Booms, Busts, and Markets

I’ve spoken a lot about prices and how they act as signals.  I’ve spoken a lot about how individuals are more likely to make productive choices than governments.  However, I do want to stress one point so that no one among you, dear readers, may be accidentally lead to an incorrect conclusion based upon my own sin of omission.

Markets are not perfect.  Prices act as signals, yes, but it is not always a perfectly clear message.  Individuals generally make better choices than governments, but they still mess up.

All too often, we free-marketers tend to focus on bubbles, how they lead to recessions, and how government messed it all up.  But even in a perfectly free-market society bubbles would still happen.  There will still be bouts of irrational exuberance.  There still will be people who spend too much for too little.  There will still be bad bank loans and debt problems.  None of that would go away.  Why?  We’re all human, folks.  We make mistakes and those mistakes do have consequences.  What is likely, however, is those bubbles would be smaller, more confined.  Government tends to turn localized crises into national problems.  Free markets would be more likely to contain the problems.

Markets are not perfect and until God Himself comes down and directs everything, they never will be.  But that is not an argument against markets.  It is merely the acceptance that we are all humans.

Minimum Wage and Poverty

There is a strange argument that is often put forth when discussing minimum wage, namely that eliminating the minimum wage would result in falling wages.  Allusions to slavery are often made.  Allow me to quote the ever-hilarious Robert Reich:

Now….there is a certain diabolical logic to [eliminating minimum wage]. Maybe, if we were willing to all work for a nickel or a penny, perhaps we would all have jobs. In fact, slavery was a full employment system.

Do you see the absurdity…To assume that the goal is just to get jobs by keeping wages down completely puts logic on its head.

(By the way, this video is certainly another case for a Reich v. Reich post since here he admits higher wages cost jobs but in his minimum wage video of the other day, he staunchly denies such reality).

Reich (and others) seem to think that wages are kept high only because of minimum wage.  Interestingly enough, there is no evidence to suggest this is true.  According to the BLS, just 3.9% of hourly workers earn minimum wage or less.  That’s about 2.6% of the total employed labor force.  Not a big number.  In order for Reich’s assertion to be correct, those working at or near minimum wage would have to be much closer to 100%.  Workers are paid according to the value they add to the firm.  If minimum wage were eliminated, it is not likely many, if anyone, would face pay cuts.  However, those who aren’t allowed to join the labor force now because they are priced out would have an easier time finding jobs.

Why I Oppose Central Planning

Robert Reich has put on quite a show lately demonstrating the pervasiveness of economic ignorance in political and general discourse.  He does an excellent job showing why economic education is needed.  Unfortunately, his plans, and their flaws, are not unique to him.

The biggest problem with his “10 Steps” plan is also found within many political plans, from Stalin’s Five-Year Plans to the New Deal to the Great Society, etc etc.  They all contain contradicting elements.  Earlier, I discussed how Reich goes from demanding raising wages to demanding falling wages (within a day of one another).  In the past, I’ve talked about his confused case both against and for automation.  But this can be seen in other economic policies: green energy (the federal government subsidizing green energy, yet imposing tariffs on solar panels to make them more expensive), War on Poverty (imposing minimum wage, which harms employment, and the EITC, which supports employment), consumer debt (keeping interest rates low to discourage saving in safe assets but providing non-taxed retirement plans), the list goes on.

When a government plans, especially in a republic or democracy, the policies change with different administrations.  Representatives hock their own special interests (Iowa senators want corn subsidies while California senators want almond subsidies), and oftentimes they contradict.  As favors are rarely repealed and vote trading is a real thing, this often leads to incoherent economic policies that do nothing but cost billions of billions of dollars.

Get politics out of economics and watch the world thrive.

Reich vs Reich Part 2

Yesterday, I discussed Robert Reich’s plan to raise minimum wage.  This video is part of a series he’s putting on with MoveOn.org to promote “10 Ideas to Save the Economy.”  So, raising wages is one of his 10 ideas.  Another one of his 10, interestingly enough, is to lower wages.

Check it out.

Reich argues for, among other things, universal childcare and mandatory PTO, the costs of both of which will be borne by employers and taxpayers.

All employees, whether they are salaries or hourly, a CEO or a janitor, receive a compensation package.  That package is some combination of wages and benefits.  That compensation package is also related to the productivity of a worker.  If certain benefits are mandatory, such as universal childcare and PTO, and such costs are to be borne by employers (even if its just partially), then the cost of such would necessarily have to come in the form of reduced wages.

Now, I have no doubt in my mind that Reich doesn’t intend this to be the consequences of his plan, but economics teaches us to look beyond the intended and see the unintended.

