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Signs of Rot

Milton Freidman often drove home the point that economic freedom was a necessary component to all the other freedoms, such as political and religious freedom.  The idea being that the freedom to choose is a vital element of being human and that economic freedom is the canary in the coal mine of all the freedoms.  It is the one that is easiest to curb or eliminate and so a society that curtails economic freedom is either on the way to curtailing other freedoms.

Of course, not all freedom results in good actions on the part of those who yield it.  The converse to Friedman’s point-of-view that economic freedom is required to have a good society is not true (nor would Friedman have espoused it) – just because you have economic freedom doesn’t mean that people will necessarily be wise in using it.

Labor unions and their interactions with management of both the steel and auto industries are excellent examples of stupid reasoning on both sides.  I personally saw, albeit from the outside as teenager, the excesses of the steel industry.  During the ‘fat’ times, union leadership secured all sorts of benefits from a management that was eager to make huge concessions on the perks each worker would have rather than rock the boat and risk a strike.  I knew steel-workers (fathers of my friends) who had 13 weeks of paid vacation each year, received a new pair of boots every two weeks, and who enjoyed other benefits that seem as extravagant to me now as they did then.

Similar excesses were rampant in the auto industry and, while there is no reason to go into details here, as they are amply documented elsewhere and in many places, the resulting unsustainability led to the movement of these jobs from the ‘rust belt’ and into the right-to-work states all throughout the south.  One need only look at the hollowing out of Detroit to appreciate the catastrophe that occurs when freedoms are abused.

Both sides of the equation, management and labor, thought little of sustainability and the long-term impact their actions would have.  They were living high on the hog and didn’t see a reason that the party would ever end.

I see a lot of similarities between these sad, old episodes and the current culture surrounding higher education.  Case in point is the news that accompanied the resignation of the president of Michigan State University amid the Larry Nassar scandal.

Much of the abuse attributed to Nassar occurred around the MSU training facility and, for better or worse, President Lou Ann Simon was pressured or felt that she needed to step down.  I am not interested in picking over the scandals, lurid details, and rumors and I only bring it up as the confluence of these events allow a glimpse into the severance packages afforded executives in big edu (we have big tobacco, big oil, and big pharma – why not big edu).

According to an article entitled Contract for departing MSU president includes faculty job, lifetime perks by Elizabeth Joseph and Joe Sterling of CNN, fabulous benefits will redound to Dr. Simon upon her resignation.  She will continue to make her three-quarters-of-a-million dollar salary for one year and over $550k for each year following, even though she will be in a rank-and-file academic role; she’ll have her health care covered for life; and she’ll get additional perks that make you shake your head.  And all of this under the umbrella of a public institution primarily funded by the tax-payers of Michigan.

Let’s take a step back and remind the reader of some of the more interesting facts about big edu.  First is the cost of tuition.  The figure below shows the average tuition costs (according to the College Board) from 1970 to 2017 in actual year dollars (i.e. raw dollars paid in the corresponding year not adjusted for inflation).

A rough fit of the data suggests that private tuition costs have risen by at least 5.2%, compounded annually, over that time period.  More surprising is the fact that public tuition costs have risen faster, by approximately 6.3%, over the same span.

A more careful analysis over the smaller time span from 2000-2017, a period in which inflation has held steady, on an annual basis, at around 2%, produces the estimates that private and public tuition have grown at rates of about 4.4% and 4.9%, respectively.  These are over twice the rate of inflation and it is not at all clear (as both a parent of college-aged children and a teacher of college courses) that the quality delivered during this time period follows this incredible rise cost.

So if the extra costs are not representative of value-added just where is all this money going and, equally troubling, where does all the money come from?

The answer to the second question is perhaps easier to fathom.  It seems that we have developed a two-headed beast of high demand and easy money.  The current system convinces graduating high-school students that college is the only option; four years of fun and intellectual stimulation will assuredly-lead to the good life; ignore the monumental student debt that you will acquire.  Advertising, in all its myriad guises, emphasizes the glamour of college life.  And a national program of student loans makes money easy to get and easy to spend.

On the other side of the equation, universities almost never say no to federal dollars (there are some that do but, on a percentage basis, they essentially add up to zero).   And, if the money that is pouring in doesn’t go to improving the educational outcomes in any substantial way, then where does it go? Well, to new administrators, student liaisons, shiny new facilities and the like.  None of these ‘improvements’ have a data-driven rationale or justification, no hard studies bear out their impact into student outcomes but the money has to be spent somehow so why not spend it somehow.  (Note that I leave of the alarming trend that more and more students are being taught by adjunct professors; this is just bitter icing on bad cake).

So in the end, I am forced to conclude that, although the residents of the ivory tower will take umbrage at the comparison, they are just as stupid, short-sited, and greedy as the steel-working fools I grew up around.  Part of me hopes I live to see the day when the bubble bursts; part of me hopes I will be comfortably and cozily dead before it does.

 

 

The Worst Economic Myths

New Years:  a time to reflect; to look back and to look forward; to greet the future with hope; to make resolutions to better one’s life.  In short, starting the new year with a new perspective.  And perhaps no other mode of thought needs a new perspective as much as common beliefs about economics do.  So, in keeping with the theme of this month’s issue of Blog Wyrm, this article will look at the top 5 myths or misconceptions that still plague the how we think about the dismal science.

5.  Wealth is a Zero Sum Game

It is all too common to hear even highly-educated people claim that the wealth of the rich was obtained and is built on the backs of the poor.  And, unfortunately, there are some cases where this is actually true – isolated and small cases when measured against all of human progress – but, nonetheless still there.  But, as discussed in the earlier post A Provocative Question, it is an unsupportable position that all wealth is based on zero sum game.  Additional proof, beyond the mere standard of living increases discussed in that post are the fact that these improvements are enjoyed mostly world-wide.  Consider, Ukrainian hackers who hold your computer hostage, Nigerian scammers who go on phishing expeditions, or South Korean gamers who ‘pwn a noob’ in Call of Duty.  None of these characters can exist in the world without having access to computers, electricity, and a culture of specialized labor that allows them to hone their craft.  It is undeniable that wealth is created.

