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There is no doubt about it, Elon Musk knows how to generate excitement and how to sell product.  Tesla motors recently announced plans for the relatively affordable Model 3, a much less expensive version of their famous electric car (although some beg to disagree).

One of the selling points that Musk accentuates is the notion that buying a Tesla helps save the planet.  Driving an electric car contributes to the environmental changes so desperately needed for the big blue marble.  This very claim about lifestyle is just ludicrous.

Don’t get me wrong.  I like the idea of competition in the market place and a greater number of choices available for the consumer.  And I like the idea of electric cars in general and the Tesla in particular.  What I don’t like is some of the shoddy economic thinking that drives certain people to think that the Tesla Model 3 will be the revolutionary next word in environmental stewardship.

The simple reason for this is the enduring and unassailable law of economics – everything has a cost.  This is what is known in common parlance as ‘there’s no such thing as a free lunch’.   But surely, goes the common wisdom, driving an electric car is much friendlier to the environment; it has zero emissions.

Well Frederic Bastiat would be quick to point out that such a conception is based on thinking that is only looking at what is seen.  The so-called hidden costs remain just that, hidden.  What are this hidden costs?  The generation of the electricity still comes from almost exclusively from fossil fuels.  This fact leads to two complications that may actually be serious enough to turn the notion that electric cars are contributing to the solution on its head.

The first and most benign complication is something about which I’ve written before.  The tax structures and incentives that are currently in place encourage the electric car owner to be a free rider; to use public goods without contributing his fair share.  Since the maintenance of the public roads depends on revenue almost exclusively arising from gasoline taxes, the electric car owner gets to use the roads without directly paying for the maintenance.  It is entirely possible that law makers will then have to keep gasoline prices low enough to encourage more of the conventional drivers to buy enough fuel to offset the loss.  This additional consumption has the opposite effect on the environment that what was originally intended.

The second and much more serious complication is that fossil fuels are the primary source of electrical energy in this country.  So as more electric cars find their way on the road, the use of fossils fuels will recede from the public view and become hidden behind the long lines of copper that remove us from the power plants where the chemical energy is converted into electrical.  There may even be a thermodynamic argument that shows that it is more inefficient to generate the needed energy and transmit it to the electric car than it is to simply burn gasoline in an internal combustion engine.  I don’t know one way or another – I simply know that very few talk about this hidden face.

Of course, the typical zealot who thinks only about the upside to the electric car will point out that the great and powerful Musk has a solar panel business as well and that we can all simply move to renewable energy powered by the Sun.  Unfortunately, that doesn’t work.

The table below has a modest estimate of the cost required to outfit the country with solar panels that exclusively provide the energy needs of the USA.  The amount of available solar energy is over estimated in several spots (6 hours/day is about 30% too large; 40% of total power captured is 10-20% too large).  The efficiency of the solar panels is put in the middle range of what is currently achievable and the cost is brought down by at least two orders of magnitude.  The estimate for total energy used in the US is taken as the lowest value found (about 10% low).

So even if the country were of a mind to do nothing but make solar panels, it would take over 5 years just to outfit our national needs (that means no growing crops, to manufacturing food or housing or anything else, no health care, no fun).

There would also be serious environmental effects with so much solar panel manufacturing.  The chemicals and materials are far from safe (many are downright toxic) and the industrial process requires energy itself.  Clearly solar power isn’t the answer.

The energy densities needed to transform the national use from fossil fuels to clean energy are really only found in nuclear power but even that approach is not without cost and risk; even if the cost and risk were appropriately mitigated there still remains the political opposition to this energy source; an opposition that is firmly rooted in an irrational fear of a nuclear holocaust that ever far less dangerous than global warming; and this fear is, itself, deeply rooted in the same muddled thinking that leads these same people to cling to the notion that solar is the answer.

So at the end of the day, I’m all for the consumer buying a Tesla just so long as he understands that he while he may be saving money he isn’t saving the environment; that he has yet to find a way to get a free lunch.

A peculiar thing happened a few weeks ago.  On March 22^nd, thousands of JavaScript developers were faced with broken builds and failed installations due to a missing piece of code, 11 lines in length.  Much like the events in the Day the Earth Stood Still, a single superior force brought the much larger but far more primitive press of humanity to a grinding stop.   But unlike that iconic movie, the motive in the internet crisis wasn’t moral but rather economic (although there is certainly a moral aspect to this story as well – as there is in all things economic).

The timeline of events is disclosed in detail elsewhere.  The key features for the sake of this argument are simply these.   There exists a common JavaScript code repository called NPM which dubs itself as the place to “Build amazing things” and describes itself as:

One such developer, by the name of Azer Koçulu, had provided to all of humanity, 250 JavaScript Modules.  Of these, the reader must focus on only two of them.  The first was named kik, which is also the common short form name of Kik Messenger, a messaging app for smartphones.  The second, called left-pad, was the 11-line piece of code that brought much of the internet to its knees and opened lots of new horizons in the ownership of intellectual property.

As might be predicted by the common name, a clash developed between Azer and Kik’s corporate office.  The latter requested that Koçulu surrender the name of the module since they legally owned the trademark.  When he refused their less than polite request, they went to NPM to force the issue and, when NPM management complied, Koçulu unpublished all his modules.  The resulting elimination of “left-pad” broke the systems that depended on it, precipitated NPM’s unprecedented step of restoring “left-pad” (so-called un-unpublising), and launched a controversy that is likely to become a watershed event discussed for decades to come.

