Sam Peltzman on Harold Demsetz

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I have just learned of Harold Demsetz’s death.  I knew he had been in decline for some time, but the news still occasioned a great sadness.  Harold was a major influence on me and on the world at large.  It is this larger significance of his work that I want to emphasize here.  We have lost one of the giants of economics in the past century.

Many will rightly cite his 1972 AER paper with Armen Alchian on team production or the 1967 AER paper on property rights.  Either would have been sufficient for the Nobel Prize that he inexplicably didn’t get.   I want to highlight here a couple of other papers that also had an outsized influence.  Here the influence was as much outside the profession as within. Harold’s work had profound effects on public policy, or at least on the framework of how policy is analyzed and discussed.

His 1973 Journal of Law and Economics paper, “Industry Structure, Market Rivalry, and Public Policy” fundamentally altered our understanding of the relation between market structure and market performance, and it had a significant impact on how economists think about competition policy.  This paper represents a continuing challenge to the intellectual basis for that policy in the field of mergers. The prior orthodoxy about how market structure affected competition reigned from the time of Edward Mason’s work in the late 1930s until well into the 1970s. It was embedded in a “structure-conduct-performance” (SCP) paradigm whereby market performance was ultimately determined by a market structure that was treated as exogenous.  A large empirical literature developed that generally showed a positive correlation between price-cost margins and the concentration of output among sellers.  Since concentration was treated as given, the correlation was interpreted as demonstrating the price-enhancing effects of oligopolistic interaction.  If merger policy has any factual basis today it would be rooted in this empirical SCP literature.  The “Demsetz critique” of this literature in the 1973 JLE paper showed how the same profit-concentration correlation could arise from the cost and price reducing effects of competition in innovation. He also showed that much of the previous literature was more consistent with the competitive interpretation, whereby concentration was not a given but the result of innovative “winners” taking market share from other firms.  This work dramatically altered empirical research in industrial organization: the search for cross-sectional correlations between profit margins and concentration ratios basically ended, and few industrial organization economists today would draw the kind of causal inferences from such correlations as in the SCP literature.  Competition policy makers would also today be less likely to infer harm to competition solely from evidence that sellers’ profitability was above some norm. Merger policy has evolved away from a mechanical restriction on market concentration to a more “rule-of-reason” approach, whereby evidence of efficiencies from mergers can be weighed in the balance.   I think this quite profound change in how both economists and policy makers think about market concentration is Harold’s legacy.

The other paper I want to discuss also lives on in public policy.   His 1968 JLE paper “Why Regulate Utilities?” showed how “competition for a market” could marshal private information to achieve the public policy objective of price regulation more efficiently than direct price regulation.  Utilities are of course the canonical price regulated natural monopoly. Harold proposed to substitute a “Demsetz auction” for the government price regulation.  This was an auction whereby bidders competed for the right to be the monopoly supplier by specifying the lowest price they would accept for output.  Such an auction would mobilize private information on who was the low cost supplier.  The real innovation here is to clarify greatly the distinction between the objectives of public policies on market failure (in this case the objective would be the lowest price consistent with efficient supply) and the mechanisms that could implement these objectives most efficiently.  While the “Demsetz auction” has had limited applicability in the precise form he proposed, the essential logic appears in much of the subsequent wave of privatization, in the vertical restructuring of natural monopolies such as electricity, and in the provision of public services. To mention just one example, those London double decker buses used to be government run. They are now run by private operators who compete to bid the lowest acceptable subsidy (positive or negative) to run the buses on the terms specified by the government.  Very Demsetzian.  Perhaps such innovation would have occurred with or without Harold’s paper, but the fact is that such marshaling of competition for provision of public services was virtually unknown before.

Few of us who analyze and debate public policies leave a mark on the practical affairs of the world.  Harold’s work did so, and we are all the poorer for losing him.

Sam Peltzman

Booth School, University of Chicago (Emeritus)

Lee Ohanian in the Wall St Journal

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Nearly half of millennials say they prefer socialism to capitalism, but what do they mean? “My policies most closely resemble what we see in the U.K., in Norway, in Finland, in Sweden,” Rep. Alexandria Ocasio-Cortez told “60 Minutes.” Yet Sweden’s experiment with socialist policies was disastrous, and its economic success in recent decades is a result of market-based reforms.

