Seen and Unseen

I think one of the hardest things to do when thinking about economics is to take into consideration the hidden consequences of actions and policies. Here's and example of that in the fallacy of the broken window.



If you didn't know better, you'd think a hoodlum breaking a window creates a bunch of economic activity, and so is actually good for the economy. But of course, the unseen is the economic activity that would have happened anyway as the butcher spends the money, not on a window, but on some other good.

The same problem arises in the debate between free trade and protectionism. We feel bad for people losing their jobs when their jobs go oversees. We see the jobs leaving, and think that they aren't going to come back. But of course, we've had a similar free trade policy for a a couple decades now, and in actuality our unemployment rate hasn't gone up as a result. But real income (when taking into consideration benefits) has gone up. (you can see an hour long, but good debate between Don Bordreaux and Thea Lee here making these points) What we don't see is the net benefit to consumers through lower prices because it's not immediately apparent.

The benefits of past economic growth are also hidden in plain sight. Here's a pretty funny and insightful clip of comedian Louis CK pointing out how far we've come, and how little we appreciate it.  Brink Lindsay makes a similar point in a very interesting but more academic way in this podcast. Basically he talks about how like, 100 years ago 99 percent of us would have been poor farmers toiling day-in, day-out to make ends meet. People talk about how we have meaningless work, but unless you wanted to be a farmer (which is still a possibility), we have endlessly more opportunities for self realization and interesting and meaningful work. We also have 6 hours more free time a week for self realization. Even the poorest of us have a lot more money to buy books, music, musical instruments, to give to charity and to do all sorts of things to make our lives more meaningful, not to mention longer and more convenient.

My final unseen is what is going to happen in the future. Or more specifically what could happened had we pursued a different course. I understand in the early 50s France and the U.S. had approximately the same GDP per capita. That is people made about the same amount of money in each country. Now the U.S makes about $13,000 per person.(and I've read elsewhere that the gap is even larger). It's generally accepted that higher taxes mean less economic growth, and that is exactly what France (and Germany, who has a similar story) have had for the last several decades). We now are now on an unsustainable path of taxes too low to pay for all the great benefits we've promised people. At some point we're going to have to raise taxes. That'll mean less money to invest privately. It'll also mean less incentive to innovate an create new technology, which is really the driving force for economic growth. So we see the immediate benefits to the money that is spent on  benefits, but don't see the companies that were never started and the technology that was never invented.

These four fallacies are so common because people assume that what they see is all there is to reality:

1. We see that inefficient spending stimulates economic activity, but don't see that the money could have been spent in another more efficient way.
2. We see that people lose their jobs to outsourcing, but don't see that trade creates new jobs, and that trade lowers prices for consumers.
3. We see current economic problems and blame them on our economic system, but we don't see, or we take for granted all the progress and benefits our less-than-perfect economic system gives us.
4. We see the current benefits of spending, and we see the path the economy actually takes, but we don't see the opportunity cost of that spending. We don't see technological breakthroughs and innovations we have lost or would have enjoyed earlier with faster economic growth.

Noodling Productivity

Don Boudreaux asks us to find the problem with this article. Here is his answer. I'll give you the summary. The article argues that increases in American productivity over the last several years are illusory. Productivity is measured by the amount of work or a unit of output. The article contends that work done overseas is not being considered, and is improperly hidden in productivity calculation. Someone is still doing the work, the article contends-- it's just not Americans. Thus American's really aren't that much more productive.

Don's answer is this:

If yesterday American workers required two hours to produce an electric drill, and today those same workers require only one hour to produce an identical drill, those workers’ productivity has risen.  Whether this higher productivity is the result of importing (rather than producing in the U.S.) more component parts of the drill, or instead the result, say, of a new machine that today produces some parts that yesterday were produced by hand, the result is the same: it requires fewer hours of work by Americans to produce a given amount of output.