Now I’m not going to weigh in on the various legal points that have been raised, such as did Kik have the right to the name, did NPM have the right to give it away or to un-unpublish the “left-pad”, or did Koçulu have the right to unpublish the code in the first place.  As interesting as these questions are there is a much more interesting question.  Was “left-pad” a public good?

To appreciate this question one must first understand how economists place goods into the four categories of private, club, common-pool resources, and public.  Each good is judged in terms of two attributes:  excludability and rivalry.

A good is termed excludable if a person or entity possesses legal rights that enable them to prevent others from using it.  A good is non-excludable if no one either possess such a right or if the right is effectively non-enforceable.  The term open is synonymous with non-excludable in what follows.

A good is rivalrous if the use of the good by one entity precludes its use by all others.  A good is non-rivalrous if it can be used by many entities without harm being done to any of them.  The term shareable is synonymous with non-rivalrous in what follows.  Note that only intangible things likes ideas and concepts can be truly shareable but that in many cases some goods are so much closer to shareable than not that the idealization is useful.

The four possible combinations of excludable/open with rivalrous/shareable give the four categories of goods:

• Private good – excludable and rivalrous
• Club good – excludable and shareable
• Common-pool resource – open and rivalrous
• Public good – open and shareable

These definitions are abstract and difficult to think about so a common tool is to construct a 2×2 table with instances of each type.  Common tangible goods can be placed in such a table and on such version is

The next step is to create an analogous table for digital goods and then, using the resulting categorization, conclude in which of these cells the innocuous but vital “left-pad” module should live.

Adapting the 2×2 table to cyberspace is a bit more challenging than tangible goods precisely because of the blurred lines that exist in the digital world between ownership and right-to-use.  For example, when one buys a videogame, one is really buying the right-to-use the game on a game console and not the game itself. Unlike Monopoly, where the owner really owns the matter/hardware that goes into the game and can transform it as he sees fit, the owner of Halo really owns the ability to interact with that particular copy of the game he purchased.  The situation is further complicated by the fact that there is a fundamental difference between the embodiment of the game (the pit and blanks on the DVD, the DVD itself, the game console, etc.) and the code that makes up the game.

Nonetheless, after some thought, it is possible to come up with good examples in three of the four categories; the common-pool resource being the only one that seems to lack a digital analog.  One such instance is

The only step that remains is to determine where in this table “left-pad” finds a home.  The natural first reaction is that “left-pad” is a public good; an opinion mostly endorsed by Nadia Eghbal.  But this question isn’t really well-defined enough to answer.

Certainly, the code concept itself, taken as an abstract entity, is a public good.  Koçulu neither claimed copy-right nor did he regulate (exclude) use.  But the embodiment that he maintained on NPM was more like a club good, where for much of its life the club was everyone.  Then after the debacle with Kik, Koçulu simply redefined the club to be no one. The delicate point here being between the particular copy or instance of the code and the ownership of the code itself.

As time progresses and society, in general, and economists, in particular, have a chance to analyze the fallout from this event and others like it, I suspect that whole new modes of thought will have to be developed about who owns what in digital realm.

Klaatu barada nikto!

So, once again, I decided to learn a little more about how economists see the world.  The basic ingredients of their studies center on two pieces: goods and services; and the transactions and behaviors whereby they are produced, traded, and consumed.  Many of my past blogs have dealt with the behavioral aspect so it seemed reasonable to ponder a bit more at just what the term ‘goods’ means (obviously expanded to include tangible items like cars and intangible items like tax preparation services).

And so off I went on a rambling intellectual walk-about through a variety of sources, both written ones, collecting dust in my home library, and virtual ones, collecting cyber-dust somewhere in the great digital repository that we all casually call the net.

I held one goal close enough to my heart that its achievement would fill me with satisfaction for a time, but far enough away that its failure would not disappoint.  I greatly want to understand how the classical economist ever embraced the clearly flawed idealization of a rational consumer/actor.  People rarely act rationally if, by rationally, we mean the narrow concept that they seek material gain as the primary, or perhaps even only, aim.  The Ultimatum Game being one of the surest refutations of that position.  Certainly I am mindful that all disciplines need approximations and idealizations to progress but at what point did the idealization cease being a model and started to become gospel was the question.  Perhaps the answer lay in how economists look at the goods people produce, trade, and consume.

I wasn’t really expecting an answer but I would have liked to have even a hint.  Alas, even a hint was too much to ask but I did learn some interesting things about goods that is worth at least a few more paragraphs.  In short, there are three categories that, with apologies to Sergio Leone, I call good, bad, and ugly goods.  Economists, of course, don’t call them that, but their categories match mine quite closely so I’ll not be shy in using my lingo interchangeably with theirs.

Good goods are what are generally termed ordinary goods by economists.  An ordinary good possesses a negatively sloped demand curve.  As the price of the good rises, there is less consumption of it as consumers seek out substitutes and alternatives.  A substitute is a good that serves the same function but costs less.  Switching out Bombay Sapphire for Beefeater is the kind of switch that economists mean by the term ‘substitution’ although they, no doubt, would never stoop so low as to buy a lesser gin.  In contrast, giving up gin and tonics permanently in favor of tea-totaling falls under the heading of ‘alternative’.  In either case, the consumer generally responds to an increase in price by changing their behavior so that they consume less when the vendor asks more.

