In Stark Contrast

In booming economic times, the detrimental effects of policies like minimum wage, immigration restrictions, protectionism scarcityism, or socialism, can be hard to see.  The good growth outweighs the bad from the policies, obscuring their effects.  However, once times get tough, then the negative aspects of these policies stand in stark contrast.  By way of metaphor, imagine going downhill in a car.  Lightly applying the brakes won’t do much (depending on how steep the hill is, you may actually gain speed!).  However, if you are going uphill, even a light tap will have a large effect on the car.

Unfortunately, the obscurity generated by the good times can cause less careful thinkers to determine that there are no negative effects of the policies they want.  We see this quite often with protectionism.

We are now seeing the negative effects of protectionism and immigration restrictions here in the US following three major hurricanes that have hit in the past month: Harvey in Houston, Irma in Florida, and Maria in Puerto Rico.  In normal times, the detrimental effects of artificially high prices and artificially scarce resources tend not to be noticed.  Like the farmer who grows 100 acres of corn, and 1 acre is destroyed by parasites, it’s not too noticeable.  But if a disaster hits, and how only 10 acres can grow with 1 acre being destroyed, it’s very problematic.  When times are tough, and resources scarce, the market needs to work.  These artificial restrictions only make the scarcity worse.

Looking at disasters like Irma, Harvey, Maria, etc give us an excellent chance to test the claims of the scarcityists, that protectionism, minimum wage, and immigration restrictions grow the economy, not shrink it.  Given the tough time Texas, Florida, and Puerto Rico have is recovering basic supplies, it’s hard to believe the claims of the scarcityists.  Abundance is wealth, not scarcity.

Why Have Property Rights?

The purpose of this essay is to flesh out some aspects and properties of property rights.  For many readers, this is probably redundant.  Nothing I will write here is original or particularly new.  However, following recent conversations I have had, I feel it is worth it to rehash some of these ideas.

Property rights, defined as the right to use resources*, exist to help resolve conflicts.  In a world of scarce resources with more than one person in it, conflicts will inevitably rise.  The prototypical Robinson Crusoe, who finds himself alone on a desert island, need not worry about conflicting uses of resources.  He can choose to eat the berries or plant them, and there will be no other objections to their use.

However, once Friday comes ashore, now there is the risk of conflict.  If Robinson wants to eat berries and Friday wants to plant them, then there is a conflict; doing one necessarily means the other cannot happen.  The clear delineation of property rights, who owns the berries, in this case, helps solve/prevent the conflict.  If Robinson and Friday agree that Robinson owns the berry bushes and Friday owns the fruit trees, then Friday can use the fruit trees and Robinson can use the berry bushes to their hearts’ content.  Indeed, they could even trade with one another!

But, what about if there are conflicts with the use of the resources?  Does Robinson have any right to object to Friday’s use?  In other words, are property rights absolute?  Let me be absolutely clear by what I mean by “absolute,” and here a very little mathematical formalism would be helpful: By “absolute,” I mean that the use of the resource will be determined by the resource owner with a probability of 1.  If Joe owns a resource, and its use is determined by Joe and Joe alone 100% of the time, then his ownership is absolute.  If the probability is less than 1 at any time, then the property right is not absolute.

Going back to Robinson and Friday, let’s say that one of Friday’s trees is a coconut tree.  I have already said above that Friday has the property right to the trees.  He can use the trees for his purposes.  But does Friday and only Friday determine how those resources are to be used?  Can we think of an example where his right might be restricted, that is its use would not be determined by Friday?  Yes: Friday may not use his coconuts to bash in Robinson’s skull.  One can think of many other examples.  Therefore, Friday’s property right is not absolute.

Another example: I own a crowbar.  I can use that crowbar for many things, but I cannot use that crowbar to pry open my neighbor’s door without his consent.  Therefore, the use of my crowbar is not 100% determined by me.  For a very select few set of cases, the use is determined by my neighbor.  The property right is not absolute.

The discussion of using property to harm another (whether intentionally or not) is of major importance in law and economics.  As Ronald Coase pointed out when property rights are ill-defined, that is to what extent their use is defined, then conflicts arise.  If rights are absolute, then conflicts are inevitable and cannot have a just resolution.

To be clear, just because property rights are not absolute does not mean they are arbitrary.  They cannot be revoked, renegotiated, or reneged without due cause.  But the glorious thing about common law is that it allows for the flexibility needed to address conflicts which are at the present unseen but may arise down the road without sacrificing the right itself.

