Unemployment Rates are No Conspiracy

The official definition of unemployment used by both the Bureau of Labor Statistics and economists world wide is: a person who is part of the labor force, actively looking for a job, but does not currently work.  This definition excludes people who are discouraged job seekers (that is, they would like a job but aren’t actively searching), students, prisoners, institutionalized people, military, stay-at-home parents, and retirees.

When some laymen (particularly those whose preferred political party is not in power) discover this definition, they tend to scream “conspiracy!” or “fraud!” But, as GMU professor Alex Tabarrok explains in this video, there is no grand conspiracy; it’s merely just one of six definitions used for unemployment.

In fact, if you look at the six unemployment rates takes together, they all move in the same direction.  That is because the unemployment rates measure levels.  Since all six track the same thing (unemployment), and that their positioning is important relative to previous points along the same line, and not to each other, one definition is a good as the next for discussing the trajectory of the trend.  However, one must be consistent in comparing previous time periods. The U-6 unemployment rate can only be compared to a previous U-6 rate.  Comparing it to U-1 through U-5 makes no sense.

Ultimately, choosing what unemployment rate to use is a matter of preference.  The U-3 rate (the official rate cited above) tends to be the cleanest of the 6; broad enough to get an idea of the trend but restricted enough to avoid a lot of the ambiguity that comes with the broader U-4, U-5, and U-6 measures.  But there is nothing wrong with using U-6, either.

Regardless of the method preferred they all tell the same story: the unemployment rate is falling.

It Ain’t All About the Benjamins

Economists sometimes get a bad rap by non-economists because we supposedly only care about money (and, to carry that even further, someones only care about the rich).  I can see how such a misconception could arise.  Economists spend a lot of time discussing prices and we often use money as proxies for things.  However, we use money for proxies because many of the things we talk about are not measurable.  It’s currently the best way to measure things.

But do not confuse the proxy for the actual variable of interest.  One of our primary interests in economists is utility, that is the amount of use (or happiness) a person gets from the consumption of a resource.  In other words, a person’s well-being.  Economists generally argue that people are rational, that is they take actions designed to achieve a certain end-goal and increase utility.  Some of these actions may align with acquiring more money, others may not.  For example, I left a well-paying job and took at 80% pay cut to go back to school.  It did not increase my money (obviously), but has greatly increased my well-being.

By focusing on utility, rather than just monetary, goals economists can study, and our theories account for, all kinds of selfless things: altruism, charity, family, etc.

Money is part of what we study, but it is not the major focus of what we study.

Correlation, Causation, or No Connection?

The question posed in the title of this post is what makes the task of interpreting economic data (indeed, any scientific data) very difficult.  It is also why it is impossible to just “follow the data.”  Theory, properly rationalized, must be present in order to make sense of data and evaluate whether it makes sense or not.

Allow me to start with a silly, but 100% true, example:

Every time I have watched a New England Patriots game from start-to-finish on TV for the past 16 seasons, the Patriots have won.  That’s quite a lot of data points over a decently long period of time.  It’s a correlation of 1 (perfect correlation).  If we were to just “follow the data,” one could claim that I somehow cause the Patriots victories.  After all, the correlation is there.  Of course, such a conclusion would be erroneous.  By simply pointing to the theory that it is good coaching and good players that affect the outcome of the game, not someone watching a game in Massachusetts/New Hampshire/Virginia, one could easily refute the claim.  Further, if the claimant replied “you’re just being ideological!” in defense of his argument, he would be rightfully ridiculed.

While rightfully derided in sports situations, this kind of analysis is distressingly common in economic situations.*  A perfect example is this NELP study and response by Nick Hanauer.  Both do exactly the kind of poor analysis I mentioned above; by only looking at minimum wage’s correlation with employment growth (and no other factors), it leads to the incorrect conclusion that the Law of Demand is a “scam.”  It’s pretty strong words to call a scientific law a scam based off of one flawed study’s conclusions.  Going back to my example above, this would be akin to claiming “Bill Belichick and Tom Brady are scammers because this study proves Patriots victories are related to Jon Murphy watching the game!”