 4. Things Have Unique Values

Closely related to the zero sum fallacy, another puzzling misconception that is widely held is the notion that a good, service, or commodity has a fixed value that can be assigned by the market or that is agreed upon in a transaction.  As pointed out the in the previous posts Value and Trade and Candy and Wealth, value is strictly in the eye of the beholder.  In any type of transaction, financially-based or strictly bartered, each side gains from the transaction.  This must hold, else the transaction would never happen.  When party A agrees to pay $10 for an item and party B agrees to take the money in exchange, both sides or gaining (or, at least, perceive that they are gaining).  That means that party A values the item greater than the $10 he is willing to pay just as party B values the $10 more than the item he just delivered.  The prices found in any market, for example a grocery store, are simply the shorthand for the seller saying that he values the monetary value listed more (not equal to) the item in question.  The item for sell must be substantially less in his eyes than the price listed, else why would he go to the trouble of displaying, listing, and ultimately exchanging it.

3. Any Activity is Good for the Economy

It is often said by people either citing John Maynard Keynes or by those purporting to be Keynesians that any economic activity is good.  They will say things like: ‘In a time of crisis, get people digging ditches even if you have them filling them back up again.’  This myth is brilliantly debunked by Frederic Bastiat in his refutation of the Broken Window Fallacy.  As is often the case, subtle logic, such as Bastiat employs, is often easier to understand when carried to an extreme as is done in the post Save the Economy: Nuke a City.  There it is argued that if destruction were really embraceable as a valid economic strategy, then any society should always be destroying large swaths of property in order to ‘stir the pot’.  Interestingly, many of those same ditch-digging proponents who think arbitrary activity equates to an economic stimulus are the same people who are most vocal about the wastes of war.

2. Licensing Protects

This myth is so pervasive, insidious, and just plain wrong it is hard to even know where to begin.  Taken almost as a doctrine of religious faith, most people believe that licensing by the state protects consumers.  But, as a critical examination of Airbnb, ebay, or any another of the myriad services offered in the internet reveals, human interaction can be dependable done with a minimum of government oversite.  And while these endeavors aren’t perfect can an honest person say that he is somehow worse off engaging these goods and services than he would be from those offered in the highly-regulated sectors?  Compare the rider experience of Lyft to that of conventionally licensed taxi-cabs.  Does the licensing really benefit the consumer? (See Medallions for Freedom? for a look at just what licensing does to the taxi-cab owner.)  More often than not, licensing and regulation is used as a barrier to entry that protects entrenched interests that lobby the government from new-found competition.  Just ask the monks of Covington Louisiana who were prohibited from selling coffins that undercut the ridiculous profits of funeral homes (Of Monks and Coffins).  And finally, there is ample evidence that lawmakers using licensing for their own ends, ensuring that their interests are protected from scrutiny while keeping all other out (Gunless and Gunrunners).

1. Socialism Works

Closing out this list is a myth, whose scope and damage dwarfs all the others by leaps and bounds: the myth that socialism works.  One would think that all the required evidence to debunk this myth is available just by looking at the failure of the USSR, Cuba, or Venezuela.  Unfortunately, the misery of the hundreds of millions of people who have suffered and died under this economic scheme over the past century or so is a dark testament to just how wrong, and yet how eternally appealing, this idea is.  Unfortunately, its adherents are willing to look past the enormous body of empirical evidence offered by these failed states and the experiential accounts of the victims and survivors.  Neither are they swayed by historical analysis offered by those who experimented with the system (Free Riders on the Mayflower) nor by the body theoretical analyses in behavioral economics (e.g see Free Electric Riders, An Ultimatum You Can’t Refuse, or The Gravity of a Minimum Wage).  Just what will convince people that this myth is dangerous and should be shunned is beyond me – but I hope we find an answer soon.

Meet the New Normal, Same as the Old Normal

With all due apologies to The Who, the title of this post is inspired by the same cynical sentiment woven throughout and aptly summarized in the closing line of their classic song Won’t Get Fooled Again.  My cynicism is directed at the academic and professional economists who seem to ignore the breadth of US economic history (and human nature) and argue that, somehow, we are now in a unique situation not seen anywhere in the tumultuous upheavals of the past.  That the store of US ingenuity and invention has run its course and we, and perhaps the entire world, are stuck at new normal of low economic growth.  To these useful idiots I rejoin one of the wisest lines from the same tune ‘And the world looks just the same and history ain’t changed’.

To set the stage for my jaded view on these vapid practitioners of the dismal science, let’s take a look at a bit of economic data.  A simple visit to the Bureau of Economic Analysis is all it takes to get gross domestic product (GDP) figures in Excel from the years 1929 to 2016.  Yep, one URL, one click, and one download is all it takes.

I’ll confine myself to the first three columns containing year, GDP in billions of current dollars, and GDP in billions of chained 2009 dollars.  The year column is self-explanatory but the other two are worth reviewing.  The second column (GDP in current dollars) is the BEA’s best estimate, to the nearest 0.1 of a billion dollars, of the monetary value of all the goods and services produced within the US in a given year, expressed in that year’s dollars.  The third column (GDP in chained 2009 dollars) contains the BEA’s best estimate as to the value inflation-adjusted to 2009.  I can’t speak to why 2009 is chosen as the anchor.

When graphed, the GDP values, which show a general upward trend, also reveal the scars inflicted on the economy over these past 88 years.

The Great Depression’s presence is clear in the minimum in the GDP in 1933.  The wartime bump in 1941-1945, the post-war let down, the stagflation of the mid-seventies, the recession in 1991 are all noticeable.  But few features are as pronounced as the onset of the Great Recession and the subsequent lower rate of growth.

GDP growth is defined by taking the difference in GDP’s between two subsequent years and dividing by the earlier of the two.   A plot of the resulting percentages,

while open to a wide range of interpretations, looks like a system that is settling to a tighter operating range after a rather turbulent start.  The horizontal line represents the average value of 3.34 over the 87-year period.

