Regime Uncertianty: NBA Edition

President Trump’s executive order last week banning entry into the nation from several predominantly Muslim countries can best be described as a charlie-foxtrot.  Among those caught in the wave of uncertainty following the order was the National Basketball Association.  From nba.com:

The NBA, its players and its coaches have waded into political waters in the months before and since the November election. But this week politics bled into the NBA when President Donald Trump signed an executive order temporarily limiting immigration from seven Muslim-majority countries.

Milwaukee Bucks rookie Thon Maker and Los Angeles Lakers veteran Luol Deng both are natives of Sudan, one of the countries subject to the temporary ban along with Iran, Iraq, Libya, Somalia, Syria and Yemen.

The Bucks were concerned about Maker’s ability to travel freely with the team back to the United States from its game Friday in Toronto. The NBA released a statement saying it has contacted the State Department for information on how the restriction might affect personnel from the seven countries.

Fortunately, there were no initial negative consequences for the Bucks.  From ESPN:

Bucks coach Jason Kidd, in announcing Saturday that Maker would start, confirmed that Maker had made it to Milwaukee without incident. Maker scored eight points and grabbed two rebounds in eight minutes in Friday night’s 102-86 loss at Toronto, where he had lived for two years prior to being drafted in 2016 by Milwaukee.

However, the fact that Maker was able to re-enter the country from Toronto does not mean there are any losses involved.  Indeed, there were many unseen consequences from the executive order:

1. Coach Kidd had to spend time devising an emergency game plan in case Maker was detained.  This subtracted from his time focusing on a “true” game plan where all his players can be used.  This may have contributed to their 112-108 loss to Boston on Saturday.
2. NBA and team lawyers have been scurrying to get clarification on the new rules, detracting from other duties
3. State Department officials have been scurrying to answer the questions poised by the NBA and team lawyers, detracting from other duties
4. Maker himself (and likely his teammates) were distracted by this non-basketball issue, diverting attention away from practice and game planning (again, possibly contributing to the loss on Saturday).

The list above is hardly exhaustive.  Further, we can imagine this uncertainty, and similar costs, multiplied across the nation for all kinds of industries and employers.  These disruptions, while perhaps at a cost of only a few thousand dollars each (a number I arbitrarily made up.  Could be higher/lower), multiplied across millions of individuals becomes a great sum.

One final NBA-specific point: 90 days (the length of the ban) seems small in the scheme of things.  But, for the NBA, that is half their season.  This ban is no small thing for the Association.

I Will Not Be Ruled By Fear

Donald Trump’s latest executive orders on immigration are pitched as a “law and order” measure to protect against terrorism, but they are anything but.  They are nothing more than a blatant attack on the rule of law in this country.  What is the rule of law?  The idea that no man (or group) is above the law and, similarly, no man (or group) is BELOW the law. The law serves and protects each individual equally, and Justice is blind to all but the facts. Legislation that targets a specific group, or treats one group with more contempt than others, in inherently against the rule of law.

Above all, however, these executive actions represent fear.  Strong fear, at that.  The real enemy are not the terrorists; they are not much more than a McGuffin. The real enemy is the leaders who will capitalize on the fear of their people to slap them into chains and claim slavery is for their own good.

Those few of us who have the guts to stand up, who refuse to compromise on our principles, are called “weak,” “pathetic,” “stupid,” “naive,” “unrealistic,” “traitors,” “cowards,” and the like.  Let those who cower in the corners, who cry like babies for Government to protect them from the boogieman, who sell their souls for the illusion of peace, insult me.  I don’t care.  I will not be ruled by fear.

This blog will continue to be a voice for freedom, both economic and political, so long as I have a breath to draw.  No one, neither D nor R nor I nor L, will change that.  In the end, the threat to our classical liberalism is not some existential threat, but rather our own leaders.

Benefits to Trade

Over at Cafe Hayek, Don Boudreaux shares some charts I made for him as his RA.  One of the charts is the Fraiser Institute’s Freedom to Trade Internationally Index compared to GDP per capita (a proxy for individual wealth) from the World Bank.  In the charts Don has, there is a linear regression line.  Below, I have the same graph, but with an exponential trend line:

This trend line fits better than the linear one.  This suggests an interesting relationship: the relationship between the freedom to trade and individual wealth is exponentially positive.  In other words, the more free the people of a nation is to trade, the faster and faster their wealth grows!  The implication of this is even marginal tariffs could have a substantial effect on economic activity and wealth.