Until the mid-20th century, Sweden pursued highly competitive market-based policies. By 1970 Sweden achieved the world’s fourth-highest per capita income…. Read full story on The Wall Street Journal

Ben Klein on Harold Demsetz

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Harold Demsetz

Harold Demsetz, UCLA Professor of Economics since 1971, died on January 4, 2019 at the age of 88.  A grandchild of immigrants from eastern Europe, Harold grew up in a poor neighborhood on the west side of Chicago, where he met his surviving and loving wife Rita.  He originally attended forestry school at the University of Washington but, as he described it, returned home after he got lost because the rule of looking at the side of the tree moss grows on for directions sent him around in circles.  He had no such problems with economics, where he was able to navigate with ease through difficult issues.

When he ultimately decided to return to live on the West Coast by accepting a position at UCLA the department was at the forefront of price theory that, rather than formal analysis, focused on questions of how alternative property rights and institutional arrangements affected competitive behavior and market outcomes.   Harold was a major intellectual force in this tradition.

When he was named a Distinguished Fellow of the American Economic Association in 2013 he was described as “one of the most creative and deep microeconomists of the 20th century.”  The fact that Harold was at UCLA had the effect of moving the department to the center of research on these issues.  His continual penetrating and insightful comments at workshops forced everyone, both faculty and students, to think in fundamental economic terms.  When visiting with him a number of months ago he still wanted to talk about economics and had retained his sharpness.  Harold was a treasured friend and colleague for over 40 years and I will surely miss him.

In Memory of Harold Demsetz

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Harold Demsetz

Harold Demsetz was a Professor of Economics at UCLA from 1971 until his retirement (if he ever really retired). He was the Arthur Andersen Chair in Business Economics and chaired the UCLA Department of Economics from 1978-1980. He was also elected fellow of the American Academy of Arts and Sciences. But the most important thing about Harold was his energy and his ideas.

Considered one of the most creative and deep microeconomists of the 20th century, Harold was one of the pioneers of “New Institutional Economics”. His most famous paper (“Production, Information Costs, and Economic Organization,” written with fellow UCLA professor Armen Alchian for the American Economic Review in 1972) was featured as one of American Economic Review’s Top 20 articles of the 20th Century. Over his illustrious career Harold’s many contributions to his field have stood the test of time.  He will be greatly missed.

Here are some tributes that have been written about Harold:

John Riley, Professor, UCLA

Ben Klein, Professor, UCLA

Tom Hubbard, Professor, Kellogg School of Management.

Sam Peltzman, Professor (Emeritus), University of Chicago

Jonathan Adler, Professor, Case Western Reserve University School of Law

Peter Boettke, Professor, George Mason University

Frederic Sautet, Professor, George Mason University

“Chicago’s Lesser-Known Free Marketer” appeared in The Wall Street Journal

American Economic Association background on distinguished fellow Harold Demsetz remarkable intellectual career.

Forbes

If you have a memory of Harold that you would like us to post, please email: stewart@econ.ucla.edu

 

John Riley On Harold Demsetz

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Harold Demsetz

Professor Harold Demsetz will be greatly missed by all who were either his friends, his students, his colleagues, or, in my case, all three!

Harold grew up on the West Side of Chicago. He received his B.A. (1953) and MBA (1954) from the University of Illinois.  In 1958 he was awarded a Ph.D. in Economics from Northwestern University. He taught at the University of Michigan (1958–60), UCLA (1960–63), and the Chicago Business School (1963–71) before returning permanently to UCLA’s Economics Department.

Harold was a true giant of the profession. He was a leading figure in the Chicago school, and was one of the pioneers of the approach now called New Institutional Economics. He is a founder of the field of managerial economics. He expanded the theory of property rights now prevalent in law and economics. Even though Harold never employed game theory, he is a major figure in industrial organization through his writings on the theory of the firm, antitrust policy, and business regulation.