A zoom into ‘recent’ history

shows a pronounced drop in annual growth in the post-Great Recession recovery.  Quantitatively, the average GDP growth over the time span from 1970-2007 (inclusive) was 3.09 percent.  This time frame includes the stagflation of the mid-seventies (runaway inflation and high unemployment), the 1987 Stock Market crash, the 1991 recession, and the 2001 tech bubble collapse as well as the Reagan recovery, and the ‘new digital economy’ of the mid-nineties.  The average GDP growth over the time span from 2010-2016 has been 2.13 percent, nearly a full percentage point lower than the short-trend average and 1.2% lower than the full long-term trend.  If the time span from 1929-2007 is considered, the average GDP growth is 3.58 percent (even including the Great Depression), making the recent sub-par growth even worse.

All sorts of theories have been concocted by the intelligencia to justify this ‘new normal’.  For example, John Fernald, in his October 11, 2016 article entitled What Is the New Normal for U.S. Growth?, states:

Estimates suggest the new normal for U.S. GDP growth has dropped to between 1½ and 1¾%, noticeably slower than the typical postwar pace. The slowdown stems mainly from demographics and educational attainment. As baby boomers retire, employment growth shrinks. And educational attainment of the workforce has plateaued, reducing its contribution to productivity growth through labor quality.

He further argues that ‘the new normal pace for GDP growth…might plausibly fall in the range of 1½ to 1¾ %...based on trends in demographics, education, and productivity.’

David Houle offers a slightly different interpretation.  In his article Low inflation and GDP growth is the new normal, dated August 15 2016, Houle lays the blame at the feet of:

…globalization and technologically induced trends and realities, making historical economic comparisons less relevant.

In the regular column Buttonwood’s notebook, published in The Economist June 2, 2016, the author had this to say

This year's approach describes the global outlook as "stable but not secure". In essence, Pimco thinks that the "new normal" will continue, with the US managing 1.5-2% growth (at or above trend, in its view), Europe managing 1-1.5% and China at 5-6%.

Leigh Buchanan’s piece entitled Report: 3 Percent U.S. GDP Growth Rate Is Unrealistic, published in Inc. on May 19, 2017, in which she relies heavily on the opinion of Marc Goldwein, senior policy director at the Committee for a Responsible Federal Budget.  Buchanan closes her piece in dramatic fashion by saying

"The bottom line," said Goldwein, "is we should not be buying magic beans. Three percent growth is not completely impossible. But it would be a heroic feat to get there."

And finally, rounding out our sample, is Mark Thoma’s What if slow economic growth is the new normal? (CBS News’ MoneyWatch on September 19, 2016), wherein he cites Robert Gordon’s explanation for this historical suppression of growth in the US, saying it is that

the country has entered an era where productivity growth will be much lower than in the past. According to Gordon, the digital revolution now underway is much less important than inventions that came about between 1870 and 1970 such as electricity, sanitation, chemicals, pharmaceuticals, transportation systems (the internal combustion engine in particular) and communication.

Of course, there were many, many more jumping on the ‘new normal’ bandwagon.

Rare (and unheeded) was the voice speaking that 3 percent growth was again realistically possible.

But here we are, with revised estimates for 2017 Q2 and Q3, showing two successive quarters with GDP growth over 3%, and that trend seems to be continuing into the fourth quarter.  I won’t try to guess what policies have changed but clearly something has.  And, for this analysis, it isn’t actually important to figure out what the change is.  It is simply worth pointing out that all of these prognosticators and economic pundits were wrong – dead wrong.

Human economy is a complex thing with an immense number of moving parts.  It is the height of arrogance to somehow label ‘now’ as extraordinary compared to ‘then’.   By what measure do you say that the transition from pre- to post-WWII US involvement was less ‘globalizing’ than the current trends now?  By what technological yard-stick do you argue that the advances from 1862 (the final publication of Maxwell’s equations) to 1929 (Solvay conference) are more important than the progress from 1990 (dawn of the internet) to 2017 (bio-engineering, quantum entanglement)?  Has human nature changed recently so that the period from 2009 to 2016 must be analyzed differently than the periods before (conveniently all lumped in as the ‘old normal’)?

You may be wondering why, then, did these pundits jump on the ‘new normal’ bandwagon in the first place.  There are looks of possible reasons.  No doubt some of them wanted to be seen as wise and erudite, others succumbed to the all-too-human tendency to view the current age as somehow harder that all others (‘in my day…’), some had an agenda for talking the economy down and some wanted to avoid controversy by criticizing the policies of the time.  And, as interesting as it may be to diagnose why they said what they said, the real question is why did any of us listen to them.  Maybe next time we won’t be fooled again.

Great versus Great

Well, it’s just about a decade since the Great Recession began and I suppose it is natural to look back and reflect on both the pain and the promises of that tumultuous time in US history.  Fueled by very irresponsible lending/borrowing behavior, the economic downturn is traced by the National Bureau of Economic research (the entity who is, according to the Wikipedia article, the official arbiter of US recessions) to state that it began in late 2007 and extended deeply into 2009, leading to 19 months of negative growth.

Widely regarded as the worst global economic crisis since the Great Depression, the Great Recession has elicited quite different responses depending on the responder's point of view.

For some, the depth of the Great Recession was mild in comparison to the Great Depression.  Peak unemployment rates during the latter reached 25% compared to 10% sometime around October of 2009 (according to the Bureau of Labor Statistics or BLS).  Misery and poverty were commonplace in the Great Depression on a scale that far outweighed anything seen before or since.

For others, the Great Recession brought real and lasting pain in the here and now; pain all the more exacerbated by the fact that the Great Depression ushered in a whole spate of policy techniques designed to help political leaders and economists avoid these sorts of downturns and to blunt their effects.  In particular, payroll employment dropped far more sharply than in the previous 5 recessions and persisted in this weakened state.

The previous graphic was taken from The Recession of 2007-2009, a fascinating (and sobering) summary of the Great Recession by the BLS that drives home just how devastating that period in US history was.

Nonetheless, the general impression is that, as a whole, the US is better off now than it had been in the aftermath of the Great Depression.   But, as pointed out in the article We’re About to Fall Behind the Great Depression by David Leonhardt, the recovery from the Great Recession has languished in comparison to its much-worse predecessor.

Leonhardt based he’s claim on a graphic produced by Olivier Blanchard and Larry Summers that shows the GDP per capita for adults aged 18 to 64 scaled by the number of years since the onset of the economic crisis.

