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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.

Haircuts and Wine

Some time ago I devoted a column to the predicament that a group of monks had found itself in when its collection of ‘scofflaw’ brothers began to sell handmade wooden coffins manufactured at their monastery (Of Monks and Coffins).  These ‘shady business men’ were finally exposed by the Louisiana Board of Embalmers and Funeral Directors.  This ‘fine establishment of honest pillars of society’ tried to use a set of state laws that regulate and license the funerary industry to block competition by the monks on the grounds that coffin making (i.e., the making of a box) should be regulated in the same way as the handling of human remains.  The tactic on display in this incident was a textbook example of how an entrenched group can use government regulation to intimidate and interfere with smaller companies as a way of stifling competition and protecting their own interests.

The regulatory burden placed on small businesses is a serious impediment to their ability to compete with well-established firms.  A business with 20 customers and 50 employees is unlikely to be able to afford the army of lawyers and compliance officers that a huge multinational corporation can field.  In addition, small businesses can’t muster the same lobbying interests nor have the same pull with Congress.  These concerns were widely voiced during the recent Senate Small Business and Entrepreneurship Committee hearing for the appointment of Linda McMahon for the Small Business Administrator.

The hearing had hardly begun when Senator Jim Risch (R-Idaho) had the following to say about the state of licensing and regulation facing the small business owner:

His perspective was shared across the aisle with both Democratic and Republican Senators pointing to smothering government regulation as the largest hurdle to small business success (the reader is encouraged to watch or listen to the whole hearing, which runs just shy of 2 hours).

This opinion is not confined solely to the legislative branch.  In a recent article entitled We Shouldn’t Have to Ask Permission to Work, Robert Fellner, of the Nevada Policy Research Institute, points out that a report  published by the White House Council of Economic Advisers, the Department of the Treasury, and the Department of Labor offered the same conclusion.  The report, Occupational Licensing: A Framework for Policymakers, states that when designed and implemented carefully, occupational licensing laws “can offer important health and safety protections to consumers” but that often “the requirements are not in sync with the skills needed for the job” and that the legal framework “creates substantial costs”.

Fellner puts flesh on these drab policy bones by citing specific cases.  He notes that Nevada is one of the most “onerously licensed” states in the nation requiring nearly 31 percent of its workforce to obtain governmental approval before being able to work.  For example, it is a criminal offense in Nevada to practice music therapy without a license.  I don’t know exactly what music therapy is (I thought that was what DJs do daily) but I find it hard to swallow that I face any health concerns and need government protection from fly-by night practitioners.  Equally nefarious are the barbers of Nevada.  By law, they are required to subject themselves to 890 days of education and apprenticeship, pass four exams, and pay fees of $140.  Consumers must demand that all of this rigmarole must be tolerated by the budding barber-to-be so that they can avoid a bad hair day.  But perhaps the most sinister of professions, lending itself to all sorts of fraud and posing a clear and present danger to consumers, is the practice of interior design.  These vultures wait for our most vulnerable moments in order to convince us to get a divan rather than an ottoman and so a rigorous form of regulation (which 46 other states are too backwater to realize they need) must be imposed.

It is easy to chalk all of this nonsense up to crony capitalism wherein an established business scratches a politician's back (in the form of contributions and lobbyist-funded junkets) while the politician returns the favor by imposing regulatory burdens that favor entrenched interests and exclude new interests with hard-to-surmount barriers to entry.  But this is only a fraction of the population.  Why do the rest of us tolerate this nonsense?

The answer to this question is difficult to pin down.  I have often argued with friends that licensing doesn’t necessarily protect us any more than we are in an unregulated market with free flow of information.  If licensing and regulation worked perfectly, then there would never be the need for medical malpractice insurance; no one would ever get sick from food poisoning at restaurants; complaints would never be filed against home contractors or auto mechanics; and, most importantly, Yelp or Angie’s List would never have been created.

