The Wonders of Trade and Multiculturalism

As long-time readers will know, I recently moved from Concord, New Hampshire, to Fairfax, Virginia.  Fairfax is a suburb of DC, about 20 miles outside the city.  Being so close to a major city, Fairfax has a lot of different people and cultures living in it.  Much more than Concord.  Concord is very mono-cultural.  It’s a predominantly white, native older population.  There is an element of Nepalese and Sudanese in the city, but they are a fairly small part (of course, this is not to say anything bad about Concord.  It is a wonderful town and a place I am proud to have called my home for 5 years).  Fairfax, on the other hand, is much more diverse.  There’s Korean, Indian, Turkish, Chinese, Japanese, African, and so much more.

Fairfax has given me exposure to so many different cultures and foods that I never would have experienced in a homogenous culture, and made the ability to access these things easier, too.  I’m drinking sour cherry juice bought from the Turkish market.  The roast chicken for Sunday night’s dinner is brining in the fridge with spices and peppers bought at the local Korean market.  Last Friday, my Chinese neighbors came over and cooked hot pot for us.  These are just a few examples in the last few days.

If America were to break itself off from the globe, turn isolationist the way Trump or Clinton want us to, then Americans will surely suffer.  These treats will disappear from Fairfax and countless other cities and towns in America.  Our citizens will become poorer.  the wonder of trade is that it provides access to things we couldn’t provide for ourselves (at least, not for a significant cost).  I needn’t go to Beijing for Chinese food, or Istanbul for Turkish goods.  I can go to my neighbors.  Without trade, this simply wouldn’t be possible.

Thoughts on Solow and Foreign Aid

One of the major models used in macroeconomics is the Solow-Swan growth model. Skipping a lot of mathematics, the model essentially tells us that economic growth is a function of capital (k), labor (l), and some mysterious A factor that sums up pretty much everything else (education, technological progress, institutions, etc).

When Solow first developed this model, he figured that he’d see economic growth was driven primarily by capital.  However, in testing this model over the years, the conclusion is repeatedly that the A factor is the driving aspect of the model, not labor or capital.

To the extent this is true (the Solow Model has many limitations, even Robert Solow himself recognized this), it would have serious implications for foreign aid.  Given the A factor accounts for everything not capital and labor, and that it appears this A factor is the main driver of economic growth, it would suggest that most foreign aid done by wealthy nations is wrong-headed.  US (and other 1st World Nations) foreign development aid is very capital-focused: building factories, expanding ports, providing machines, that sort of thing.  Given the findings of the Solow model, it would suggest this is the wrong way to handle foreign aid.  In order to be more effective, foreign aid would need to focus on the A factor.  Of course, the problem here is how broad A is.  Other models have tried to break apart A into various components, such as human capital (education), but even those aspects appear to have limited effects.  It’s an interesting question (as well as the question on, given this evidence, why foreign aid is still very capital-focused.  I hope to address this in some hypothetical sense in a future post).

Of course, none of this is to say that there should be no foreign aid.  Just because capital’s influence on the growth rate is limited doesn’t mean it shouldn’t be supplemented.  But it does suggest that the current regime of foreign aid is inefficient.

An Open Letter to Bernie Sanders

Dear Senator Sanders:

In a recent Facebook video, you deride trade barriers that prevent cheaper Canadian drugs from entering the US market.  You conclude that “that is why Americans are paying the highest prices in the world for their medications.”

You are absolutely right in this assessment.  Economics 101 teaches us that trade barriers raise the costs of goods sold domestically.  By opening trade with Canada (and other nations), the US could go a long way to reducing prescription drug costs here at home.

However, I wonder how you square this with recent pronouncements during your presidential run that free trade and imports (such as trade with China and NAFTA) are harming Americans?  If what you said during the campaign is true, then importing Canadian drugs will only harm Americans: it’d cost American jobs and only serve to line the pockets of drug companies who opt to have drugs made in Canada.  If, as you argued during your campaign, America is made stronger by limiting imports and that paying higher prices for consumer goods is a good thing, then it must also be true for drugs.  Likewise, if paying lower prices for drugs imported from elsewhere is a good thing, then it must also hold true for other goods imported from other places.