I didn't understand this answer at first. I think I do now, and I agree with Boudreaux, but I think it's confusing. Here is why. The "hours" spent producing the drill don't just include the labor of the workers working in a factory on the actual drill. It also has to include the man hours spent creating and maintaining the "new machine." For example, if it takes one hours to make a drill with a machine, but a worker spends two hours to fix the machine for every drill, or if the machine takes so many man hours to create that the equivalent man hours can never be saved, then, the machine doesn't increase productivity. (Of course, no one will ever conscientiously use a machine that lowers productivity.)

Similarly, outsourced labor shouldn't be taken into account when considering American productivity. But those foreign laborers are providing the components for other goods or services. And those American hours spent producing the goods/service that are exchanged, should be considered, just like hours spent making/maintain the machine are considered.

At the end of the day whether it's a machine or trade, no one will voluntarily use either unless they increase productivity. I think Boudreaux doesn't go down this road, because he's trying to keep it short and simple. But I think he would agree that these other "hours" are incorporated into productivity calculations.

There's another similarity between trade and technology. Both "destroy" jobs. No one, however, argues we should get rid of copy machines, refrigerators or computers to bring back all the jobs they've eliminated.

Econ Talk Quiz

My commute is about 35 minutes. That gives me a lot of time to listen my iPod/iPhone. One of my favorite things to listen to is Russ Robert's podcast, Econ-Talk.

Here's a hypothetical question Russ asked one of the podcasts. How would taxing each cup of coffee 20 cents affect the size of the cup? I'll put my answer in the comments. The blog is also supposed to have an answer,and if I find it, I'll paste the URL in the comments, too.

Economic Intuition

A conversation this week demonstrated once again how otherwise smart people do not understand or intuit the principles of supply and demand.

I and two other educated people were talking about getting a college education, and how with the bad economy, more people wanted to going to school. This increase in demand, one person thought, would decrease the price of tuition. The other person seemed to agree. I smiled. More people seeking a particular service make that service less expensive? That's exactly backwards.

Perhaps they assume that with increased demand comes an even bigger increase in supply. But there's no rule that says that is the case. Increasing supply, takes time, and in this case, some significant fixed costs (buildings, etc.) That cannot be implemented over night. The near term result of more people wanting to go to school is going to be higher tuition.

The Pardox of Thrift

I'm trying to understand Keynesian business cycle theory. I think I get this much. There's a shock to the system that causes consumers to worry about the future. In order to smooth consumption, consumer spend less and save more. Spending less decreases the demand for goods and services. The resulting drop in demand for goods and services causes a drop in demand for people providing those goods and services, resulting lower GDP and unemployment.

Classical economics says that the creators of goods and services will respond to lower demand by lowering prices, and at the lower price they will be able to sell what they could have earlier. Similarly, workers will respond to lower demand by working for less.

Keynesians believe that prices and wages are sticky--that it takes time for people to understand that the labor that used to be worth more in nominal dollars, is actually worth less now in nominal terms. Thus, the necessary adjustment does not take place for some time, and that results in prolonged periods of unemployment and depressions.

Keynesians view the solution to this problem as increasing aggregate demand, or the total demand in the system for goods and services. If demand falls because of some shock to the system, it can be restored by government stepping in to supplement the demand, by spending money.

I'm having a hard time understanding the idea that saving reduces consumption, also called the paradox of thrift. Russ Robert and Steve Fazzari go a couple rounds on this point, here. I've now listened to this podcast twice, and I still don't quite get it. And I've been thinking about this occasionally since I first studied Keynes in college some years ago.

I do understand on one level that if a dollar comes to me, and I put 20 cents under my mattress, and spend 80 cents, and then someone else does the same thing (saving 20% and spending 80%) that will result in X number of dollars of economic activity. If you "save" less, and spend more, like say you save only 10%, and spend 90%, there will be more economic activity.

