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

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

where  is the quantity they are willing to supply if they can charge price .  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

where and .

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

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

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.

What do National Review, The Hill, The Orange County Register, The Week, The New York Post, The American Spectator, NPR, Vox, The Huffington Post, The New York Times, and The Washington Times all have in common.  At first blush the answer is probably nothing substantial other than that they are all media outlets of one fashion or another that publish in English (spoken or written) in the United States and that each tends to cover political content of the day.  But there the commonality seems to end.

National Review, The New York Post, The American Spectator, and The Washington Times are all to the right-of-center while the Hill, NPR, Vox, The Huffington Post, and the New York Times are left-of-center and The Orange County Register and The Week sit somewhere in-between.

But the fall of 2015 saw each of these publications issue articles on the structural problems and the corresponding growing issues of the Affordable Care Act (ACA).  In other words, concerns about the economic integrity of the system, more commonly known as ObamaCare, are being raised all across the political spectrum and that, in and of itself, is worth noting.   Regardless of your politics, the immutable facts of economics remain constant and, unfortunately, merciless.

Now to be clear, I personally like the overall aims of the ACA. The idea of opening access to regular health care to the largest possible segment of American society is laudable.  As is the aim of lowering cost by competition and keeping coverage transportable by lessening the ties between policy and place of employment.  These are admirable requirements that are firmly couched in the ethical notion that man is intrinsically worth something – that each human being has a value quite independent of his economic output.

But while we can ignore economics in defining our ethically-based goals we can’t ignore it in our plans to achieve these goals.  Immutable laws of nature, both inanimate and human, must be taken into account.  As well discussed in this interchange

there is no logical support that allows us to go from the idea that human life, in general, is the most valuable thing in society, to the idea that an infinite value should be place on an individual human life, since there is not a infinite amount of resources to apply to the well-being of any person.

And yet, the enactment of the ACA seems to have been done in full denial of this economic reality of life.  The evidence for this is found peppered throughout the coverage that came out this past fall.

In the article Obamacare Is Dead, Kevin D. Williamson of the National Review, notes that of the 21 million participants needed to provide a cost-sharing base, only about half are actually participating.  In addition, the current demographics are heavily weighted towards the sick and/or elderly, who are looking for a payout, while the younger and healthier buyers, needed to offset the rising costs, are staying away.  There are several mechanisms used by this latter group to ‘opt-out’.  Some decide that their most rationale course of action is to simply pay the penalty rather than join.  Others, 12 million in last sign-up cycle, took advantage of the 30 exemptions.  As a result, and despite the federal subsidies, already half of the co-ops have gone under financially.  Williamson also points out that the ACA further distorts the notion of insurance, turning it into a badly-constructed cost-sharing program, and that private industry (e.g Medi-Share) does a much better job of delivering health care than government.

Robert Pear of The New York Times points out in his article Many Say High Deductibles Make Their Health Law Insurance All but Useless that many consumers are complaining that ‘sky-high’ deductibles make it impossible to actually go to see a doctor.  Pear cites many cases, the most startling being a median deductible of $5000 in Miami, with the obvious implication that there are policies for which the deductible is even higher (probably much higher depending on the spread of the distribution).

Deductibles this high cause a perverse outcome in which the healthiest people stay out of the exchanges altogether.  The reason is that the law gives them a disincentive.  David Catron, of The American Spectator, argues in his piece entitled ObamaCare Endures the Death of a Thousand Facts, that a healthy consumer faced with high deductibles (e.g. the Miami median of $5000 mentioned above) is quite rational in electing to give up their health coverage, even if the premiums are low, and pay the small penalty ($695) – it is cheaper to stay away.  This approach is especially attractive since the consumer can’t be denied coverage later if a catastrophic illness were to arise.

