Where’s Mine?

In my Econ 385 class on Tuesday (International Economic Policy), an excellent discussion on student loan debt came up.  One of my students asked the probing question: “Student debt is approaching $1.8 trillion.  Everyone seems to recognize this is a bubble.  Why is there so much resistance to student debt forgiveness?” 

I opened the discussion up to the class.  Lots of excellent, well-reasoned opinions were expressed.  Some argued that the schools have no incentives to keep their expenditures in check since the government is subsidizing the loans.  Some argued that the politicians do not bear the full costs of these loans, nor a default, so they have little incentive to address the issue.  Others noted that the banks would keep giving loans so long as they are backed by the government.  All of these are excellent points, which I’ll not rehash here (I wish I could take credit for teaching these students, but they were already smart before they came to my class).  

There is a larger issue I wanted to discuss, one which was not discussed in class (we were acting under the assumption, for the sake of the discussion, that forgiveness was the best option).  This issue is: who gets forgiven?

What is it about student loan debt that makes it worthy of being forgiven, but other forms of debt are not?  There’s credit card debt, housing debt, business debt, auto debt, etc.  All this debt can have the same effect as student loan debt.  True, student loan debt is larger than these other sources, but if that’s the case, that’s just an argument either for partial forgiveness, or for people to mount up other forms of debt.

If student loan debt is forgiven, the holders of the other forms of debt will wonder “why not me?  Where is mine?”  Indeed, recently a friend used exactly this line of reasoning when justifying tariffs for his own industry: “My competitors and suppliers get protection.  Why not me?”

This is the problem with most government handout programs.  Those that are designed to help a certain and arbitrary group can compel members of the out-group to seek their own rents.  If student loan debt is forgiven, business owners might lobby to have their debt forgiven (“I’m creating jobs!  if my debt is forgiven, then I can create more jobs!”).  Or automobile owners (“My car lets me get to my job!”).  Anyone could come up with various excuses.  

This rent seeking, of course, then results in wasted resources.  Resources that could have gone to productive uses are now trying to capture rents.  And there are other issues as well that I’ll not touch on here: the sanctity of contracts (will it become harder for people to get loans since the value of a loan contract will be reduced?), moral hazard problems (will former debtors seek even more debt since their previous amount was forgiven?).  These are all important issues to consider.

Expert Failure to Communicate

On Friday, Roger Koppl of Syracuse University presented his book Expert Failure at the Invisible Hand Seminar co-sponsored by George Mason University and the Institute for Humane Studies.  

The thrust of Dr. Koppl’s book is that, similar to market and government failure, experts can fail in their task as well.  Experts can give poor advice, he influenced by known or unknown biases, and react to incentives just like the rest of us.  An expert, for the purposes of this discussion, is anyone paid for their opinion (this is how Koppl defines expert in his book).

There is another aspect of expert failure which plays into the problem and that is a failure to communicate.*  Even if an expert does everything perfectly, if s/he cannot adequately communicate their message to the decision-maker, then expert failure can still result.  

This expert failure to communicate is a major issue in law & economics.  Economists are trained in statistics and empirical methods.  Lawyers and judges may not and juries almost certainly are not. In his 2009 textbook, Basic Concepts of Probability and Statistics in the Law, Columbia law professor Michael Finkelstein gives two examples were ambiguous wording by experts and misinterpretation of probabilities by juries led to false convictions (see pages 3-5).  These failures can lead to pro-prosecution bias in juries (or, alternatively, pro-defendant bias if other statistical fallacies are made).  In the two legal cases above, the convictions were overturned on appeal, but one has to worry about the error rate given the already confusing nature of statistical wording and hypothesis testing. 

In Expert Failure, Koppl discusses increased competition among experts as a means for solving expert failure.  A good expert can explain his argument in common-language and not necessarily hide behind jargon.  Competition between experts may indeed reduce this expert failure to communicate, but it ultimately rests on the head of the decision maker.  And indeed the more complicated a topic is, the more the reliance on expert opinion is needed, which increases the likelihood of expert failure to communicate.  

