Joining the Force!

I do not remember how I stumbled onto Jon’s blog back in its infancy when “.wordpress.” was still part of the URL. This was probably two or three years ago, and at the time I was attending Western Michigan University as an undergrad in Economics.

I think I felt a close connection to Jon because, apart from our similar viewpoints on economic and political subjects (and our infatuation with the New England Patriots!), he seemed to possess the same sort of love and respect for the study of economics that I did. And more importantly, he was talented at that very difficult task of applying the lessons of economics to modern-day fallacies in clear English!

Now add in the fact that we were close in age. In my small walks of life, it’s been tough to find a fellow my age who can carry a conversation involving economic reasoning for more than a fleeting moment before their eyes glaze over in pure boredom!

So I was an immediate fan of Jon and his blog. I’ve followed him pretty much since day 1 of his site.

For myself, I am not an economist nor am I enrolled in any economics program. After I graduated from High School, I spent some time in community college and then at Western Michigan University, actually intending to follow in Jon’s footsteps and one day pursue my Ph.D. in the field.

I will spare the readers the details of my unhappy experience in college! I am now working for my family business in the beautiful town of St. Clair, MI, where I am apprenticing to become an electrician.

Economics, though, is still a tremendous passion inside of my heart, and Jon was kind enough to bring me on as a co-author to his site. Needless to say, anything I upload to this site is my own opinion, and not that of Jon’s.

Thank you very kindly, Jon, for bringing my on to write in front of what I can only imagine is an impressively academic audience. And to the readers, I hope what I have to say will interest you!

Welcome, Nate Russell!

Today marks a big day for A Force for Good.  Nate Russell will be joining me as a co-blogger here.  Nate is a brilliant undergraduate economics student at Western Michigan University.  You can see some of his writing at FEE.org.  I look forward to having him on the team!

Coase, Transaction Costs, and Environmental Entreprenureship

Today’s Quote of the Day comes from pages 7-8 of Ronald Coase’s 1988 book The Firm, the Market, and the Law [emphasis added]:

Markets are institutions that exist to facilitate exchange, that is, they exist in order to reduce the cost of carrying out exchange transactions.  In an economic theory that assumes transaction costs are nonexistant, markets have no function to perform and it seems perfectly reasonable to develop the theory of exchange by an elaborate analysis of individuals exchanging nuts for apples on the edge of a forest or some similar fanciful example.

Many readers of Coase (including economists!) misunderstand him.  This is evident in the improperly named Coase Theorem (it’s improper in that it’s not a theorem).  In fact, Coase is so often misunderstood, he felt compelled to write the book this quote is from to clarify his point!  Coase is often understood to say that, absent transaction costs (or sufficiently low transaction costs), externality issues (eg pollution, noise, etc) can be solved by an allocation of property rights and, regardless of their initial allocation, will result in a Pareto-efficient outcome.  This is correct, but only a partial understanding of Coase.

Much of Coase’s work (and work that spun off from him, such as with Armin Alchian, Harold Demsetz, Gordon Tullock, and many others including my own) focus on the role of the market in addressing externality issues.  Detractors from Coase argue that his insights, that markets for externalities can exist only if there are no/low transaction costs, are not applicable to the “real world,” since transaction costs abound and, therefore, government intervention is necessary.  But this argument represents a misreading of Coase.  In a purely ideal world, there would be no transaction costs, but then no market would be necessary.  As Coase says in the above quote, it is in the world of transaction costs that the market is most useful!  The existence of transaction costs gives rise to firms and other means of human collaboration, which in turn reduce transaction costs, and increase the market exchange of individuals (see The Nature of the Firm (1937) for a more in-depth conversation on this point).

Expanding the idea of markets, firms, and transaction costs to environmental issues, we see the rise of “enviropreneurs” (to use the phrasing of PERC), that is people who seek out and find ways to mitigate these transaction costs in order to achieve desired environmental ends; in short, a market process of environmental concerns (for a detailed look at many different kinds of enviropreneurs, see Free Market Environmentalism for the Next Generation, especially Chapter 9).  The fact transaction costs exist is not a detriment to free market environmentalism, like the detractors of Coase argue, but rather what allows it to come about!

