The Myth of Perfect Allocation

Most economics principles textbooks have some version of the supply and demand chart below:

supply-and-demand-graph

Just your simple equilibrium analysis.  Unfortunately, misunderstanding this chart can lead to comments like this one from Mark Perry’s blog Carpe Diem:

Matthew D:

If the minimum wage causes unemployment because wages are set by supply and demand, and the minimum wage exists above the market clearing wage, this implies that market would clear without a price floor.
In other words, without a minimum wage we would have full employment.  So, the US before the passing for the Fair Labor Standards Act of 1938 had full employment, eh? Full employment was the norm?

What’s incorrect about Mr Matthew D’s comment his his implication: “that markets[s] would clear without a price floor.”  Price theory teaches us no such thing.  No price theorist claims that, absent price controls, markets will always clear (that is, quantity supplied equals quantity demanded).  Rather, that price theory, what the above chart (and subsequent price control analysis), does teach us is that, absent price controls, markets move toward a market-clearing equilibrium and price controls prevent such movement.  In other words, absent price controls, markets work toward the most efficient allocation of resources.  Price controls prevent such movements.

Price theory teaches us as compared to price controls, market allocation will be more efficient than price-control allocation.

Markets are not perfect.  That’s why we need markets.  Markets incentivize people, in ways central planners do not, to find and eliminate these imperfections.Not enough water delivered to area X?  Price of water rises, incentivizing people to bring water to that market, thus fixing the imbalance, for example.  To paraphrase one of my all-time favorite economists and writers, Steve Horwitz, markets exist because we were kicked out of Eden, not because we’re in Eden.

Trump’s Immigration Plan Cannot Make America Great Again

The other day, I wrote how Trump’s tariff plan cannot make America great again.  In that post, I promised a follow-up on immigration.  This is that post.

A quick note before I begin: many people will likely object to this post because of various social problems immigration may bring (they’ll vote away our freedoms, they’re violent, they suck welfare, etc).  I, and many others far smarter than I, have addressed those myths in the past and I will not reiterate those arguments here.  This post will focus on the economics of immigration.

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The Importance of Well-Defined Property Rights

Resources are scarce. This inevitably means conflicts will arise.  Here is one such example following a snowstorm in Boston.

In this case, the property right is well-defined.  The “space-saver” has no right to the space: “Space savers are prohibited in the South End [of Boston].”  He has no right to prohibit use of the space to other people; in fact, the other person has the right to sue the space.  Should the space-saver make good on his threat, he would rightfully be punished.

However, if there were no property rights, or if they were ill-defined, then the conflict could and likely would persist if not escalate.  Would the space-saver be in the right to defend the space?  Or would he be in the wrong?  Lack of any kind of guidance on the issue would prevent the creation of more parking spaces (which Lord knows Boston needs).

There is another element to this story I’ve not explored.  This whole time, I’ve assumed that the legislation governing the allocation of parking space property rights aligns with the law of parking spaces (that is, the customs governing their use).  If this is not the case, however, we see how legislation can actually make a conflict worse.  Let’s, for the sake of argument, assume this situation now.  Let’s say the space-saver is acting according to the law, which is whoever places something to save a space prior to a snowstorm can park in that space after/during (I know this is the unspoken, but very real, rule in North Boston). Therefore, the space-saver was acting within his expectations of a right.  In the eyes of the law (again, not legislation) he was in the right!*  The legislation, then, is attempting to override the law, which can create more conflict, rather than eliminate it!  Legislation is not the only way to define property rights.

One final parting thought: This conflict between the space-saver and the driver who parked there may be indicative that the current property right regime is inefficient for the current situation.  We may have institutional failure.  However, one should not try to read too much into the situation from this one conflict.  Institutions can and should be difficult to change, and there will always be scofflaws.  No system will eliminate conflicts, but when conflicts arise it may be an indication of the need for institutional change.  But the presence of conflict is not sufficient reason alone to change.

*His behavior is over the top, to be sure

Trump’s Tariffs Can’t Make America Great Again

For all his talk about “Make[ing] America Great Again,” Trump’s two man proposals, limiting trade (via punitive tariffs on “unfair” or “cheating” nations) and limiting immigration (via walls and watch lists) stand in direct opposition to that goal.  This blog post will focus on the first item (trade) and a follow-up post will focus on immigration.

