy of Brian Ferguson,

For three decades, water has been indispensable in sustaining the rollicking economic expansion that has made China a world power. Now, China’s galloping, often wasteful style of economic growth is pushing the country toward a water crisis. Water pollution is rampant nationwide, while water scarcity has worsened severely in north China — even as demand keeps rising everywhere.

Florida and Hawaii (and many other places) have similar problems: water is priced too low, so people overuse it. And unless prices are adjusted upward, people will continue to overuse it. And that will only lead to a much more difficult adjustment the longer the overuse persists.

More from the article:

What happened? The list includes misguided policies, unintended consequences, a population explosion, climate change and, most of all, relentless economic growth. In 1963, a flood paralyzed the region, prompting Mao to construct a flood-control system of dams, reservoirs and concrete spillways. Flood control improved but the ecological balance was altered as the dams began choking off rivers that once flowed eastward into the North China Plain.

The new reservoirs gradually became major water suppliers for growing cities like Shijiazhuang. Farmers, the region’s biggest water users, began depending almost exclusively on wells. Rainfall steadily declined in what some scientists now believe is a consequence of climate change.

Don't you wish that just once people would recognize that setting the price of water equal to zero (or way too low) causes these problems?

As most of you know, I am back teaching at Herstmonceux Castle again this summer (albeit for only six weeks this summer). I took this photo this afternoon.



Here are the Wisteria in the castle courtyard. Everything in England is blooming much earlier this year because the weather has been so warm (around +20 C for the past two weeks or so). The dryness is once again, however, raising questions about how water should be allocated (see this for a description of the problems faced last year).



Here is the view of the castle gardens from my office window (through the crenellations at the top of the parapet).

The United Arab Emirates, concerned about the health, weight, and obesity of its nationals, is considering slapping price controls on health foods to induce consumers to buy more health foods. Unfortunately, the UAE Health Ministry is only half right: Yes, lowering the price would lead to an increase in the quantity demanded, but they are ignoring the supply side. John Chilton points out that price controls will actually lead to less consumption of healthy fruits and vegetables, contrary to the intentions of the price fixers:

Introducing a price ceiling to lower the price of healthy foods would give consumers the incentive to seek to consume more healthy food, but it will also give suppliers less incentive to provide healthy foods. Consumers will find the amount or quality of healthy food decline. Consumers will end up consuming less, not more healthy food - exactly the opposite of the good intentions of the Health Ministry.

If the ministry wants to spur consumption of healthy food it needs to either convince consumers to buy more at given prices, or subsidize healthy food in the marketplace.

Follow the link to read his take on the distinction between "nationals" and "residents" and on the expansion of Krispy Kreme donuts into the UAE.

A number of bloggers have written about the effects of price controls in Venezuela, including Phil Miller, Brian Ferguson, and Lynne Kiesling among others, all pointing out that price controls, in an attempt to put the lid on inflation, have created massive shortages.

Interestingly, I have not yet come across any blog postings that mention the rapid rate of growth of the money supply in Venezuela, and yet we all know that "Inflation is always and everywhere a monetary phenomenon [Milton Friedman]."

According to The Economist data, the Venezuelan money supply increased from 2,652 to 4,228 currency units over the past year. Given such a high rate of growth of the money supply, what surprises me is that nominal interest rates and the rate of inflation are not a lot higher. That makes me very suspicious that measured inflation is not picking up the rapid growth in prices in the underground and black markets.

In other words, the Chavez price controls are probably having some effect in keeping the lid on measured prices. But the resulting shortages are undoubtedly driving many markets underground, where, I'd venture, prices have been sky-rocketing.

The problem, of course, has been that Venezuela has a massive trade surplus because of the high price of oil and its huge oil exports, but the central bank has refused to sterilize the currency inflows, letting the money supply increase instead. And that's almost surely because Chavez has wanted to use those currency inflows for his give-away programmes.

For more thoughts along these lines, see The Emirates Economist and the comments there.

From Brian Ferguson:

The Americans are taking the wrong approach to countries run by gentlemen like President Chavez. There's no need for confrontation: just wait until they start to cause trouble, then ship 'em a whole bunch of policy wonks trained in the Sociology and Development departments of US universities, and encourage them to help the government in question to free its people from the grip of nasty corporations. To take command of the economy and run it for the benefit of the people. No need even to use CIA plants - there are plenty of the real thing being churned out by dozens of universities (and not just in the US, if you want to add a bit of multinational flavour to the effort). Ship 'em out and wait for the whole place to collapse under the weight of regulation. By the time they're done such a large part of the population will be employed policing the market activities of the rest of the people that there won't be enough left to man a decent army. End of threat. A bit hard on the local populous, I admit, but no plan's perfect.