Blanchard and Summers base their onset of the Great Depression with the Stock Market Crash of 1929 but there is some dispute over whether this event caused the Great Depression or whether subsequent policies turn a market correction into a full-blown catastrophe.  Nonetheless, the initial dip in GDP per capita from this starting point was a great deal more pronounced (gray line) than the dip after the onset of the Great Recession (gold line).  And the loss of relative wealth was also more severe in the Great Depression (year 4) than in its smaller counterpart.  But the overall recovery was more pronounced by the twelfth year than the recovery of their prediction of where the trajectory of post-2009 US is headed.

Blanchard’s and Summers’s chartsmenship (or at least the NYT’s reproduction) leaves a lot to be desired and surely they’ve engineered the presentation of the data to obscure the fact that the US involvement in World War II began at the twelve-year mark.  Nonetheless, I believe their basic message is correct.  The US recovery since the end of the Great Recession has been anemic at best.

There are a host of reasons but they all fall under one broad umbrella – government policy and regulation during the aftermath of the Great Recession.

As is widely discussed, the US has one of the highest corporate tax rates in the world.  In addition, the US taxes companies who earn a profit overseas; they are taxed by the country in which they earn their profit and then are taxed a second time by the US if the company tries to bring that profit back into the US.  This has caused many companies to keep their profit invested in the countries in which they earned it and out of the investment markets here at home.

In addition, the regulatory structure has increased to unbelievably burdensome levels.   As discussed in a previous post (Haircuts and Wine), the single biggest obstacle to small business creation and subsequent innovation is the compliance burden visited on these entrepreneurs.  Since the bulk of small business profit and investment is done here in the US, regulatory hurdles and higher tax rates offer a double-whammy to increasing economic growth.

Another insidious and perverse aspect of federal policy is the growth of government largesse and the increasing incentives for people to get on the public dole and hang out.  Having a larger percentage of the population taking rather than giving hurts not only their dignity but the morale of those producing that which the takers are consuming.  Thus there is a two-fold hit to productivity – the loss of all the capability of those standing on the sidelines and the loss of motivation by those still in the game.

So, even though I think Blanchard and Summers slanted the presentation a bit with their graphic, if it serves as a rallying point for improving the economy then so much the better.

Oil Prices and the Efficiency Paradox

In my last column, I discussed how improved efficiency can enable consumption and increase demand rather than lead to conservation.  This so-called counter-intuitive behavior is codified by economists under the headings of the Khazzoom-Brookes Postulate and the Jevons Paradox.  In this column, I’ll turn from the general theory and look at these ideas in practice by analyzing oil consumption and associated prices/costs in the United States for the years 1949 through 2016.

But before diving into the numbers and performing a statistical analysis, I would like to take a small tangent to discuss the efficiency paradox and the apparent surprise and controversy it causes in economic circles.  This last assessment is based on the commentary surrounding the common literature associated with the Khazzoom-Brookes Postulate and the Jevons Paradox.

Personally, I am perplexed that some economists find anything unusual in the notion that increased efficiency leads to wider consumption of a good or a wider adoption of a technology.  Recent history is littered with examples.  Take desk-top printing.  Paper is a valuable resource; there is and should be tremendous pressure to properly use and steward the trees from which it is derived.  Paper was far more expensive (in adjusted dollars) and scarce in the 1970s than it is today.  One can barely go anywhere without finding reams of printer paper on sale; local grocery stores usually have an aisle devoted to office supplies (and some convenience stores as well).  Electronic media, like PDF, even obviate the need for it and yet there is far more paper circulating per capita today than 40 years ago.  Why? Because its value has far outstripped its cost despite the increasingly more efficient ways of producing it.  The reason for this is that efficient production of paper and printers has opened avenues for use that were effectively closed to all but a handful over a generation ago.  Professional printers were the only ones that could economically make attractive documents and signs back in the day; now anyone can.  The efficient use of paper has enabled a whole new way of enjoying its benefits and has, concomitantly, increased the demand.

The interesting and more far-reaching question is whether oil consumption reflects the ‘efficiency paradox’ as well.  There are plausible arguments that it should, based on the following analysis.

For the sake of argument, suppose that, on average, every person in the United States drove 100 miles each week.  Further suppose that, on average, fuel efficiency was 10 miles per gallon and the price of each gallon was $4.00.  Then the average demand for gasoline would be 10 gallons per capita per week.  Finally suppose that there is an increase in fuel efficiency to 11.1 miles per gallon.  We want to look at the possible responses to such a change.  There are three basic ones.

In the first scenario, the average motorist, content with his 100-mile/week habit will buy 9 gallons of gasoline and will take the $4.00 he saves and direct it to other goods and services.  In the second scenario, our average motorist says to himself that he’s already used to spending $40/week on gasoline and so he’ll buy the same dollar amount of gasoline (10 gallons) but he’ll drive a bit more for convenience or fun.  In the third scenario, our motorist may think that since gasoline prices have come down in a relative sense – the cost per mile he bears is now less – he will finally take those weekend trips to the beach he’s always dreamed about and he steps up his consumption to 12 gallons a week.

A bit of reflection on the above scenarios should drive us to two conclusions.  First, very few people are likely to fall into the first scenario.  All of us dream of doing more than scarcity allows.  Second, the above analysis assumes that the only thing that changes is the behavior of the average motorist. Two significant drivers are left out:  1) the response of the oil producers to the changes in fuel efficiency and 2) changes in the motorist population.   It is very unlikely that the oil producers will do nothing in the face of increasing fuel efficiency.  Not wanting to risk a drop in demand they are likely to down-adjust the price as that is easier to do compared to down-adjusting the supply.  The latter course of action requires laying off workers, scaling back factory production, and curtailing distribution all along the supply chain.  It is also very unlikely that the average motorist can be thought of as anything other than a statistical snapshot in time.  People are born, grow, age, and die.  Tastes, habits, and behaviors change.  And the number of people in the population grows as a function of time.  These later factors make it far more difficult to analyze real-world data like oil consumption.

To that end, I pulled 4 sets of data to try to see the Jevons Paradox in action.  These were:  1) total oil consumption by day (thousands of barrels), 2) average raw cost per barrel in dollars, 3) US population by year, and 4) GDP by year (raw not inflation-adjusted).  The sources are:  Item 1, Item 2 (both from www.eia.gov), Item 3, and Item 4 (both from www.multpl.com).