Good goods further sub-divide into three categories called: inferior, normal (or necessary), and luxury.  This sub-categorization reflects the natural evolution in most consumers that, as their income grows, they themselves grow accustomed to better styles of living.  I borrowed this latter terminology from the divorce court lawyers who argue that their client is entitled to alimony that supports the client in the style to which the client has become accustomed.  Levity aside, each category reflects the income elasticity of demand of a good found within its bounds.  Economists define income elasticity of demand (eM) as the ratio between the percentage change in the quantity demanded to the percentage change in the household income.

As a person’s income grows his fractional change in income is positive.  If he decides that he no longer needs to eat ramen noodles every night because he now has enough money to go out for a burger from time to time, then the fractional change in ramen demand is negative.  The ratio between the two is also negative and the good is inferior.  More simply put, as a person’s income grows his need to settle for a good he would otherwise not buy diminishes.  Thus ramen is an inferior good.

Normal and luxury goods have positive elasticity, meaning that the quantity demanded typically grows as income grows.  The difference between these types of goods lies the magnitude of the elasticity.  An elasticity less than one means that changes in income do little to change the quantity of the good demanded whereas an elasticity greater than one means that a small change in income (or in a related fashion price) makes a big change in the amount demanded.  Normal goods fall into the former category (as a result they are sometimes called necessities) and luxury goods fall into the latter.  Food is typically a normal good and the consumer will buy his staples, say a gallon of milk, each week for the most part regardless of the change in price or his income.  Fine gin is regarded by many as a luxury item (although it shouldn’t be); to be bought when the price is right or the take home pay is sufficient to allow an indulgence.

In deference to any actual economists who may read this, I do want to be clear that in the last paragraph I played fast and loose and blurred the distinction between income elasticity of demand and price elasticity of demand.  They are distinct but highly-interrelated concepts, ultimately connected in a much broader definition of elasticity in personal value.  Here I am imagining something like elasticity defined as the ratio of percentage change in demand to percentage change in the percent of the household expenditure associated with buying the good.  A professional can either work that concept out in detail or prove/argue why it can’t work – it won’t change the fact that each of us weighs the demand for a good by more than the change in price or in income with all other things held constant.

Bad goods are what economists call Giffin goods. These goods defy the law of demand in that their demand curve is upward sloped.  As the price increases so too does the demand.  The big brains claim a Giffen good is typically

• an inferior good
• does not have easily available substitutes
• purchase of it must be a substantial fraction of the total household expenditure meaning that the good is purchased only due to the limited income of the household.

The oft-cited, Giffin-good, example is a staple food depended upon by the poor.  As its price rises, additional income used to buy other goods becomes slimmer and the household is forced to buy more of the cheaper but price-rising good just to be able to eat.  In the example above, if ramen increases in price, our hypothetical burger-muncher may have visit Five Guys less often because he has to sink more of his income into ramen just to have something to eat each day.  Sir Robert Giffen claims to have seen this behavior in Victorian England but certain economists assert that there is no such thing.

The ugly good is synonymous with what economists call a Veblen good.  Like the Giffen good, demand for a Veblen good rises as its price rises.  However, the rise in the demand reflects the good as a status symbol showing that the purchaser is truly a king among men in that he can afford more of what others can’t afford at all.  Conspicuous consumption, which is another name for the kind of behavior that supports a Veblen good, is featured prominently in the rather amusing first part of Chesterton’s The Queer Feet and the reader is directed here for a nice quote.

So there you have it.  A concise, if not precise, summary of how economists categorize goods and their corresponding elasticities.   It would be an interesting follow-up to see if their analysis, papers, and books, which are goods in and of themselves, are good, bad, or ugly.

A recent death in the family has gotten me thinking about, amongst other things, free enterprise and economic liberty.  I know that that is a strange combination but it all stems from a fairly recent legal battle between an abbey of Benedictine monks and the Louisiana Board of Embalmers and Funeral Directors.  At the center of the conflict was whether or not the monks had a constitutional right to sell hand-crafted coffins as a way to raise money for the abbey.  As the dispute worked its way through the courts two things became clear.  First, the monks had a clear, constitutional right to engage in free enterprise and, second, that the state laws put in place to protect the funeral industry were a textbook example of how licensing and regulation often shields businesses from competition under the guise of protecting the public from harm.

The genesis (if you can forgive the biblical pun) of the showdown started just after Hurricane Katrina had devastated much of the gulf coast portion of Louisiana.  The Benedictine monks of St. Joseph Abbey near Covington had lost much of their timberland and looked for a new way to supplement their income.  For years, like other monastic orders, they had fashioned coffins for the burial needs of their departed brothers.  In 2007, the abbey established St Joseph’s Woodworks to sell their hand-made caskets to the public.

No sooner do they get started than the Funeral Directors slap a cease-and-desist letter in their direction citing a state law that only allows caskets to be sold to the public by a state-licensed funeral home. The letter threatened the monks with thousands of dollars in fines and prison sentences up to 180 days for noncompliance.

The monks didn’t take that lying down and, aided pro bono by the Institute for Justice, sued in Federal court to have the law overturned on the grounds that it was an unconstitutional statute designed to protect “cartel for the sale of caskets within Louisiana”.

