## Monday, February 20, 2012

### Some Confirmation That I'm Not Crazy

In the seventh grade, after learning that I wasn't the first one to figure out that (a + b)2 = a2 + b2 + 2ab, I was convinced that I would never have a novel idea in my life. At the time, this was a sad thought, because I wanted to be original, and make discoveries. But since I began writing this blog, I've enjoyed finding some of my thoughts in other places. Here's a metaphor to explain why:

When I sit down to write my blog, sometimes I feel like the commander of a small space vessel, zooming through vast galaxies of ideas.

Most of my journey passes in solitude—just me (and what appear to be) parsecs and parsecs of uncharted territory. The world of ideas seems so vast. At first, because of the thrill of discovery, I preferred the emptiness. But after a while I started to wonder whether I was just lost. So when I happen to chance upon another traveler, out in the reaches of a distant nebula (where I imagine some of my ideas tend to lie), I find welcome confirmation that really I'm not as lost as I thought.

Regular readers of the blog will know that a little under a year ago I wrote a blog post entitled "Why Profit Doesn't Work in the Media Business," which tried to link the blatant biases in today's journalism with the fundamental economic structure of the business. The idea was that profit, which is supposed to encourage firms to do the socially optimal thing, actually skews their incentives away from it (where in this case the social optimum was a perfectly informed and unbiased electorate).

When I wrote this blog post, I felt I was the only economist arguing that markets may make the news industry more biased. After all, Ronald Coase (1974), Timothy Besley and Robin Burgess (2002), Besley and Prat (2002), Djankov et al. (2003), David Stromberg (2001), and Alexander Dyck and Luigi Zingales (2002) have all advance arguments for why increased competition in the media should result in greater accuracy.

But it turns out I actually wasn't alone. In a working paper called "The Market for News," Harvard economists Sendhil Mullainathan and Andrei Shleifer (M & S) agree that market competition doesn't give us a fair and balanced news media, though their argument is much more detailed.

In my blog post, I developed had two separate explanations for why competition didn't lead to unbiased news, depending on whether consumers of news were either witlessly or willfully misinformed. In the first case, I argued that consumers get biased news because they don't know it's biased. This was more of a power-elite type explanation, which assumed that the owners of the media had certain political reasons for advancing bias, which consumers weren't savvy enough to figure out. Consumers in the media industry today, I said, may be like consumers going to grocery stores before the advent of health standards, not knowing whether the meat was tainted or not.

My argument in the second case was much more straightforward. Basically (if I'm to tease the empirical argument out of the highly normative argument I was making), I said that biased news was a particular kind of product that news media could sell, and that if demand was sufficiently high companies would provide it. This seemed intuitive enough, but I didn't have any model of how that worked.

That's where M & S's paper comes in. M & S propose a simple model of how firms bias their news by essentially constructing a variant of a Hotelling model. In a Hotelling model, customers are distributed over some space, and firms position themselves in the space so as to "catch" as many of them as possible. In this case, the relevant space is ideology. Firms compete by announcing their "slanting strategy" and the price for their product, and customers choose the news source that most aligns with their bias, for the lowest price.

In M & S's framework the way competition leads to bias is that it causes firms to segment the market. To avoid competing for the same customers, firms find it optimal to maximally distance themselves from their competitors. Practically, this means separating themselves ideologically as much as possible—even if that means taking more extreme positions than even their most biased readers. The average reader will find, then, more and more extreme positions (a.k.a. bias) in the news after competition.

This model helps explain the perception that the media has become increasingly biased in recent years. Since the entrance of competitors in the market increases bias, one important contributing factor could be that
changes in media technology have lead to signiﬁcant entry, especially in television. If these media sources divide the market along ideological lines, we expect them to become more biased than they were in the regime of moderate competition.
Unfortunately, the model also suggests that news bias is very difficult to remove. No firm would find it advantageous to become less biased; but even if one firm credibly committed to ending bias, the other firm would still gain more profits by choosing to bias. This is more or less the conclusion I reached, and why I argued that the only way to reduce bias was for firms to commit do so based on moral or ethical reasons.

## Monday, February 13, 2012

### Why does no one like free trade?

Most states engage in protectionism, and lots of it. Brazil, for example, just put up a significant tariff against Chinese imports, amidst fears of de-industrialization. And Obama, in his State of the Union, signaled that the U.S. isn't about to let its manufacturing jobs go either.