The first graph of the data shows a comparison of total oil consumption and per capita use over the time span from 1949-2016.

With some minor variations, total oil consumption has risen steadily, except for three periods: 1) the aftermath of the oil shocks in the mid-1970s, 2) the breaking of stagflation in the early 1980s, and 3) the Great Recession of 2008-2010.  Interestingly the total oil consumption per capita remained flat from about 1982 to 2008, a 26-year period where, while fuel standards were getting continuously better, oil demand per capita remained steady.   This is direct evidence of the Jevons Paradox and it indicates that the vast majority of us fall into scenario 2 – we’ve allocated a certain amount to spend on gasoline and we drive appropriately so that we consume roughly that amount on average, regardless of how many extra miles we record.

Further support for the idea that most consumers fall into scenario 2  is found in the following plot of total oil costs as a fraction of GDP, which is a reasonable measure for judging the relative cost of oil in the economy.

Note that oil prices held fairly steady (between 2-4% GDP) through much of that 26-year time span where oil consumption per capita remained constant.  Had the majority of us been scenario-3 types, the additional relative price reduction (efficiency and actual price reduction) would have spurred a rise in per capita consumption.

The Efficiency Paradox

It is one of those curious things that often, in life, the course of action that seems best to our naïve common sense is, in fact, quite bad.  Following what seems like ‘a good idea at the time’ leads to the opposite – a bad result.

The current wisdom is that same holds for economic logic writ large.  The case in point is energy conservation and the concept of the Khazzoom-Brookes Postulate.  The narrative of the postulate, which is attributed to the ideas of the economists Daniel Khazzoom and Leonard Brookes from the 1980s, in goes something like this:

For decades, we’ve heard from the powers that be that the energy crisis can be averted simply by conserving energy.  If only we were to use less electricity or drive more fuel-efficient cars or turn the thermostat down low, the world would be a better place.  Since the US would use less fossil fuels, the population would be able to lower its dependence on foreign oil, reduce greenhouse gas emissions, and so on.

Unfortunately this public policy has exactly the opposite effect.  As efficiency goes up by choices made at the microlevel, overall demand increases at the macrolevel and thus what seems like the right approach – use energy more efficiently – is in fact wrong.

The argument for the Khazzoom-Brookes postulate is often discussed within the context of the Jevons Paradox, which is basically an observation of seemingly non-intuitive behavior observed by William Stanley Jevons.  Jevons observed that the overall demand for coal shot up dramatically after James Watt showed how to more efficiently use coal.   Such a demand increase seems to go against the basic notion that a more efficient process should lower the consumption of a scarce resource and is due to the rebound effect.

A rebound effect is a measure of the difference between an efficiency improvement associated with a resource use and the corresponding change in its use.  According to the Wikipedia article, the rebound effect (RE) is defined as: RE = (E-D)/E, where E is the percentage increase in efficiency and D is the percentage change in demand or use, with the convention that D is positive/negative for a decrease/increase in consumption (note that neither this notation nor the sign convention are discussed  in that narrative).  For example, a 4% increase in efficiency that corresponds to a 3% decrease in demand gives a RE = (4-3)/4 = 25%.

The Jevons Paradox occurs when the demand for the good is elastic; the slope of the efficiency-use curve (essentially a price-demand curve) is negative and less than 45 degrees.  In this situation, the change in the relative price, due to the efficiency, is smaller (in some normalized sense) than the corresponding change in the use (relative demand).  The paradox doesn’t result when the demand is inelastic (with a negative slope greater than 45 degrees) or when a decreasing price causes an even bigger drop in demand.  The cases of elastic and inelastic demand are shown in the following figure (patterned after the ones in the Wikipedia article).

In both pictured cases, the fuel cost per 100 miles effectively drops by 10% due to improvement in efficiency.  In an idealized, fantasy, world, where everyone only needed/wanted to travel 100 miles per week, the actual demand would drop as fuel efficiency lowered the number of gallons required.  In a real-world situation, the lowered effective cost spurs additional activity.

If the new activity is inelastic, then the increase in demand offsets the savings and only 6% reduction of consumption is realized (10% in savings – 4% increase in usage).  The rebound effect value is RE = (10%-6%)/10% = 40%.  In the case where the activity spurred elastic, the lower effective cost spurs a great deal of additional activity and there is a 30% increase in consumption (10% of the 40% increase in travel is due to efficiency and the rest reflects the additional activity).  The rebound effect value is RE = (10%+30%)/10% = 400% (the change in sign is due to the 30% being an increase in consumption rather than a decrease).

The spurred activity may result from two primary sources:  1) direct rebound and 2) indirect rebound.  Direct rebound reflects the fact that consumers may choose to redirect additional spending at a now lower-priced commodity, perhaps taking that tour of the US that they always dreamed about but couldn’t afford.  Indirect rebound reflects that as direct rebound effects takes place, the economy grows as does the demand for more resources.

This is all well and good from a theoretical side of the equation but specific observations of this behavior in a real economy are not so straightforward.  Next column, I’ll examine the poster child of Khazzoom-Brookes and Jevons: US oil consumption.

Dose of Economic Medicine

There’s a common theme in philosophical circles that draws analogies between society at large and the human organism.  The body politic is likened to the human body with concepts of specialization, interdependency, and cooperation in the organic being reflected in the societal.  Western writers such as Plato and St. Paul use these themes extensively in some of their most notable works.  So, taking it as given that one can use terms associated with a human being when speaking about society, what can one say about the health of the American body politic?  In short, the country is having a nervous breakdown – the head is positively suffering from a psychosis over capital and the heart seems to vacillate between euphoria and resentment over those that hold it.

At the center of this mental and emotional anguish is the notion of the concentration of capital into the hands of the relative few.

General unease about the wealth held by others has always been something that the American mind has worried about.  In healthy times, this feeling is normally repressed as most people simply get on with the business of living their lives and building their own wealth.  However, in times of stress and economic dowturn, these feelings creep from the dark corners of the mind and become a paranoia that drowns out rational thought.    We are currently experiencing just such a flare-up with a severity not seen since the late-60s to the late-70s when the US last lost its collective mind.  Not convinced? Just take a cold-eyed assessment of the aimless discontent and rampant suspicion expressed by the Occupy movement against the one-percenters.