Like Coase (and Buchanan and many others) before me, I realize the market is not a panacea.  There may be conditions for government to get involved (namely where involvement by the firm or an individual are too costly).  But the work of Coase (and Alchian and Demsetz and Buchanan and Tullock and Anderson and many others) show us that the mere existence of an externality and transaction costs is not enough to justify intervention.

Today’s Quote of the Day…

…is from Page 10 of Ludwig von Mises’ 1949 treatise Human Action (emphasis added):

It is true that economics is a theoretical science and as such abstains from any judgement of value.  It is not its task to tell people what ends they should aim at.  It is a science of the means to be applied for the attainment of ends chosen, not, to be sure, a science of the choosing of ends.  Ultimate decisions, the valuations and the choosing of ends, are beyond the scope of any science.  Science never tells a man how he should act; it merely shows how a man must act if he wants to attain definite ends.

Far too many economists, both in Mises’ day and today, make the very mistake Mises warns against: treating economics as a science of the choosing of ends.  They consider themselves enlightened for building models that can maximize this or minimize that, and then call for said models to influence policy.  But building models like such, as Jim Buchanan said in his 1964 paper What Should Economist Do?, is the purview not of economics, but of applied mathematics.  Indeed, anyone with even an elementary level of calculus would find such a task trivially easy.

But economics is not this; it is not merely optimizing some constrained function with some universally desired “social goal.”  Economics is the study of exchange; Of competing interests for scarce resources and the institutions that arise to deal with these issues.  In short, the study of human action.

Economics as a Positive Science

Following a natural disaster, one can count on two things in the opinion pages and blogosphere: economists of all stripes decrying price-gouging legislation in a disaster and proponents calling economists immoral for questioning such legislation.

The conversation/disagreement between these two is a microcosm of a much larger discussion: the difference between the normative (subjective) and the positive (objective).

Economics is a positive science.  It deals with what is, not what ought to be.  When economists argue that price ceilings (like price-gouging legislation) cause shortages, that is a positive claim: it is a claim of what is.  This claim can be empirically tested, but it does not reflect the moral positions or suppositions of the economist.  In fact, the claim carries with it no moral implications whatsoever.  The claim price-gouging legislation causes shortages carries with it no more or less moral weight than the claim the sky is blue.

Conversely, morality is a normative science.  It deals with what ought to be, not what is.  When moralists argue that raising prices during a disaster is immoral, that is a normative claim: it is a claim of what ought (not) to be.  This claim cannot be empirically tested (although it can be tested to see if it falls into various moral criteria).  It reflects the belief structure of the person making the claim.  The claim raising prices during a disaster is bad carries with it no more or less empirical weight than the claim the sky is blue is good.

Allow me to elaborate, lest I give the mistaken impression that normative and positive sciences are opposed.  Normative and positive are not opposed; in fact, they compliment each other quite well.  Normative can prevent positive from becoming abusive (think, for example, our modern sensibilities against eugenic human breeding [normative] despite knowing certain traits are genetic [positive]).  But positive can also keep normative from being “pie in the sky,” by explaining how the world is.  For example, normative claims like “one should not kill his neighbor,” are all well and good, but the positive claim that “murder happens,” is important to know, too.  Knowing the two together brings us to the conclusion that police are needed for the few who do break the law.

To apply this reasoning to disasters, knowing price-gouging legislation makes the logistical system worse is important to know, as it can help inform better forms of aid and legislation.

In short, answering a positive claim with a normative claim will get us nowhere, but the two must be given, and understood, concurrently.

Price Gouging Legislation Means Fewer Resources for Search & Rescue

Police, like any resource, is scarce: there simply is not enough to satisfy every want and need.

Because of this simple fact, anti-price-gouging legislation has two perverse effects on a disaster.  The first, and the one economists tend to focus on, is what I discussed the other day, namely that price controls create shortages.  The other, as the title of this post would suggest, is even more of an immediate threat to life and limb.