The properly schooled free-trading economist is supposed to dismiss all these efforts as "politics" (or so I've been told); and sigh that their advice is once again ignored. But I think it's telling that time and time again, when push comes to shove, most governments are not willing to embrace free trade, even though almost all economic theory shows that the benefits of free trade clearly outweigh the costs in the aggregate and in the long run. Such a consistent pattern begs an explanation.

Whether a country pursues free trade policies or not depends on how it balances the resulting costs and benefits. Clearly, the people who bear the costs and benefits are often different—and this is dilemma that the political economy literature has seized upon to explain opposition to free trade. The way the explanation goes is that because the winners and the losers are different people, and particularly because the benefits are small and dispersed across the population, while the costs are concentrated for small sectors of the economy, politicians find it more expedient to cater to the losers (who put up an effective lobby, since they have much at stake) rather than to the winners (who only stand to gain a little at the margin, and so won't notice if they lose their gain from trade). So free trade is blocked.

This is a powerful explanation, and goes a long way towards explaining a lot of the resistance to free trade. But it makes it seem as if opposition to free trade is inevitable.

Here's an alternative explanation that gives some clear conditions for when individuals will choose to support free trade. It relies on turning the focus away from the distribution of costs and benefits across different individuals, and instead to the costs and benefits over time.

The costs of free trade are most often immediate: lost jobs, industries, careers, and livelihoods. The benefits—economic growth, cheaper and higher quality stuff—come much later. Economists know well that people discount future benefits—that is, people value future costs and benefits less than those in the present. So if the discount factor is large enough, the benefits may come too far in the future to offset present losses.

To illustrate the effect that discounting can have, consider the following numerical example. Suppose a voter is deciding whether to support free trade or not. If she supports it, she'll face a stream of costs and benefits. Denote them by $\inline c_t$ and $\inline b_t$. If she doesn't support it, then (in her mind) nothing changes and the net cost/benefit is zero. So it follows that if her valuation of the benefits is greater than her valuation of the costs, then she will support free trade.

Note that this is different than asking whether the benefits are greater than the costs for that individual. This question is given by:

whereas the inequality that the voter checks is instead the following:

where  $\inline 0 < \beta < 1$  is the discount rate. These sums can produce substantially different values. For example, the following seems to me to be a reasonable graph of the costs and benefits of trade over time.

The costs start very high, but fade quickly. The benefits increase significantly over time. I have set the cost and benefit values so that the sum of the benefits is approximately 3 times the sum of the costs (43 to 16). That, in itself, seems to be a strong argument in favor of free trade. But given a reasonable discount rate of 0.9, the present value of the benefit stream is only 9.5, compared to 15 for the costs! Rationality demands that the voter vote against free trade.

Within this framework, how would we get the individual to support free trade? There are three clear options:
1. Mitigate costs in the present.
Since the initial impact has such a strong effect, even small reductions in the initial cost can significantly alter the cost-benefit calculus.

2. Accelerate the arrival of the benefits.
The sooner they arrive, the more they are worth.

3. Allow people the wherewithal be more patient.
The easier it is for people to wait for future benefits, the more willing they will be to do so
These general principles, in turn, recommend specific policy prescriptions. Mitigating costs in the present often takes the form of a social safety net: unemployment insurance, compensation funds to those who lose their jobs, and the like. Accelerating the arrival of the benefits can mean something like including provisions in free trade agreements to require foreign investment to begin immediately. And a policy that would allow people to be more patient could include setting up a robust and ready job retraining program so that people know they have future benefits to look forward to. [Incidentally, ideology, control, and repression are also ways to make people more patient and more willing to support free trade, and unfortunately this is the way many countries (particularly in Latin America) have gone about it.]

Often I hear economists say that people oppose free trade because they are misguided, or stubborn, or selfish. But my point here is that people may oppose free trade, even if they know full well its implications, simply because the timing of the costs and benefits are unfavorable. The timing of some of those costs and benefits can't be changed—but a lot of them can, and that means there is a lot of scope for policy to shift the politics of free trade. Focusing on concrete policy steps to alter the cost / benefit calculus are likely to go much farther towards increasing trade than the 300 years of sermonizing that economists have been doing.

### Absence

Sorry for the long absence, everyone. It's application season, and I've been busy with that. But I plan to get back to the blog now that I have more time. Plan to see a couple new posts in the coming weeks....I've had ideas brewing.