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.

Perpetual Economic Ignorance

CNN.com has a story about biofuels, featuring a cross-country trip using biodiesel. There's no comment about the economic impact of biofuels on food prices, but there is this priceless gem, showing that 200 years after Adam Smith wrote The Wealth of Nations, that very few people understand economics.

About $333 billion exited the United States in 2007 due to the purchase of oil, according to Scahill, illustrating the high cost of importing foreign energy. Biofuel is produced and sold in the United States -- which keeps money from those transactions circulating inside the U.S. economy.

Yes, old fashioned mercantilist thinking. And the unavoidable logical implication is that every country will be better off if it produced everything it needed for itself.

Surely, if every country would be better off if it was wholly self-sufficient, so would each state in the U.S. And if each state is, surely each county would be. And if each county would be, surely each municipality would be. And if each municipality would be, surely each family would be. In other words, I should start growing my own biodiesel--after all roughly $2,000 per year exits my household economy.

It may be objected that I'm making false analogies, that a family is not like a country. But both Adam Smith and Frederic Bastiat thought that, in economic matters, they were alike. And more to the point, I'd challenge anyone to make a compelling argument explaining at which of those political boundaries the economic logic changes from trade to self-sufficiency.

Bad Economics in Literature I: Isaac Asimov

I like to read fiction, including, at times, some really cheap crappy stuff that doesn't require me to think (Hello, Dean Koontz). But, of course, I can't help thinking anyway, especially when the author says something inane. For example, in one novel Tom Clancy has a Governor of some state running for the Senate to improve his chances at the presidency, when anyone who's paid even casual attention to U.S. politics should know that we normally elect governors, not senators (not this year will be the first time in 48 years we've put a senator in the executive seat).

So here I begin a short series on bad economics in well-known novels, choosing as my first target, the esteemed science fiction author Isaac Asimov's I, Robot, a book I have re-read several times, and whose quality should never be judged by the execrable movie of the same name.

As Asimov is universally considered to be a genius, he must know everything about everything, right? Unfortunately not.

In the last chapter of I, Robot, the Earth has been divided into 4 economic/political regions, and it is the "machines" (supercomputers) that are managing the Earth's economy. As Asimov develops the idea, the machines are perfect calculators with perfect information, and consequently they make perfect decisions that keeps the Earth's economy humming along smoothly and efficiently.

This information is developed only sketchily, in just a copule of sentences:

"The Earth's Economy is stable, and will remain stable, because it is based upon the decisions of calculating machines...The population of Earth knows that there will be no unemployment, no overproduction or shortages."

Given the era in which Asimov was writing (the book was published in 1950), this misunderstanding of economics as merely a technical process of avoiding surpluses and shortages--a process that could be handled by a central planner with sufficient information--is understandable. On the one hand, the Walrasian approach to economics focuses on a system in equilibrium, where the allocation of resources is merely a mathematical problem--that is, Asimov's concept is, at heart, consonant with the great tradition of neoclassical economics. But more practically, the industrial revolution led to much larger firms than had been seen in the preindustrial era, and it was not uncommon to interpret this as evidence that eventually all production would be brought under one central authority. [Francis, oops, I mean] Edward Bellamy's Looking Backward, 2000-1887 (published in 1888) contains perhaps the premier statement of this belief.

[T]he absorption of business by ever larger monopolies continued…The railroads had gone on combining till a few great syndicates controlled every rail in the land. In manufactories, every important staple was controlled by a syndicate…Then a struggle, resulting in a still greater consolidation, ensued…

…The movement toward the conduct of business by larger and larger aggregations of capital, the tendency toward monopolies, which had been so desperately and vainly resisted, was recognized at last, in its true significance, as a process which only needed to complete its logical evolution to open a golden future to humanity.

Early in the last century the evolution was completed by the final consolidation of the entire capital of the nation. The industry and commerce of the country…were intrusted to a single syndicate representing the people, to be conducted in the common interest for the common profit. The nation, that is to say, organized as the one great business corporation in which all other corporations were absorbed…the final monopoly in which all previous and lesser monopolies were swallowed up…

While Bellamy was a utopian (who didn't recognize the problem of linear projection) the most influential American economist of the mid-10th century, John Kenneth Galbraith, was only slightly less enthusiastic about the inevitability of central planning. In other words, despite being a futurist, Asimov was clearly a product of his times. But his static and purely technical view of economics as merely the planning of how to use resources misses both the reality and the beauty of markets.

So why is Asimov wrong? One argument we can eliminate is Hayek's claim that the information needed for such planning would be too great and the ability to analyize insufficient, because Hayek was assuming human efforts, whereas Asimov is assuming "thinking machines" nearly limitless in their capacity--as such a fair critique must assume, however unrealistically, the theoretical existence of such machines, able to efficiently organize an equilibrium system (even in the absence of prices although one take on Hayek is that they would have too much information, which would diminish the quality of their decision-making). Perhaps we should also eliminate the claim that no centrally planned system will operate efficiently because managers lack profit incentives. While that may be true of humans, who never do seem to reach the socialist ideal of "from everyone according to their abilities," Asimov's "Three Laws of Robotics" force the robots to take care of humans as well as they can, so perhaps the thinking machines built-in sense of purpose would satisfactorily eliminate the need for financial incentives.

Ultimately, Asimov's thinking machines will fail because their economic approach is too static, to reliant on a Walrasian general equilibrium. And while every microeconomics course still taught today instills in economists the usefulness of equilibrium analyses, we know that it is not an accurate model of markets, which are actually tremendously dynamic.

