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One of the greatest lessons I learned so far in my life is that you should not miss the forest for the trees.  Although the lesson sounds simple – not to get lost in details while missing the big picture – it is very easy to fall into such a trap.  In some of my economics classes in college, for example, we learned many specific details about how to calculate different measures of economic growth, how to use regression analysis to tease causation effects out of many variables, and other interesting topics.  However, the most important lessons I learned about economics were from Econ 101.  The rest – the details – are worthless without understanding the essence of economics, which all econ 101 students learn: that the economy is about trying to allocate scarce resources to their highest valued users.

In plain English, this means that the economy is about me exchanging money or my time as a worker for things I want, like money, food, or clothing.  In the most basic terms, consider a barter economy, where no money exists and individuals exchange one good or service for another good or service.  If I am good at producing fur coats, I will only produce fur coats if I know I can get something back from producing that fur coat that I value more than the fur coat.  Otherwise, producing that fur coat is a net loss for me.  In a money economy, I will buy a good only if I think it is more valuable than the money I exchange for that good.  I will not hand $10 to someone for a $5 bill, nor will I hand $10 to someone for a good I value at $5.  That would result in a net loss, and would not be rational.

Furthermore, when you exchange money for something you value more highly than money, you are better off.  If you buy something with $10 that you value at $15, you are better off by $5.  On the other hand, if you buy something for $10 that you value at only $5, you are worse off by $5.  Likewise, if someone agreed to sell you that good, he or she is better off.  If they sold you the good for $10 and they only valued it at $5, they are better off by $5.

You can also exchange your services as a worker for money.  If I work somewhere for $5 an hour, and I value my time at $10 an hour, I lose $5 per hour by working (assuming I get no benefit other than money from the job).  Likewise, if an employer’s only benefit from employing me is that I produce $1 per hour in goods for the employer, then the employer is out $4 per hour while I work.  If we go back to the basics of Economics, that a net gain in the word of Economics is about me exchanging my time for something I value more highly and an employer exchanging its time for something it values more highly, then this is not a net gain.  In other words, this is a situation where it is bad for the economy for the employer to employ me.  To make a broader point: employment is not per se good; employment is only good when it yields a net benefit to the economy.

Suppose X works at Tablemaker, Inc.  Tablemaker makes tables, and X is a professional Table sander.  One day, Tablemaker receives a free robot that can do X’s job for $3 per hour less than X, and at the same level of quality.  If Tablemaker continues to employ X, Tablemaker is effectively out $3 per hour.  Employing X, in other words, is not good for the economy, it is bad.  While this might be unfortunate for X, who must find a new job, arguing that X should be allowed to work as a table sander because unemployment is “bad” is preposterous.  That is like arguing that someone that used to make slide rules should keep his job even though calculators have replaced the slide rule.

So where does this leave us today?  Well, right now the Bush administration has decided to throw money at the American automakers purportedly to preserve jobs.  Allegedly, if the American automakers fail, then they will not be able to employ workers who previously had jobs, and the suppliers who supply the American automakers with parts will be unable to employ workers, and so on, and so forth, and lots of people will lose their jobs.  However, the American automakers make an inferior product that has not been selling, which has led to their horrible financial status.  They have been over-producing, and thus over-employing (and perhaps overpaying) workers who are producing goods worth less than the amount that the American automakers have been paying them.  Thus, continuing to employ these workers is draining the economy – a firm is paying for something that it values less than the dollar amount it is paying.  Moreover, the suppliers who supply the goods to the American automakers are supplying goods that are not being used for a more valuable use – they are sitting on lots in unsold cars.  Thus, these suppliers who are employing people to supply extra goods to American automakers are wasting supplies, and the people they are employing to waste these supplies are not helping the economy, they are hurting it.  People are not getting something we prefer for their employment – we are getting something less valuable.

So if the government steps in and pays to keep people employed for the sake of employing them, and we do not receive something we value more in return, then essentially, we are exchanging a $10 bill for a $5 bill.  Although it sounds fun to talk about all of these unemployment figures, and look at graphs of GDP and GNP and unemployment and whatnot, the underlying notion of a job is that an employer is paying someone to produce a good or service that is more valuable to the employer than the amount the employer pays.  We cannot get lost in the trees and miss the forest.  If jobs are not worthwhile, they should not exist.

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Dec/08

11

The Auto Buyout: Logic Optional?

I just cannot wrap my head around the idea of an auto industry buyout.  The “logic” behind it seems to be that if GM, Ford, and Chrysler fail, people will lose jobs.  Thus, the US government should pony up to pay these American automakers so that people don’t lose their jobs.

The obvious assumption here is that jobs are per se good.  The truth is, they are not.  Therefore, the only principle reason I can see behind an auto bailout – to keep people employed – stands on shaky ground.