Unfortunately, these same kind of poor analytical outcomes are legion.  To quote a list provided by Don Boudreaux:

 Forcing wages up by legislative diktat helps workers exclusively at the expense of business owners or rich consumers – or maybe even at the expense of no one at all?  Check!  Allowing people to buy especially low-priced imports harms the domestic economy?  Check!  Trade deficits are both a signal and a source of domestic economic decline?  Check!  The destruction by natural disasters of buildings, inventories, and infrastructure is really an economic blessing?  Check!  Markets unregulated by politicians and bureaucrats poison consumers with foul foods, kill homeowners with shoddy construction, maim workers with perilous workplace conditions, and cheat savers with fraudulent investment services?  Check!  The simple key to a booming economy is maximum spending, especially by government?  Check!  Government debt held by that government’s citizens is no burden upon that economy because we owe it to ourselves?  Check!  Growing income and wealth inequality means stagnant economic fortunes for the middle class and increasing poverty for the poor?  Check!  In markets lightly regulated and lightly taxed by governments, the rich get richer and the poor get poorer?  Check!  In markets women, blacks, and other minorities are underpaid because of discrimination – a problem that can be solved only by government regulation?  Check!  Economic growth devours precious resources, making these resources ever-more scarce?  Check!  The more you “buy local” the more you enrich your community and protect the natural environment?  Check!  Free lunches abound?  Check!!

Each one of these conclusions, which fly in the face of theory, are very popular (for various reasons), and yet they all suffer from the same problem I mentioned earlier.

Economic analysis is difficult.  One shouldn’t be so willing to discard theory lightly.  The important question to ask, regardless of the field, is this: “Does this make sense?  What else could be influencing this?”

*I suppose other sciences it is as well, but I do not know enough about them to say anything definitive.

Value is What Matters

There is one mistake I keep seeing over and over again, in the media, by politicians, by laymen, etc.  I feel it is my duty as an economist to correct this mistake.

Not all resources are equally productive.  The purpose of economic activity is to maximize benefit (output) while minimizing costs (input).*  However, not all mix of factors of production will get you there.  In short, when discussing economic activity, we must be sure to stress productive factors of production.

Consider the following: A nation has an army of ditch diggers (assume ditches are a useful output).  Each is employed with steam shovels.  Then something happens, and the steam shovels are replaced by an equal number of spoons.  What would happen?  The productiveness of the ditch diggers would fall, thus reducing the value of each ditch digger.  This is true even though the numerical amount of capital in the nation (its capital stock) has remained unchanged.  Why?  The productive capital has been replaced with less productive capital.  The value of the capital has been reduced.

Of course, it is possible to maintain the same level of output by adding in more ditch diggers, but since resources are scarce this would mean less laborers for other outputs.

Why do I bring this up now?  Well, a common mantra heard throughout this election is that “jobs are good.”  The US needs protectionist tariffs and closed borders to maintain jobs here in the United States.  But no one asks the important question: are the jobs being “lost” unproductive compared to alternative use of the resources?  A job program is easy: just ban all labor-saving devices: eliminate electric fans, washing machines, automobiles, elevators, computers, construction machinery, light-bulbs etc etc etc.  You’d easily create millions of jobs overnight.  But these jobs wouldn’t be productive!  Indeed, I predict one would see standards of living fall considerably should these measures be implemented.

The goal of economic activity is to maximize benefits, not maximize efforts.

*Not everyone constantly operates in this “profit-maximization” fashion, but that doesn’t mean it’s an unreasonable assumption.  Consider this: if you were offered two identical cars, one was $10k and the other was $5k, which would you choose?

There Is Still No Difference Between Immigration and Free Trade

At Cafe Hayek, Don Boudreaux posts his prepared remarks from a recent talk given in Atlanta. The whole thing is worth a read, especially if you want a quick summation of Econ 101.