If licensing and regulation aren’t a perfect shield against malfeasance then, clearly, they are meant to minimize the number of occurrences and the impact of each.  But a reasonable question, especially in this age of instant communication across social media, is whether it is better for the market to police itself, for no additional cost since all parties have ‘skin in the game’, than for a disinterested government bureaucracy to spend a great deal of taxpayer dollars doing this for us.

The most common argument I’ve heard in opposition to a market solution, particularly applied to health care, is that such an approach would lead to the lowest bidder, and “you don’t want to trust your health to the lowest bidder, do you?” was the inevitable response.  My retort is that I always trust my health to the lowest bidder when I look for the cheapest, reputable place to replace my brakes.  Nonetheless, this argument has never worked for me.

It took some years before I put two and two together.  What I had forgotten was that people generally don’t value things that they don’t pay for.  This tried and true maxim is really well summarized by Vox’s wonderful short on just why wine tasting is bunk.

What is fascinating is how the wine tasters valued the wine when they knew it was expensive.  Their assessment was adapted to match their expectation that “you get what you pay for.”  And while this little psychological reflex may be harmless or even amusing in the world of luxury goods, it is positively harmful in the world of licensing and regulation.

Board Games and Bucks

One of the most puzzling aspects of the last 10 or so years of economic and political discourse in the United States is the growing affection towards socialism and collectivism.  Forget the obvious historical lessons that the former soviet bloc taught the world about the failures and incompetencies of socialism.  After all, the Berlin wall fell in 1990 and the Soviet Union dissolved just over a year later – events far too distant in the past to resonate with a culture habituated to instant gratification.  What boggles the mind is how the social-media generation can look past the ongoing misery in North Korea or Cuba

and the incredible collapse of Venezuela.  These events are happening in the here-and-now and, surely, should be part of the digital discussion.

I’ve often wondered how to explain the discrepancy between the ‘slights’ that draw public attention to the ‘benefits’ of socialism (free college being a recent favorite) and the serious and wide spread problems that show the deep social and economic costs of that system.  How can relatively small first-world issue, such as the pain of student debt, dominate the social media sphere while reports of widespread misery, such as interviews with average Cubans, who report that new toilets typically cost 2 years of wages, receive almost no attention?  Is it a product of willful ignorance, poor education, fear of new ideas outside the comfort zone, myopic focus on self at the expense of others, simple unawareness, or some combination of these?  And while I don’t expect that one answer will apply in every situation, I am convinced that most cases are largely explained by a poor education and an over-emphasis of the self at the expense of neighbors.

Oddly enough, I think this conclusion is strongly supported by the large and growing popularity in board games.  This idea occurred to me over the recent Christmas holiday when I had ample time to play lots of board games with economically savvy friends.  Many of the situations that arose drew snarky comments about the economic leanings of the game designers, how particular moves smacked of socialism, and so on.

Let there be no mistake, I am a fan of board games, especially the European style games like Catan, Princes of Florence, Ticket to Ride, and so on.  Board games are a favorite pastime at my household and the holidays always afford ample time to gather everyone together to play.  Ordinarily, I analyze the game mechanics and strategy in a bid to win, but due to the many comments flying around, I began to think about board games within a greater context.

I began to realize that, while they are fun, many board games may be contributing to the problem of economic ignorance rather than helping it.  The reasons, in a nutshell, are two.  First, a large majority of board games typically are built around an economic mechanic, such as growing a civilization or increasing trade, and provide players with a bank from which to draw funds periodically during the game.  The bank comes as starting equipment with no recognition what the money contained represents nor where it comes from. Second, board games are often adversarial and zero-sum, in which the gain of one character comes at the expense of the others.

These two notions fly in the face of economic realities.  As I’ve covered elsewhere, money in banks are not simple piles of currency used to prime the pump at the ‘beginning of the game’.  Money represents the storehouses of the collective labor/time and expertise of untold numbers of people who have come before.  We draw on this collected effort every time we get a loan, draw a dividend, or receive interest.  We contribute to the pool every time we buy stock or make a deposit in our accounts.  As a society, we grow wealth together, a point best exemplified by the parable of the pencil – which brings us to the second point.

