Warts and All

Yesterday was Opening Day for the Washington Nationals at Nationals Park in Washington, DC.  Some 40,000 people made their way to the Waterfront to see the Nationals take on the Miami Marlins.  At the corner of N and First Streets, SE, the traffic and pedestrian crossing was a nightmare.  People were flooding out from the Metro headed to the Park.  The crossing guards could barely keep order, and both cars and pedestrians were getting frustrated (this effort was compounded by the fact the traffic lights were still on, often contradicting the guards’ orders).  It was, in short, a charlie-foxtrot.  One might even say it was a government failure.

Although the government’s solution to the pedestrian issue was less-than-ideal, it would be incorrect to immediately jump to the conclusion that a laissez-faire approach would automatically be better; that a “free-market” approach would be better than the government approach.  The free-market approach would come with its own set of problems (perhaps, for example, since pedestrians have the right-of-way, tens of thousands of people would have crossed the streets and no car would have been able to move for hours).  It’s indeed possible that the free-market approach would have generated a worse outcome than the government approach.

Harold Demsetz (among others) warns us against the Nirvana Fallacy; that is, assuming a different (often preferred) method would not contain the same flaws (or flaws at all) from the current method.  We see this very often in politics (eg socialism), but free-market supporters can run aground of the fallacy, too.  Markets, just like governments, are populated with humans with the same foibles.  The incentives are different, to be sure, but markets can fail, too.  One mistake I think far too many market supporters is to assume that markets are not only perfectly efficient (the “efficient market hypothesis”), but also they instantly adjust.  That is not the case.  By arguing, as many do (especially many anarcho-capitalists) that the market solution is always the superior solution is incorrect for the exact same reasons that socialists arguing the government solution is always superior to the market solution.

Markets are extremely powerful.  Generally speaking, they provide excellent results.  But markets are just one of our institutions, and they function best when search and transaction costs are minimized.  For certain problems, there may be other institutions out there that would perform better.

Reality vs Perception

Over at the Liberty Law Blog, Prof. John McGinnis has an excellent piece on legislating.  He writes (emphasis added):

A Nebraska Senator has introduced a bill to require photo identification for voting, not because voting fraud is an actual problem, but because Nebraskans perceive there to be such fraud, whether it exists or not.

If voting is a fundamental right protected by the Constitution, legislation should burden its exercise only to address actual harms, not some people’s impressions of reality.  Thus, the legality of these laws should turn on the question of actual voter fraud and the utility of voter identification in curbing it.

I agree with the good professor, and think this rule should apply not to just legal matters, but economic matters as well.  An argument I’ve heard more and more in recent months in favor of protectionism from people who are nominally free market is that, with our current trade policy, it creates the perception of unfairness; it creates the perception of China “stealing jobs”, of a “hollowing out of the manufacturing base,” of “economic stagnation.”  It doesn’t matter that the data say otherwise, but the perception is there and that’s why Trump won.  Therefore, they conclude, we need some trade barriers to keep the protectionists at bay.

This argument is very similar to the one McGinnis addresses: there is this perception, so therefore we should pass legislation to combat the perception, even if it infringes on people’s rights.  For the same reasons McGinnis rejects the argument in the link, I do so here: legislation that burdens the free exercise of a right should only address an actual harm, not a perceived harm.  Given that free exchange is a fundamental human right, the infringement of such requires the burden of proof to be on those calling for tariffs; they must demonstrate actual unique and substantial harm, not just the perception of it and demonstrate the usefulness of their proposed actions in addressing the harm.*

In short, the perception of harm is not enough to justify the infringement of the right to trade.

*Notice I said “actual unique and substantial harm,” instead of just “harm.”  The reason for this, which will be addressed in a forthcoming blog post, is because any action whatsoever can conceivably harm anyone, but that alone is not grounds for outlawing it.

Can a Trade War Create Free Markets?

Craig Walenta’s comment on this blog post at Cafe Hayek got me thinking.  Craig says:

“Well they’re [tariffs] also a way to maybe compel a foreign country to cease its protectionist activities they’re engaging in.”

Craig makes a common (at least among some free market supporters) argument for tariffs on the grounds of promoting free markets, but I’m not quite sure it’s a likely outcome.  The reason is incentives.