I see he still has not learned how to spell "gubmnt".

When ATMs were first introduced over 30 years ago, financial institutions encouraged their own customers to use them, hoping to reduce teller costs. And for the most part this change has been successful.

When I was in England last summer, I was both pleased and surprised to notice that the financial institutions there all (at least all that I used) had official-sounding notices on their screens, telling people that they did not charge fees for using their ATMs. I could withdraw cash pretty much anywhere and not be charged for the service.

That's weird, isn't it? I was doing something, using a service, that used scarce resources (restocking time, interest costs for the cash in the ATM, depreciation of the machine) but I wasn't paying anything to cover those costs. I didn't bank at those institutions. I (and most of us from Canada who were there) was just receiving a freebie at the expense of the stockholders of those institutions. At the time I liked it, but I figured there must be legislation requiring these kind people to treat us so generously. It just didn't seem to me that zero transaction charges for ATM use would emerge in a competitive, profit-maximizing equilibrium.

And yet politicians continue to try to win votes by telling banks they should give away the ATM service. From the January 26th Nat.Post (courtesy of Jack, no link though),

Finance Minister Jim Flaherty is demanding Canada's banks explain why they charge fees to customers for using automated bank machines.

Mr. Flaherty said yesterday he has raised the question of scrapping the fees with the banks, and he is awaiting their response.

Bank customers use the machines, also known as automated teller machines or ATMs, for more than a billion transactions each year. Customers are charged for some of those transactions — typically there is a fee of $1 to $2 for withdrawing cash from a machine owned by a bank at which the customer does not have an account.

... Mr. Layton said the NDP will press for changes to the banking laws to eliminate the fees.

Why don't these politicians just come right out and say what they mean:

The banks earn profits and we want to redistribute those profits to our constituencies.

Is there some way to force an RSS feed from this blog to these politicians? Here is an excerpt of what I wrote on this topic earlier [see here and here]:

Where did we obtain the idea that we are entitled to no-charge ATM services? ATM hardware is expensive, and so is replenishing the machines. Banks usually provide ATM services for their own customers at no charge, as a way of attracting and retaining customers, but why do we think they should provide these services at no charge to everyone else?

... [P]eople's use of an ATM from another bank or using an independent for-profit ATM service is a convenience. But we do have choices:

* We can pay for most purchases with our debit or credit cards
* We can walk or drive a few extra blocks to a place with lower ATM fees.
* We can plan ahead and get more cash when we are at our own bank or at a no- or low-fee ATM.

In other words, we do have choices. We may not like the inconvenience of the remaining options, but it just plain silly to promote the idea that we have no choice.

We have enough choice that it is unlikely the chartered banks are monopolistically exploiting their ATM users.

For more, see this at Gods of the Copybook, which says, in part,

On a perhaps obvious sidenote, does it strike anyone else as absurd that people complain about these fees? ATM machines don't exactly spring from the ground ready made and filled with multi-hued cash, ready to be dispensed. Does it not seem at least a little reasonable that banks should not be subsidizing the financial activities of their competitors' clients?

Again, from the Nat.Post:

"Mr. Layton said that customers in the United Kingdom are not charged these fees," Mr. Protti [Cdn Banking Association President] said. "However, he should realize that services are not delivered for free. There is a cost to providing banking services. Looking at one service in isolation does not take into account that the costs to provide it are recouped through higher costs for other products and services."

Update #1: One of the costs of operating ATMs is fixing/cleaning them after people take out their frustrations and anger on them. See this [h/t to King]

Update #2: For a taste of real William Jennings Bryan-type populism and how much some people seem to detest or envy bank profits, see the comments to this same posting at The Western Standard.

Several recent postings highlight the phenomenal strength of market forces and consumer sovereignty.

1. The Emirates Economist links to an article showing that consumers are getting (choosing?) more nicotine in their cigarettes. His point is that the market conveys information about a product, even if the suppliers might not want a big fanfare about that information.
   

   Those who don't understand how markets work often worry that firms routinely cheat their customers. Certainly there are cases where that can happen, but most often firms are disciplined by a simple mechanism: consumers quickly learn the quality of the product and adjust their demand accordingly.