I hope you can see where the confusion lies with your contradictory positions.  I look forward to an explanation from you.

Sincerely,

Jon Murphy
George Mason University
Fairfax, VA

Skittles, Math, and Risk

Donald Trump Jr tweeted a rather old (and idiotic) meme the other day, sparking conversation about refugees.  There are many, many things wrong with that meme, but others far smarter than I have covered them.  Instead, I want to focus on the bad math and conversation about risk contained therein.

In the meme it shows a bowl of Skittles, which I estimate holds probably two bags, so about 100 candies.  Assuming Junior Trump’s statement correct, 3 of those would kill you.  That would put the risk of death at 3 in 100, or 3%.  Rather high.  But the true risk of death from refugees is not 3 in 100.  It’s 1 in 3.64 billion.  In other words, 0.00000003%.  Effectively zero.  Whereas the risk of dying from food poisoning is 0.00006%.  You are far more likely to die eating actually poisoned Skittles then by refugees represented by Skittles.

But it is also important to remember risk is a part of everyday life.  If you get out of bed in the morning, you are taking a risk.  If you get in a car, you are taking a risk.  If you enter a high-rise building, you are taking a risk.  Let’s put some risks into perspective using the same candy metaphor:

Killed by Cancer: 1 Skittle in 540 is poisoned
Killed by Car Accidents: 1 Skittle in 8,200
Homicide (non-terrorist related): 1 Skittle in 22,00
Drowning in the Bathtub: 1 Skittle in 950,000
Killed by Home Appliances: 1 Skittle in 1.5 million
Killed by Deer: 1 Skittle in 2 million
Commercial Aviation Accident: 1 in 2.3 million

(Source for above numbers)

Notice that all of these have significantly higher risks of death than refugees.  So, let me flip the script: Mr. Trump, Jr: if I had you a bowl of Skittles, and just 1 in 8,200 of them are poisoned, do you take a handful?

Thinking about Wage Gaps

Over the last few days, two new items have been making their way around the Internet: one, a video with Kristen Bell by the Huffington Post discussing the female wage gap, and two, a report by the Economic Policy Institute on the increasing black-white wage gap .  In both cases, the creators/authors attribute the gap to discrimination.

Discrimination certainly is possible, but is it a likely explanation for these gaps?  From an economic point of view, it doesn’t make sense.  If we assume that firms are profit-maximizing organizations, then we could reasonably conclude that if wage gaps did exist, and were not some statistical aberration, then firms could easily lay off white men and hire females and minorities to perform the same work for far less, thus increasing profit (indeed, this is suggested as a reasonable course of action in Ms. Bell’s video).

And yet, this does not happen.  Why?  It certainly is possible that a chauvinistic attitude is rampant throughout the United States and that it is so powerful as to override the profit motive.  Were that true, our initial assumption that firms are profit-maximizers would not hold true and would make any policy designed to end this gap difficult to implement since the firms’ operators have a high cost tolerance to the point of sacrificing profit.  I suspect that, as the Department of Labor showed some time ago, much of the wage gaps are due to different characteristics and preferences among people.

To the extent that the wage gaps do exist, I suspect they are largely due to policy as opposed to outright discrimination.  Policies nominally in favor of women, such as maternity leave or special health benefits increase the cost of female employees relative to men (this is true even if the policy is gender-neutral, but more likely to be used by women). Given the relative cost, men are more attractive to potential employers at a lower price point.  Women, to remain competitive, then need to lower their salary expectations.*

There is a similar situation with black-white wages, but this comes about more due to policies like minimum wage.  Walter Williams (who is a professor of mine at GMU), has done extensive research on black-white employment and wages since the Bacon-Davis Act (the Act that effectively established a minimum wage).  In the decades prior to the Act, unemployment rates and wages were similar among black and white workers.  Since the Act, the black unemployment rate has skyrocketed, and with it came falling wages.  Since the minimum wage limits teenage unemployment for blacks (a time where valuable skills are learned which do have a dramatic effect on future earnings potential), it trickles down into adult earnings, leading to the gap.