Ultimately, I think this all adds up to a rather strong presumption of liberty.  The more control experts have over our lives, the more likely it is for expert failure to occur.  Indeed, some of these highly complex functions, like contract issues or tort issues, may be best left to arbitrators rather than judges.  The more complex an issue is, the less one would want to centralize it.  

*Full disclosure: this point may come up in the book.  I have not read it, having ordered it shortly after the seminar

Tariffs Harm Suppliers, Too

Michael Hicks of Ball State points us to an important bit of news regarding the current Administration’s strategy of using tariffs as a billy club:

The landed cost of U.S. beans in China is currently similar to Brazilian soybeans even with the 25-percent tariff, but Chinese crushers are reluctant to take U.S. supply as they fear authorities may not approve cargoes and that tariffs could climb further.

Hicks adds:

Game Theory 101 (prerequisite is Trade 101): Reduce volatility over the long run by trading with more stable and predictable partners. Signaling through ‘crazy’ behavior, with uncertain payoffs is higher risk.

And while the Chinese may be the ones primarily reducing their imports, this can affect other US trading partners as well.  Once solid allies like Canada, Mexico, South Korea, and the EU suddenly find themselves targets of tariff aggression.  If the behavior of your trading partner’s government is erratic, you face increased costs in dealing with them.  Higher costs, ceteris paribus, mean less quantity demanded.  All firms, then, likely face costs of the tariff, not just the immediate industry facing the tariff.

An erratic tariff regime can be seen as akin to political instability.  Economic actors (buyers and sellers) like certainty.  Countries with greater political uncertainty, where things are more governed by arbitrary legislation rather than principled actions, tend to see weaker economic performance and less economic dynamism as these actors have to take into account these increased costs.

Trump’s supporters may hail his behavior as “4-d chess” and “superior negotiating,” but it comes at a real cost.

Be Skeptical of Regulations Because Knowing the Market is Difficult (Even for Experts)

Given how much money business consultants make, one would think they have pretty good insight into a given industry or market.  And sure, they may have lots of information unavailable to most people, but does that necessarily imply they are better?

All data received, we must remember, is context-dependent.  Data never, ever, speak for themselves.  Interpreting and developing models for given market structures is extremely difficult in this regard because it requires certain assumptions.

Consider the following real-world example: when the guys from Xerox (the copy machine company) wanted to start selling their machines to businesses, they met stiff resistance from consultants and financial backers.  “Why would anyone spend thousands of dollars on a copy machine when we have a perfectly good, cheap substitute: carbon paper?  Copy machines will never sell.”  Prima facie, this criticism seemed legitimate.  Firms and experts observed secretaries and typists using carbon paper to make copies for distribution.  There didn’t seem to be any demand for copy machines.

Undeterred, the Xerox guys pressed on.  They decided to give companies the hardware, toner, and paper for free up until the first 2500 copies per month.  Firms jumped at the idea.  After all, how were they ever going to use 2500 copies a month?

Well, the rest is history.  Xerox is still around.  Carbon paper is not.

Why?  What did the experts get wrong?

They got wrong the scope of the market.  Copy machines weren’t for people writing letters.  They were for people receiving and distributing letters!  The market for copy machines was for the owner who got a letter from his lawyer who wanted to distribute it to the rest of the team.  It was for the product manager who needed to itemize his costs for different departments.  Etc etc.

There is an implicit conceit in economics that we know the market, the shapes of demand and supply curves.  But the reality is, we never do.  We have only data points in a certain context which may or may not provide useful information about other contexts.  This implicit conceit becomes vitally important when we start talking about regulation or “optimal taxes,” which require knowledge of the scope and shape of the market.  Knowledge we simply do not have.

Should Economic Growth be Traded for National Defense?

One of the stronger arguments against free trade is the national defense argument: some industry may be so vital to national security to warrant its protection from foreign competition.  This justification may be easily abused, but let’s ignore that possibility for the moment.  Is it still worth restricting trade and reducing opulence for the sake of national security?