Governments tend to like tariffs for multiple reasons, and among those are: 1) they’re vote-getters, 2) they generate tax revenues.  If we assume governments, like all organizations and people, are self-interested and rational, then the case for tariffs becomes obvious: it’s a relatively cheap (in terms of political effort) method of promoting one’s political power.  It is not in the interest of the government to reduce tariffs.  Reduction in tariffs would either mean an increase in other, perhaps less politically safe, taxes or cutback in spending (assuming this to be revenue neutral) and the politician himself would need to look elsewhere for votes.  When a foreign nation enacts protectionist measures against a country, it is unlikely they would respond to removing their tariffs because they face the same incentives as the host nation.  Further, the host nation has no incentive to reduce tariffs even if it “wins” the trade war.

In short, I strongly suspect an “arms race” will develop among the competing nations, one which will only lead to higher tariffs and lower standards of living.  Just as war cannot promote peace, a protectionist trade war cannot promote free markets.

Benefits to Trade

Over at Cafe Hayek, Don Boudreaux shares some charts I made for him as his RA.  One of the charts is the Fraiser Institute’s Freedom to Trade Internationally Index compared to GDP per capita (a proxy for individual wealth) from the World Bank.  In the charts Don has, there is a linear regression line.  Below, I have the same graph, but with an exponential trend line:


This trend line fits better than the linear one.  This suggests an interesting relationship: the relationship between the freedom to trade and individual wealth is exponentially positive.  In other words, the more free the people of a nation is to trade, the faster and faster their wealth grows!  The implication of this is even marginal tariffs could have a substantial effect on economic activity and wealth.

Other than putting together the graph, I haven’t played around with the data too much, something which I aim to remedy in the near future.  But, at a first look, this suggests a strong positive relationship between trade and economic well-being, and certainly hurts the case that trade, as Trump has put it, is “beating us to a pulp.”

The Myth of Perfect Allocation

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


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.

What Human Action Can Tell Us

As Ludwig von Mises taught way back in 1949, economics is, above all, the study of human action. The two main assumptions of economics back this up: 1) economic actors are rational (that is, with the knowledge they possess, they are working toward some goal), and 2) economic actors seek to improve their conditions (that is, their goal is improvement of wealth, utility, happiness, etc rather than the reduction of such).  Essentially, these assumptions boil down to: people, generally speaking, know what they’re doing (as the incomparable Walter Williams likes to say: “never assume someone is stupid until they prove themselves otherwise”).  One should deeply consider these two assumptions as what follows is derived from them.

The study of human action in the present can provide us with important insights. In this author’s opinion, I fear this study of present conditions is not done enough by economists.  Many economists focus too much on the future (what will the effect of this policy be, etc) rather than an analysis of the current situation.  Current-situation analysis can provide us insights into the future, too.  For example, an oft-heard defense of minimum wage is the “efficiency-wage theory,” that is, employers, when faced with a mandatory higher wage, will increase the productivity of their workers through training or other programs in order to meet the new wage.  Any lost profits from the higher wages would be offset by the higher profits from the increased productivity.  However, given the two assumptions mentioned in the first paragraph, we can look at the current situation and question the validity of the prediction: if employers could already increase productivity (and thus their profits) of workers, why aren’t they already doing it?  From this point, this current-situation analysis, should the conversation begin, rather than the future-situation analysis of a post-minimum wage world.  We should be further skeptical of any answer to the current situation question that involves tossing away one or both of the two main assumptions discussed in the first paragraph.

The current-situation analysis is also helpful in understanding why institutions and law pop up where they do.  Why was a private-property rights regime adopted in one area but not in another?  Why do people in New England act a certain way compared to people in North Carolina?  And so on.

The current-situation analysis prevents us from falling into the pretense of knowledge problem.  For future-situation analysis, there can always be models or logical steps that can come to all sorts of conclusions (eg, the efficiency-wage theory and minimum wage example earlier). Current-situation analysis helps us avoid this mistake.

An Important Caveat

The above discussion holds most true when the acting parties feel the majority of costs of their actions.  In situations where this is not true, where the costs of an individual’s actions are diffused over a large group that may not even involve the actor himself, it becomes harder to derive a clear picture from his current-situation actions.  For example, voting.  With voting, and politics in general, the cost of the action (or, more importantly, being wrong) is diffused among a large group of people that may not include the actor himself.  For example, if a voter votes to increase minimum wage, he is not paying the cost for such an action.  Rather, he is (potentially) compelling others to do his preferred action with no or minimal cost to himself.  His action is consistent with our two assumptions, but it is not a clear picture of what his preferred action is.  In other words, we cannot draw a conclusion from his action here as we could with the businessman in the above example.  For this reason, we should be careful drawing conclusions from political actions. Rather, his actions where he bares the brunt of the costs gives us more information.