If obsessive paranoia of the rich marks one component of our collective malady, illogical expectations about wealth and how much of it we deserve marks the other.  Bordering on schizophrenia, our sense of entitlement blinds us to the practical aspects of living in the real world.  We have a bizarre love-hate relationship with business – swinging back and forth between irrational exuberance and petulant condemnation.  One moment we become weak at the knees and positively gush at the announcement of some new gadget or product line.  The next we turn around and launch blistering social media campaign calling for a boycott against the same business for the smallest of slights.  Most of us no longer understand how hard it is to achieve success in any venture of merit.  We don’t grow our own food, produce our own energy, build our own houses, and so on.  We’ve become conditioned, by the slickest devices of advertising, to expect our every need and whim will be addressed by the undefined machine around us.  Most of us never bother to look deeper into how the machine works and so we end up with unfounded notions about business, unreasonable assumptions about hard work, and unsustainable expectations of our own comfort.  How else to explain the rise in the popularity of socialism in the face of all empirical evidence?

There is no doubt that the country would be well served by some quiet time in an asylum.

If general dysphoria is the prognosis, what is the cure?  By and large, the remedy consists of one part critical thinking and one part economic literacy, applied broadly to the population before the onset of any pathological conditions.  And so, as a public service to our ailing society, I offer the following case studies about our collective feelings toward the rich and towards wealth.  Look for the tell-tale signs of their symptoms in those around you and help those unlucky ones get the treatment they need. (Note:  all the names have been changed to protect the economy.)

Case 1:  Patient Name: Edith;   Diagnosis:  Hordus Maximus Jealousy

Edith suffered from the common delusion that the rich hoard their wealth.  Just how much money does one person really need?  Fortunately, Dr. Milton Friedman had just the medicine.  He points out that concentrations of capital result in jobs for those not rich via the vehicles of investment and capital development.

While the records are sparse from this era (being thankfully dropped along with the choice of clothes), all available evidence indicates that there was a good chance that Edith was able to put her jealousy in check and lead a relatively normal life after the administration of the treatment.  Unfortunately, she was already too far gone for us to hope that a new hair style and wardrobe would follow.

Case 2: Patient Name:  New York Hipsters;  Diagnosis: Widespread Ignorance Epidemic

Ami Horowitz performed an epidemiological survey of an economics illiteracy infection currently plaguing the New York Hipster scene.  The illness causes unfounded feelings of god-like certainty, rampant self-righteousness, and general stupidity where taxes and fairness are concerned.  By the time Ami had arrived at the hot zone, he found that the malady had become a full-blown epidemic of a particular strain of information-resistant fallacies.  Note how many of the victims are so far gone that they can’t even listen to reason or detect when they are being told outright lies.

Lost on these poor souls is any notion of numbers, the mechanism and purpose of taxes, – who should pay, who does pay, how much should be paid, etc. -  and what fair (or even free – in the case of the Norwegian woman) means.  The idea that the concentration of capital in the hands of a relatively few number of people evokes a reflexive hostility in the moderately affluent victims examined.  There is small hope for those infected.  For those with little or no symptoms, the current treatment involves wide-spread inoculation with a broad spectrum of economic truths and campaign of wide-spread dissemination of facts.

Case 3: Patient Name: Ryan the iPhone Occupier;  Diagnosis:  Terminal Self-Contradiction

In our final case study, we examine a truly tragic case of a man infected with terminal self-contradiction.  This delusion, for which there is no known cure, causes the victim to be impervious to any kind of logical thinking.

At this advanced stage, the victim simultaneously employs the market-based system of capitalism on his own behalf while decrying that very system as destructive and immoral.  He is incapable of recognizing that concentration of capital is what developed the technology required to build: 1) the iPhone, 2) the YouTube infrastructure that provided him his 5 minutes of fame, 3) the free time so that he can protest and still eat, 4) the sidewalk on which he stands, 5) free time for others to create entertainment such as the Transformers, and so on.  The only known approach to contain this pathogen is to quarantine the victim and wait.

As I close out the case studies, let me extend one last comment.  I hope that this PSA will go a long way to helping you recognize these diseases when they begin to rear their ugly head and to confidently administer the only known treatment – rational thought about the economy.

Telemarketing, Traffic, and the Tragedy of the Commons

Two recent experiences, profoundly annoying and time-consuming ones at that, have driven home the basic economic idea that we should all learn to share a bit more and temper our desire to always reap the greatest benefit without thought to the negative externalities that we may be visiting on others.

The first experiences should be very familiar to cellphone owners in the United States: the relatively recent and sharp rise in the number of telemarketing cold calls that we receive on a weekly basis.  Barely a day goes by that I don’t get a call from some unknown number that my caller id identifies as originating from Massachusetts or Michigan or wherever.  Often the call comes in during the work day when I am in a meeting or otherwise importantly occupied.

If answered (yes, occasionally, I stupidly decide to listen to what the interloper on the other end wants to say – it’s a weakness), the call inevitably is from someone who is trying to sell me something I don’t want for more money than I can afford to spend.  I’ve never summoned enough patience to ask how the telemarketing drone, whose robotic software has graciously selected me from amongst hundreds of millions of possible cellphone numbers, feels about disrupting my day.  Nonetheless, I am fairly certain just how the conversation will go.

Me:    How do you feel about disrupting people’s lives with your cold call?  How would you feel if I were to call you at home?

Drone:  Hey! I’m just trying to make a living.  It’s not like I’m killing or robbing you.  I’m just exercising my rights to try to sell you something.  It’s a free country and your telephone number is listed, so what’s the problem.

Me:        Sigh… never mind.  I’m hanging up now.

Drone:  Thanks for wasting my time with your stupid question!

Of course, the words and tone exhibited by your drone may be different from mine but the sentiment will be the same – nobody’s being hurt.  But is it true that the drone’s cold call isn’t harming me?  The answer is clearly no.  Even when I decline to answer, the telemarketing intrusion kills a portion of my time that could have been spent on something more enjoyable or productive.  It robs me of concentration; disrupting my thoughts and actions.  It also wastes valuable bandwidth that could be used on all sorts of better things, like emergency calls, long enjoyable conversations between friends, and so.  Leaving the cellphone off or unattended fixes these problems by running the risk of missing important calls and depriving one of the enjoyment that cellphone brings.  In short, these telemarketing calls exact a tangible cost from the receiver, even if that cost can’t be precisely monetized.