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Economics vs Business

Whenever President-Elect Donald Trump’s misguided claims about trade are questioned, his supporters tend to respond with something like “Trump knows what he’s doing.  He’s a successful businessman!  How many businesses have you owned?”  This question is important in and of itself because it represents a fundamental misunderstanding of what economics is and its relationship to business.

Donald Trump’s business acumen no more makes his an economist than Jeff Gordon’s car-racing skills make him a mechanic (or Bryce Harper’s batting skills make him a physicist).  The two are related, sure, but that’s it.  There are many important differences between economics and business.

Economics is the study of human action in a world of scarce resources.  How do people react?  What institutions are formed?  What are the signalling devices?  That sort of thing.  One of the institutions we study is the firm (or “business.”)  Businesses are part of the economic picture, but not the whole picture.  To that end, one who excels in business is not necessarily (or even likely) a good economist, simply because they are different disciplines.  Whereas the economist must study the effect of a variable change, not just on the seen parties but the unseen parties, the businessman need only see the effect on his own business.  He cares not for the unseen consequences (if he is even aware of them).  Because of these differences, the businessman and economist may reach different conclusions over different policies:

-The economist opposes subsidies, since they tend to impose costs on those who receive no or limited benefit, encourage over-use of resources, and discourage competition.  The businessman who receives subsidies supports them as he is seeing increased demand (and hopefully profits!) for his product.

-The economist encourages competition (both domestically and internationally) among firms, as competition tends to keep the power of firms in check, forces them to innovate, and determine the best way to serve the customer as opposed to serving their own interest.  The businessman tends to despise competition because it keeps his power in check, forces him to innovate, and determine the best way to serve the customer as opposed to serving his own interest.

-The economist tends to oppose excessive regulations, as they tend to squash competition.  The businessman tends to support regulation because it squashes competition.

The list goes on.

The competent businessman is no more uniquely positioned to be competent in economics any more than my competence in economics makes me competent in finance.  Deferring to the judgement of businessmen on economic policy simply because they’ve been successful in business is dangerous.

Prices are Always Present

There is a price for everything, and nothing can change that price.  Government legislation cannot lower it.  Personal wishes cannot change it.  The price of a good is based off of its relative scarcity compared to other resources, and thus rations.  Just as no act of Congress can repeal the law of gravity, no act of Congress can change a price.

Sure, Congress could change a monetary price, but the price of a good is more than just its monetary price; that is merely a rationing tool.  When the monetary price of a good is unnaturally forced down (say, via legislation), then other non-monetary aspects of the price will rise.

By way of example, assume we have Good X. Free from interference, the total price (monetary + non-monetary) of Good X is $30.  At this point, the market is supplied.  However, some legislative body decides that $30 for Good X is too high, so they pass legislation to lower it to $15. Since rationing via monetary price can no longer occur, and nothing has changed to decrease the scarcity of the good, other forms of rationing, such as queuing must occur.  People’s willingness to accept these other forms of rationing will depend on their value of such a good.   In other words, if a person earned $15/hr and they valued the good at $30, they’d not be willing to spend more than an hour in line ($15 monetary price + $15 opportunity cost of standing in line = $30 total cost).  Any more than that, and they’d be worse off than prior to the price injunction.  The total price of Good X has not changed, just the monetary price.

Trade, Tariffs, and Property Rights

In my post earlier today, I wrote about how tariffs affect the value of different resources.  I promised a follow up post on attempting to determine whose value should take precedent, the producer’s or the consumer’s.  This is that post.

Tariffs increase the value of the producer’s property while deceasing the value of the consumer’s property.  All actions have this sort of mirror effect: when I choose to buy my groceries at Giant as opposed to Safeway, the value of Giant’s supplies marginally increased by the $X I spent there and the value of Safeway’s supplies fell.  This is simply the nature of living in a world with scarce resources.  So, how can these conflicts be resolved?  Simply by the assignment of property rights.  By determining how property rights are allocated and assigned, then conflicts can be avoided.

For most of our commercial society (that is, the aspect of our interactions concerning commercial activity), property rights of income are generally assigned to the consumer.  No producer can compel any consumer to purchase his goods/services.  In fact, compelling the purchase of goods and services is illegal.  Further, producers cannot require all other producers in an area to sell at a given price (again, that is also illegal).  This rather simple examination of property rights tells us that, generally speaking, the consumer is sovereign. Property rights of income, we can say, are assigned to the consumer.