This blog post is a little over 600 words.  I will not pretend to have done justice to the issue of property rights here.  For a more detailed discussion, I’d recommend the following readings:

The Property Right Paradigm, by Armen Alchian and Harold Demsetz

Toward a Theory of Property Rights, Part I and Part II by Harold Demsetz

The Problem of Social Costs, by Ronald Coase

*Source

Equilibrium is Dead, Long Live Equilibrium

The other day, I wrote: “[T]he market is always (absent externalities, interference, taxes, asymmetric information, etc) in equilibrium.  In some sense this is true*, but it is not the whole story. ”  At the time, I promised a future blog post explaining what I meant.  This is that post.

The world is always at equilibrium and always in disequilibrium.

What I mean by “the world is always at equilibrium” is twofold: 1) equilibrium analysis, as provided by the standard supply and demand chart, is a useful analytical tool.  It provides a person with a good initial understanding of exchange and production and provides reasonable predictions for things like price floors/ceilings, minimum wage, taxes, tariffs, etc etc., and 2) Any given trade, by the virtue of the fact that it is a voluntary trade, can be said to be an equilibrium trade.  That is, any trade that occurs between two individuals can be said to establish an equilibrium.

What I mean by “the world is always in disequilibrium” is that there is no “global” equilibrium, no global steady state.  Supply and demand curves are functions of endowments, and as trade occurs, endowments change.  This necessarily leads to a different set of supply and demand curves, giving new prices and new trading opportunities, leading to new trades, leading to new endowments, leading to new supply and demand curves, on and on.

The world is always in equilibrium and always in disequilibrium.

WHO is Responsible for Drug Shortages?

CNN reports in a breathless headline: The World is Running Out of Antibiotics, WHO says.  

The article is interesting as a whole.  The article begins with a description of the problem:

Too few new antibiotics are under development to combat the threat of multidrug-resistant infections, according to a new World Health Organization report published Tuesday. Adding to the concern: It is likely that the speed of increasing resistance will outpace the slow drug development process.

While the article goes on about these drug shortages, there are no questions as to why too few antibiotics are under development and why the drug development process is so slow.  A major reason for the slow development of drugs is drug regulatory agencies like the FDA!

The purpose of drug regulatory agencies is to slow down development of drugs.  The FDA (and its global counterparts) require extensive (and expensive) testing, large sample sizes, and the like, all which slow down the development process.  If these regulations were loosened, then the speed of development would increase.

However, this is not to say reducing FDA regulations are necessarily desirable.  A cost-benefit analysis would need to be done.  Are the costs of delayed drug developments, like what the WHO complains about here, worth the benefits from the FDA regulations?  It may be, in which case the slow development will have to be accepted.  However, if the costs of the delayed development are too high and exceed the benefits of the regulation, then one would need to accept a higher risk of dangerous drugs getting through in favor of quicker drug development.

In an ideal world, we would have both quick development and safe drugs; there wouldn’t need to be a trade-off between the too.  But in this less-than-ideal world we live in everything is scarce, including time.  Every second spent doing testing and meeting regulatory requirements is one second less to spend on development of new drugs (and vice versa).

Happy Constitution Day

Via Lawrence Reed‘s Facebook page:

Happy Constitution Day! Delegates to the Constitutional Convention signed the document 230 years ago today in Philadelphia.

“The government of the United States is a definite government, confined to specified objects. It is not like the state governments, whose powers are more general. Charity is no part of the legislative duty of the government” — James Madison, Speech before the House of Representatives during a debate in 1794 over a proposal to send federal aid to Saint-Domingue (now Haiti).

Beyond Stage 1–Income Inequality

Jordan Peterson recently went on the Joe Rogan Experience and talked a little bit about income inequality.

And although he wasn’t nearly as mistaken as a committed leftist on this issue, I did sense that the two share a common, basic premise.

Deep down, Peterson seemed to agree that governments need to tackle the problem of income inequality, albeit in a way that doesn’t hurt the economy’s efficiency. Peterson doesn’t think “we” know how to do that, yet.

This is quite a popular mentality when it comes to income inequality, and utterly dominates the political left.

I call this Stage 1 thinking: Identify an uncomfortable attribute of a country’s economy, such as the large variations in economic well-being amongst all the individuals; point to research that says income inequality drives crime; call on politicians to figure it out.

Clearly, Stage 1 rests on an assumption that “government” is an institution staffed with wise, doctor-like technicians standing on-call to heal the market economy from its own inherently fatal diseases.