This can best be explained with an example.  Assume that 1,000 people are very talented at making spoons, and this is what they do for a living.  Next, assume that a robot is invented that can make all the spoons these people can make for 1/1000th the price and twice the quality.  Should the United States government prevent the robot from coming into existence to “preserve jobs?”  Or should the government subsidize spoon-makers to keep these people employed even though they are effectively doing nothing good for society?

I hope that your answer to the above two questions is no.  We live in a world of progress.  Sometimes, certain employment becomes obsolete.  Although it is truly unfortunate that some people will lose their jobs because their jobs are unworthy of continuance, that is just the way capitalism works.  If people in the US don’t like that, perhaps we should give up on capitalism.

Like this example, the US auto industry is hideously inefficient and produces an inferior quality product as compared to foreign automakers.  Foreign automakers have much larger profit margins, and have been willing to adapt to consumer demand to sell fuel efficient cars.  US automakers have been poorly managed, have buried themselves in union obligations, and have refused to adapt to consumer demand.  Fuel efficiency is the biggest indicator.  People have repeatedly made it clear that they want more fuel efficient cars by their purchases in the market over the past five years or so.  Yet American automakers have not provided cars that are nearly as fuel efficient as foreign automakers; instead, they have run a lot of commercials claiming that ~20 miles per gallon is fuel efficient for a mid-sized sedan, or low 30s is fuel efficient for a small car.  [And let’s not forget about how American automakers consistently rank behind foreign automakers in reliability rankings…]

The whole idea of an auto bailout totally perverts the idea of comparative advantage.  The US does not have a comparative advantage in producing cars.  The USA should be focusing its economy on things that it is good at producing, rather than trying to preserve the US auto industry for old time’s sake or because we want to preserve an certain number of worthless jobs.

P.S. Why are we thinking about bailing out all three automakers?  Why not just one?  If we let two fail, there will be less market competition, and automakers will do better in general?

P.P.S. Look at this amusing graphic about the bailout.

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Both John McCain and Barack Obama, like many politicians, are guilty of overusing rhetoric and eschewing substance.  Particularly, there has been a lot of talk by both candidates about helping “main street” rather than “wall street.”  I wanted to write about this, but the latest issue of The Economist did a better job of expressing my feelings than I could have.

Bankers have always earned their crust by committing money for long periods and financing that with short-term deposits and borrowing. Today, that model has warped into self-parody: many of the banks’ assets are unsellable even as they have to return to the market each day to ask for lenders to vote on their survival. No wonder they are hoarding cash.

This is why those politicians who set the interests of Main Street against those of Wall Street are so wrong. Sooner or later the money markets affect every business. Companies face higher interest charges and the fear that they may one day lose access to bank loans altogether. So they, too, hoard cash, cancelling acquisitions and investments, in order to pay down debt. Managers delay new products, leave factories unbuilt, pull the plug on loss-making divisions, and cut costs and jobs. Carmakers and other manufacturers will no longer extend credit (see article) and loans will become elusive and expensive. Consumers will suffer. Unemployment will rise. Even if the credit markets work well, the rich economies will slow as the asset-price bubble pops. If credit is choked off, that slowdown could turn into a deep recession.

Financial markets need governments to set rules for them; and when markets fail, governments are often best placed to get them going again. That’s pragmatism, not socialism. Helping bankers is not an end in itself. If the government could save the credit markets without bailing out the bankers, it should do so. But it cannot. Main Street needs Wall Street; and both need Washington. Politicians—and President George Bush is the most culpable among them (see article)—have failed to explain this.

I feel as if it is common knowledge that the whole idea of a bailout package is to prevent a catastrophic economic event.  If this is the case, why are politicians allowed to get away with this “Main Street v. Wall Street” stuff?  Why are moderators not calling them on this stuff in debates?

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Jul/08

12

Faking the Issues

Generally, candidates for any election in the United States do quite a bit of pandering.  And generally, the pandering they do is a wholly illegitimate take on a given issue.  One such issue that strikes me in particular is free trade.  Politicians regularly attack free trade by claiming that trade takes away jobs from Americans, and that it is bad for the country, etcetera.  They do so even though virtually 100% of economists agree that free trade helps a lot more than it hurts.  Yet, somehow, politicians get votes by bashing free trade.

My question is: how in the world is this strategy successful?  For instance, during the nasty Obama-Clinton primary debates, both candidates continually tried to one-up each other by bashing free trade.  Obama is now backpedaling on that issue for the general election, which indicates he was probably just trying to pander during the primary.  If that is the case, then why would he not respond to Clinton’s anti-free-trade rhetoric with: “Your assertions are wrong.  All economists disagree with you.  Economists are trained to know whether free trade is good or bad.  Would you want a professional bowler to act as your doctor when a doctor says the bowler is wrong?  No.  Would you want a doctor doing your taxes when a tax professional says the doctor is wrong?  No.  Would you want Joe Schmo down the street telling you how to set trade policy when all economists say he is wrong?  Hell no.”