In the most extreme case, where every telemarketer calls everyone in a single area code, there is even the possibility of a denial of service attack that would put people’s lives at risk.  So, even though it may be a free country, the actions of these marketing drones aren’t free of what economists call negative externalities.

Recently, I escaped these costs, ever so briefly, by journeying south of the equator to visit family in Peru.  Unfortunately, I landed in a collective economic situation that had an equally high negative outcome: the traffic of Lima.  In case you’ve never had the (bad) chance to experience this, hardly any main avenue or road is absent bumper-to-bumper traffic at almost all hours.  The skill and bravery exhibited by the average driver is as epic as the congestion is dense.  Crisscrossing cars narrowly missing each other; horns honking at irregular intervals; drivers on motorcycles weaving between lanes – these are the common road motifs.

It’s worth considering how this situation has come about.  The average motorist clearly is working under two basic rules.  First, he needs to get somewhere in the least amount of time; after all his time is valuable.  Second, his fellow drivers are working at cross purposes to him, since they are obviously trying to get where they are going as fast as possible as well.  Therefore, he can only trust himself and must drive in a dog-eat-dog fashion.  As a result, each driver is willing to break lane discipline at a drop of a hat, cross multiple lines of traffic to make a sudden turn right turn from the far most left lane, and look for any way to get from here to there without regard to the effect his actions have on those around him.

There is a prisoners-dilemma dimension to this whole scenario.  Each motorist can choose to cooperate or to betray his fellows.  Cooperation would entail politeness, sharing of the road, and allowing others to get in front – all at the expense of a slightly longer commute.  Betrayal would entail ruthlessly cutting other drivers off to get ahead, abruptly changing lanes to jockey for position, and other assorted chicanery – all for the benefit of making the commute short.  Of course, if all the drivers could be convinced to cooperate then the payout for each would not be as great as it would be for only one betrayal, but it would be much better than if all of them resort to the ‘every man for himself’ approach. A hypothetical payout table for such a scenario illustrates the point.

In both cases, cellphone telemarketing and congested traffic, the lack of awareness of how one’s actions lead to negative externalities for others, leads to what economists call the tragedy of the commons.  The Wikipedia article summarizes the tragedy of the commons as:

… an economic theory of a situation within a shared-resource system where individual users acting independently according to their own self-interest behave contrary to the common good of all users by depleting or spoiling that resource through their collective action.

All in all, this isn’t a bad description.  It does lack in one important way.  The individual users do act independently but not in their own self-interest.  Rather they act in what they locally perceive as their best interest – as if all other users are somehow stupider than they are.  As a result, they betray not only all the other users but their own best interest as well.  And the truly sad part of this realization is that it isn’t clear at all how to improve the situation without properly educating and persuasively arguing for cooperation.

Taking a Bite out of Apple

An overwhelming number of people (economists and normal) agree that government intervention and regulation of the market is necessary.  The key question is just how much.  A new situation with Apple Inc. may help frame a small corner of that debate.

As reported in the Business Insider article entitled Dropping Imagination Technologies gives us a rare look at how ruthless Apple can be, Sam Shead details a recent tiff between the giant California computer company and Imagination Technologies, a UK-based chip manufacturer.

According to the article, Apple was in a partnership with Imagination Technologies (IT) for the last 10 years for purchase of the latter’s GPU-based chip set and accompanying technology.  These purchases amounted to just over half of IT’s £120 million revenue and made it into something of a UK darling in the technology arena.  Their GPUs power Apple’s family of mobile devices including the iPad and iPhone and it partnership seemed like a marriage made in heaven.

Well the divorce proceedings are underway and it started, as in most cases, with covetousness.  Apple really wants to own IT’s GPU technology.  It tried to purchase the company, has poached some of its key executives, and finally issued a public message that they will be dropping IT in the near future.  The net effect was to tank IT’s stock by 65% and put the solvency of the 1700-person company in serious doubt.

Two questions are why does Apple want to own the GPU technology and why issue a public statement announcing the dissolution of the partnership well in advance?

To answer the first question, the article cites Benedict Evans, who makes the case that Apple, which already owns an industry-leading design for System on a chip (SoC – chips that control other chips), is now looking to acquire and control GPU-based technology.  Evans believes this will give Apple a competitive advantage in computational photography (a heading under which all the panoramic and motion features Apple advertises falls) and in machine learning.  That seems all well and good.  Apple believes that controlling the hardware it uses helps it control its own future.

But the answer to the second question is a bit more disturbing.  After failing to buy IT, Shead suggests that Apple’s strategy behind the public issuance of the divorce proceedings was to make IT vulnerable to outside purchase.  With its stock depressed, Imagination Technologies can now be acquired for far less of a capital outlay than before.  Apple has positioned itself to purchase IT on the cheap and to have its own management, which it lured away from IT, ready to step in and run it. In his piece, Shead aptly points out that this move by Apple sends

[t]he message that other companies are likely to hear — whether Apple intends it or not — … "cooperate or die.

If you are uncomfortable with what seems unfair business practices then you are arrived at precisely the point where we can talk about government intervention and regulation of the market.   What role does the government have in this situation?  Are Apple’s practices part of a predatory stock manipulation or shrewd business sense?

Before answering, consider that Apple is not the chrome-plated squeaky clean company either it or its adherents like to pretend.  It has had a long history of putting out operating systems for iPad and iPhone that are devoid of the amenities its customer base take for granted on the Mac computers.  Apple sits back and watches the app development ecosystem and then swoops in for the next release with a built-in feature that mimics a popular app, thereby advancing its own intellectual property at the expense of the independent developer who had the idea in the first place.  This practice, sometimes call freesearch and development, should raise some eyebrows about the ethical standing of the ‘Cohort of Cupertino’.

Clearly the EU is already taking aim.  As Shead puts it

But acquiring Imagination after sinking the company's stock would attract criticism and a lot of bad PR for Apple, which would be especially unwelcome now that the European Union is scrutinising the company's every move in Europe.