Bringing this back to our conversation in the previous post, who has the proper property claim right?  The producer whose goods are lowered in value pre-tariff or the consumer whose value is lowered in value post-tariff?  I think, judging by the above analysis of property rights, the claim rightfully belongs to the consumer.  Therefore, the tariff, insofar as it is currently constructed (a tax on the buyer, not seller) is a violation of those property rights.  The value of the consumer is protected and the producer must find some other way (other than tariff) to seek redress.  He has no legal claim to the consumer’s income stemming from competition.*  I argue that the existing property rights regime requires tariffs be rejected, and the implementation of such is a violation of the property rights regime, thus weakening both property rights and the rule of law.

A larger point I want to make in conclusion: the assignment of property rights, and more importantly their consistent enforcement, will go far in reducing or eliminating conflicts that will arise simply from the fact of scarcity.  Without property rights, economic well-being cannot be enhanced.

*I can even cite legal precedence, see “Illinois Transportation Trade Association v City of Chicago”, where the judge ruled: ““Property” does not include a right to be free from competition. A license to operate a coffee shop doesn’t authorize the licensee to enjoin a tea shop from opening. When property consists of a license to operate in a market in a particular way, it does not carry with it a right to be free from competition in that market.”*

Trade, Tariffs, and Value

One of the glorious things about trade is it increases the value of resources.  Let’s say I earn $10.  With that $10, I can consume 3 apples.  The value of my labor is 3 apples.  Now, let’s say that trade opportunities arise.  Via trade, I can now consume 6 apples with my $10 worth of labor.  The value of my labor has doubled!

Now, let’s say local apple growers, angry that more apples are entering the market, successfully lobby for a tariff on apples.  The effect of the tariff means I can now only consume 4 apples.  The value of my labor has fallen!*  Tariffs (and taxes in general) from the prospective of the consumer are value destroyers.  Tariffs, in this manner, are akin to a disease destroying apple crops (or, perhaps more accurate, bandits constantly raiding apple crops).

Let’s look at the mirror image here – the same situation, but from the producer’s point of view:

In autarky, the value of apples are $3.33 per apple.  Following the opening of trade, that value falls to $1.67.  With the implementation of the tariff, the value rises to $2.50.  From the prospective of the producer, tariffs are value creators.

In an upcoming blog post, I will be writing about some rules of thumb I think (with the help of Armen Alchian) are helpful in determining whose value perspective should prevail.  However, I wanted to emphasize the value-changing nature of tariffs in this blog post, so I will end it here.

*To the untrained eye, one might argue “You were consuming 3 apples.  Even with the tariff, you’re consuming 4.  You still are made better off!  So why not enact the tariff?”  While it is true that one is better off in this tariff-trade scenario than in autarky (no trade), we must look beyond the seen effects for the unseen effects.  One would be considerably better off (to the tune of 2 more apples) without the tariff.  The negative effects of the tariff, while unseen, are very real.

Punitive Tariffs and Regulatory Reform

Much has been written on Donald Trump’s contradictory stance to both decrease regulations and increase tariffs (for example, see Steve Horwitz’s article in FEE).  Some try to address this contradiction by saying “on net, he will reduce regulations, and that will offset any disruptions from the tariffs and grow the economy.”  Given Trump’s own comments on the issue, I am skeptical on the matter.

It is important to remember he is not proposing tariffs just large enough to make his other actions revenue-neutral.  He wants punitive tariffs.  In other words, he wants tariffs large enough to alter people’s behavior, not just fund necessary government reforms or operations.  These are not small changes, but rather significant, long-term changes.  By punishing companies and individuals from using the most efficient means possible to produce (and thus, preventing the most efficient means possible to increase wealth), Trump is proposing a large regulatory burden fall on Americans.  And, not to mention the unseen effects of the lost potential of growth because foreign companies reduce investment in the US.

And here is where we run into the problem of the justification espoused above: if Trump’s regulatory reductions actually stimulate growth and make America more competitive in the global market place, then there is no need for the tariffs.  The tariffs would simply reduce the effectiveness of these regulatory reforms then were the tariffs non-existent.  However, if these reforms do not stimulate growth, then it would suggest deeper issues with the US economy, one which punitive tariffs would only exacerbate.

The long and short of this post is: punitive tariffs are incompatible with regulatory reform and will only serve to limit the effectiveness of such reform.