But "saving" in this instance is putting the money under your mattress. Saving, at least in common parlance, also means putting the money in the bank. The bank, however, is going to lend all but a small portion of that money out. So suppose you put a dollar in the bank instead of spending 90% of it, the bank will lend most of it out, and the person who get that loan will spend the money on consumption. It seems to me that, saving, then is actually mostly investing, which is also a specific type of consumption, which does not, in fact, reduce consumption, triggering the paradox of thrift.

So despite Fazzari's efforts, I don't understand the paradox of thrift.

UPDATE: ask and ye shall receive. Here is an article about Keynes by Richard Posner. Still not sure I understand the paradox, though.

Climate Change as Macroeconomics

Here's a graph showing the projected unemployment rate with the stimulus (dark blue), the projected unemployment rate without the stimulus (light blue) and then the actual unemployment rate with the stimulus (red dots).

Is the stimulus working? You wouldn't think so after looking at this graph. In fact, according to the graph, not only are we worse off than we should be with the stimulus, we're also worse off than we should have been without the stimulus. The graph seems to suggests that, not only did the stimulus not help, it actually hurt the economy.

But the counter argument is simple: The predictions were wrong! The economy was much worse than thought when the Obama administration make it's unemployment projections, and unemployment actually would have been much higher without the stimulus.

Of course, with this we-underestimated-the size-of-the-problem argument always at hand, there's no real way to determine whether the stimulus is actually working. (Greg Mankiw already made this same point much better than I can, here.)

This same prove-me-wrong problem applies to climate change science, too. It could be that human activity is changing the temperature on earth, even though the earth's temperature has steadied in the last few years. But for human activity, the earth might have cooled significantly during that period. Instead, the human interference may kept the temperature of the earth artificially high. Or the affect of human activity might simply be sporactic warming such that we shouldn't expect the earth to warm consistently (although from what I've read I understand that most models predict consistent, gradual warming).

Because of these uncertainties, there is basically no way to prove or disprove anthropogenic global warming, just as there is no way to prove or disprove the effect of the stimulus. We simply don't have any scientifically rigorous way of controlling for all of the other factors that can affect the variable we are trying to measure.

That's ok. Both economics and climatology still provide useful ways of organizing and thinking about the world. But from now on, let's give climatologists the same credence we give economists.

Demand Up, Price Down

So, after giving today's lesson in Elders Quorum about how we shouldn't seek happiness through the consumption of goods, I'm researching HDTVs. I came across this website which explains the advantages and disadvantages of DLPs and LCDs. Having explaining all the advantages of DLP TVs the author of the article concludes:

Therefore, we expect this technology to gain in popularity. This increase in demand will drive the price down and provide even more of an advantage over other options.

The author might know something about TVs, but apparently s/he doesn't know much about the law of demand.

The Professor Asks

Two piers are located next to each other. One, government run, drastically undercharges for dock spots and so has to run a lottery every year to determine who has a right to dock at the pier. The other, privately run, charges approximately 5 times as much for a spot, but always has spots available for those willing to pay.

What happens to the price of a spot at the private pier if the government owned pier raises its price?

Here's my guess, assuming that the docking at one pier is as good as docking at the other:

Generally you'd think that if the price of a substitute goes up, then the item's price would go up too. So, if frozen yogurt goes up in price, people will substitute ice cream. The increased demand for ice cream will cause the price to go up.

I don't think that's the right way to think about this problem, however. Instead, raising the price at the government pier will cause some people who currently pay for a lottery spot at the pier to lose interest. Thus, demand will be lower for spots at the government pier at the higher price. But there is clearly excess demand, so they should still fill all the slots. Furthermore, some of the people at the private pier, who are now paying 5 times as much for spots are likely to get spots over at the public pier. Thus, demand for spots at the private pier will fall. Falling demand will result in the price for private pier spots to fall.

That's my answer.

Milton Friedman

I've probably watched this video 3 or 4 times. The product of Milton Friedman's giant brain is mesmerizing.