Of course, pure discrimination could be the answer here (although if it were, it’d violate several laws already on the books.  Considering no lawsuits have been filed, I doubt it).  But, as an economist, I look at things from the point of view of economics: I assume people are, generally speaking, rational, profit-maximizing, self-interested individuals.  This assumption is useful enough, and broadly true for the whole population on a number of issues.  Furthermore, the idea of price theory (discussed in this post in terms of the cost of discrimination) is broadly true.  For either of those assumptions to be overturned, we’d need very compelling evidence.  Unfortunately, there mere existence of a wage gap is not compelling enough.

*As an aside, this also makes the cost of discrimination fall.  These sorts of policies make it easier for hiring managers to discriminate since there is less of a cost to do so.  This is also true for racism.

Shit Happens

Markets are not perfect.  They are filled with mistakes, failures, and missteps.  What’s more, disruptions (like a flood wiping out food crops) happen.  Free market advocates, such as myself, do not disagree nor do we think that markets are this always-perfect, never disrupted, recession-proof process.  Indeed, quite the opposite: the fact markets can fail, and are subjected to natural forces, is why we advocate for markets over other forms of resource rationing.

The market process is extremely flexible:

-Market participants need not wait for a diktat from On High to enter (or leave) a market; they get signals (such as profit) that help guide those decisions.  If a firm cannot earn enough profit, they leave a market.  Likewise, if firms are earning very high profits, firms will seek to enter the market.

-Market participants need not wait for directions from some governing body on how to react following a disruption. Signals from prices(and good ol’ fashion human kindness) help drive that.  If a flood in Louisiana destroys the city’s stores of food and other goods, firms not affected can and do send aid immediately.

-Market participants need not have perfect information, guided by an omnipotent governing agency, to make rational decisions.  They need only the knowledge of their own goals to accomplish this.

-Market participants need not wait around doing nothing until a government agency saves them from recession.  Through the signals of price and profit, people can (and will) do what they need to do and determine a way to survive.

Yes, bad things happen.  Such is life.  But the mere fact that bad things happen does not justify intervention by a governing body or outside force.  The reason is simple: such intervention has no promise to make things better; in fact, it often makes things worse.  Government intervention is inherently rigid.  Governments are inherently rigid.  It is not dependent upon the type of government, nor even the people who make it up; you could have a social democracy filled with the purest men and women who ever walked the face of the Earth or a totalitarian dictatorship lead by Satan himself, and the outcome would still be worse than the market process because they do not have the flexibility or knowledge to handle ever-changing (and sometimes dramatically changing) situations.

Markets have failed.  Long live markets

It’s All People

The other day, I discussed the human decision-making element contained in economics (the short version: people, not collectives, make decisions).  At this point, I want to make explicit what has been generally implicit in my posts (or, just taken as given as understood by the reader).

Economics is, as Ludwig von Mises described it, the study of human action.  Economists look at how people act and react in a world of scarcity (that is, not enough resources to satisfy every want or need).  There are other definitions of the science of economics (the study of the allocation of scarce resources is another popular one), but they all generally derive from this since, at the end of the day, we are looking at people.

Why is this important?  Misunderstanding this fact leads to “this time it’s different!” claims.  Things like “labor doesn’t react to demand curves in the same way as machines/commodities because it’s people!”  Or “immigration [free trade of labor] is different from free trade of capital because it’s people who can potentially vote!”  I chose these two examples specifically because they are common tropes on the left and right, respectively, but they both make the same mistake.

This is the point I want to make explicit: Capital (machines, factories, other inputs) and labor inputs (simply called labor) are not people.  They are resources and churn out output.  The sellers and buyers of capital and labor are people.*  As sellers and buyers, they face the same issues, the same incentives.  For example, a man selling a computer no less is insulted if you try to low-ball him then a man selling his labor.  To address the right-wing criticism mentioned in the above paragraph, a laborer is no less likely to vote for protectionist measures to protect his job than a steelmaker. Both are threatened by free trade (the laborer from immigration and the steelmaker from imported steel).  It is incorrect to say that one will vote on the matter but not the other in response to free trade.  To address the left-wing criticism, the fact that buyers and sellers of labor are no different from capital is why minimum wage legislation fails to raise the lowest income workers out of poverty; why they are likely to be replaced by capital when the relative price of labor rises.  Labor is subject to the same demand conditions as anything else.