Over his lifetime, his papers garnered over 63,000 citations. This is a stunning number. Harold’s most famous paper (“Production, Information Costs, and Economic Organization,” written with his colleague Armen Alchian for the American Economic Review in 1972), has over 18,000 citations. It is one of the most cited papers in all of economics.  His next nine most cited papers were all cited over 2000 times.  The titles of some of these papers provide a glimpse of the depth of his research on the theory of the firm:

I arrived at UCLA in 1973. Harold had just started UCLA’s first field focused research (the IO workshop) and a string of luminaries were invited to make their presentations.  It would not take many minutes before Harold would ask his first question and usually there was a follow-up question as well.  This was exciting stuff for students and faculty and as an assistant professor it was an essential part of each week.

Knowing that I was writing on the theory of signaling, Harold arranged for me to give a talk on the topic at the Chicago Business School. It was understood that surviving this was a necessary condition for earning his respect as an economist. A talk on competition with private information of course generated a huge amount of discussion at the workshop so I did not have to talk too much. It was a huge confidence boost for a young assistant professor!

Not surprisingly, Harold attracted a large number of students to his graduate classes and deeply influenced many of their doctoral dissertations.  He also had a strong influence on undergraduate education. Around 1980 he stimulated on ongoing lunchtime faculty club debate on how to best teach economics to undergraduates.  If the vast majority were seeking jobs in business, why were we not offering a program designed to prepare them to understand finance, theories of firm boundaries, the regulation of monopoly, and so on?  Not only would this be good for the students but it might also attract funding for the department.  In 1983, as a result of Harold’s determined leadership, a new major in Business Economics was born and it proved wildly popular.  Very high entry barriers were established and it quickly became a quasi-honors program for the economics undergraduates. Businesses took notice both in their recruiting efforts and in their financial support. In particular Arthur Anderson funded the Arthur Andersen UCLA Alumni Chair in Business Economics.  Of course Harold was by far the most distinguished candidate! Thirty-five years later, the Business Economics Major continues to attract exceptional students.

I will conclude with another vivid personal memory.  It begins with Harold carrying his sneakers as he headed down the elevator at lunchtime. “Off to run at the track!” he told me. I was invited to join him some day. I agreed and as we arrived at the starting point he said, “John this is your first time, so don’t feel you have to keep up with me.”  While it was a crisp pace I realized that I could keep up with my very senior (42 year old) colleague. I decided to do some training with the goal of being able to lap him in a 2 mile race. I completed my preparations and challenged him.  It seems stupid now! The day arrived.  I had a simple plan. Sprint the first lap, get a big lead and watch Harold give up. Away I flew. 440 yards later he was still right on my heels.  I was the one who knew I was going to fall short and so I did.  Harold always recalled this event with great satisfaction even though he admitted it was one of the hardest things he had done in his life!  But that day proved much more important. It was the beginning of a long and close relationship.  We were often competitive but always good friends.

By John Riley

Rodrigo Pinto Paper Makes “Best of 2018”

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Each year Quartz, a digital publication that’s part of Atlantic Media, publishes a list on Economics Research That Shaped Our World. This year include Professor Rodrigo Pinto’s paper on “Noncompliance as a Rational Choice”. This paper finds that growing up in an affluent neighborhood leads to better economic outcomes as an adult.

Nobel prize winner Jim Heckman writes: “Randomized control trials are considered the “gold standard” of economic evaluation research. Yet, many people assigned to treatment status do not comply. Noncompliance compromises simple interpretation of experimental evidence. Using basic economic choice theory, Pinto shows how to enhance the information from experiments. He applies his tools to the analysis of the Moving to Opportunity experiment, which offers low-income families the opportunities to move to better neighborhoods. Pinto shows that, contrary to influential claims based on results from naïve application of experimental methods, there are substantial impacts on neighborhoods of the outcomes of both the adults and children of families. His work greatly bolsters the evidence on the power of place and the ability of policy to reduce inequality within and across generations.”

Moritz Meyer-ter-Vehn appointed Editor of Review of Economic Design

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The UCLA Department of Economics is very happy to announce that Associate Professor Moritz Meyer-ter-Vehn has been appointed as an Editor for the Review of Economic Design!