But are we really to be so naive as to join the chorus and implore the politicians to end their wicked timidity in solving this issue? Have politicians in the government really just sat by all these years in commitment to laissez-faire principle and let their constituents become more and more unfairly unequal? Are politicians ever reticent to jump in and interfere with the economy when they can buy some more votes?

At this blog, readers are already aware of a thousand different arguments against government “solutions” to income inequality: such things as the difference between malicious political entrepreneurs and productive market entrepreneurs; that government policies (like printing money and handing it out to banks…) are already driving income inequality; that income inequality can go hand-in-hand with rising living standards for all groups of people; that income inequality statistics are often (intentionally?) misleading; that government “solutions” are always laden with unintended consequences that will eventually justify their own set of boondoggled surgical policy procedures; and on and on…

In other words, far from contriving some ingenious plan to tackle inequality, the best thing governments could do is to drastically reduce the strain and disruptions they’re already piling onto their economies.

There are countless reasons why we object to the idea that it ought to be a politician’s role to keep a watchful eye on the levels of income inequality. But these reasons are so far outside of the purview covered by the Stage 1 radar, and unfortunately the left seems more and more entrenched in this mode of thinking by the day.

The Market Institution in Disequilibrium

The standard supply and demand model is familiar to most people, and especially to economists.  While the model serves an analytical purpose (and an important one at that, in this man’s opinion), if not properly understood in the context of the market mechanism, it leaves a false impression.  The lessons of the model are subtle and the goal of this post is to address some of the popular misconceptions about the model and what it means.

The first misconception that the model gives is that the market is an equilibrium institution; that is, the market is always (absent externalities, interference, taxes, asymmetric information, etc) in equilibrium.  In some sense this is true*, but it is not the whole story.  If the market is in equilibrium, then there is no impetus for change: no profit opportunities (for buyers or sellers).  In short, there is no need for a market.  In equilibrium, all quantity demanded is met with supply and there is no longer any need for the coordinating efforts of the market institution.  The standard supply and demand model in equilibrium is a model without a market!

The misconception that the supply and demand model suggests the market is an equilibrium institution leads people (including economists!) to conclude that when the market is in disequilibrium, whether because of some frictions (ie rigid wages), or asymmetric information, or externality, or even disaster, then the market institution cannot work (or does not work as well).  But this is a misunderstanding both of what equilibrium is and what the lessons of the model are.

Equilibrium, as I discussed above, is the hypothetical point where quantity demanded and quantity supplied meet and thus economic profits equal zero.   I stress hypothetical because of many people, again including economists, assuming this equilibrium point actually exists, it is (or can be) known, and it is just a matter of pulling the right supply/demand policy levers to get to that point.  But the equilibrium cannot be known; both in the model and in real life, it “results” from the interactions of suppliers and demanders exchanging at various prices.  When a supplier raises his prices for his good, he thinks of the profit he earns, not that the current price is below equilibrium.  When the demander consumes more than he had originally planned, it was not because he saw the price was below equilibrium, but because the consumption of one more unit was more valuable to him than the alternative uses of the resources he has to give up.  If these opportunities for personal advancement (ie profit or bargains) do not exist, as they don’t in equilibrium, then there is no desire for exchange and thus no market.

The actions of suppliers and demanders searching for profit brings me to my second point: the market is a disequilibrium institution.  The market operates at its best when there is disequilibrium.  That is the lesson of the supply and demand model.  When the market is not at perfect equilibrium, then there exist opportunities for entrepreneurs to enter the market on either the supply or demand side (I emphasize this point because many people only think of entrepreneurs as suppliers, but consumers can seek to be entrepreneurs as well).  These entrepreneurs are seeking profit (in the supply side, from selling their goods above what they value them and the demand side, from consuming either more goods or paying for goods less than they value them).  The profits these entrepreneurs seek exist only when the market is in disequilibrium.  In other words, the fact the market is not in perfect equilibrium means the mechanisms of the market institution are at their best!

The interesting thing about the conclusion that markets are a disequilibrium institution is that most of what economists call “market failure” are exactly these entrepreneurial opportunities that make the market work!  Transaction costs, asymmetric information, externalities, and the like can all be exploited for entrepreneurial gain!  Efforts to “fix” these market failures block the market mechanism, leading to actual market failure!  The evidence of efforts to fix “market failures” leads to actual market failures is obvious (and can be derived from the supply and demand model): price controls (minimum wage, price gouging legislation) lead to waste, trade barriers lead to poverty, etc.