Other than putting together the graph, I haven’t played around with the data too much, something which I aim to remedy in the near future.  But, at a first look, this suggests a strong positive relationship between trade and economic well-being, and certainly hurts the case that trade, as Trump has put it, is “beating us to a pulp.”

Compared to Heaven, Earth Looks Like Hell

Economists have many models that exist in highly stylized theoretical settings (this is just a fancy way of saying “perfect settings”).  When we compare real-world institutions and situations to these stylized models, the real world often looks awful in comparison.  There are externalities, corruption, misallocation, a general lack of equilibrium, asymmetric information, etc etc etc.  Thus the models compared to real life look ever more better.  It’s severely tempting to use the flaws of the real life outcomes to justify moving toward theoretical approaches (eg. using market failures to justify government intervention).

But, as was discussed the other day in the Alchian quote, alternative institutional arraignments have flaws, too.  To compare a flawed institution to an ideal alternative is what Harold Demsetz called the “Nirvana Fallacy” and can lead to mistaken conclusions.  We need to compare institutions using the same assumptions about each one.  For example,   market operations are subject to externalities because of information asymmetry among the participants?  Government intervention must also be subject to such information asymmetry.  Markets misallocate due to imperfect information its participants?  The same must be said for government operators in the market.  And so on.  This application of consistent assumptions when comparing alternative institutions is, ultimately, at the heart of economics in general and Public Choice Theory in particular.

It is also important to note these flaws as well as virtues of alternative institutions because the situation may change and warrant different approaches.  Take, for example, trade tariffs.  As a general rule, the lower the tariff the better (I will refrain from proving this at this time and we will proceed with the assumption it is true for the sake of discussion)*.  Let’s say that the current tariff on Good X is 25%.  The economist would argue for lower tariffs.  Now, let’s say that a new government comes in and declares that tariffs on Good X will rise to 35%.  The economist’s position will now change to maintain the current 25% tariff.  The situation has changed and the comparatively better option is to maintain the status quo.**  Compared to Heaven, Earth looks like Hell.  But compared to Hell, Earth looks like Heaven.

When looking at institutions and discussing institutional change, we need to compare like with like.  Comparing a market failure with a highly stylized government intervention is unfair (and, likewise, comparing highly stylized markets with government failure is also unfair).  The flaws in each must be recognized and honestly discussed.  The existence of flaws in any given institution is not a reason to abandon it.

*If you disagree with this assumption, it doesn’t change the discussion.  Simply reverse the signs of the discussion in the paragraph.

**Of course, this is not to say the economist won’t/shouldn’t advocate for even lower tariffs once the 25% is met.  We’re just looking at this one situation.

Trump, Regime Uncertainty, and Why Rhetoric Matters

Some defenders of President Trump have tried to justify his trade rhetoric as just that: words.  They argue that Trump will never enact the tariffs, or do so at much lower rates, so firms and individuals will not change their behavior.  However, this is a mistake.  We all make choices in an uncertain world and our actions depend, in part, on our internal calculations of the likelihood of different events (not to mention our own risk tolerances).  With these calculations, we make our actions.  If something comes along to change our perceptions, then we also adjust internally.*

Let’s, for the sake of argument, say that Firm X is considering expanding operations in the US. Let’s say they want their annual profits in the US to be $50 million/year.  They need to spend $100 million to enter into the US and set up.  Through various research, the firm concludes that, given current expectations on 1 November 2016, they have a 95% chance of achieving that goal (or a 5% chance of earning nothing and losing their $100 million investment.  The binary nature of this situation, while perhaps unrealistic, is done so the point doesn’t get lost in the math).

So, the expected value of their operation on 1 November is ([95/100]*50)+([05/100]*-100)=$42.5 million.

Now, let’s say that Trump wins the presidency and the likelihood of tariffs has increased. Given that the firm imports some of their material and may wish to import more in the future depending on conditions, they now conclude the likelihood of earning $50 million per year has fallen to, say, 80%. So, now, the expected value of the move is: ([80/100]*50)+([20/100]*-100)=$20 million! That’s a decline of 52.9%!