As the rule, not the exception, we benefit by cooperation and not by competition.  We not only draw on the collected financial wealth of our society but also on its collected intellectual wealth.  Specialization and the division of labor can’t work without each of us sharing our talents and expertise with each other.  This observation is not meant to dissuade one from the idea that competition is bad – it is not.  Competition is the mechanism by which we decide on those goods and services that best serve society; but it needs to be recognized for what it is – an essential ingredient for vetting new ideas against old – but not the norm for everyday life.

At this point, we can return to the central conjecture that board games contribute to the overall misinformation of how the economy truly works that many people suffer from.  As a case in point, consider one of our current favorites, the game called Machi Koro.

Machi Koro

The basic theme of the game is that each player has just been elected mayor of a small town (that’s what machi koro means) and their goal is to grow the town into the largest city in the region by building developments and public works and by ‘stealing’ from the neighboring coffers.  The game mechanic is built around the payout that these investments yield when the active player roles a die or dice.  The investments come in four types, designated by their background color.  Blue investments payout upon any matching role while green ones only yield an income when the active player gets a match.  The payouts come from the bank with no connection as to why the investment produced a return.  Red and purple investments operate analogously to the blue and green, with activation coming either on any turn or from the active player, respectively, with one difference.  The resulting money comes not from the bank but from one’s opponents.

The red investments feature mostly eating establishments with names like Sushi Bar, Café, and Pizza Joint.  The idea being that the unlucky player who activated them on his role is being charged for eating out.  As bad as the red properties are, the purple investments are far more debilitating.  Featuring large public works with names like Publisher and Tax Office, the purple properties can positively cripple your economy.  Since they activate last in priority, a purple establishment can take profit out of a player’s hands seconds after it is earned.

Machi Koro Cards

Don’t get me wrong, Machi Koro is absolutely fun and I highly recommend it, but it is a poor model for the economy.  Each player is not required to do anything to earn the money that comes their way.  No customers exist whose needs must be satisfied, no voters must be courted, no supply chains, no production tradeoffs, no distributing or marketing of goods – in short no cooperation with anything or anyone else.  Of course, it is the competition that makes it fun to play but, under no circumstances should it be thought of as a model for the real thing. Perhaps the only thing it gets correct, is the burdensome nature of taxes and crony capitalism.

So, what to do about board games?  Well, it is important to recognize that the games that are popular are so because they reflect something we like.   They reflect our ideas and values rather than causing them.  So, continue to play them and have fun.  And if you can slip into some discussion about how the economy really works then you’ll be a winner regardless of the final score.

Division of Labor


This Thanksgiving I thought I would focus on an aspect of the economy, one for which I am extremely thankful and which doesn’t get a whole lot of attention:  the division of labor.   For the past several Thanksgivings, this column has focused on the lessons of private property that the pilgrims experienced (the hard way) as they tried to setup a life in the new world.  This time around, I thought it would be appropriate to examine the division of labor as one of the central pieces that make up a voluntary economy.

I’m not sure where the division of labor was first noted in the historical record, but it is clear that human society has organized itself for millennia around the idea of a person training to learn a set of narrowly-defined skills  and then working within a ‘trade’ that allows them to apply those skills effectively.  There are at least three basic, fundamental reasons for why specialization helps.

First there is always a setup, an overall cost for getting things in order.  This cost includes the time spent on the learning curve wherein the tradesman learns the specific set of skills required and the capital required to support the activities.  Since it is a non-reoccurring cost it will be ‘cheaper’ when amortized over a large number of the same tasks.  This ensures that the cost passed on to the consumer will be smaller, and thus more economical, when spread over multiple items.  The only way to realize these per-unit savings is to have experts devote their time to reaping this benefit.

Second, there is the fact that with practice comes speed.  A person who focuses his time on a limited set of tasks becomes much faster, since he is not distracted with the need to ‘change gears’ in his thinking or actions.  The increased speed results largely from the fact that the uncertainty and the wrestling with what to do and when is taken out of the activity.  An excellent example of this is the speed that results from someone who knows how to type using all ten fingers compared with the hunt-and-peck typist.  The net result is an improvement in overall productivity.