The Review of Economic Design explores the art and science of inventing, analyzing, and testing economic, social, and political institutions and mechanisms.

The journal applies normative and positive economics and the strategic analysis of game theory, using novel ideas for designing and assembling diverse legal-economic instruments. Among these instruments are constitutions and other assignments of rights; mechanisms for allocation or regulation; tax and incentive schemes; contract forms; voting and other choice aggregation procedures; markets; auctions; and a variety of organizational forms.

Congratulations, Moritz!

Learning Dynamics in Social Networks

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Moritz Meyer-ter-Vehn

How do societies learn about the quality of innovations? How does the structure of social interactions affect their diffusion? These questions are critically important to modern economics, and to social science more broadly. They are relevant for the diffusion of new innovations, production techniques, and new business models. For example, consider how consumers learn about a new brand of electric car from their friends purchasing decisions. Or, how farmers who learn about new crops by observing neighbors’ planting choices. Or, how new financial products diffuse across villages in developing countries.

Over the last thirty years, researchers have studied such processes via sequential learning models and have identified important forces that impact whether or not societies eventually learn the truth. However, in the words of a recent survey: “A significant gap in our knowledge concerns short-run dynamics and rates of learning in these models.”

Professor Meyer-ter-Vehn’s research fills this gap. In “Learning Dynamics in Social Networks” (with Simon Board), he proposes a tractable model where the full learning dynamics are described by a differential equation, enabling him to study the effect of network structure on learning and diffusion. The model is simple, and is inspired by a classic “purchasing funnel”. First, each agent develops a need for a product at a random time (e.g. their car breaks down). Second, the agent sees which of her friends have already adopted. Third, she chooses whether to inspect the product (e.g. taking the car for a test-drive) and adopts it if the quality is high and it fits her needs.

Networks are very complicated objects, with each agent making inferences from the adoption decisions of their neighbors who, in turn, make inferences from them. To make progress on the problem, the paper first considers tree networks (e.g. a corporate hierarchy, or a large random network) and provides conditions under which all direct and indirect links contribute to an agent’s learning.  That is, an agent benefits if she has more friends, if her friends have more friends, and so on. This may sound obvious but, beyond trees, not all links are beneficial: An agent’s learning decreases when her neighbors are linked to each other, and when her neighbors learn from herself. Looking across all feasible networks, the paper shows that an agent’s favorite network is the directed star with herself at the center. These results also imply that learning is better in “decentralized” networks than “centralized” networks.

Professor Meyer-ter-Vehn’s research contributes to our understanding in three ways. First, it develops intuition for how network structure affects learning. Second, it can be used to structurally estimate diffusion in arbitrary, real-world networks while maintaining standard Bayesian rationality assumptions. Third, it informs policy experiments that affect network structure and the information of participants.

Ryan Snyder

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Ryan Snyder

Ryan Snyder graduated from UCLA with a bachelor’s degree in Economics, and later returned to earn a master’s degree in Urban Planning. As an undergraduate, Snyder was interested in a wide variety of subjects, from Geography to Anthropology.  The diversity of classes offered by the Economics major at UCLA gave him the freedom to study and explore all these subjects. Later, he would find out that his background in Economics gave him the perspective needed to critically analyze interdisciplinary problems from those fields and more.

As an undergraduate, Snyder was involved in the Office of Environmental and Consumer Affairs, a progressive, student-led organization. He focused on establishing a groundbreaking recycling program for the Daily Bruin. This experience taught him that the principles and ideas of economics directly applied to environmental issues. His background in the subject allowed him to not only identify key societal problems, but also develop innovative solutions for them. His time in the Office of Environmental and Consumer Affairs sparked his interest in alternative transportation options, particularly in the bicycle, which continues to be a central focus of his career.

In his senior year at UCLA, Snyder took an Introduction to Architecture and Urban Planning course taught by Harvey Perloff, a UCLA Dean and highly influential figure in modern urban planning. Perloff broadened the concept of urban planning to address environmental, social, and economic problems in addition to physical planning. This approach showed Snyder that Urban Planning was the intersection of all the subjects that he was interested in. Furthermore, it demonstrated that planning methods could become a powerful tool in solving the societal problems that Snyder cared about. Perloff’s class eventually convinced him to pursue a career in Urban Planning.