Markets are not in perfect equilibrium.  That’s why we need markets.

*Explanation of this point will require a second blog post, which I will provide in the near future, but I do not want to distract from the conversation at this point

On Monopolies

Earlier today, my friend Vanessa texted me the following question (small edits made for grammatical purposes):

So almost dr of economics- Am I correct in thinking monopolies are bad for consumers, thus must be bad for the economy?

Vanessa’s intuition on this question is good.  As Bastiat said, we must evaluate economics through the lens of the consumer.  Below is my response to her (sorry for the weird spacing.  I don’t know how to fix it):

“Are monopolies bad for consumers?”  This depends on what the meaning of the word “bad” means.  Monopolies are output restrictiors (that is, they get a higher price by reducing the output they make), and they produce not where price equals the marginal cost of output (ie the “zero profit” level), but the highest price they can get.  So, compared to “perfect competition,” the monopoly produces less at a higher price; they are inefficient compared to the perfect competition model.  Since “bad” is a judgment call. I’ll leave that up to you.

However, there are some situations where monopolies, as inefficient as they are compared to perfect competition, are the preferable option:

1) In economics, the only way a monopoly can naturally arise is if there are natural barriers preventing entry into the market (eg. high start-up costs, geographical barriers, that sort of thing).  We call these, shockingly enough, natural monopolies.  The implication of these conditions is that multiple forms of similar firms could not exist at the same time (ie, competition).  So, breaking up of this monopoly would not lead to lower prices and more output, but no output at all!

2) Imagine we have a firm who is a major polluter of the water.  For every item they produce, they dump a gallon of waste into the local river.  Further, assume (unlike the example in item 1 above), that this firm is not a natural monopoly.  If an effort to break up this company were undertaken, and output was to increase, then one would see an increase in the pollution dumped into the river!  From an environmental POV, this the monopoly is more efficient since it pollutes less!

Just like all economic questions, the answer is ‘as compared to what?”  It’s possible, as I explain here, that monopolies may be the preferable option.  A blanket statement like “monopolies are bad” or “monopolies are good,” depends on the context in which we’re speaking (and also what “good” and “bad” mean).

Institutions Matter

While cruising around Facebook this morning, I came across this argument against immigration by one Jasen Tenney:

Illegal immigration is down over 50% with Trump and now to get legal immigration way down. Glad to see them go. Since these people are so good for an economy they can make their own crappy home country a better place to live.

Jasen’s argument is somewhat typical of many man-in-the-street arguments against illegal immigration (and immigration in general).  If immigration is good for the US, if specifically, these people are really a net benefit to the country) and not, as President Trump said infamously, criminals, rapists, and drug dealers, why don’t they stay in their own country and make it a better place?

The economist’s response to this question is simple: institutions matter.  Institutions like rule of law, secure property rights, impartial judiciary, individual rights, etc (in other words, classically liberal institutions) go a long way in producing economic growth.

A person is more likely to flourish, and help others flourish, in an area with institutions that encourage economic growth than s/he is in an area that discourages or predates upon economic growth.  Why produce in an area where property rights are insecure (eg, roving bandits can just steal your stuff, or government can appropriate anything at will)?  Even the best producer may not produce anything under such circumstances.  But, under a different institutional structure, s/he may thrive.

To return to Jasen’s question that motivated this post: why can’t these immigrants simply return to their “crappy” home country and make it a better place?  Quite possibly, because the institutional arrangements necessary to make the country a better place do not exist (or are sufficiently weaker compared to the country the immigrant was headed to)!

Economics as a Human Science

When discussing a new paper by GMU alum Vipin Veetil and GMU professor Richard Wagner, Scott Sumner makes the following comment:

[Veetil and Wagner] criticize the standard view, which is that in a large diversified economy the impact of micro level disturbances tend to balance out.

It is absolutely true that, at the macro level, micro level disturbances tend to balance out.  That is what’s wrong with macroeconomics.  All this aggregation masks the human element that is the core of economics.  At the end of the day, we are studying what Mises called “human action”, and what Adam Smith called “a certain propensity in human nature…the propensity to truck, barter, and exchange one thing for another.”  We are studying human behavior.  Economics is a social science; to aggregate so far as to balance out micro (ie, human) disturbances is to remove the “social” from the social science.  Our focus as economists should be on these social aspects, on these individual aspects and the institutions that arise to deal with the human element, of economics.  Anything else is, to quote James Buchanan, just applied mathematics; technically interesting, but economically useless.