Efficiency Rules, mostly

I've been posting quite a bit on economics lately, and was engaged in yet another heated economics debates on Ed Brayton's blog. I left my email address on one comment there, inviting people to contact me that way if they had more questions. Two did, and one of them asked where I stood on various regulations to keep corporations from abusing people. That's a good question, although I don't love the way it's phrased, because that's still a question I struggle with.

Economics is primarily about efficiency, and efficiency is a damn good thing because it allows us to maximize the ratio of benefits to costs, thus maximizing wealth. And wealth, particularly having a wealthy society, is a great thing. We in the western world are wealthier than people in the developing countries, so we can afford clean safe water, good food, medical care, better housing, books, travel, and all the other things that make our lives good.

But efficiency is just one value, and contra Plato, not all values are commensurate. It's not just that efficiency doesn't necessarily distribute wealth evenly (as long as we all continue to become wealthier, it's little harm to me that others are wealthier yet--absolute, rather than comparative, well-being, is the proper standard), it's that efficiency may at times place much too little value on individual humans.

So given that all regulations are market-distorting, yet markets may not respect humans as much as I like, when is regulation ok? It's not always easy to answer.

For example, if there is an oversupply of labor, workers become dispensable, and subject to very abusive treatment. This is the real story behind Sinclair's The Jungle, not that he realized it. Massive levels of immigration resulted in a tremendous oversupply of unskilled labor looking for factory jobs, with the consequence that none of them had much market value. Although it's guaranteed that the government regulation will be inefficient, I don't mind regulations about workplace safety and treatment of employees in such a case.

And as much as I am skeptical of nationalized health care, it does seem to me that government can be an effective insurer of last resort in cases of traumatic health care problems. Should the fact that no one's devised an economically efficient way of providing health insurance for someone who's never going to work again but will have have mounting medical bills throughout their life mean they should be left to die?

Although I'm a staunch free marketer, I do recognize that efficiency is not the only meaningful value we should try to achieve in our society. So I do support some regulation not justified by efficiency, particularly to support those who really do have no hope of supporting themselves anymore. But I also think that efficiency as a value is under-rated by too many people--after all, it's what provides the wealth that allows us to set efficiency aside and "waste" it on people who need it but can't earn it.

Are Oil Prices Inflationary?

A commentor on Ed Brayton's blog claims that the recent high oil prices are "hyperinflation of a commodity." Of course it's not hyperinflation by any reasonable measure. Oil prices have roughly doubled--a 100% increase--in the last two years. In Germany, following WWI, they experienced inflation of around 300-400% per month. In several south American countries in the 1980s, the inflation rates were between 2,000 and 12,000% per year.

If 100% is "hyper," then I guess my first experience with hyperinflation was back in the '70s when the price of Bazooka Bubble Gum increased from 1 cent per piece to 2 cents.

The issue of real interest, however, is whether it is proper to call the increase in oil prices inflation? The commentor is not the only one to effectively call all price increases inflation, and a quick google search shows any number of articles linking oil prices and inflation.

Being influenced by the Austrian school, I dislike using the term inflation to refer to price increases caused by changes in supply or demand. Nothing is inflated there, because the real market value of the goods are being revealed by the price increases.

Inflation, proper, is the consequence of an increase in the money supply, an increase that is too great to be soaked up by increased production. Assuming, for example, that production is fixed, and no more can be produced. Then assume that overnight the money supply doubles. Since no more could be produced, prices would double. But goods would not be twice as valuable--the price increase would not reflect any increase in the value of the goods.

I think it is important to distinguish between the two types of price increases because they represent fundamentally different phenomena, and the appropriate response to each is fundamentally different. The proper response to real price increases is to conserve and purchase less, while the proper response to inflation is to reduce the money supply (as Fed Chair Paul Volcker did so successfully in 1981-2).

Furthermore, a rise in oil prices, even though it may cause an increase in costs for oil-dependent businesses, cannot cause an overall rise in prices unless the supply of money also increases. Because if the cost of oil goes up, and the supply of money remains fixed, then after buying oil (assume, for the moment, they buy the same amount), consumers have less money left over to buy other goods than they did before the price increase. If the price of something else--plastic containers, for example--also goes up because the price of oil goes up, they have again less money than before left over for other purchases. If all prices go up, consumers will have to purchase less. If consumers purchase less, goods will go unsold, and their prices must fall.

This is where politics and economics meet. Confusing the two causes of price increases leads to confusion about the proper political response. The appropriate political response to inflation is to reduce the money supply, while the appropriate political response to real price increases is to inform the public that it is real, and to disseminate information about ways to reduce their usage. Disseminating information is one of the things governments can do well.

Another appropriate action would be to improve the economic education in our elementary and high schools. The commentor on Dispatches accused me of an ad hominem attack on K-12 education. Far from being an ad hominem--I didn't accuse teachers of being stupid or lazy--I was just pointing out the regrettable fact that we don't teach much economics before college, and I think it's a disservice to our children. Supply and demand effects are easy to teach, and particularly appropriate to elementary school as they can be demonstrated with fun classroom activities. As long as most Americans think price controls are an effective cost to price increases (whether real or inflationary), that free trade makes us poorer, that subsidies help the economy, and that businesses can charge as much as they want, we'll never have have good economic policies. And, unfortunately, both our presidential candidates are true men of the masses on this score.

Ecologists,Engineers and Economists, oh my!

This is the second of two posts on economic nincompoopery. 

The commenter on  Ed Brayton's blog didn't like being called a nincompoop (although I'll say once again, I was referring to only one line in an otherwise intelligent comment).  He responded, in part:

Ecologists and engineers don't take economists seriously.