U.S. District Judge Stanwood Duval agreed with the monks and ruled the law unconstitutional. He noted in his ruling that the coffins sold by the monks were significantly less expensive than those sold at funeral homes and that

The Louisiana Board of Embalmers and Funeral Directors took their case to the 5^th Circuit Court of Appeals but to no avail.  The appeals court upheld Duval’s ruling noting in addition that regulation is aimed at restricting intrastate competition and that

The matter finally came to closure when the Supreme Court refused to hear the case, leaving the finding of the unconstitutional nature of the law in place.

For those unwilling to parse some of the legal wordsmithing in the previous two quotes a simple summary does just as well.  The courts found that the state law was not concerned with protecting the public from shoddy coffins.  Indeed, no coffin seems to be required in Louisiana – just dig a hole and plop the body in.  But the law was concerned with protecting funeral homes from in-state competition from a bunch of monastic hooligans.

Apparently coffin business is quite a market – I suppose because no one is particularly inclined to haggle when dealing with the death of a loved one.  I was curious how much caskets cost and one quick trip to internet brought me to Best Price Caskets.  Several interesting admonitions sit top and center on their website including

and

and this curious image

All the monks were trying to do was to engage their economic freedom and supply a demanded good in return for monetary compensation.  They were filling a need at a reasonable price and that competition was feared by the entrenched businesses that lobbied for the state law that protected them.

So the final question to ask ourselves is this: what other industries, through the mechanism and licensing and regulation, are pretending to protect us while really protecting themselves?  Look around, I think you’ll find more than you might, at first, expect.

There is a curious thing about the Eurozone that doesn’t get much notice but it really should.  On the surface, the Eurozone seems to be a similar economic model to the United States, but the lack of a common culture and free movement within the member countries results in barriers that can actually cause wealth transfer from poorer members to richer ones.

In the US, an individual can move freely between the states (although setting up residency is a bit harder).   Interstate purchases are open and easy, especially in the age of the internet.  Workers can move from states with declining economic prospects to those with an uptrend, resulting in the kind of demographic shifts such as the recent influx into Nebraska and Texas and corresponding exodus from California and New York.  In other words, things have a way of evening out since the barriers for trade between the states are very low (but not nonexistent – consider that many decisions made in California set standards across the other 49 states).  Very few products made in the US are distinctly branded by the state in which they were produced.  Most of us are aware that there are Florida Oranges and Idaho Potatoes but beyond that few of us know where a good is produced.

Take automobiles.  Once it was obvious which cars were produced in Detroit but now few people actually know, or care, in which state is located the manufacturing plant that birthed their car.  Likewise, few of us are conscious where most of the things we purchase originate.

The Eurozone, in contrast, is much more rigid.  The euro is the shared currency throughout the Eurozone but the mechanics of inter-zone trade works quite differently from the US experience with the dollar.  The major difference is that in the Eurozone goods, services and labor from one country are produced essentially independently from the other countries.  When one is in Germany, say in the city of Munich, one is clearly aware what products are imports (mostly clothes) and what products are German in origin (most everything else).  This is especially true in the realm of cars.  It makes no sense to talk about Pennsylvania cars as distinguished from Montana cars but it is quite natural to talk about German cars as compared to those from France, Sweden, or Italy.  In addition, French workers can’t just pick up and head for Germany any more than they could to Japan.  There are barriers – political, cultural (language in particular), legal, and bureaucratic – that really impede that kind of movement.

To see how these barriers provide a mechanism for wealth transfer, start with a simple model of international trade limited to just two countries.  Let country G stand for Germany and U for the United States.  Both countries have their own currency (gold coin denoted as D for G and greenbacks and silver denoted as U for U) and the exchange rate between the two is shown in the yellow box.  Time progresses from left to right.

Now suppose the good that is being traded is cars; G has cars it wants to sell to people in U.  At the initial time, the exchange rate favors G, as its currency is undervalued compared to U, and G promptly ships some number of cars to U.  Upon arrival in U, the cars make their way to a dealership where a citizen of U, call him C, purchases one.  C pays for the car with U currency and happily drives away completely unconcerned with how the money makes its way back to G; that isn’t C’s problem.  G’s agents in the U have to deal with that.  They do so by finding someone willing to buy Us for Ds.  Since the supply of Ds in the exchange market goes up, there is a upward pressure on the value of Us compared to Ds and soon the exchange rate reflects that by adjusting the buying power of G, compared with U, down to parity.  This floating currency exchange serves to naturally limit the number of cars that G can sell in U and an equilibrium results.

Next, expand the model so that G is part of a larger economic entity comprised of itself and H (H stand here for Greece – either because H comes after G or because Hellenic is an adjective used for ancient Greece; the reader is free to decide for himself).  Also suppose the H has no goods to trade with U at all.

Now suppose the same situation occurs in this new model as occurred in the old.  G has cars to sell and U has people wanting to purchase them.  H is a complete bystander in the first leg of the transaction, having no goods to ship to U.  However, H plays a pivotal role when the currency exchange occurs after the purchase.  Since there is a larger supply of U, as H has a supply in addition to G, there is less of a mismatch on the exchange market and less of an upward pressure on D (or downward on U).  Simply put there are now fewer Ds chasing Us in a relative sense.  It takes longer for an equilibrium to set and during this time, H’s purchasing power is remains low.