The dynamic view of markets is most strongly associated with the Austrian economists (von Mises, Hayek, etc.), who wholly rejected the equilibrium approach, believing that we need to focus on the actions of individuals rather than the state of systems. But by far the most famous explanation of market dynamism came from Joseph Schumpeter (not generally considered Austrian, but a student of noted Austrian Eugen von Bohm-Bawerk at the University of Vienna). Schumpeter, Capitalism, Socialism and Democracy, coined the phrase "creative destruction." Here is Schumpeter's explanation of the dynamic:

Capitalism, then, is by nature a form or method of economic change, (emphasis added) and not only never is but never can be stationary. And this evolutionary character of the capitalist process is not merely due to the fact that economic life goes on in a social and natural environment which changes and by its changes alters the data of economic action...The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers' goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates.

This, then, is why Asimov is wrong: he missed the real driving factor of economic development; creativity. Every new product that takes the market by storm is the product of some creative person's vision. So are the 90% of new products that do not take the market by storm, and that is the key--nobody can predict what products people will want, until people reveal their preferences by buying those products.

The calculating machines would be no more capable of predicting what new products people would want because there is no available information that will tell us what they want! The world of Asimov's machines would be a world without fax machines, waffle-soled running shoes, ipods, cell phones, pet rocks, labradoodles, carbon fiber golf clubs, antilock brakes, transformers toys, McDonald's happy meals, and essentially anything else that was created after Asimov wrote.

Asimov may have preferred a future where perfect rational calculators made all our economic decisions, but I prefer a world in which shortages do occur, because suddenly everyone wants a Cabbage Patch doll for Christmas, and surpluses, because it turns out nobody did want Crystal Pepsi.

World's Least Shocking Economic News!

From Foreign Policy Passport:

Russia's leaders have created a legal system in which it's essentially impossible for a business to operate legally, making anyone who does business there subject to arbitrary prosecution. It's an arrangement that's well-suited to protecting state power, but not very effective at promoting economic growth. If Medvedev really wants to make Russia the world's fifth largest economy by 2020, he's going to need to try a littler harder.

Livin' it Up on the Internet

I'm amazed, but only partially, by the number of internt cafes available. My friend, Maher, said before I came that he had heard that one opened up in Damascus. What an undercount. There're 4 million people in Damascus, it's a big city, so I wouldnt't try to guess how many there are, but I haven't had trouble finding them, just as I didn't in Dubai.

Consider the economics of it. Buy a half-dozen to a dozen used computers,a few chairs and desks, and that's your capital investment. It's really, really cheap. Heck, I could get this many computers for free from my college, and Goodwill won't take them, so the market for used PCs of that sort has to be a buyer's market.

Then you rent a small shop space. Fortunately, to serve the clientele you're most likely to get, you can do that in a place where the rent won't be high... a place where backpacking travelers (the luxury hotels provide internet access to guests) and either immigrant workers or families of workers who have emigrated cluster. And young people, but not rich young people or they'll have it at home.

And for that small capital investment, a person can open their own business, becoming an entrepreneur and improving their life. Maybe after a few years they sell it and move up to a more lucrative business, or maybe they save and open another internet cafe.

And this is how the developing world will develop, if their governments and well-intentioned but misguided development agencies will leave them alone.

My Inner Economist Screams

This morning at the Dubai airport I was at first delighted to see that they had free internet...for about 2 seconds, before my inner economist hollered at me. And then I thought, there will be an undersupply/overdemand. And sure enough, I had to wait in line. But it's not just that the free-ness created more demand; it also caused people to linger longer, further delaying other would-be users.

That was the overdemand side. The undersupply came in the form of non-working terminals--the first three I tried to access! (Of course I got to them first, they were the first to open up because no one lingered at them.) The grubby little storefront internet cafes near the Gold Souk in Dubai, which were not free (although at 85 cents an hour it was almost like free to an American) were in better operating condition--all their terminals worked. Of course they were doing a booming business, and a down terminal meant a loss of revenue.

The only surprising thing about the event was that I actually bought in to the idea of free internet service for a moment. I guess my inner economist was still drowsy.

And now I sit in an internet cafe that is right beside my nicely old-fashioned hotel in the old city district of Damascus, again blogging effortlessly at a pittance per hour. The concept of government providing for the public good is so compelling, but it just turns out so often that greedy individuals just manage to provide it so much better. "Invisible hand" indeed.

Tired Old Protectionists

The New York Times has an opinion article by a trade lawyer named Robert Lighthizer claiming free traders act on principles, regardless of facts.

They see nothing but dogma — no matter how many jobs are lost, how high the trade deficit rises or how low the dollar falls.

Frederic Bastiat knew this criticism well, back in the 1830s.

"We advocates of free trade are accused of being theorists, of not taking practice sufficiently into consideration." Economic Sophisms, First Series, Chapter 13.

Too bad Lighthizer hasn't read the relevant literature.

More amusing though is this tidbit.

Free trade has long been popular with liberals, and it remains so with liberal elites today.

I could introduce him to quite a few liberals, but none that heartily support free trade. And, noticeably, this anti-free trade screed appears in....the New York Times.

Lighthizer is correct when he says

Conservative statesmen from Alexander Hamilton to Ronald Reagan sometimes supported protectionism...

That's exactly the problem--we can't even rely on our conservatives to support free trade consistently, which is why I'm concerned for our future.

And somehow Lighthizer thinks the best way to build "a prosperous middle class" is to make me pay more for the things I buy. Somehow he missed Adam Smith's lesson that the amount of goods and services you can command determines your wealth, not how much money you make, or where it is produced. 

Really, it's too bad he hasn't read the relevant literature.

Part II on Laffer Curve

Part II of the video explanation of the Laffer Curve is now available. It's a good use of the next 8 minutes of your life. Thanks to Cafe Hayek for the link.

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?