2. In a second posting, EmEc reiterates the concern so many economists have about the minimum wage:
   

   [T]he majority of Americans (and other peoples for that matter) believe the minimum wage benefits the intended beneficiaries. It benefits only the lucky ones who don't lose work.
   
   The "power" to the buyer that exists here, exists purely because of the minimum wage. The owner/manager is going to cut the hours because the incentive to hire labor has changed (not to make a political statement). And those whose hours get cut are the ones the manager likes least -- something that's possible to do with profit consequences because the minimum wage has created excess supply.

   In that posting, EmEc raises a serious issue, namely that decisions makers have a much stronger incentive to discriminate against unfavoured groups when there are price controls.
   
3. The third item is a nice, succinct piece by Cafe Hayek pointing out that if credit card interest rates are "too high" (whatever that means), then market forces will drive them down:
   

   If there are government-imposed restrictions on the ability of banks and other firms to compete to offer consumer credit, then credit-card rates would then likely be too high. But absent such restrictions -- and I know of none -- then our best guess is that rates are appropriate. If rates were too high, then the greedy quest for profit would prompt one or several firms to lower rates or offer better terms to consumers.

   Boudreaux also makes the telling point that the market is generally a better regulator than are politicians:
   

   Am I naive? Certainly no more naive that is Mr. Mintz and others who suppose that an investigation by Congress into credit-card rates will uncover trustworthy information and use this information as the basis for sound corrective actions.

With all the on-going discussion in the blogosphere concerning the effects of minimum wage legislation (e.g. see this at Cafe Hayek, this at Market Power, and this by Greg Mankiw; and see this earlier piece by Craig Newmark), I'd like to add these observations.

Some years ago, a professor in socionomology argued that raising minimum wages wouldn't cause job losses in the fast food industry because you'd still need workers (graduates from his department, probably) to flip burgers.

There are two problems with this so-called analysis.

1. It assumes a fixed-coefficents production function [you need a fixed proportion of labour and capital, no matter how much you produce] in the fast-food industry. But as one who has happily worked and consumed in the fast-food industry for nearly half a century, I can assure you that production techniques are changing all the time. And much of the technological change that is implemented seems to allow the substitution of capital for labour.
2. The second problem is both larger and more subtle. As minimum wages increase in the fast-food industry, prices rise too. And as the prices of fast food increase, people start buying more microwavable food in grocery stores, storing it at home in freezers, and preparing it themselves. The substitution of capital for labour takes place in the factories that produce the food, in the grocery stores, and people's homes, not in the fast-food restaurants themselves, but it is every bit as important a phenomenon.

For a good but lengthy summary of the economics of minimum wages, see this.

I didn't realize I had written so much on medical tourism in the past, but there have been three or four postings on the topic (see here, here, and here for example). But the fact remains that at current, gubmnt-set prices (mostly zero), we have a shortage of physicians in Canada. The result, of course, anytime a price is set below the market price, is that some of those potential purchasers who would otherwise be rationed out of the system or who do not wish to join the seemingly interminable queue, look for quasi-market solutions; they look for some other way to receive the services, even if they have to pay for them. And in health economics, one very attractive solution is medical tourism — travel to some exotic locale during a season when the weather there is much better than in Canada and as an aside while you're there, have a medical procedure carried out.

After my most recent posting, which listed some links for medical tourism, Lauren H sent me a message with several more links:

I have been working on the wikipedia page on medical tourism lately:
http://en.wikipedia.org/wiki/Medical_tourism

CBS News did a very informative story on medical tourism in 2005:
http://www.cbsnews.com/stories/2005/04/21/60minutes/main689998.shtml

Another great article was from the University of Delaware's UDaily:
http://www.udel.edu/PR/UDaily/2005/mar/tourism072505.html

Time Magazine wrote an article just this year:
http://www.time.com/time/magazine/article/0,9171,1196429,00.html

I expect I am being unduly risk averse, and I have no idea how I would respond if I really wanted to have a medical procedure but would otherwise have to wait two years or spend tens of thousands of dollars, but no matter what Lauren and Jack have told me, I might tend to be somewhat hesitant. But at the price differentials listed in some of the above articles, and if the length of the queue continues to grow in Canada, who knows?

As I have written so often before, when water is priced below the market-clearing price, shortages develop at those prices (this is probably the best of my previous postings on the topic, but also see this and the others listed here).

Now we can add India to the collection. It appears that ground water, which is a common-property resource, is being pumped at a much faster rate than nature is replenishing it. And the cause is three-fold:

1. Water itself is underpriced:
   

   [A]t a village called Peeplee Ka Bas... the wells have run dry and the water table fallen so low that it is too salty even to irrigate the fields.
   