It is true that not all plans have high deductibles.  Policies with relatively low deductibles use higher premiums to offset the cost.  So the consumer has to pay one way or another – either up front with the premiums or on the return with deductibles.  And, as Sarah Kliff of Vox notes (Why Obamacare premiums are spiking in 2016), it looks like premiums are heading up across the board.  So even affordable premiums, independent of deductible size, may be a thing of the past. In her analysis, Kliff lays the blame at the feet of insurance companies who “underestimated how sick health law enrollees would be.”

But the flood of sick enrollees shouldn’t have unexpected and, therefore, underestimated.  The ACA attracts the sick while giving the healthy (and their money) a reason to run and hide.  These kinds of perverse economic incentives are at the root of massive losses in the state-run co-ops.  Akash Chougule (Obamacare Enters a Downward Spiral as Co-ops Fail and Enrollment Slows) notes that:

• 22 of 23 co-ops lost money in 2014 despite receiving $2.4 billion in taxpayer support
• Iowa and Nebraska co-op offered artificially low rates causing a tenfold increase in enrollment over what was expected; this forced the co-op into liquidation
• Louisiana’s co-op went under due to “onerous burdens” sending 16,000 enrollees looking for new policies

Chougule also points out that individual-market insurance costs rose by 49% in 2014, so the additional increases that Kliff sees on the horizon amount to adding salt to the wound.

I could go on but I’ll stop here by noting that I barely scratched the surface of all the articles that are out there.  Additional food-for-thought is easy to find.  Here is a sample

• ObamaCare's predictable collapse – Rick Manning of the Hill
• Obamacare at 5: Sick and getting worse – Mark Landsbaum of The Orange County Register
• The quiet unraveling of ObamaCare – Shikha Dalmia of The Week
• A new taxpayer bailout to cover up ObamaCare’s failure? – Betsy McCaughey of the New York Post
• Many Health Co-Ops Fold, Others Survive Startup Struggles – NPR
• The Figment of Affordable Health Care - Washington Times

Each and every one, spanning all parts of the political spectrum, is touting the gloom and doom of the ACA.  Each and every article serves as a reminder that there is no such thing as a free lunch.  To bad the champions of the ACA didn't want to recognize that.

Well we just finished another haul through that end-of-year spending frenzy that passes for yule-tide spirit.  This bit a crass consumerism in the name of the virgin birth often leaves a bad taste in my mouth and a reasonably large dent in my wallet.  But it also gives ample opportunity to observe and even dissect American economics with particular focus on the household-to-firm side of the three-legged stool that comprised the bulk of our economic activity.

Now before I report on my observations, I think, in the interest of full disclosure, that I make it abundantly clear, that I prefer to make the majority of my holiday purchases online.  There are several reasons for this.  The most important reason is that I would rather spend my precious time with family and friends rather than slogging through a mall but I would be remiss if I didn’t mention that I simply don’t like interacting with people that much.  It helps that the majority of gifts I look to purchase are easily obtained with a little cyber-spending.

All that said, this past holiday season emphasized one point with emphasis.  Despite dire predictions to the contrary, I see no end in sight for brick and mortar establishments.

Often over the past 10 or 15 years we’ve all heard that brick and mortar establishments – ranging from big box stores like Best Buy to mom-and-pop stores just across the street – were facing insurmountable competition from the online presences.  The end was nigh so said the gloomiest of the economic pundits and yet here we are years later and brick and mortar shops are still here.

To be sure, they are not quite in the same embodiment that they were in before the internet revolution.  The fierce competition from online vendors, particularly Amazon, has substantially changed the face of how books are purchased. But brick and mortar establishments have adapted in the face of this competition.  They’ve capitalized on those facets of their business that give them the greatest advantage and have responded to free-market forces in a way that would make Adam Smith proud.

And what are those facets that give them an edge over the internet providers?  Well, a little bit of thought should convince you that the primary advantage that brick and mortar provides its customers is what I like to call purchase certainty.  Purchase certainty takes several forms that are best illustrated with examples.