So although there is no direct exchange of either currency or products between them, H effectively transfers wealth to G in the form of better export conditions for G and poorer import conditions for H.  The poorer H is, the more pronounced is the drag it produces on the upward trend in D, the longer it takes to reach equilibrium and the more wealth is transferred.  If people could move freely between H and G, then a mechanism would exist to equilibrate faster and more citizens of H would share in G’s windfall.  In some real sense, it’s like U is robbing H to pay G.

Although these models are highly simplified, they reasonably capture the essence of some of the tricky situations that result with import/exports and currency exchanges.  Several interesting articles exist (a nice one can be found here) on similar situations during the Nixon presidency that ushered in the end of the Bretton Woods System.  But that is a story for another day.

A while back I wrote on the Ultimatum Game, an experiment in the psychology of behavior in the marketplace which showed that people rarely act purely in their material self-interest.  More often, they balance the possibility of material gain against the other, less tangible or intangible factors, such as self-esteem and pride.

The premise of the game is that two people are put into the situation where they stand to both benefit materially by splitting a sum of money between them.  The catch is that the details of the split can’t be negotiated.  One person is granted the authority to propose a split (e.g. 50-50, 90-10, etc.) and the other is granted the authority to either accept or reject the proposal.  Acceptance nets both parties the agreed-upon sums.  Rejection makes both parties walk away empty-handed.  Classical economic theory predicts that the deal is accepted in all cases where the second party stands to receive something in the way of a split – that is to say when the split is anything other than 100-0.  Real experiments with real people suggest that splits far from equitable (i.e., 50-50) have little chance of succeeding despite the fact that the second person stands to walk away with a material gain.

One of the criticisms leveled against the outcome and analysis of the Ultimatum Game is that the stakes may be too low to really make a difference.  After all, the argument goes, most of the real world experiments are done with sums like $100, which is, relatively-speaking, chump-change.  Economists and psychologists have attempted to address this critique by normalizing the results by offering the same sums in different economic scenarios, like the third world, where $100 has significantly more buying power than in the US.  Nonetheless, the critique that the game hasn’t really been played for high stakes is a valid concern.  Perhaps there is a mind-bogglingly large sum for which even a 90-10 split will be always accepted.

Well, Shankar Vedantam, of NPR, ties the Ultimatum Game to one of the biggest stakes out there – the negotiations on climate change.  The report, entitled The Psychological Dimension Behind Climate Negotiations, aired on NPR the week of Nov. 24, 2015.  In it, Vedantam argues that the same psychology seen in the Ultimatum Game explains why countries with the most to lose by adverse climate change may actually walk away from a deal that benefits them.

To back up this claim, Vedantam called upon the expert testimony of David Victor, a professor in the School of Global Policy and Strategy at UC San Diego and the director of the UCSD Laboratory on International Law and Regulation.  Victor, who has published extensively on the politics of climate change, had this to say about the interplay of gain and fairness

In other words, despite the fact that each of these negotiators represents millions of people, and that they are, ostensibly, rational professionals, they are still human beings who value fairness over material rationality.  In fact, according to studies cited in the report, professionals may actually value fairness more, especially when negotiating with other professionals.

That may be true, but I suspect that the answer is closer to a point touched upon by Vedantam himself later in his report, although he muddled up the thinking.  Said he, when asked about the fairness component of the climate-change negotiations

A careful reading of the above quote can actually lead to a different interpretation.  Perhaps the ‘poor countries’ (developing countries) recognize a greater rational self-interest in continuing to industrialize than in limiting their growth in order to limit their carbon emissions. Unlike the Ultimatum Game, where the outcome is clear cut – walk away with some cash or no cash – the situation in climate negotiations is quite different. The developing countries must decide between two options, each with both a gain and a loss.  So it is entirely possible that they have a rational reason for refusing a deal that benefits them in one sphere but harms them in another.

The genesis of this week’s column is mostly based on chance; a chance visit, a chance purchase, and a chance reading.  Nonetheless, the end result is a nice example of how government interventions in a market can look good on the surface but have a less attractive side underneath.

Let’s start with the chance visit.  Recently, I had an occasion to stop off at a used bookstore near a college campus.  The basic function of this establishment is to buy back textbooks at a cheap price, resell the products back to others at the going rate for used textbooks, and to store the unwanted product as tastes and approaches in teaching and the professors who teach them change.  The fact that the resell price is significantly higher than the buy-back price seems to irritate the bulk of the clientele (judged by my casual viewing of the interactions at the register).  The reason for this cost differential – that this particular book store needs to pay for the storage of the books, the labor of the various people who catalog and handle the product, as well as the rent and upkeep of the shop – slips by the average consumer.  And, although this column is not explicitly about this mismatch of expectations, the basic theme of the unseen cost is.  Looking back in hind sight, these preliminary observations of mine were perhaps a foretaste of what fate had in store.