However, I want to call attention to one point in particular, spoken by Don but also by my professor Walter Williams:

I here, at the last minute, add an eleventh point to the elemental case for free trade.  I was reminded of this point just this morning by an e-mail from my great colleague Walter Williams.  Walter asked me to remind you that countries don’t trade with each other; people trade with each other.  China doesn’t trade with America.  Individuals who reside on that part of the earth that we today call “China” choose to trade with other individuals who reside on that part of the earth that we today call “America” and who choose to trade with people in China. [original emphasis]

The concept that economics is just human action is vitally important to understanding.  All too often, people will make the mistake of forgetting this vital, yet simple, fact.  When people trade in goods, it is the owners of goods swapping.  In other words, people.  When people trade in labor, it is the owners of labor swapping.  In other words, people.

I hear far too often from many people who are nominally free trade that we can’t have free trade of labor (that is, free movement of labor across borders, not just within) because labor is people and people can corrupt (or be corrupted).  But this is no different than the false argument “demand analysis doesn’t apply to minimum wage because these people are workers not commodities!”  Both statements are wrong.  The owners of capital, people, are just as likely to subvert liberal values than laborers (who do you think calls for protectionist tariffs?  Subsidies?  Regulations?).  In fact, I’d argue the owners of capital are more likely to subvert liberal values because they, unlike immigrants, can actually vote and participate in the political process.

Does increased immigration run the risk of importing people hostile to liberal culture (or creating a “Trump effect” backlash against liberalism by natives)?  Yes.  But that danger is not unique to immigration.  It holds just as true for capital.  Economics is human action.

Protectionism Does Not Guarantee Jobs

A repeated trope heard throughout this election cycle is how foreign nations (specifically China) are “stealing” American jobs.  Supposedly, they are “beating” us at trade because they supply many cheap goods to Americans, rather than have the goods made in the States.  There are, of course, many things wrong with this, but for the sake of argument I will grant it to be true.

Assuming that importing more than exporting is bad for the economy, and that it is a universally desirable goal to pay more for domestically-produced goods in order to protect jobs, protectionist measures (tariffs, quotas, etc) are unlikely to generate substantial job gains (if any at all).  The reason is simple: automation.

We must ask ourselves the question: why were elements of manufacturing “moved” overseas (that is, why did it become easier to import vs produce domestically)?  The standard economic answer is that the relative* cost is lower to manufacture overseas and import than manufacture here.  The relative cost of labor domestically was rising compared to internationally.  A tariff seeks to fix this by raising the relative cost of imports, making the relative cost of domestic goods fall.

However, domestic labor is not merely competing against international labor.  It is also competing against other domestic substitutes, such as automation machinery.  If the relative price of labor remains higher than the relative price of its substitutes (in this case, automation machinery), then labor will still be substituted when production is brought back domestically.  In other words, protectionism may bring back physical plants, but there is no promise whatsoever jobs will follow!

Even assuming the politicians right, that trade deficits are bad, it’s quite likely you end up in a lose-lose situation: the costs of goods are higher (since tariffs block out lower-priced imports), and there are few/no additional jobs created.

*I emphasize “relative” here as it is the key for this, and indeed all, economic discussions.  Absolute costs are less important; what matters are the options.  For example, say you are buying a car.  You have two options, Car A and Car B.  Car A costs $10k, Car B costs $12K.  In relative terms, B is more expensive than A, so you will opt to buy A.  Now, let’s say there is a third option: Car C.  Car C sells for $8k.  In relative terms, A is now higher priced even though its absolute price hasn’t changed.  This is because its price relative to the alternative options is higher.  This is key for the discussion in this post.

Spontaneous Order for the Hungry

The above two pictures I took while at Farragut Square in Washington DC today.  To the naked eye, there is nothing remarkable going on in these pictures.  It’s just people ordering food from trucks.  We see this all the time in cities across the world.  What’s so special about this?