If police resources are diverted toward price-gouging enforcement, then that means there are fewer police resources for search and rescue operations!  A cop who has to spend his time making sure merchants don’t charge too much is not spending his time looking for people, or preventing looting, or distributing goods.

Just your daily reminder: scarcity is a thing

The Short-Sightedness of Anti-Price-Gouging Legislation

Columnist Michael Hiltzik wrote a piece in the LA Times the other day calling economists’ opposition price-gouging legislation wrong “both morally and economically.”  By pure coincidence, I addressed the “moral” argument yesterday on this blog.  Allow me now to respond to a very large economic error he makes.

Hiltzik writes:

Another factor commonly overlooked by defenders of price gouging is that natural disasters tend to be (1) short-term and (2) not amenable to rapid response by market forces. If there’s no physical way to get a new supply of bottled water into some part of Houston, then allowing unrestrained price increases won’t produce a larger supply. Retailers lucky enough to have a few cases in the back room when the crisis hits, however, will reap a windfall. But who does that help, except the lucky retailers?

Strictly speaking, he is correct that natural disasters tend to be short-term, at least the disaster itself.  It may also mean that it is not amenable to a “rapid response by market forces.”  But that doesn’t necessarily mean that anti-price-gouging legislation is the way to go.

Take a look at the following diagram:

IMG_20170830_125948

Source: Price Theory and Applications, 7th Ed., by Jack Hirshleifer, Amihai Glazer, and David Hirshleifer, page 214.

This is just your standard supply and demand chart with price on the vertical axis and quantity on the horizontal.  Let’s assume that curves IS (Immediate Run Supply Curve) and D (Demand) are immediately before Harvey hits Houston.  Immediately after, demand shifts to the dashed D’ curve.  IS doesn’t immediately change because there are now frictions (ie flooded roads) preventing new supplies coming in.  The price level now rises to PI (the intersection where the D’ curve intersects IS).  This increase in price is what people call “price-gouging.”  The “lucky few” retailers who have the inventory on hand may enjoy a brief windfall.  This is where Mr. Hiltzik’s analysis ends.  What he doesn’t consider is what happens as we move away from the immediate period and into the longer run (the days that occur after the disaster).  Higher prices induce more supply to the region, especially as entrepreneurs discover ways to overcome the physical barriers preventing supplies from arriving.  And, as the Second Law of Supply says, the longer prices stay relatively high, the more elastic the supply curve becomes.  We see the development of the LS (Long-run Supply curve) in the diagram above.  If there is no interference in the market, we now see increased supply in the market (represented by the delta-S section in the above diagram).

However, Mr. Hiltzik demands a price ceiling to be imposed to prevent this higher price level.  On the above diagram, that is represented by the original price level, Po.  In the immediate run, there is no deadweight loss to the community stemming from the price ceiling (eagle-eyed readers will notice this is identical to the question from my microeconomics comprehensive exam from three weeks ago).  There is no deadweight loss, but there is a shortage, represented by area H on the above diagram.  However, what is important to note is that with the price ceiling enforced, even as the supply curve becomes more elastic and more supplies can make it into the devastated area the shortage does not disappear!  No additional supplies make it into the market despite the need!  The quantity the market supplies never shifts off of Qo.  Nota bene: This means that, so long as the demand for goods and services are higher than the pre-disaster level (ie, so long as disaster conditions persist), there is a persistent shortage of needed goods in the market! This stands in stark contrast to the increase in supply created when prices are allowed to adjust.

In short, Mr. Hiltzik’s analysis is too short-sighted.  He looks at just the immediate run (which is dire) but fails to account for anything beyond that (including the very next day).  And we are already beyond the IS curve for Harvey; the supply curve is becoming more and more elastic every day.  And it is becoming that way because of the price signal.  Even in the immediate run, anti-price-gouging legislation has major negative consequences.

I’d also like to add that the situation described above is probably a bit optimistic.  In all likelihood, following Harvey, we saw both an increase in demand (D’) and a decrease in supply (a shift from IS to an IS’ curve somewhere to the left of the IS curve).  So the shortage, H, caused by the price ceiling would likely be larger than depicted here.