In any event, I began to wander about the store; an adventure in and of itself considering the vast number of abandoned titles piled precariously all over the floor.  Training in the high hurdles would definitely be an advantage when browsing the inventory.  Turning a corner, I came across the store’s collection of Schaum’s outlines.  Overall, I am a fan of these do-it-yourself study guides.  Not so much due to their teaching style, which is often minimalistic and confusing, but rather the vast number of worked problems that one can immediately dig into.  The effect they produce is a lot like finding a bunch of how-to videos on YouTube with the convenience of the at-your-own pacing that books afford.  Glancing at the shelf, my eye caught the title Microeconomic Theory, 3^rd Edition, by Dominick Salvatore of Fordham University and, almost on a whim, I decided to purchase it for a mere $5 dollars (which goes to show that one can get a bargain if one is willing to settle for yesterday’s textbooks and study guides).

In odd moments, here and there, I began to dip into the outline and amuse myself with some of the questions and solved answers.   Early on in the book, Salvatore goes to some effort to set the scope of the study to be strictly microeconomics.  Interconnections of one market to the next are to be kept to a minimum.  So I can’t blame him for what I found shortly thereafter but I thought it made for a good ‘teachable moment’ about ignored or unseen costs.

The scenario he explores is clearly contrived for pedagogical purposes, but I reason that if it is sufficiently illustrative to go into a Schaum’s outline, it is also sufficiently realistic to serve as a valuable thought experiment.  In this scenario, the micro-portion of the economy that is being examined consists of 10,000 consumers and 1,000 producers of a particular product, which he calls ‘X’.  For simplicity, each of the consumers possess the same demand curve given by

\[Qd_x = 12 – 2 P_x \; ,\]

where $$Qd_x$$ is the quantity demanded of for a given price $$P_x$$ that they must pay.  Likewise, each of the producers follows a supply curve given by

\[Qs_x = 20 P_x \; ,\]

where $$Qs_x$$ is the quantity they are willing to supply if they can charge price $$P_x$$.  The prices that the consumer pays and that the producer demands equal each other when the market is in equilibrium.  The following figure shows the demand and supply curves for this market.

From the figure, the equilibrium point, where the two curves cross, falls at $3 and 60,000 units produced.  We can confirm this result by solving the equation

\[N_c Qd_x = N_p Qs_x \; ,\]

where $$N_c = 1,000$$ and $$N_p = 10,000$$.

Salvatore then directs the reader to consider the case where the government decides to intervene in this market by providing a subsidy to the producer of $1 per unit produced. He asks:

Part (a) is a bit tricky to solve in that one must first decide what is exactly meant by a $1-dollar subsidy.  In short, it means that the producer now perceives that he can charge a dollar higher than he could without the government intervention.  Ignoring for the moment that the new equilibrium will move, the producer gets $4 when a consumer pays him $3 since the government is stepping in with an additional $1.  As a result, the producer’s new supply curve is

\[Qs_x’ = 20(P_x + 1) \; .\]

Functionally, this looks as if the producer’s supply curve has been shifted down by $1 as seen in the figure below (the new, shifted curve is labeled ‘Government’).

The new equilibrium is solved as before, and either direct inspection of the graph or algebraically solving

\[ N_p Qs_x’ = N_c Qd_x \]

results in the new equilibrium of 70,000 units produced at $2.50 per unit.  Salvatore then points the student to the conclusion that this government intervention has benefitted the consumer since price has fallen by 50 cents per unit.  By analogy, this analysis also suggests that the producer is better off in that more units have been produced.

And this is where I got perturbed by the strict adherence to microeconomics.  It is true that this market seems to have been helped but there are unseen costs that at a minimum could have to be discussed even if the implications to other markets were avoided.

Specifically, before the government intervention, a total of $180,000 dollars moved from consumer to producer in this market (60,000 units at $3/unit).  After the government intervention, a total of $245,000 dollars moved to the producers in this market.  It is true that the 10,000 consumers only shouldered $175,000 of that cost but it is wrong to ignore that the producers actually received $70,000 in government subsidies.

Where did that additional $70k come from?  It is easy and tempting to say that it comes from the government and to stop there, but that misses the point.  Where did the government actually get that money?  Well it could have printed it or it taxed it.  If it printed it, the cost of that action eventually comes back in the form of inflation, which devalues the consumers buying power, resulting in a new set of supply and demand curves.  More likely, it taxed it, which means it took money from consumers, some who weren’t that market, and injected it into this market.  It made some consumers reap a benefit at the expense of others suffering a loss.

Of course, this scenario is contrived but the logic and the lesson is not.  The point here is that it is easy to see the direct costs and to ignore the hidden or indirect costs.  As long as a citizen doesn’t dig too deeply, he probably never knows when he is being robbed blind.

I came across two articles recently that caught not just my attention but also my ire.  They were excellent examples of what is wrong with much of the policy material that comes out of the ‘dismal science’.

Simply put, the presentation of evidence and the offered arguments built on this evidence are too scant to be respectable.  The conclusions reached are too certain with no countervailing opinions considered or addressed, except in passing.  The tones of the articles are too much schoolyard ‘see I told ya so’ and too little of the scholastic ‘let’s weigh all sides and pick the best path, regardless of who is right.’ Their logic is faulty and their argumentation depends on tautologies and equivocation rather than well-formed formulas required.  In short, they are polemical opinion pieces better suited for a candidate running for office than they are serious pursuits of truth.  And the validity of their conclusions is, shall we say, dismal.

