Quote of the Day

Today’s Quotation of the Day comes from Armen Alchian and Harold Demsetz 1973 article in the Journal of Economic History, The Property Right Paradigm (Original emphasis):

Economics textbooks invariably describe the important economic choices that all societies must make by the following three questions: What goods are to be produced?  How are these goods to be produced?  Who is to get what is produced?  This way of stating social choice problems is misleading.  Economic organizations necessarily do resolve these issues in one fashion or another, but even the most centralized societies do not and cannot specify the answer to these questions in advance and in detail.  It is more useful and nearer to the truth to view a social system as relying on techniques, rules, or customs to resolve conflicts that arise in the use of scarce resources rather than imagining that societies specify the particular uses to which resources will be put.

Since the same resources cannot simultaneously be used to satisfy competing demands, conflicts of interest will be resolved one way or the other.  The arrangements for doing this run the full gamut of human experience and include war, strikes, elections, religious authority, legal arbitration, exchange, and gambling.  Each society employs a mix of such devices, and the difference between social organizations consists largely in the emphasis they give to particular methods for resolving the social problems associated with resource scarcity.

These two paragraphs, which begin their relatively short but interesting article on property rights, are an important discussion of the economic problem: when faced with scarcity, how are resources allocated?  The three questions they discuss as leading off economic textbooks are ways of addressing the economic question, but can be misleading to the young economist or layman since they imply that the answers are conscientiously chosen can be known.  However, as Hayek teaches us, that sort of information is highly decentralized and extraordinarily context-dependent.  So, the real question is what techniques are used to allocate these resources.

Some techniques are better than others in differing contexts, and in a near-future post (inspired, in part, by this article) I will be expanding on one particular technique, the allocation of property rights.

Illegal Immigration Follows The Laws of Supply and Demand. Who Knew?

Writing at CATO, David Bier has an excellent article on illegal immigration.  The whole thing is worth a read, but there are two particular points I want to focus on:

Border patrols and deportations were increased to stop the flow of unauthorized immigrants, but they had little effect. “I’ve no doubt whatever that the man finally deported is back here,” the Assistant Secretary of Labor told the Times. “Easily 50 per cent of them return.” In July 1929, Congress gave in and provided “amnesty” or citizenship to the undocumented immigrants. Then, the Great Depression dried up demand for workers, temporarily resolving the issue.  When the economy finally picked up again following World War II, illegal immigration returned.

Illegal immigration finally nosedived after the housing bubble burst, and the illegal population shrunk from 2007 to 2014.

[Emphasis Added]

Lest I be accused of cherry-picking, the trend of immigration tapering off during recessions and increasing during booms holds throughout history (obviously, the more severe the recession, the more pronounced the decline in immigration).

This pattern is exactly what one would expect: when the economy is growing, labor demand is growing, and the wage rate (the cost of labor) is increasing, more supply (immigration) is attracted to the market.  When the economy is shrinking, labor demand is shrinking, and thus the wage rate is falling, supply is repulsed from the market.  Just a simple analysis of the labor market.

Harold Demsetz, Emergent Order, Property Rights, and Poverty

In his 1967 AER article Toward a Theory of Property RightsHarold Demsetz discusses (among other things) the emergence of property rights among the Naskapi, a tribal group located on the Labrador Peninsula.  The whole paper is worth a read, but it is on this section, located on pages 350-353 in the AER, I want to focus this blog post.

The thesis of the referenced section of Demsetz’s article is:

It is my thesis in this part of the paper that the emergence of new property rights takes place in response to the desires of the interacting persons for adjustment to new benefit-cost possibilities. [Emphasis added].

He demonstrates this discussing the change in property rights regime the Naskapi experienced before fur-trading (communal hunting) vs during fur-trading (privatized hunting and barriered hunting grounds).  What’s interesting about this example is the change in the property rights were not imposed on the Naskapi by their European trading partners, nor the governments of the Naskapi.  Rather, the property rights regime emerged on its own in reaction to the new set of incentives facing the Naskapi: whereas before hunting was done for food and not for trade, the cost of enforcing any private property rights in the forest were prohibitively high.  Following the introduction of the fur trade, the cost of enforcement now fell relative to the benefits received from hunting and this new property rights scheme emerged.

While Demsetz is writing exclusively about property rights and externalities, his article also provides us with interesting insights into the emergence of other institutions beyond property rights.  The benefit-cost analysis performed by the Naskapi that ultimately lead for them to alter their property right institutions likely also shapes the development of other institutions: market and market enforcement mechanisms, social taboos, societal hierarchies, languages, laws, religion, and other institutions.  This provides us with a framework to explain why some institutions work well in some places but not others and why attempts to impose institutions from the top-down tend to end in disaster.

Furthermore, Demsetz’s insight could provide us with a useful framework for considering foreign aid and poverty alleviation (both domestically and in the US).  When aid is targeted (for example, providing all mosquito nets to villages in Africa or food stamps that can only be used for milk purchases), it tends to be an inefficient method of solving the problem the imposer is trying to fix.  The relative cost or preference of, say, milk may be low for the person receiving their stamps vs, say, a satellite dish.  They’ll sell their aid and use the funds to buy whatever they wanted anyway.  This will not change unless their relative price or preference situation changes.

This also suggests to us a problem with tying aid or other issues to institutional changes.  For example, if the US were to provide aid to North Korea on the condition they alter their property rights regime, it may lead to resistance or waste (or corruption: a nominal change in institutions without any real change).  Rather, it would be better to increase trade with the nation and increase the benefit to them to adopt new property rights and institutions.  This will lead to far less resistance in the nation.  Another interesting implication of this is embargos and sanctions will have the opposite effect from those intended: not trading with a nation because of human rights violations or because they’re communist is likely to entrench the regime, not weaken it.