Or, better yet, he could explain why economists think trade is so great.  He could explain that, yes, indeed, there are some downsides to trade, but the upsides are much greater.  He could explain the concept of comparative advantage once explained by David Ricardo and the basic idea of the source of wealth from Adam Smith’s The Wealth of Nations.  It would be a glorious moment for Mr. Obama and the entire country.  It would be a rare occasion when a politician actually explained the pros and cons of an issue in a debate, and then explained why his side prevailed.  It would not be the generic politician’s response to a question: say something incomprehensible and then throw as many buzz words and campaign slogans out to the crowd as possible.  And significantly, it would require the opposing candidate to respond in a substantive manner.

How would someone respond to a clear argument about the benefits of free trade, an argument supported by an entire profession, followed by the question: if you disagree, please explain why?

If two candidates were in a debate, with one candidate pro-trade and the other anti-trade, and the pro-trade candidate explained the benefits of trade and uttered the “explain why” question, it would be a glorious moment of awakening in this country for several reasons.  First, everyone watching the debate would learn about free trade – a topic most Americans are ignorant about.  Secondly, it would be a rare occasion when a politicians in a major election actually debated the pros and cons of an issue rather than uttering buzz words and catch phrases to pander to whom he or she hopes is the majority voter.  Finally, the candidate willing to actually debate the facts of an issue would likely be one of the smartest, most candid, and best candidates the country has seen for a long time.

The cynic in me says this would never work.  The cynic in me says that Americans are too stupid to listen to real pros and cons of issues and figure out their own opinions – that is why buzz words and catch phrases at debates work so well.  The cynic in me says that Americans would rather hear “I’ll get the government out of your pockets” than “A study by this prominent professor shows that tax structure X is better than tax structure Y.”

But I believe that this country is smart enough for real facts to come to surface in major political debates.  Back in the revolutionary era, our founding fathers had nowhere near the kind of education that Americans have today.  Even the worst educational systems in America today are miles ahead of anything our founding fathers had.  Yet our founding fathers debated serious issues in politics, and people were very interested in knowing the cold hard facts.  I think a lot of it had to do with the fact that politicians in those days treated the voters with respect.  They didn’t try to pander the way politicians do today – they debated the theories of Locke and Montesquieu and argued passionately and intelligently.  Regular citizens regularly read what the prominent politicians had to say and often wrote to the papers to voice their opinions.  There are plenty of people out there today that would do the same, if today’s politicians would treat them like adults and argue the issues, rather than trying to argue using empty dialect.

This article is not an endorsement of either Barack Obama or John McCain.

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Bloomberg.com reports that while economists have overwhelmingly ridiculed the idea of suspending the gas tax over the summer, Hillary Clinton has continued to stick to her guns. Clinton, after hearing that the economists thought the idea was ridiculous, stated:

I’m not going to put my lot in with economists

Ya know, it’s perfectly fine to say that you’re not going to listen to a consensus of football players giving you advice on filling out your taxes. Or a large group of lawyers giving you advice on how to paint your house. But generally, if you’re untrained in a subject, and practically an entire professional field gives you advice on the subject they specialize in, you should probably listen. And if you’re not going to listen, you’d better have a darned good explanation beyond “I know where you’re coming from, small folk,” for why you’re deviating from trained professionals. So Hillary (and Mr. McCain): if it makes sense to suspend gas taxes, please come forward and explain why rather than giving the same old pandering political speeches about how you’re trying to help “the little guy.” Call me an elitist, but I would rather that economic decisions follow the advice of trained professionals than “the little guy,” who hasn’t learned a thing about economics in his entire life.

But this isn’t even about elitists versus “the common folk.” This is about whether we want to help the country or hurt it. If I had a choice between having a mechanic fix my car or a random neighbor, why the heck would I pick the neighbor? And if I have a choice between having Hillary Clinton or John McCain making economic policy based on hunches or someone who is going to defer to a trained professional, I’m surely going to pick the person who defers to the trained professional.

This proposal to suspend the gas tax sickens me. This is why I hate politics so much.

Please note that this is not an endorsement of Barack Obama. He’s got plenty of problems, too, the gas tax is just an area where he pseudo-shines.

Update 5/6/2008: Greg Mankiw writes:

Why, then, are candidates proposing the holiday? I can think of three hypotheses:

Ignorance: They don’t know that the consensus of experts is opposed.

Hubris: They know the experts are opposed, but they think they know better.

Mendacity with a dash of condescension: They know the experts are opposed, and they secretly agree, but they think they can win some votes by pulling the wool over the eyes of an ill-informed electorate.

So which of these three hypotheses is right? I don’t know, but whichever it is, it says a lot about the character of the candidates.

Update 5/7/2008: From The Wall Street Journal

John McCain and Hillary Clinton want to send cash-strapped consumers on holidays from the federal gasoline tax. But the law they can’t rewrite — the law of supply and demand — suggests it would backfire. Lower taxes would encourage people to drive more, meaning more demand that would push prices higher again.

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