The first example is a recent article about economic inequality by Christine Lagarde, entitled Equality is key to global economic growth.   Lagarde is currently the managing director of the International Monetary Fund (IMF).  A lawyer by training, she has held a variety of economics-related roles, including as an antitrust and labor lawyer and as France’s Trade Minister and Minister of Economic Affairs.  So I had hopes that her article would offer a well-thought-out support of the position so concisely summarized in her title.

Instead, I found a fluff piece with numerous examples of equivocation.  For instance, the third paragraph of the article reads:

Surely a definition of ‘excessive inequality’ would be coming after such a lead-in.  Does she mean wealth inequality, income inequality, or some other form of inequality?  After all, the inequality between Warren Buffet and the average wage earner in the US is much smaller when considering their incomes versus net wealth.  Buffet makes a comparatively small income (defined as wages and salaries) every year but resides over a vast fortune.

But alas no.  Lagarde does say about inequality that:

What kind of logic is being used in this sentence?  It is almost certain that wealth inequality is a necessary by-product of economic activity.  But where did income inequality creep in.  And what is excessive inequality.  At what value of the Gini Coefficient does income inequality become excessive?  And so what if there is income inequality; it doesn’t mean anyone is poor.  Both the players and owners in the National Football League are quite well-off, even though there is a distinct income inequality between the scant millions earned by the players versus the meatier hundreds of millions and billions earned by the owners.

Without any additional support, Lagarde then goes on to say that:

How much faster and how much more sustainable is the growth – would 0.1 % be statistically significant?  How little is little adverse effect on growth – would 20% be little?  Sigh…

Lagarde ends with this chestnut

There is no rational statement in that sentence other than to say the ‘excessive inequality’ (still undefined) makes people say that they feel bad.

So much for Lagarde!

The next candidate in the bad logic hit parade is the article entitled Free Trade With China Wasn’t Such a Great Idea for the U.S. by Noah Smith.  Smith’s bona fides tell us that he is an assistant professor of finance at Stony Brook University.  So I had hoped for a well-reasoned discussion.  But those hopes were soon dashed.

Smith is more subtle with his equivocation and, as a result, his misdirection is harder to spot.  His starting position is that:

These two paragraphs, examined closely, open all sorts of questions about Smith’s positions.  First, by his own rules, should we be regarding Smith as a preacher rather than a scientist, since he is talking in public?  Second, is being a preacher bad or, perhaps, is Smith revealing both his ignorance and his bias when it comes to faith and science?  Anyway, let’s leave these questions aside and focus on the question he would like us to focus on.  Is free trade with China bad?

To support the premise of his title, Smith provides us with this little gem:

Increased trade equals free trade? How many workers constitute many? Is 3% of the workforce many? And how many counter-examples are there on free trade? Would 10 papers out of 100,000 be enough to paint a ‘very different picture’? I don’t know the statistics and since Smith doesn’t say how he defines free trade and what criteria he uses to say that the picture is different, I never will know.

Smith then argues that:

My response is – so what?  I feel for these people who have been hit hard and have not recovered.  Collectively, we as a nation should do something, and individually, me as a person should do (and am actually doing) something.  But where is the evidence that free trade is the culprit?

How do I know that some economists or lawyers or professors of finance haven’t rigged the trading with China to favor themselves?  After all, income inequality (or is it wealth inequality) has to come from somewhere.  Or maybe government policy has left trade unfettered but has prevented these displaced persons from finding other jobs. Perhaps welfare and unemployment benefits are perversely constructed so that the displaced worker has no incentives or options to support himself while he looks or trains for new jobs.  Perhaps, in an imperfect world, the benefits to society as a whole far outweigh the localized losses, as painful as they may be.

There are lots of questions and no forthcoming answers because Smith avoids examining these questions entirely.  He seems to simply want to inflame the passions of a populist subject.  Just the kind of behavior I would expect to see from a fly-by-night preacher.

So let me close by saying that one should stay on one’s toes when reading articles that pass for economics but are really politics.  When the author argues without defining terms, without presenting quantitative evidence, and with liberal shortcuts through logic, the article probably isn’t worth one’s time.

Unintended consequences.  That phrase could be the rallying cry for millions of people adversely affected by either poorly conceived or too-broadly applied regulations.  Often these regulations, which are usually put in place to protect the economic interests of one party against the encroachments or abuses of a second party, have harmful side-effects on a third party – what economists call negative externality.  Net neutrality seems to be one such type of regulation rife with all sorts of unintended consequences.

The aim of net neutrality seems noble.  Keep the internet free from interference by the internet service providers (ISP) so that there is an uninterrupted conduit from content-provider to content-consumer, regardless of the nature of the content or the identities of provider or consumer.  The ISP should act as a public utility maintaining the infrastructure through some equitable fee structure so that big and small alike can achieve the same throughput but, otherwise, should stay out the way.

The concern that is being addressed can be best illustrated using a hypothetical situation.  Suppose that two content-providers are competing for the hearts and minds of the great movie-streaming audience out there.  One is a large well-established firm, like Netflix, and the other a smaller, newer company, like Hulu, that can be view as upstart competition.  The situation that net neutrality is supposed to prevent is where an ISP, such as Comcast, enters into an agreement with the larger provider.  The nature of the agreement is that the ISP will enhance the bandwidth of the larger streaming service, throttle the flow from the smaller competitor, or both in return for additional compensation.