In economics, we often get lazy and simply refer to these things as ‘labor” and “capital,” rather than sellers of labor and sellers of capital.  Perhaps it doesn’t matter as much within the profession (although I have met and read a fair number of economists who have made arguments similar to that which I discuss above), but it certainly causes great confusion among laymen.  Imprecise language is bound to confuse.  I can only hope that this is just a small contribution toward eliminating that confusion.

PS: I hope, after reading this post, you can now see what I think “study of the allocation of scarce resources” is a necessary, but not sufficient, definition of economics.

*This may sound strange, especially when referred to labor, but it is merely a method of categorization necessary to better think of the issue.  Consider this: a store needs 3 cashiers to operate. it currently employees Jack, Jill, and Chris.  Chris leaves and is replaced by Joy.  The physical sellers of labor has changed, but not the amount of labor.  Just as if I bought a Dell computer to replace an HP, my capital hasn’t changed just the brand-name.

Baby, You’re A Rich Man

On this post at Cafe Hayek, commentator Thomas Hutcheson had this comment in response to the post on the myth of middle-class stagnation:

Thanks, but I’d reather [sic] see [middle-class stagnation] debunked with data showing higher real wages.

Mr. Hutcheson’s comment is typical of an oft-made mistake: monetary income is the same as wealth (riches).  However, it is by consumption, not money, that we become richer.  Let’s look at this in two ways, first with a simple mathematical example, and second with a thought experiment.

Imagine that to live decently (a home, a car, full belly every day, clothing, utilities) costs $1,000 a month.  Your salary (income) is $1,000 a month.  You break even.  Now, let’s say that, though the magic of the market process, the prices of your food, clothing, and utilities falls.  It now costs just $800 to maintain the same standard of living.  You spend that extra $200 on something nice you couldn’t have before (let’s say a pet).  Your wealth has increased by $200 even though your income has stayed the same!

Now, to think about this is a different manner, let’s have a simple thought experiment:

Suppose you see two people.  The first man has a home, car, fully belly, etc.  The second man is homeless, starving, dressed in tatters, etc.  Which of these men would you say is wealthier?  You’d probably say the first man.  Notice no monetary income was given, but you were able to make a judgement.

None of this is to say that there isn’t a correlation between monetary income and wealth; the absolutely is.  But to measure wealth solely upon income is to confuse the issue.

The Problem with Macroeconomic Rationality

Today’s Public Choice Seminar at George Mason University featured Yale University’s Truman Bewley.  His talk was on his interview study of pricing practices.  The talk featured many good points (which can be found in the first link I provided), but he also said something important.  Dr. Bewley said (and I am paraphrasing as I do not recall the exact quote): “If you find someone is acting irrational, you may not understand the person’s objectives or the constraints they face.”

This is an incredibly important fact to remember when discussing economics: rationality is about a person acting to achieve a certain goal.  An act in one context may be rational but in another context it is not.  For example, if a person’s goal was to lose weight, then not exercising and eating junk food would be irrational.  Conversely, if a person’s goal was to gain weight, eating junk food and not exercising would be rational.  The end objective is different.

This explanation of rationality is not problematic when doing microeconomic analysis.  We reasonably assume that people have a goal in mind and a way to achieve it; that is, they are rational.*  However, problem arise when discussing a collective (a town or a nation, for example).  Given multiples of people, it becomes more and more difficult to determine what objectives are, and even more so what rational courses of action are.  Remember that collectives do not make choices; only individuals choose.  Therefore, there cannot be a “collective” decision, or a “collective” goal.  Furthermore, measuring those outcomes becomes problematic.  What one person might consider a step forward, another might take as a step back.