Enriching the Common Man


This is a picture of a common programmable coffee maker.  For about $60, you can have one of these nearly ubiquitous items.  However, 100 years ago, these items were not available.  Those rich enough to afford servants were able to have coffee ready for them when they woke up, but many Americans went without this small luxury.  However, since this invention came about, ordinary Americans have been able to have what had only previously been available to the very rich: hot coffee ready for them when they awoke in the morning.  With other programmable devices like slow-cookers, common Americans can have a whole breakfast waiting for them!  The luxuries of the 20th Century uber-rich were commonplace not 100 years later.

This marginal improvement in living standards reminds of of a very important fact: most innovations do not benefit the wealthy, but rather the poor.  Indoor plumbing did not benefit the wealthy; it just replaced running servants with running water.  It was the great masses of people who benefited from indoor plumbing; those who did not have the running servants.

It’s easy to dismiss capitalism and innovation as only benefiting the rich, since they are seen to be the ones who gain the most monetarily from it.  But to do so requires dismissal of the unseen mass of benefits accrued to the poorest, to the common man.  These benefits are unseen not because they are hidden, but rather because they are so obvious numerous as to not warrant noticing (similar to how one blinks or breathes without conscience effort for either).

Ruminations on Central Planning

Since the semester ended, I have had some more free time on my hands to read for pleasure, not just for work.  One of the books I picked up was Don Lavoie’s 1985 book Rivalry & Central Planning: The Socialist Calculation Debate Reconsidered.  While I have only just started reading it, it’s an interesting reexamination on the age-old central planning question.  What follows are two thoughts of mine on the same matter.

Continue reading

There Is No Correct Answer

On this Cafe Hayek post, commentor Chris Killingsworth asks:

What is the correct free market solution, then, for workers in towns around the country who are left jobless en masse when a major local employer packs up and moves overseas?  Go back to school with the money they have hopefully saved up, then move to ‘where the jobs are’?

This question represents a fundamental misunderstanding of what a free market (or market-based economy) is.  Free market is a term used to describe the voluntary interaction of peoples.  As such, each person, using his unique knowledge of time and place, will map out the best way for him/her to respond to different situations.  In short, there is no “correct free market solution,” for any given situation.  For any given situation, there can be millions or billions of “correct” solutions, each one just as valid as the next for differentiating individuals.

In short, Mr Killingsworth’s question is unanswerable because there is no one answer.  His second sentence may work for some, but not all.  Others may make different choices.  It is impossible to know, irresponsible to guess, and unbecoming as an economist to offer “one size fits all solutions.”

Remember Thy Broken Windows

Taking credit for about 1,000 jobs “staying” in Indiana from a Carrier plant’s decision not to move to Mexico, President-elect Trump proclaimed “Companies are not going to leave the US anymore without consequences.  Leaving the country is going to be very very difficult.”  This statement should strike fear into the hearts of liberty-loving, crony-capitalist hating people everywhere. Unfortunately, many of praised it as a step in the right direction, that the $7m in tax breaks is a “good deal.”  However, this is anything but a good deal.  It sets dangerous expectations that will cost Americans jobs, investments, and wealth.

Let’s start with the explicit threat in Trump’s words.  Firms, that operate or expand into the US, will lose their freedom to make business-effective moves.  This will increase the relative cost of doing business in the US (since the cost of relocation outside the country is now higher), making operating outside the country, not expanding operations at all, or automating, more attractive options. Firms will be far more cautious about their operations, thus reducing the total number of potential jobs and investment in the US.  This is the “unseen” effects of Trump’s threats.  The 1,000 jobs “saved” could come at the cost of many more unseen jobs “lost.”

Another side effect (which flies in the face of one of Trump’s campaign promises to “drain the swamp”) is this move will increase lobbying.  As Justin Wolfers tweeted: “Every savvy CEO will now threaten to ship jobs to Mexico, and demand a payment to stay. Great economic policy.”  There is now an increased incentive for firms to lobby government for funds should they want to leave or relocate.  Given lobbying is certainly an arms race, firms will pour more money into lobbying and less into R&D or their employees.  To be sure, this is already a norm in the US, but Trump is merely perpetuating and expanding it, as opposed to ending it.

So, we have reduced investment into the US and increased interest in lobbying, both of which are economically inefficient activities.  Seems like quite a steep price to pay to give a temporary stay of execution for 1,000 jobs.