The trade-off between security and opulence doesn’t appear too clear cut to me.  Protected industries tend to become listless, stagnant, and non-dynamic.  Protected from the forces of competition, they can become complacent.  As AEI economist Mark Perry likes to say: competition breeds competence.  These protected industries may become so undynamic, so technologically backward or stagnant, that in the event of a national emergency, they are unable to handle the military needs.

Furthermore, protected industries (especially if they are subsequently subsidized) may discourage development of newer technologies that may be better suited for national defense.  Let’s say, for example, that the steel industry is vital for national defense.  Since steel is protected from competition, it can make it a more attractive investment for people given its security.  This would divert resources away from other developments that could rival the industry, say some sort of lighter metal or steel substitute.

If an industry is protected from competition and it becomes listless and non-dynamic, not only is it coming at a sacrifice for national wealth but may also be a hindrance to national defense as well if it cannot adapt to changing war needs.  This becomes deadly true if a climate of rent-seeking rather than innovation takes hold in the national economy.

In short, while theoretically, tariffs could be helpful for national defense, they could very well end up being detrimental.

Thinking about Collective Nouns

This semester at GMU, I am teaching two sections of international trade (Econ 385: International Economic Policy and Econ 390: International Economics).  In both classes, I began with a lecture (reiterated in subsequent lectures) that the focus of analysis is the individual: the government does nothing.  The decision-makers in government do something.  Ford Motor Company does nothing.  The CEO (or COO, or purchasing manager, etc) do something.

As such, these collective nouns (the government, the firm, the society, etc) can be useful shorthand so long as it is understood that the individual remains the focus of analysis.  But they can also be highly misleading.  In international trade, for example, nations do not trade.  It doesn’t make sense to talk about China trading with the US or the US specializes in X and Croatia specializes in Y (even as a shorthand).  Bobby in Boston buys a toothbrush from Li in Lanzhou.  End of story.  These transactions may be aggregated upward based on all the transactions that occur within some political boundary, but ultimately it is still individuals who trade.

When does it make sense to use a collective noun such as government or firm?  When the action taken calls for collective action.  In other words, when there is a margin being adjusted upon that the individual cannot adjust upon.

Perhaps an example will help.  Consider two men trying to load a heavy box into a truck.  The effort is not merely the summation of their two efforts.  If Joe lifts and then Richie lifts, the box ain’t going anywhere.  It is only through their combined efforts at the same time that the box is moved.  The two men working as a team adjusts along a margin (moving the box into the truck) that individually they could not do alone.

So, it makes sense to refer to a collective noun as a collective noun when there is some effort going on that only the collectivity can achieve.  Only Ford by its nature as a firm man design, manufacture, market, distribute and retail cars. It is the collective action taken by many individuals whose individual contributions are hard to separate from the collective goal; where anyone individually working alone would face costs too high to make the action occur.  The team of Joe and Richie does and Joe and Richie cannot alone do.  It makes sense to refer to them as a team.

The way international trade is discussed and taught is largely misleading if one is not careful about this subtlety.  International trade remains, ultimately, a microeconomic event.

So Much for “Draining the Swamp”

In a recent tweet, Alan Tonelson argued that Veronique de Rugy’s warning against tariffs is actually an argument for tariffs.

His argument that downstream tariffs should be approved every time upstream tariffs are approved is weak, both economically and ethically.  But such a scheme would also undermine the supposed goal of the Trump Administration to “drain the swamp.”  Opening up the possibility of protections for downstream industries will increase the lobbying by said industries to get protections.

Furthermore, we run into an issue of who, exactly, are “downstream” industries?  Economics teaches us there are countless unseen connections we may be unaware of.  For example, let’s say a tariff on steel and washing machines causes people to buy fewer washing machines: people use more laundromats.  In turn, they now refloor the old laundry room with hardwood rather than tile.  Tile manufacturers would be injured here.  Would they be eligible for protections?  They’d certainly try.  And subsequently, the hardwood flooring manufacturers would lobby.  As would, then, the distributors, the loggers, the facemask and chainsaw manufacturers, etc etc.  There is no logical stopping point here.

Rather than drain the swamp, this scheme would vastly increase it.