Supporters of net neutrality point to the fact that the net result of such an agreement is that the smaller provider faces an extremely large barrier to entry.  They need to have capital to cover not only their operating costs but also to ‘grease the palms’ of the ISP.  Small business thus starts out on a playing field that is far from being level.  Furthermore, consumers are harmed when denied access to all content and that they end up paying more for two reasons.  First, the larger content provider has less competition thus ensuring that it has a consistently high demand almost independently of the price it sets.  Second it wants to pass on the cost it incurred in making the deal with the ISP onto its customers and can do so without fear.

Detractors point to the fact that government intervention in the free market often does more harm than good, that the government regulation stifles free speech and harms entrepreneurship.  An additional critique that occurs to me (but which I haven’t seen expressed in the debate) is that compliance with government regulations is often so expensive that it constitutes a barrier to entry for small businesses.  So net neutrality may enhance completion between service providers big and small but it may substantially diminish competition in the ISP market.

Obviously, the net neutrality argument is heavy and heated and extremely complex, with government being asked to balance a multitude of competing wants and needs.  I’m not sure what is the best solution and I am not going to remotely try to explore all of the pros and cons.   Rather I wish to comment on a small and interesting l little corner that has recently come to my attention.

In her piece Net Neutrality and Religion, Arielle Roth points out that an unintended consequence of the net neutrality is the chilling effect it would have on smaller ISPs who tailor their offering to a particular customer base that wants certain corners of the internet off limits.  The usual scenario is one where a religious demographic would like to restrict access to pornography, or sacrilegious or blasphemous content.  These customers want to enter into a legal contract with the ISP in which they pay to the ISP to deal with the segments of free expression for them.  In other words, these customers want someone to shield them from content they would find offensive and they are willing to pay for the service.

Such a service would be in violation of net neutrality since it would disadvantage a ‘dirty’ provider (say Playboy) relative to a ‘clean’ provider (say Billy Graham) even though the customer wants that disadvantage.  And it isn’t clear at all how to write an exemption that respects one scenario without running afoul of another scenario.  How should the government define ‘excludable content’ from ‘essential content’ without encounter the slippery slope type of arguments that manage to make all content excludable or essential.

Some free speech advocates will, no doubt, say that this is the price we pay for free speech. But that argument is not persuasive.  Free speech protections guarantee an individual’s right to say just about anything (within some narrow limits) but it doesn’t guarantee that anyone must listen.  And besides, there is an equally valid constitutional argument that says individuals have the right to freedom of association, which means they have the right to not associate with content they deem unacceptable.

And so this little corner of the net neutrality debate shows just how complicated and thorny it can be to try to regulate economic behaviors.

It was only about 4 scant months ago that I wrote a column about China and the real and present dangers it presented to the global economy.  And here we are on the edge of the meltdown, watching as the Chinese stock market drops and drops in value.

Nothing seems to help during this latest flurry of devaluation on the Chinese Stock Market.  The automatic circuit breakers halted trading on two separate occasions before the Chinese government concluded that they were doing more harm than good.  The market then proceeded to tank again.  And despite all this turmoil, the central government keeps beating the drum that growth in the economy is still on pace for 6-7%.

Meanwhile, back in the United States, many market participants on the NYSE or NASDAQ have lost their collective heads and have begun selling everything off in sight.  Of course, cooler, less-emotional heads are buying and at a discount but it looks like the public at large doesn’t care.  There is an old saying, which goes something like “the beatings will continue until morale improve”, that applies here.

I bring up these crazy, irrational responses as way of a prelude to the main point here.   Human behavior gets muddled when strong emotions are roiling under the surface.  Nothing new there! And few things engender strong emotions as much as money – or more precisely the freedom that having lots of money implies.  But the less-cynical-me had hoped that paid professionals in both the financial and media sectors to be able to detach emotion and discuss objectively.

Anyone with common sense and the ability to keep their emotions in check would have been able to warn that the ‘China miracle’ was anything but.  There was no shortage of voices who were questioning the Dragon’s wisdom in constructing high-rise apartment buildings in which no one lives, or the raising of large malls where no one shops.  And yet, China’s ‘new economy’ made headlines all over the world.

Even now, with the precipitous loses of the last two weeks, the best that seems to come out of ‘money reporting’ are tame and vapid pieces like Heather Long’s Why China doesn’t know what it’s doing.  Ms Long’s lead in reads

Huh?  When did China ever know what it was doing?  I’m willing to bet that she is someone who would dismissively scoff at the ordinary sorts of miracles that those religious ‘country bumpkins’ accept.

Later in the piece she is willing to ask the question

I would love to see what she would have said if she were reporting on the pyramid scheme of Bernie Madoff.  Perhaps her text would read

And so the more-cynical-me jumps to a conclusion that it wishes to share.  There will always be buffoons in the market, like rubes in at the circus.  Eager to see something new or strike it rich or whatever, they are willing to suspend not only disbelief but common sense.  They are quite willing to look the other way while their pocket is picked clean.  Some members of the financial industry and of the intelligentsia in the media aid in this shearing by acting as either side-show barkers or as those encouraging bystanders who tell us “What have ya got to lose.”  Other members act as the ‘friends’ who consoles us with platitudes about it not being our fault or how could we have known or it was just bad luck.  Only a few, honest ones continue to tells us that there is no such thing as a free lunch.  I just don’t think many of us will ever listen those guys.