What Shead is referring to is the ongoing battle between Apple and Ireland, on one side, and the EU on the other.  The latter claims that Ireland offered Apple illegal state aid by setting the technology giant’s effective tax rate at 0.005% in 2014.  The former are claiming that the EU is “failing to act impartially”.  However, this particular dispute ends, it is clear that Apple is already in the government crosshairs across the pond.

But should it be?

What, if anything, is wrong with the above practices?  Apple is a big company.  It represents the intellectual capital and inventiveness of tens of thousands of intelligent and skilled people.  It’s market capital reflects the confidences of millions of investors.  And its products are bought by hundreds of millions of customers each year.  It is hard to argue, from this perspective, that society isn’t being served well.

Nonetheless there seems to be a sleazy nature about Apple’s business practices.  They swing their collective might around to get sweetheart tax deals.  They encourage development for their app ecosystem and then stamp out innovative teams by co-opting their intellectual property.  And now they are poised to do it on a large scale with Imagination Technologies, where, by their own actions, they may have spelled the end for a 1700-person tech company.  What’s more, is that it is uncertain, as IT points out, that Apple can develop its own GPU substitutes without deeply infringing on IT’s intellectual property.  So, from this perspective, it’s hard to argue that Apple should be allowed to bully its way around the market simply due to its size.

Where does the balance live?

Well, I think it doesn’t live in the government intervening, at least not directly.  Certainly, laws should protect Imagination Technologies’ intellectual property and the full weight of the court should be brought to bear if Apple infringes it in any way.  But should the government try to make nice between the companies?  I don’t think so.  Imagination Technologies knew what it was getting into bed with or it should have.  Whether they go out of business or manage to survive their divorce with Apple, the clarion call has already been sounded to all other businesses who think about partnering with Apple: be careful of doing business with them.  Some of these businesses would then seek deals with Google or Microsoft, neither of which are any more innocent and pure than Apple.  But these niche tech companies can play one giant against the other.  The market can correct itself if given a chance.

Government intervention would result in a quick fix but with two long term negative side-effects.  First it would stave off the needed competition between the tech giants.  Second, it would send the message “go ahead and screw up, the government will fix it” to all the smaller firms that they don’t need to be careful when they partner with the big boys.

Of course, there is another sector of this story that would ordinarily also contribute to market self-correction: the consumer.  Ordinarily, the PR associated with the tactics Apple employs would leave a foul taste in the mouths of customers and sales would drop.  The message would be sent by the most critical component of the market that these practices are not to be tolerated.  Unfortunately, I don’t think the Apple customer base is that enlightened.  As the Onion so aptly satire in their piece on the Macbook Wheel, the Apple customer may be a bit blind.

On The Dignity of Work

There were a lot of ideas running through my head as I pondered what to write about this month.  Some of the most reoccurring concepts centered around the ballooning student debt (1.31 trillion last year – the 18th year in which it rose), the sluggish participation rate, and the general stagnation of wages and opportunities that seem to be the new normal.  Competing with these grimmer ideas were the job creation news (227,000 in January and 235,000 in February), which has been better than expected of late, and the success of a stock market that is clearly enthusiastic about the future.

Unfortunately, none of these felt right.  After all, March, being the month that straddles winter and spring, should be a time of hope and encouragement and not dry numbers and statistics of either the good or the bad or the ugly variety.

Fortunately, I found someone who was willing to do all the work for this column and to do it with a lot more skill than I can muster.  Someone who is both down to earth and charming at the same time.  I am speaking about Mike Rowe.

The former host of Dirty Jobs, Mike Rowe has become something of a spokesman for the importance and dignity of work.   During the eight seasons that Rowe worked on the show, he participated in a wide variety of jobs performed by “hard-working men and women who earn an honest living doing the kinds of jobs that make civilized life possible for the rest of us.”

Based on his experiences with these jobs and the celebrity that the show afforded him, Rowe has become something of an advocate for the dignity of work and the importance of a wide range of jobs that society has unfortunately judged as uncool.  And the great thing about him is, his sense of humor enables him to talk about serious subjects in a light-hearted fashion.

The one serious topic that Rowe focuses on is the skills gap that exists in this country.  What skills gap, you ask?  Well, the one Rowe has identified.  And what he has identified is that there are over 5.5 million blue collar jobs, seventy percent of which don’t require a four-year degree, that go unfilled because society deems those jobs as ‘uncool’ or as some ‘vocational consolation prize’.

And why should we believe him?  Well….


Footage from the Bill Maher Show used in fair use.

As Rowe often points out, these jobs not only pay well, generally, but they impart a sense of dignity and satisfaction to the people who hold them.  The ability to start a new day and accomplish something like hanging new drywall or rewiring a room or fixing a leaky faucet is a powerful thing.

If this basic joy were simply being passed over by people more interested in higher-paying but less-satisfying jobs (I’m thinking of lawyers here) that would be one thing. But as pointed in many places, including numerous times in this column, the real unemployment rate in this country is far higher than the measure the government presents each month.  Many students are graduating from four-year colleges with crushing debt and very little in the way of skills.  Rowe puts it succinctly when he says


Footage from the Bill Maher Show used in fair use.

So how to fix this skills gap?  Rowe also has some suggestions.  Primary amongst these is not to search for a job that matches our wish fulfillment but to pursue the opportunities.  In a video commencement address he narrated for Prager University, Rowe argues that the best thing a person can do is to follow opportunity not passion; to be open to a variety of opportunities in excellent careers:

And how did we get to this sorry state?  As Row explains to Tucker Carlson, the core problem comes from the lack of an underlying appreciation for work.  This lack of appreciation has its roots in the fact that we eliminated vocational training from high schools and have sold students on the idea that the only real success comes from earning a degree from an institution of higher learning.

As Rowe points out, guidance counselors all too often fail to talk about alternative careers.  Even the term alternate careers is demeaning, making it sound like something you settle for if you can’t hack it in higher education.

But as anyone who has ever experienced it knows, there are very few feelings in the world equal to the pride one gets when one finishes a job making something and can claim ‘I made that.’  Kudos to Mike Rowe for championing the dignity of work.