HT: Tim Worstall

Robert Reich’s Econ 101 Mistake

Recently, Robert Reich released a video promoting the idea of a $15/hr minimum wage.  There are many, many issues in this video, from incorrect information, to poor reasoning, to cherry-picking data.  To quote Dr. Don Boudreaux, “Nearly every sentence out of Reich’s mouth in this video is flawed.”

But Reich makes a more basic, fundamental error.  It’s an error that Econ 101 students are taught, usually in the first week, not to make.  Reich confuses a shift of the demand curve with a movement along the demand curve.

In his video, he claims businesses recently raised wages and that it proves minimum wage can rise without the need to harm workers.  But there are two separate things going on here.  Let’s start with a quick lesson:

Here we have a simple supply and demand chart.  This is just a graphical representation of the Laws of Supply and Demand.  Where the supply and demand lines meet is called equilibrium.*  If the demand curve is shifted to the right (representing an increase of demand, such as companies wanting to hire more), we can see that, in the new equilibrium, price rises, and so does quantity (in labor terms, prices are wages).  This is what is going on now in the labor market.  Wal-Mart et al are facing a generally improving economy.  Their demand for employees are rising, and employees are thus able to command a higher price.

But what happens when a price floor, such as minimum wage, is imposed?  Take a look at this chart.  With a price floor, there is no change in demand or supply, as the factors of demand or supply did not change (unlike the first example).  But what does change is the quantity demanded and the quantity supplied.  You can see the quantity demanded is considerably lower than the quantity supplied, creating excess supply.

Reich is seeing a price change from normal supply and demand movement and basing conclusions off that.  To quote Scott Sumner, he is reasoning from a price change, but this gets the reasoning backwards.  In other words, he is ascribing a cause to the effect, and an effect to the cause.

To be sure, if the demand curve is shifting to the right at the same time a price floor is passed, it is very possible that the minimum wage would have no effect on employment, but this is merely an illusion.

*Realistically, equilibrium is impossible to know as there really isn’t a single price point and quantity point for everything in a market, but this is a simple demonstration to show the mistake Reich, and many econ and business students make too, when they first start out, including myself.

Exports: The Other Side of the Coin

The other day, I talked a little bit on imports.  Today, I want to talk about the other side of trade, exports.

Exports are a cost.  Exports are domestically-produced goods and services a nation must give up in order to obtain imports (going back to our GDP identity, “exports” are a positive since they are domestically produced).  But exports are a cost to the economy because it means there are now fewer goods/services the domestic population may consume.

An example:

Imagine a nation.  This nation exports everything it has: every tree, every ounce of food, every scrap of metal, everything.  Their exports would be relatively high, but where would their standard of living be?  Unless the nation imports its food, resources, clothing, consumer good, etc, the people will have nothing because they’ve sent it all away.

Now, none of this is to say exports are bad.  Exports are a cost, yes, but costs often provide benefits, too.  Just as a new employee costs a company (in salary & compensation), it also provides a benefit (new labor).  Exports can provide benefits in an economy: creation of jobs, trading a resource or good for a different kind of resource or good not available within the national borders, that sort of thing.  But once should never let the idea that the exports themselves are the benefit cloud their judgement.  When exports are subsidized (think of the Ex-Im Bank), the increase of costs is subsidized, not benefits.

Hayek and the Minimum Wage

Today is Frederich von Hayek’s 116th birthday.  Hayek is probably best known for his book The Road to Serfdom, but his greatest contribution to the world is the description of what has become known as “the knowledge problem.”

In 1945, Hayek published in the American Economic Review his brilliant (and relatively short) essay The Use of Knowledge in Society.  In it, he demonstrates how the particular knowledge of a time or space goes into economic decision making, and how central planning is so often doomed to fail because it doesn’t take into account these individual factors.

Hayek’s essay has had a profound effect on me.  It is the primary reason I reject many of the macroeconomic policy solutions that are put forth by other economists.  Heck, I might even be called a Keynsian if it weren’t for this.  I do think government could, in a theoretical situation, enact policies and procedures that could boost economic growth.  The problem is making them work for everyone, not just some people.  No central planner, or committee, or Congress could possibly get all the knowledge necessary to make such a decision.

This applies to minimum wage, as well.  There are countless arguments against minimum wage.  Study after study has been conducting showing the negative effects of minimum wage (they number in the several hundred, at least).  There are mountains of anecdotal, logical, and empirical evidence and yet, despite all this, the myth persists.  In the past, I’ve argued against minimum wage on a moral level.  Now, let me try on a Hayekian level:

A “one-size-fits-all” policy like minimum wage is incredibly foolish. Minimum wage, remember, is spread across everyone. Cost of living and wage rates vary incredibly across the nation, and even within states.  $15/hr may be just right for Boston, but too low for New York City, and too high for Savannah. Heck, it might be just right for South Boston, too low for Back Bay, but too high for Dorchester.  Some people will surely benefit from the minimum wage hike, but far too many (and typically the most vulnerable), will suffer as well.