To kickstart a successful career in Urban Planning, Snyder earned a master’s degree in Urban Planning from UCLA. He then used his education, coupled with his passion for alternative modes of transportation, to promote active transportation in urban design. He started his career by working on transportation demand management, a field which focuses on understanding how people make their transportation decisions. He then became involved in bicycle and pedestrian planning, where he designed streets with important features such as adequate walking area, accommodations for people with disabilities, and spaces for bikes lanes.

A cornerstone in Snyder’s career was developing Los Angeles County’s Model Design Manual for Living Streets. His idea was straightforward yet pioneering—to create a modern framework for designing cities that incorporated many progressive aspects of urban planning. The project was a tremendous undertaking. He first organized a conference composed of leaders from several public interest groups and the best street design experts in the country. Together they collaborated on refining the implementation of his people-oriented design proposals. He then spent several months compiling the innovative ideas developed at the conference into a comprehensive design manual. After its publication, Snyder saw the potential for the manual to have a far-reaching impact in the field of urban planning. He shared the manual, not only with LA County, but also with cities across the nation—encouraging them to use it as a template for revamping their own urban developments. His project quickly flourished, and was adopted by many cities. Due to the project’s creative ideas and widespread implementation, Snyder received the National Planning Achievement Award for Best Practice from the American Planning Association.

Snyder has remained active in the UCLA and Westwood communities after his graduation. For years, he has taught a graduate course in Bicycle and Pedestrian planning at the UCLA Luskin School of Public Affairs. In order to improve the lives for future Bruins, Snyder ran and was recently elected to the North Westwood Neighborhood Council. He plans to apply his complete streets planning approach to make Westwood a more vibrant neighborhood.

Written by Kevin Kato

 

Former UCLA PhD Student Fights Extradition

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This piece originally appeared in the Wall Street Journal.

Political persecution drove former Colombian agriculture minister Andrés Felipe Arias to flee to the U.S. in 2014. The U.S. Embassy in Bogotá helped him escape, and when he arrived in Florida he immediately applied for asylum.

But if Mr. Arias thought he was safe, he wasn’t taking into account the U.S. Justice Department. For reasons that are hard to figure out, much less understand, Justice officials are working hard to send Mr. Arias back to Colombia.

Mr. Arias was once on track to succeed Álvaro Uribe, his political mentor, as president of Colombia. That’s when trumped up corruption charges emerged in the media. The Colombian Supreme Court, which is notoriously political, convicted the UCLA-trained economist of corruption after he had fled the country. He received a 17-year sentence in exile—from a country where the narco-terrorists known as the FARC enjoy amnesty these days. Mr. Arias was given no opportunity to appeal.

The Supreme Court—a longtime opponent of Mr. Uribe and his political allies—has continued to pursue Mr. Arias in the U.S. and under Colombian law it has the power to do so. In 2016 it asked the U.S. to extradite Mr. Arias, using a treaty that Colombia has never ratified. The Colombian Supreme Court has said it was never ratified; Mr. Uribe and former President Juan Manuel Santos have said there is no valid extradition treaty.

That should be enough for the U.S. to deny extradition and grant Mr. Arias’s asylum claim, which is making its way slowly through U.S. court. Meanwhile, Mr. Arias sits in a Florida jail. On Dec. 10 Colombia’s ambassador to the U.S., Francisco Santos, wrote the Justice Department Criminal Division requesting bail for Mr. Arias. The ambassador said Mr. Arias is not a flight risk and asked for the “rapid implementation of the steps necessary to ensure Mr. Arias may be released on bond, so that he can spend time with his wife and young children, especially during the holiday season.”

Colombia is the Justice Department’s client in this case, yet Justice is fighting the bail request. That makes no sense, but then neither does its determination to help the partisan Colombian judiciary fulfill what on the evidence is an unjust political prosecution.

Appeared in the December 18, 2018, print edition.