The third reason that specialization thrives is that with practice also comes innovation.  The expert has a chance to see the same operations over and over; to experience what works well and where improvements in the process can be made.  As a result, new techniques, materials, or processes and organizations are more likely to occur to the expert compared with someone only tangentially familiar with the trade.

Adam Smith noted the amazing effects of the division of labor in his An Inquiry into the Nature and Causes of the Wealth of Nations (which most people shorten to simply The Wealth of Nations).   In Chapter 1, Smith notes:

[T]ake an example [of] the trade of a pin-maker: a workman not educated to this business … could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty. But in the way in which this business is now carried on, not only the whole work is a peculiar trade, but it is divided into a number of branches, of which the greater part are likewise peculiar trades. One man draws out the wire; another straights it; a third cuts it; a fourth points it; a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on is a peculiar business; to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is … divided into about eighteen distinct operations.  I have seen a small manufactory of this kind, where ten men only were employed, … make among them about twelve pounds of pins in a day. There are in a pound upwards of four thousand pins [and] …. [t]hose ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day.

A conservative estimate of the gain that results from this specialization is to over-estimate the non-experts output at 10 pins/day and to under-estimate the 10-man factory at 40,000 pins. The gain is then a factor of 400 per person.  This is but one aspect of what can be achieved by the division of labor guided by what Smith termed the Invisible Hand; the social benefits that result from individual pursuit by members of an economy of their own rational best-interests.

There is an interesting consequence that results from the division of labor; no man really knows how to make anything.  By this is meant that no man can really know how to start purely from natural resources and, by expending his time, effort, and knowledge, build even the most modest of modern objects that society as a whole takes for granted.

In a famous essay entitled I Pencil, Leonard E. Read explores the complex set of operations, events, processes, and connections required to make something so ‘mundane’ as a pencil.  Written in 1958, the essay emphasizes four points about the pencil and, by extension, the economy as a whole:  1) its creation is contingent on innumerable products and services that precede it, 2) no single mind knows all of these products and services nor knows how to put them together, 3) its creation is a miracle of the Invisible Hand, and 4) that men and women can accomplish amazing things when free to try.

Unfortunately, the essay is a bit old fashioned in its language and lacks what is probably the most essential element in today’s modern, hyper-stimulated world: pictures.  To this end, I thought it would be fun to try to give a visual interpretation.

So, start with the pencil:

pencil

nice, simple, no moving parts.  And it is easy to build one of these, right? All one needs is wood, some graphite for the ‘lead’, a bucket of paint, some rubber for the eraser, and a bit of metal to hold it on the end.

pencil_parts

But wait!  How does one put all these components together?  One needs a factory.  And how does one get the components to the factory?  One needs a truck, and the roads upon which to drive, and fuel to power the engine.

pencil_factory

And how does one get the truck?  Well…, a truck is made of steel, iron, glass, copper, rubber, and so on.  So one needs all these materials; a means to transport these materials from the factories that made them to the factory that builds the truck; fuel to power each factory and the trucks used to transport them (yep – you need trucks to build trucks). The number of linkages is truly mindbogglingly complex and intricate.  And we actually haven’t even touched upon the services side of things, like operating a distribution network, running a store, or marketing and advertising.

Even abstracting the pictures of the objects away until nothing is left besides labels and links doesn’t help in the final analysis.  The following image is an attempt to capture only some (the barest few) of the most superficial connections, and it is already hopelessly complicated.  The web-work of the economy is truly beyond the understanding of any human or group of humans.

pencil_connected_economy

 

And yet, there are some who think that the central planning can be done by a core group of wise and intelligent bureaucrats who are smarter than their fellow citizens.  Those who think this way are not intelligent or honest enough to look at the interconnectedness of the economy and realize that it is beyond the scope of human understanding.   As for me, I’ll continue to trust in the Invisible Hand and be thankful for it.