The reality is there is nothing special per se, but there is something miraculous: These food trucks appeared to feed the hungry people of Farragut Square, not by diktat but by spontaneous order.  No one in Washington City Hall or Congress said “There will be people at Farragut Square around lunch time.  They will need something to eat.  Dispatch exactly 8 food trucks to the area!”  No, as if guided by some invisible hand, the owners of the food trucks knew where to set up in order to maximize their exposure (and furthermore serve!) the hungry people of DC.  And after the lunch rush, they closed up and went to go serve some other group in another part of the city.

But that is just part of the miracle happening here.  Look at the people.  What do you see?  To the quick observer, it looks chaotic: a bunch of people running around, eating and ordering.  But, if I recorded a video, you’d see it’s very orderly.  People form lines to order their food, and then move to the grassy area or back of the sidewalk to wait for their food.  There are no signs, no police, no instructions of any kind enforcing this.  It is merely the law of the food trucks.  Even I, a newcomer to this culture, could not turn away from this law.  Just as a spontaneous order developed to bring the food trucks to Farragut Square, so did an order emerge with the patrons.  No design necessary.

It is truly amazing to think this came about without any conscience thought, any planner, and yet here it is.

Why Is Economic Growth So Hard To Plan?

Today’s Quote of the Day featured a discussion of economic growth, how the planner’s problem can lead to the growth of a predetermined variable but not necessarily economic growth.  History is rife with examples like this (heck, the book I linked to in the QoD is filled with examples).

So why is planned economic growth so hard to achieve?  The answer is as obvious as it is simple: there is no magic formula, no silver bullet, for achieving growth.  Even Robert Solow, the grandfather of economic growth modeling himself, said “[I]n real life it is very hard to move the permanent growth rate; and when it happens…the source can be a bit mysterious even after the fact.”  There have been many who have run tests trying to determine what the factors are (including Xavier Sala-i-Martin’s 1997 paper “I Just Ran Two Million Regressions“), but the results are just a jumbled mess; hard to interpret and even harder to build policy off of.  The results tend to be rife with omitted variable bias (for example, Sala-i-Martin finds that Islam tends to correlate with economic growth.  Well, is it Islam that is driving the growth or some omitted variable that is occurring along with Islam?).

Another issue that arises is: how to measure economic growth?  There are many ways to measure it, but none are perfect.  GDP (and its derivative, GDP per capita) are among the most common, but they suffer from the same “output vs economic growth” problem I discussed above.  GDP is a measure of the final output of all economic actors within a nation.  It makes no distinction between economically beneficial output and non-economically beneficial output.  For example, let’s say there are two countries: Country A produces $100 of goods its citizens consume (things like housing, food, automobiles, etc).  Country B produces $100 of goods no one uses (things like “a road to nowhere”).  Both countries have 10 people in them.  Mathematically, the two countries would have the same GDP ($100) and the same GDP per capita ($100/10 = $10 per capita).  However, it would be a gross mistake to claim the two are identical economically speaking.  Country A is filled with welfare-enhancing goods.  Country B has no welfare-producing goods, only welfare-detracting goods.  So we need to be careful with our measurement devices lest we fall back into the Planner’s Problem (as an aside, this is the exact issue the USSR and Maoist China ran into.  Both focused on increasing their GDP without any regard to producing economically useful goods.  This is why, despite similar (and sometimes higher) GDP growth rates, the USSR and Maoist China remained so poor compared to the US).

While GDP is just a single example, this is true regardless of what measure one wants to use.  They all have the same issues and all run the policy risk of simply increasing the predetermined variable vs actually generating economic growth.

Since the goal of all economic activity is to improve welfare, and welfare varies from individual to individual, region to region, and even country to country, there cannot be any any single, unified policy agenda to generate growth.  Even the institutions I heartily endorse (free trade, open borders, rule of law) can run into the same planner’s problem issues if treated as a policy goal instead of an organic institution.