That point deserves discussion because, as a friend of mine always says, "it's so wrong in so many ways I don't know where to start."

So let's begin with the fact that this is a blanket claim about all ecologists and engineers.  Does this person really expect us to believe that there are no ecologists and engineers who take economists seriously?  I want to see documentation on this.  Has he done a study?  Is there actual data to support this?  Somehow I doubt it.

Then there's the "so what" factor.  This is just an appeal to (questionable) authority.  Are ecologists and engineers necessarily well-educated in economics?  That is, do they have the expertise to make an informed opinion on whether to take economics seriously or not?  Or is s/he just assuming that all ecologists and all engineers are more knowledgeable about all things than all economists are?  Nobody is qualified to talk knowledgeably about fields in which they have no training.

Finally, there's the delicious irony that engineers and ecologists (whatever individual ones may think about economists) work in fields where economics is crucially relevant.  We'll start with the easy one, engineers.  First we need to define what economics actualy is.  Here's a nice succinct one:

1 The study of choice and decision-making in a world with limited resources.

The important implications of making choices about how we use limited (scarce) resources is that we have to choose between competing uses of them.  We want, ideally, to choose the option that gives us the greatest benefit for the least use of resources.  Therefore, economics is the study of cost/benefit analysis, as much as anything else.

How does that apply to engineering?  Let's say I'm designing a bridge.  If resources were not limited I could just build a massive bomb-proof, earthquake proof, even meteor-proof edifice.  But in a world of scarce resources, that would be a waste--the extra resources (not just material ones, but also time and labor) that went into could be better employed elsewhere.  Engineers are masters of cost/benefit studies--they want to use minimum materials to achieve their design goals.  If you find an engineer who says cost/benefit analysis doesn't matter, you can figure that he also means the cost you pay and the benefit you receive doesn't matter, so don't hire him!

OK, that was easy.  But what about ecologists?  Not quite so obvious, but economics still apply.  A colleague of mine in my college's Biology department studied imported red fire ants for his Ph.D. work.  He asked me to read a paper he was trying to get published (he was successful), and I noticed that he was looking at the ants' nutrition loading in relation to the distance they had to travel to access those nutrients.  He explicitly discussed it in cost/benefit terms, and if I remember correctly he even referenced an economist in explaining that part of his research.

He's not precisely an ecologist (his specialty, as you might guess, is entomology), but he was looking at the relationship between ants and their environment, which is ecology.  And very simply, animals that thrive and reproduce successfully are the ones that master (even if its instinctive) their cost/benefit ratio in interaction with their environment.  

Consider a simple model, where we assume an animal with only two behavioral options, eat or screw.  Let's further assume--just because I like the example--that it's spring in Yellowstone National Park and the animal is a bison bull.  If you've ever been there in spring, you might notice that the bison aren't especially aggressive then, all they're focused on doing is eating.  The relevant facts are (1) that they've just gone through a harsh winter with little food availability and they now have only a few months to bulk up, and (2) the cows aren't receptive for mating until fall.  Now imagine some bison bull looking around and thinking, "Hey! Nobody else is going after those females!  Now's my opportunity!"  So he spends all spring and summer chasing cows instead of eating.  He fails to reproduce then (because the cows aren't receptive), and when fall comes he's too weak to compete for them.  And of course he goes into winter without adequate fat and dies before next spring.  Now if you don't think that's a cost/benefit issue for bison because they're not making reasoned choices, you're a bit slow.  Natural selection will favor those who make the best choice of resource use, and their offspring will come to populate the ecology, rather than those who make poor resource choices.  That is, evolution will favor instinctive behaviors that have the same results as wise cost/benefit decisions.

So, ecologists don't take economists seriously?  I'm willing to predict that the good ones do.

Are there non-natural economic opportunities?

This is the first of two posts responding to stupid arguments on another blog.

On Ed Brayton's blog a commenter argued

This is what happens where there is no more natural room for an economy to grow: companies have to start extorting "growth" from areas that were never considered before.

 The rest of the comment was intelligent enough, but I called this comment "nincompoopery."  I'm right and s/he's wrong.  Most people who know anything about economics would say that finding growth opportunities in areas never considered before is entrepreneurialism.  In fact the growth of economies--always and forever, from the ancient past to the far future--depends on people finding economic opportunities that weren't previously considered.  If they were previously considered, they wouldn't be opportunities for growth!

For example: the richest woman in China, Zhang Yin, made her fortune by recycling scrap paper from the U.S.   She imported the waste paper cheaply, because container ships regularly head from the U.S. to Asia empty, meaning you can get a really good price on cargo going west.  She then used that waste paper to make cardboard boxes and packaging material for goods being shipped right back to the U.S.  How rich can a Chinese woman be?  Try $3.4 billion worth of richness--more than twice what Oprey Winfrey is worth.

Here's the funny part; countless people around the world, including a non-businessman like myself, knew each of the pieces to this puzzle.  

1. There's a surplus of waste paper in the United States--there's not enough demand in the national market to purchase it all.

2.  Waste paper can be used to make packaging for shipping goods (heck, I've done that myself just by wadding up old newspapers).

3. Lots of things are shipped to the U.S. from Asia, creating demand for packaging material.

4. The surplus of container capacity heading from the U.S. to Asia means cheap shipping.

And yet this was an area "never considered before," because even those of us who knew all the pieces didn't realize we should put them together to solve the puzzle.  Consequenlty it was wide open for Zhang Yin to step into and make a fortune.  Was this an "unnatural" economic opportunity?  Or just a case of someone else being more clever than I was?