As a (rather snarky) aside: I saw another study last night showing no link between the MMR vaccine and autism.  Despite the preponderance of evidence out there, some people (including medical professionals), still believe the vaccine can cause autism.  It’s good to know mine isn’t the only profession beset by pseudoscience and myth.

Intentions vs Results

Milton Friedman once said “One of the great mistakes is to judge policies and programs on their intentions rather than their results.”  Nowhere is that more true than when it comes to economic policy in the political sphere.

Take, for example, minimum wage.  Minimum wage is often sold as a method of helping the poor, of providing a living wage, of generally making people’s lives better off.  So, then, why do so many economists from all walks of live and political views, oppose minimum wage?  The reason why is simple: because it doesn’t achieve its stated goals.

Personally, I have never met anyone, economist or otherwise, who opposes helping the poor, helping people achieve a livable wage, or making people’s lives better off.  I’m sure they’re out there, but I’ve never met one.  In fact, I’d argue the goal of the study of economics is to do these very things.  Economists, from Paul Krugman on the left to Greg Mankiw on the right, have come out against minimum wage because it does the opposite of what it intends.

The topic of conversation is not about whether or not to help the poor, or to get corrupting influences out of politics, or to feed the hungry, etc.  The conversation is, rather, how to best achieve those goals.

Imports, Trade Deficits, and the Economy

I came across this article today in the Financial Times.  The Times talks about the current US trade deficit (which means that imports exceeds exports).  The Times makes a crucial (albeit common) mistake.  To wit:

A surge in imports caused the US to record its biggest monthly trade deficit since the 2008 global financial crisis in March, prompting economists to say the economy probably contracted in the first three months of the year.

This is actually an incorrect interpretation of the data (even the economist they quote in the article doesn’t support this conclusion).  Trade deficits and imports do not drag on the economy.  They drag on GDP.

A quick definition lesson:

GDP stands for Gross Domestic Product.  In other words, it is a measurement of the production of goods and services that takes place within national borders.  Since imports, by definition, take place outside of national borders, they must be removed from GDP, thus the formula for GDP is:

C+I+G+(EX-IM) = GDP, where:

C = consumption

I = investment

G = government spending

EX = exports

IM = imports

Due to this mathematical identity, rising imports would naturally lower GDP.  But that does not mean imports are a drag on the economy.

GDP is often used as a proxy for economic activity.  It’s a pretty good tool, to be sure, but it shouldn’t be the only tool used to gauge economic activity.  Other indicators can, and should, play a part as well: industrial production, retail sales, standard of living, prices (in terms of labor-hour costs), that sort of thing.  By relying on a single measurement, such as GDP, it gives rise to false notions, such as imports harming an economy.

The truth of the matter is imports help economic growth, not hinder it.  Remember that all trade occurs because both parties benefit.  Imports occur because the buyer (who just happens to be of a different nationality from the seller) obtains a better value for a good/service than he could get domestically.

Let me try to put this in “real-world” terms to make my point that imports are beneficial for an economy crystal clear:

If, indeed, imports harm an economy and exports strengthen an economy, why do nations bother with embargoes?  Just prior to US involvement in World War 2, the Japanese were invading everyone in Asia.  The Japanese main source of oil for their war machine was the US.  President Roosevelt, in order to put the squeeze on Japan economically, ordered an embargo and stopped shipping oil to Japan.  The reason?  Japan was benefiting from these oil imports!  If imports actually harm a nation, then FDR’s actions should have been the exact opposite: he should have flooded Japan with oil.  Their imports would have skyrocketed (making them worse off), our exports would have skyrocketed (making us better off during the Great Depression) and maybe World War 2 could have ended right then and there.  But nobody believes that because intuitively people know (to some extent) imports are a good thing, economically.

The real fear with imports is that a nation might become so dependent upon another that said nation would acquire some kind of monopoly power over them.  This fear, regardless of how realistic it may be, at least acknowledges that imports are a benefit and the lack thereof is a cost.

EDIT: All this is not to say that there are not costs associated with imports.  Imports may cost jobs, for example.  What I am saying is there are no special costs associated with international trade that are not seen in domestic trade.  If a firm decides to buy wine from New Hampshire as opposed to California, Californian jobs can be lost.