There are many questions in this topic and people far smarter than I can ever hope to be have been struggling with them for over a century.  If there is any takeaway from this post, it is to beware anyone selling a “miracle cure for growth.”  They are most likely con men.

Quote of the Day

Today’s Quote of the Day comes from page 73 of my GMU professor Chris Coyne’s 2013 book Doing Bad By Doing Good: Why Humanitarian Action Fails:

Indeed, foreign assistance is often presented in terms of contributing to countrywide economic progress…but in reality the best it can accomplish, owning to the planner’s problem, is to increase predetermined outputs.

Dr Coyne’s point is not limited to just foreign aid.  Indeed, it applies to all top-down economic plans.  By focusing on a predetermined output, all one is guaranteeing is increasing that output, not addressing the underlying problem.  For example, Obamacare’s focus (the predetermined output) was increasing the number of people insured.  By using both a carrot (subsidies) and stick (uninsured fines), it was able to accomplish this goal.  However, Obamacare has not addressed the underlying issues in medical care.  Indeed, by some measures, health care has gotten worse in the US because of Obamacare.

I used Obamacare as an example, but there are many others: education (higher test scores but no change necessarily in the quality of graduates), trade (higher exports but no change necessarily in the quality of living), and so on.  Whenever any kind of growth plan (or “national industrial policy” to use the more modern jargon) is implemented, it is easy to achieve growth in the variable(s) measured.  Achieving true economic growth (as opposed to a series of bubbles) is another thing all together.

Restricted Immigration Will Not Protect Liberal Values

This comment fragment was left on this AEI blog post today:

Of course, many, if not most, commenters here are acolytes of diversity and scream RACISM at the top of their lungs with any suggestion that having large amounts of immigrants who have a culture the polar opposite of life, liberty, and the pursuit of happiness is a dumb idea.

The commentator’s point is that an influx of immigrants from what is deemed illiberal cultures will ultimately change America’s liberal* culture into a carbon copy of wherever they came from.

The arguments against this are legion.  I’ve written on them multiple times here on this blog.  But there is a larger, more fundamental error contained in the argument: illiberal values can coexist in a liberal society.  However, liberal values cannot coexist in an illiberal society.

Within a liberal society, many kinds of value systems can coexist.  Indeed, that is the emphasis of liberalism: individual freedom to live as he so chooses so long as he doesn’t involuntarily violate the rights of anyone else.  Mini dictatorships, communist societies, socialist, they all can (and, in fact, do exist) within relatively more liberal societies.  Corporate structures can be dictatorial.  Family structures tend to be communist.  Religious organizations can be socialist.  And yet, none of these illiberal institutions threaten the overall liberalism of a society.

However, in an illiberal society, liberalism cannot exist.  Illiberal societies require conformity and homogeneity.  They tend to ruthlessly squash dissent (and that ruthlessness need not be overtly violent.  For example, imagine a social-democratic society.  They vote to build a bridge.  One person dissents and refuses to pay.  The others throw him in jail for tax evasion.  This is an example of the kind of ruthlessness I mean).  Liberalism is not tolerated in this kind of a society, even as a sub-culture.

To bring this back to immigration, people who make the argument like I quoted above, under the guise of liberalism, advocate for very illiberal policies.  While an immigrant can come from an illiberal place and have an illiberal culture all his own, in a liberal society he cannot foist that upon anyone else. He can live as he so chooses, but cannot compel anyone else.  Liberal values are preserved.  However, in an illiberal society, such as the one advocated for by the commentator quoted above, by necessity destroys liberal values (in this particular case, the right to pursue property and liberty of both the domestic citizen and immigrant) and indeed promotes illiberal values (hegemony).

The restriction of immigration will not, indeed cannot, preserve liberal values.  It can only seek to undermine them.

*Please note I am using the word “liberal” in its classical sense.