The Danger of Wrong Signs

Last night, I was driving home through the I-93 tunnel in Boston.  Near the entrance of the tunnel stood one of those big highway signs that read “Accident Ahead!  All Traffic Must Merge Left.”  Being good motorists and wanting to avoid adding to the accident, everyone on the highway obeyed the sign.  This, naturally, caused traffic to slow to a crawl.  Moving ahead at about 10 miles per hour, we edged our way into the tunnel…the perfectly clear tunnel.  There was no accident.  All the debris has been cleaned up.  There was nothing to see.  Upon realizing this, the motorists naturally resumed their regular speed.

Why do I tell this story?  What does this have to do with economics?  Surprisingly, a lot.  Earlier today, we discussed how prices are signals.  A manipulated price, whether a price floor (such as minimum wage) or price ceiling (such as a cap on gas prices) act in the same manner as the aforementioned highway sign: they provide false information that can disrupt the flow of traffic (ie economic activity).  In other words, even if the fundamental economic conditions do not change (no accident in the tunnel), a signal saying otherwise still messes up the flow.

No One Promised You’d Be Happy

I had a conversation with an individual the other day regarding the price mechanism.  His argument, essentially, was that since he was unhappy with the price for the good/service he was attempting to purchase, there must be some kind of market failure and therefore the government needed to step in and impose a price ceiling.  With respect to this individual, nothing could be farther from the truth.

Prices are signals.  They are no different from a traffic light or Yield sign.  If a traffic light turns red as you are hurrying toward some destination, would you claim there was some sort of traffic light malfunction?  Of course not.

It is important to remember all resources are scarce, no matter how vital they are to life: food, water, medical care, electricity, labor, plastics, oil, trees, and even time itself, are all limited in number.  Prices adjust to reflect this: when the price of a certain good/service is relatively low, it means there is a relative abundance of the good/service.  When prices are high, there is a relative shortage.

When prices rise, the consumers of that good/service aren’t happy.  Assuming all else equal, they can now afford less of the good/service.  But that doesn’t mean the prices are wrong or there is something wrong with the system.  It simply means the good/service is now more scarce than before.  If governments impose price controls, it can encourage over-consumption of the good/service, making the shortage even worse.

Prices are signals: ignore or manipulate them at your own peril.

Why Monopolies Don’t Exist or How I Learned To Stop Worrying and Love Globalization

Writing in Forbes, Tim Worstall writes brilliantly on a recent 60 Minutes piece regarding rare earth mining.  60 Minutes tries to raise the fear of the US being beholden to the Chinese since they are a virtual monopoly (90% of the world’s supply) of rare earth minerals, which are used in all kinds of things, but most worryingly, electrical components of defense equipment.  The news report discussed how, back in 2010, China disrupted global supply lines by raising their prices.  But, as Worstall reports, their move backfired:

If rare earths are so precious, why isn’t the United States working harder to collect them? The main reason is that, for these last 25 years, China has been supplying all we could eat at prices we were more than happy to pay. If Beijing wants to raise its prices and start using supplies as geopolitical bargaining chips, so what? The rest of the world will simply roll up its sleeves and ramp up production, and the monopoly will be broken.

And what did happen? China did try to exercise its monopoly, the world did roll up its sleeves and both Molycorp and Lynas [two non-Chinese mines] went into production. Between the two of them they produce very much more than 10% of global consumption of rare earths (in fact, reasonable estimates are that they produce more than total non-China consumption of them) meaning that China simply doesn’t have that monopoly being talked of.

Emphasis Mine.

In short, China tried to exercise its monopoly power and found out very quickly a simple rule of Supply and Demand: when prices increase, it entices new suppliers into the market.

This is exactly why monopolies don’t last long is a free market situation.  They win their position by being the best (offering the best available for low prices), but if they try to exploit that, the market is swift in its retribution.

Many protectionists like to try to paint some fear that trade, for some reason, makes us beholden to foreign nations.  The exact opposite is true.  There is no “market power,” so to speak.  A monopoly does not have special powers over its costumers.  There are just firms competing with one another, and even if one has a monopoly, it must always fear competition.  That is why the only time you see monopoly abuses occur, it is done by firms that are legally protected from competition (think telecoms, utilities, police, most government services).

Protectionism is Trickle Down Economics

The opponents of free markets often refer to the concept as “trickle-down economics,” that any change is designed to benefit the richest of the rich and then prosperity would then trickle down to the rest of us commoners.  Most of us in economics realize how ridiculous such a notion is, mainly because the free market works in exactly the opposite: it’s trickle-up economics.  The majority of benefits conferred by free market transactions are obtained by the consumer, the worker, and the average person.  According to a study by William Nordhaus, entrepreneurs capture about 2% of the surplus from their activities.  The remaining 98% goes to you and I.

Interestingly enough, what is trickle-down economics is the protectionist policies many of these same people propose.  The purpose of a protectionist tariff is to protect domestic firms from foreign competition.  This, in turn, protects the firms profits.  Protectionists hope that, by protecting the firms, the firms will, eventually, hire more domestic workers, increase wages, or some combination of the two.  In other words, the protectionists hope that the unnaturally high profits enjoyed by the protected firms will trickle down to workers or the rest of us.



Quotation of the Day

is by Dr. Don Boudreaux:

The “Progressive” notion seems to be that if each individual can, on his or her own, choose which offerings of private businesses to accept and which to reject, and all without having to coordinate these choices with other individuals, people are slaves to corporations – but that individuals regain their freedom and dignity only by voting to use government power to regulate businesses, with every individual forced to abide by the ‘will’ of the majority.

As notions go, this one is among the weirdest.

Reich vs Reich

Yesterday, I blogged about Robert Reich’s Luddite concerns regarding technology.   Today, I came across a Facebook post from him regarding teacher pay.  What struck me about the two pieces is his contradictory conclusions.

Let me explain:

In the Alternet article, Mr. Reich is concerned technology is making labor obsolete, that more and more can be provided by fewer and fewer.  In the Facebook post, he lays out a logical scenario (presumably one he supports) that would lead to exactly the same conclusion he decries at Alternet.

In the Facebook post, he talks about how increasing the pay of teachers would lead to more people seeking teaching positions.  This is true: a minimum wage does indeed increase quantity supplied of a good/service.  But, as Mr. Reich says “the law of supply and demand isn’t repealed at the classroom door.”  The effect of such a minimum wage on quantity demanded is to lower it.  Higher wages mean schools will be unable/unwilling to higher more teachers.  Assuming no one shuts down and schools still want to service the same number of children, this means there will be fewer teachers educating the same number (or more) students.  These teachers would likely have to rely on technology to help them meet demand, lest they face overcrowded classrooms.  So, we can see that, by advocating a minimum wage in teaching, Mr. Reich would ultimately lead us down the path to “production [in this case, of education] by a handful” that he claims is “a recipe for economic and social collapse.”

I’ve written an email to Mr. Reich asking him to reconcile these two views.  if I hear back, I’ll be sure to post the response.

HT: Robert Murphy via Don Boudreaux.