   The train came bearing precious cargo: 15 tankers loaded with nearly 120,000 gallons of clean, sweet drinking water.
   
   The water regularly travels more than 150 miles, taking nearly two days, by pipeline and then by rail, so that the residents of a small neighboring town can fill their buckets with water for 15 minutes every 48 hours.
   
   It is a logistically complicated, absurdly expensive proposition. Bringing the water here costs the state about a penny a gallon; the state charges the consumer a monthly flat rate of 58 cents for about 5,300 gallons, absorbing the loss.

2. And so is the electricity used to operate the pumps:
   

   Electric pumps have accelerated the problem, enabling farmers and others to squeeze out far more groundwater than they had been able to draw by hand for hundreds of years.
   
   The spread of free or vastly discounted electricity has not helped, either. A favorite boon of politicians courting the rural vote, the low rates have encouraged farmers, especially those with large landholdings, to pump out groundwater with abandon.
   
   With the proliferation of electric pumps ...it took only 20 years for [one farmer's] groundwater reserves to sink to their current levels. Twenty more years of the same policy could be catastrophic.

3. And of course the lack of property rights to the water contributes to the problem:
   

   Indian law has virtually no restrictions on who can pump groundwater, how much and for what purpose. Anyone, it seems, can — and does — extract water as long as it is under his or her patch of land. That could apply to homeowner, farmer or industry.

With these three problems, the situation can only get worse. Nobody owns the water, so there is a huge incentive for everyone to pump it out faster than would be optimal if (a) there were well-defined property rights to the water and (b)the price of electricity were higher.

But it is difficult to implement policies that will reverse the current problem:

• Voters want low water prices (and expect the gubmnt to subsidize them), and so long as water prices are low, people use too much water.
• Voters want low electricity prices (and expect the gubmnt to subsidize them), and so long as electricity prices are low, people use too much electricity and pump too much water.
• And, sadly, politicians who allow prices to rise often face problems being re-elected.

The upshot is that things will have to get much worse before they can possibly get better. And in the meantime, residents of India can only hope that calls for more gubmnt intervention in the markets will not make the situation even more worse (!)

This past summer I spent three months in southeast England, where there were water "shortages" and concerns about the effects of two summers of drought conditions. I wrote about these conditions here and here. In the second of those two postings (which is longer and more detailed than usual for me), I wrote,

My neoclassical inner being tells me that the reason for the water shortages is that the price of water is too low.

This is the same explanation for water shortages in the western United States, provided by Robert Glennon in Perc Reports.

In his article, Glennon systematically shows that attempts to increase the supply of water will meet with little success and will have very high costs. He then turns to schemes to limit the growth in demand for water. He concludes,

States should avoid conservation standards that require elaborate monitoring because they may be neither cost-effective nor successful. ...

Even though water is a valuable resource, many Americans pay more each month for their cell phones and cable television than they do for water. Indeed, residents in some cities pay nothing for water. In Fresno, California, a controversy erupted in 2003 over whether meters should be installed in people’s homes so that actual water use could be measured and paid for. Until now, city residents have been able to use as much water as they wish without any charge for it. Meters enable a city to insist that residents be responsible in their water use or pay financial consequences. The absence of meters has significance for water use. Fresno residents use about 300 gallons per capita per day but in neighboring Clovis, which has meters, water use is about 200 gallons per day. Sensible water pricing would encourage all water users to carefully examine how they use water, for what purposes, and in what quantity.

Exactly. As I wrote this summer, installing meters and pricing water at a reasonably high price would work wonders toward avoiding water future crises.

The castle where I will be teaching this summer is in southeast England, in the heart of the region experiencing a water shortage. Hosepipe and watering bans are already in place, long before the real dryness of summer will be upon them.

I bristle every time I read or hear the words "shortage", "rationing", and "ban on watering". I know that any time there is a shortage, the price is below the market-clearing price. There wouldn't be a shortage if the price were raised (or allowed to rise). I wrote the same thing last month about water in Phoenix, Arizona.

Recently, I asked a person at the castle whether showering had been banned yet and whether the castle would receive special dispensation, allowing them to water their gardens and flowers. She replied,

Water situation is dire - they're talking about standpipes in the streets.

However we're all still quite clean here at the moment. I don't think the Castle will get any special consideration when it comes to watering the gardens.