As an extreme example of my point, let’s take a look at a recent campaign slogan: “Make America Great Again.”  That is an objective.  But what does that mean?  To some, it means preventing non-whites from entering the country; they feel our culture is being tainted.  For  them, it’d be perfectly rational to erect a border wall, deport, or disenfranchise those groups.  For others, making America great means lifting the economic welfare and standard of living for all.  To this group, kicking out non-whites would be irrational, as would be scaling back international trade.  For a third group, it may mean increasing funding for social programs.  For that group, raising taxes and building redistribution programs would be rational.

You can see the problem of looking at collective (or macroeconomic) rationality; it doesn’t really exist.  Often, as pointed out by James Buchanan, the “rationality” and “objectives” are determined by the analyst’s prejudices.  As we just demonstrated in the paragraph above, that can cause problems.

None of this is to say macroeconomic or collective analysis serves no purpose.  Despite my obvious Austrian economic sympathies, I’m not ready to jump on the “Macro is voodoo” bandwagon of many of my colleagues.  What this is to say is one must be careful in analysis and interpretation, especially when discussing the collective “we.”

*Some do object to this assumption by pointing out mistakes that people may make or how they may be manipulated.  While this is true, no part of economic analysis assumes perfect rationality 100% of the time.  We’ve quite a lot of tolerance for mistakes.  However, it is a general assumption that has been shown to be reasonable over time.  Generally speaking, people are smart.  To quote Walter Williams, if your theory requires people to be stupid, it’s going to be a bad theory.

Time Matters

Having spent a lot of time in the past few weeks looking over minimum wage studies, surveys, and summaries, I noticed something important to note: the studies are consistent with the Second Law of Demand.  The Second Law of Demand states that the longer a price change persists, the more elastic the demand curve becomes.  This is very true in discussing minimum wage.  The studies that show little/no negative employment effects tend to be short-term studies, whereas the ones with more pronounced negative effects are longer-term.  In fact, in one of the longest outlooks, GMU economist Walter Williams looked at teenage unemployment and labor force participation rates among blacks and whites and he finds dangerously negative consequences (he finds in 1948 that white and black teenage unemployment rates were about equal and black LFPR was higher than whites.  Now, black teen unemployment is around 28% (has been as high as 50%), white teen unemployment is around 13%.  Since 1948, black teen unemployment has averaged about 19.5 percentage points higher than  white teen rates.  Williams attributes this to the minimum wage (as well as other factors).

The lesson here is that time does matter.  The longer a price control is left in place (or, God forbid, it be indexed to inflation), the more pronounced the negative effects will be.  In the short run, there may be little/no effects (a la Card-Kruger), or the effects may be negative, (a la Mark Perry), but there’s really too little information to tell.*  There’s not much a person can do in the short run to adjust.  In the longer run, however, his ability to adjust is much greater.  In the case of the minimum wage, a person can bring in capital (or invent new equipment) to offset the increases.  He can retool/reconfigure his workforce.  In the longer run, the margins he can adjust along are more numerous, allowing for more of the negative effects of minimum wage to appear.

This also has consequences on cost-benefit analysis.  Although I have made it clear I do not believe any meaningful cost-benefit analysis can be done at the macro-level, there are those who do and thus bravely plow ahead.  But, given the longer-run issues discussed above, the cost-benefit analysis would need to take into account an ever-elasticizing demand curve.  The costs would continue to rise at a quickening pace the longer the trend persists (the exact nature of that trend I will leave to some econometrican to figure out), eventually surpassing the benefits.  This would need to be taken into account when doing any kind of analysis or having the conversation.**

Time matters because economies are dynamic, not static.  Failure to take into account this simple fact will lead to poor decision-making.

*None of this is to say short-run analysis doesn’t have use, of course.  What it is to say is to urge caution from drawing conclusions based on short-run data.

**Perhaps some math-savvy person can figure out where exactly this inversion occurs.  it won’t be me, however, as I find minimum wage incredibly immoral and  that arguing sacrificing some people is ok so long as another group benefits more is outright despicable.  I fear if I were to develop such a model, it’d be used for determining the “exactly right” minimum wage and I will not have my name tied to such a thing.