The firm is now faced with a decision, just as all firms are, based on their assessments of probability. The expected value of the firm’s move has fallen, which means the firm is less likely to enact the move at all. And all this is based off a change in probability, not just the tariffs themselves.

Another important thing to note is this still holds with small changes in probability, too.  Let’s say, for example, the firm’s initial probability of 95% still holds.  However, after the election the firm determines there is still a remote, but still real, possibility of tariffs and thus their probability estimate falls to 94.9%.  Their expected value drops to $42.35 million, a decline of just 0.04%.  But it is still a decline.  What this means is many marginal investments may be cancelled.  These now nonexistent marginal investments, which would have produced jobs and goods for Americans, are weighing on US economic growth.  All because of words.

With rhetoric flying about, it becomes harder and harder for firms to determine their probabilities.  In this sense, it is no different than arbitrary policy changes that causes other forms of regime uncertainty.  In short, rhetoric matters, even if it doesn’t translate into policy.

*For the sake of clarity, I am not saying people walk around and manually calculate probabilities before each and every action they take, but they often act as though they do.  For example, if a person knows a particular part of town has a higher crime rate than another, he may avoid that part altogether.  However, if that part of town becomes more safe, he may venture in there more often.  These decisions are made based on his perception of probabilities, not his actual probability.

Thank You!

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Thanks again!

Support Us

Hello Readers,

As many of you know, I began graduate school this year, which unfortunately left me with less disposable income and I am looking for help to pay for the hosting fee here at A Force For Good. It’s not expensive, $100 for the year, but on a grad budget it is not insignificant. 

This blog is a passion of mine, and a labor of love.  I write this because of my love of economics and as part of a mission to make this sometimes esoteric subject more accessible to all.  Please assist if you can, even if it’s just a dollar or two.  All funds will go to pay the hosting fees; I will keep none of them.

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Thank you,

Jon

A Discussion on Crony Capitalism

“Crony Capitalism” is a politically-charged term that is often tossed around regardless of its meaning; some actions that are decried as “crony capitalist” are not and some that are defended against the charge are.

Let’s begin with a definition of crony capitalism.  Crony capitalism is not more than the merging of business and political interests.  This can be done through regulations (using regs to limit or drive out competition), special tax breaks, subsidies, tariffs, etc etc; essentially whenever government interferes in private business on behalf of a party or special interest group.*

What’s important about the above definition of crony capitalism (which can be obtained via a simple Google search) is that it makes no difference whether the outcome of such crony capitalist interventions are net beneficial or net harmful.  Many people attempt to justify (or defend against the charge of) crony capitalism by arguing such intervention has net-beneficial results, or sometimes just that they have beneficial results.  Planned Parenthood, trade tariffs, green energy subsidies, and HUD subsidies are often justified under this argument.  But, as we discussed in the last post, all things have benefits (and costs).  The fact of their existence does not justify/condemn a particular institution or program.  The interventions are still crony-capitalist, even if they produce a net benefit.

Another important takeaway is that one’s intentions don’t come into play.  Whether these interventions are taken for the “greater good” or for one’s own personal gain is irrelevant.  One may be more despicable than the other, for sure, but that is a moral judgement call.

With the establishment of what crony capitalism is, let’s now talk about what it isn’t.  Crony capitalism is not the use of business practices one may dislike.  For example, a firm selling below cost to gain market share is not crony capitalism.  A firm buying up lots of Resource X to limit its use by competitors is not crony capitalism.  A union negotiating with a firm for a “closed shop” is not crony capitalism.  In order to justify the charge, one must show some form of government involvement (for example, by government license, a firm has exclusive first rights to purchase Resource X).

The distinctions here are important because in the public discourse crony capitalism is often used as a pejorative (and rightfully so, in my opinion).  However, not everyone believes crony capitalism is a pejorative.  In fact, many people support crony capitalism when they’re the ones benefiting from it (quelle surprise).  The charge is often levied against one person in order to discredit him or his policies, without regard for what the term means.  I hope to change that.