Jack was visiting Phoenix recently. He had many interesting things to tell his friends about Phoenix and Scottsdale, but one that stood out in my mind was this:

Water has to be a major issue here. Terrible quality, rationed, and, with the population explosion, certain to be a crisis at any moment.

I have a solution for Phoenix, which I am offering, free of charge:

Raise the price of water!

Water is rationed in nearly every community of which I am aware. For many communities, though, the price system does most of the rationing by inducing water users to cut back on the less highly valued uses of water. Those communities that refuse to raise the price of water up to the market clearing price are begging for a "crisis" like that which Jack predicts for Phoenix (and, let me add, many other communities in the semi-arid Southwest).

When the price of water is kept too low, people use too much of it, and shortages develop. That's when politicians and bureaucrats institute rationing plans like these and try even harder to control our lives. One sure way to cause a shortage is to keep the price too low; and one sure way to get rid of a shortage is to raise the price.

After all, people respond to incentives. Mike Hanrahan: Are you listening?

Update: Raising the price of water might also cover the costs of constructing desalination plants in Southern California, too [h/t to Newmark's Door].

Water is a necessity, right?

And so its price must be kept low, right?

Not necessarily.

While we need water to live, we don't need it (to live) in the amounts that most people use it. And so keeping the price of water artificially low is not necessary to preserve life. But doing so will have many undesired effects. Larry White reports these effects at Division of Labour:

Five years ago in Cochabamba, Bolivia, the New York Times reports, local leftists ran an American monopoly franchise (Bechtel) out of town for trying to raise water rates. A victory for the people!
One small catch: today, because the local public utility has kept the old low rates, they can’t cover the cost of keeping the pipes filled, let alone extending them. Half the population still has no piped water service (they rely on wells and freelance water trucks), while even for the lucky households the taps run only a few hours of the day. Maybe not such a victory for all of the people.

For more about Bolivia's misguided utopianism, see this [link via Newmark's Door]

Politicians who have tried to make a name for themselves by attacking price gougers commit several economic errors. One of the errors involves the implicit assumption that demand curves are vertical. They seem to believe that when prices go up, consumers do not change their purchasing patterns at all. This assumption is clearly wrong, and yet it persists, as noted in this piece by Steve Horowitz about gasoline pricing at a convenience store (cited by King Banaian):

The owner of [a] store ... reports that over the weekend when his price was at $3.80, his sales dropped significantly. He sold 1358 gallons on 9/2, 738 gallons on 9/3, and 429 gallons on 9/4. This was also Labor Day weekend, when lots of car travel happens. His sales didn't reach 1000 gallons again until 9/9. So the result of his supposed "price gouging?" A drop in sales! Gasp!! Demand curves slope downward after all! As the owner says in his defense "why would I purposely gouge somebody and watch my sales drop?"

The response from the AG's spokesman: "Consumers paid a markup over the three days. They had to pay the retail price he asked, and they did." They "had to pay" it? Evidently they did not, given the drop in sales the owner saw. Yes, he's located out in the country, but his price was so out of line with other prices that many consumers (gasp again!) found another retailer that weekend. Some chose to buy there, of course, but it's not like they had a gun to their head or no other options (there are 3 very competitive gas stations 7 or 8 miles down the road in my town). Notice how the AG's office treats consumers as passive victims, even though the evidence clearly shows they made active choices in the face of high prices.

Be sure to read the entire piece for all the background and details.

One would think politicians could have a positive marginal physical product in some other activity and forget about cases like this, where their marginal physical product is clearly negative.

Update: For more evidence that higher prices lead to a reduction in the quantity demanded, see James Hamilton's recent piece on gasoline markets.

We teach our economics students this all the time: if the gubmnt sets a cap on prices that is above the equilibrium price, it won't have much, if any, effect. The reason is that market forces (competition among suppliers) keep prices down; there's no need for gubmnt officials to intervene.

Phil Miller, at Market Power, presents a terrific example:

Now that New York City is snarled in a transit strike, we might be hearing claims of price gouging as public transit riders seek other forms of transportation.

Or maybe not!

One driver, Dennis Blair, 23, of Jamaica, said ridership had at least doubled. Another, Hassan Hall, 21, of Queens Village, said: "The city says we can charge riders a flat fee of $5 for anywhere in Queens today. But we're still charging the usual rate of $2 because there's too much competition around here with other vans." And, he added, "we don't want to lose a lot of our regular riders by overcharging them during the strike."

As Phil commented,

Markets. Competition. Capitalism. What a concept!