One final point to make that Demsetz emphasizes as well is these institutional changes are not quick.  They take time to happen.  The Naskapi property rights change appears to have taken about a generation or two to fully materialize.  This is because institutions are, rightfully so, difficult to change even by the participants themselves.  Institutions exist by reason and tradition, and short-term fluctuations aren’t likely to change them.  The fact that these institutions take so long to change is a factor of the fact the variable that is the impetus of change needs to show that it is not a temporary fluctuation but rather a new norm (think of it like this: if your water bill rose one month due to an abnormal drought, you wouldn’t be running out to rip up your lawn and put in a rock garden, would you?  However, if the drought lasted many years (or you live in Arizona or California where such conditions are normal), you just might).*

A Theory Toward Property Rights is a very interesting paper, both for considering property rights but also exploring how we think about emergent order.

*I hasten to add that this is not meant to imply the changes in institutions are a conscience effort.  They slowly emerge through common law, through interaction, through individual decision-making.  Just as each person learns to walk, from a tipsy toddler to a confident adult, without any conscience efforts to change one’s gait, same with the institutions.

The Myth of Unfettered Trade

By its opponents, free trade (I’d include free markets, but I’d be repeating myself) is often called “unfettered trade.”  Such a term represents a fundamental misunderstanding of trade.  Trade is always fettered.  Competition, both from firms and from consumers, fetters trade because trade must be mutually beneficial.

Since trade must be mutually beneficial (since, if both parties don’t benefit, the trade would not occur), then even monopolies face fettered trade.  Even though monopolies are, in technical terms, price-makers (that is, the firm can choose what price it operates at), this does not mean they can charge any price and get the same results.  Firms face downward-sloping demand curves from their customers.  This means that, as price rises, quantity demanded falls (and vice versa: as price falls, quantity demanded rises).  If a monopolist charges a price too high, it may not maximize its profits (think of it like this: which earns more: selling 1,000 units for $1 each or 10 units for $70 each?).  Further, if a monopolist harms their consumers, their consumers can ultimately choose not to consume the product and seek substitutes or other alternatives.  These forces constrain the firm’s actions; in other words, these actions fetter the trade.*

The phrase “unfettered trade” is used for justification for government intervention in trade, but the argument is a red herring; a false representation of market forces.

*By the way, the opposite analysis holds, too: if a buyer offers too low a price, the seller may not choose to sell and so on.

Predatory Pricing and International Trade

A classic piece of industrial organization literature is John McGee’s 1958 article in the Journal of Law and Economics Predatory Price Cutting: The Standard Oil (NJ) Case.

In the article, McGee looks at price-cutting allegations leveled against Standard Oil in the early 1900’s. He examines the evidence of the case but also lays out a rather brilliant critique of price cutting as an effort to secure/gain monopoly power in a market. In short, he logically shows that price cutting is, by far, the least effective means of accomplishing this. It tends to be far more devastating to the price-cutting firm and, if the market is competitive, such price cutting could go on for years and years. It is far cheaper to simply buy up competition.

Dr McGee’s analysis should give us pause when considering “dumping” allegations in regard to international trade.  Dumping is a form of predatory pricing: manufacturers exporting goods to foreign markets and selling well below cost in order to grab market share.  As Dr McGee logically lays out in his article, predatory pricing tends to be extremely costly to the predator.  This could be why governments need to subsidize the firms in order to perpetuate the scheme.  However, as GMU economist Don Boudreaux points out in this blog post, subsidies harm the economy as a whole, while enriching the few who receive them.  Assuming China is subsidizing exports for the purpose of monopolizing highly-competitive markets, China is opting for short-term gains for firms by socializing the losses from the predatory pricing behavior on the off-chance they can monopolize a market.  Dr McGee’s analysis in the article indicates this is an extra-risky strategy (mergers and partnerships with US firms would be a far more effective way of accomplishing this goal).

Upgrades

I apologize with all the different looks the blog has had over the past few days.  After a year and a half of the old stuff, I figured it was time for a new look.  I am happy with the way things look now, so I shan’t be changing things.  At least for a while.  Thanks for your patience.

Why Can’t Success Just Be Success?

The above video is a Foot Locker ad featuring Tom Brady.  The ad takes a humorous swipe at Deflategate, but there is a larger issue I want to discuss, specifically this quote:

“Just because something’s great year after year doesn’t mean something’s going on.”

In the context of this ad, Brady is talking about Deflategate and the other scandals that have faced the Patriots over the past 10 years.  However, in a larger context, this statement is equally relevant.  People often point to inequality and success as proof “something’s going on.”  Peter Thiel pointed to the US’ trade deficit as proof “something has gone wrong.”  Income inequality is pointed to as proof capitalism is broken.  “Windfall profits” are proclaimed evidence of unfair business practices.  In baseball, accusations of steroids follow a player’s successful as sure as night follows a sunset.

To be fair, these inequalities may be a sign of something amiss.  But they alone do not mean something is amiss.  With respect to Frued, oftentimes success is just success.  A baseball player becomes successful because of hard work and luck, just as a businessman becomes successful through hard work and luck.  Their successes (higher home runs/higher profits) are not because of nefarious dealings but the natural end result of their efforts.  The fact they outperform their colleagues/competitors is a sign what they are doing is working, and should be encouraged, not deterred.  Legislation designed to go after successful people simply because of their successes (re-distributive taxation, windfall profit tax, tariffs, and the like) can and will have the effect of driving down competition, or forcing it away from maximizing gains into more risky and less socially beneficial areas of competition (for example, see Armin Alchain and Reuben Kessel’s 1962 paper Competition, Monopoly, and the Pursuit of Pecuniary Gain.