*I want to stress that, while the terms are often used interchangeably, this is not the same as socialism or communism where the government nationalizes firms or industries.  Public education in the United States, for example, is not crony capitalism since government owns and operates those schools.  Furthermore, the fact the government is willing to operate at a loss with these enterprises is not crony capitalism.

Today’s Quote of the Day…

…comes from Armen Alchian’s 1961 RAND Corp. publication Some Economics of Property, as reprinted on page 43 of the Liberty Fund edition of The Collected Works of Armen A. Alchian: Vol 2: Property Rights and Economic Behavior [original footnote]:

I should, I suppose, avow at random intervals that all this is not a condemnation of public ownership any more than certain “deficiencies” of marriage, the human eye, the upright position of the human being, or smoking are to be regarded as condemnations of marriage, eyes, walking on two feet, or smoking.  The “lesser” evils in some institution – and they exist in all – are borne for the greater good in some of them.  We are not arguing that private property even in its purest form is perfect in the cost-bearing sense.  No standard of perfection is available.  All of our statements have been comparative in degrees of cost bearing.

The converse of this “apologia” is that others should not speak of the imperfections of the marketplace, either.  Nor should they assume that in those instances where the marketplace is inferior in certain respects to, say, public ownership or government control, we should switch from the market to the government.*  The presence of one kind of relative deficiency does not simply justify a switch to another agency which has other kinds of deficiencies.  We can’t have either agency without also having all its attributes.  We repeat that this neither justifies nor condemns more private or more public ownership, more market- or more government-directed activity.  All this may help form such decisions, but it is only part of the story.

*We are mindful that rabbits have greater skin-healing power (even for some especially large [100cm^2] sizes of skin injury) than do human beings.  Should we deduce that rabbits should be used as soldiers?

Alchian’s point is an important one, but one oft-lost, even among economists: there are no solutions, only trade-offs.  Everything is subject to the question “as compared to what?”  There are no silver bullets and institutions form in response to their surroundings (and their surroundings respond to the institutions).  The mere fact a given institution has deficiencies is not a reason to replace it; its replacement will also have deficiencies.

On (Im)Perfect Subsitution

Another Econ 101 mistake people make, especially with regard to immigration and international trade, is some form of “foreigners (immigrants) can do all the work we do but for much lower prices!  Without subsidies/tariffs/minimum wage, they’re just going to take all our jobs!”  Other versions of this include “if a bunch of immigrants enter the nation, they’ll drive down wages!  Law of Supply and Demand!”

Both the above arguments make the same mistake, namely they assume foreign labor is a perfect substitute for domestic labor.  They treat all labor (or all low-skilled labor) as a homogeneous blob, one part easily replaceable with another.  But, alas, that is not the case, as price theory can show us.

Looking simply at the wages of laborers, we should ask the question “why do immigrants/foreigners command lower prices than domestic workers?” The fact that there hasn’t been wholesale replacement of domestic labor with foreign means we can rule out any cultural/biological/cost-of-living reasons such as “lower cost of living in 3rd world” or “they have a lower standard of life and thus demand lower pay” etc.  If this were indeed the case, domestic companies could just pack everything up and ship it overseas (that is, stuff that can’t be staffed by immigrants) and make tons of profits (while I have no doubt some people believe that is what is happening, the data say otherwise).

What’s more likely is that foreign workers and immigrants are simply less productive than domestic workers.  Immigrants coming into the country, legal or otherwise, face major barriers, not the least of which is the language barrier.  The manager at McDonalds cannot simply fire an American order-taker making minimum wage and hire a foreign worker for half the cost. The foreigner, simply by virtue of not knowing the language, will be less productive, thus his lower salary.  A similar argument for offshoring can be made: foreign workers, by virtue of less capital augmentation, will be less productive and thus command lower salaries.

In short, foreign workers/immigrants are not perfect substitutions for domestic labor!

It may make sense for some firms to replace/augment domestic labor with foreign labor, but the mere fact it is cheaper is not the reason why.  David Ricardo’s powerful idea shows there are times it is prudent to replace more productive resources with less productive resources, but to do so on a large scale with disregard to opportunity cost is a recipe for disaster, and why firms and individuals do not do it.