First type of purchase certainty is certainty in the quality of the product.  Most of us, I am sure, have had the experience where the item online looks good but when it arrives it is a disappointment.  The one that personally affects me is the purchase of comics.  I like to selectively collect comics and my emphasis is on finding good stories.  I am willing to compromise on the art provided that the story has good exposition and is thought-provoking.  Individual comics can run between 2 and 4 dollars for 32 pages of material at a comics specialty shop and, when it is realized that a good story can run between 10 and 40 issues, the dollar cost can be quite high in comparison with other mediums.  This cost can be substantially reduced by buying in advance through online services (e.g. Discount Comics Buyer Service), which gives discounts of, on average, 40%. Of course, the publishers are willing to provide this discount to receive the improved certainty in forecasting the number of books they will need to print.  The flip side is that as a consumer I pay for their improved certainty with loss of certainty of my own as to the quality of the product.  The brick and mortar establishment allows me to directly observe the product before purchasing at the cost of a higher price that is the premium associated with the freedom they provide and the corresponding uncertainty they face (will I or won’t I buy).  Of course, brick and mortar stores are most vulnerable in this advantage since a consumer may go to the showroom to see the quality and then turn to online to buy.  But I believe people are starting to become economically savvy to the fact that they can’t have their cake and eat it too and are willing to not exploit this vulnerability.

The second type of purchase certainty involves returns.  As a consumer buying from a brick and mortar you know that you will have a much easier (and more certain) experience trying to make a return.  Recently, my wife purchased a costume from the Amazon marketplace.  When the package arrived, the item sent looked nothing like the item shown online (another example of the item quality certainty discussed above) and she resolve to return it.  However, the process to return it was slow and cumbersome.  It took weeks to get the vendor to even agree that they had made a mistake and another month or so to get the shipping label and receive the refund.  The closure process for brick and mortar stores is faster and more certain again offering a tangible advantage over the online experience.

The third type of purchase certainty is the certainty in enjoyment. Being able to go to a brick and mortar store and find what you wanted (even if you didn’t know you wanted it until you saw it) means that there is greater certainty in getting instant gratification than is possible online.  The extra time that one gets to enjoy the purchase is valuable in its own right and is yet another advantage that brick and mortar businesses offer over their online competitors.

So while it is true that some businesses have suffered from their competition with online rivals, the majority of brick and mortar stores have adapted to showcase their unique advantages.  The ultimate winner is the consumer and the ultimate loser is those pundits who predicted the demise of the brick and mortar experience. Brick and mortar businesses are there to stay.

It’s always interesting to get perspective on things associated with the economy before jumping to conclusions.  Taking a long, hard look at things from the vantage of a few years after the events have come and gone help to put them in context and also help to frame the right kind of questions to ask, which often leads to interesting answers.

Gasoline prices are a case in point.  Only a few years ago the average price of a gallon of gasoline ranged between $3.00 and $4.00 and people were lamenting the high prices – sometimes in very funny ways.

That trend continued well into 2014, before trailing off substantially in the fall of that year as the influence of the world-wide energy boom finally propagated into the US economy as a whole.  These trends are nicely summarized by AAA’s historic fuel report chart reproduced here

Of course the energy boom has to be understood as really resulting from two different forces.  The first is the well-publicized increase in oil production around the world (supply) and the second is the profound change in driving and car-purchasing habits that many people engaged in during the oil price-peaks in 2011-2013 (demand).  It is difficult to judge the interplay between these two effects to the point where a sharp line can be drawn which delineates the influence of one from the other.  Nonetheless, it is clear that increase of supply of oil on the world stage is the main force driving prices.

During the ‘high price’ years, the accusation was often leveled against the oil companies that they were price gouging – their greed led to our misery.  That claim may or may not be true, but it is well-supported that their ‘greed’ is the primary motivation for the current downward pressure on gasoline prices, giving us one of the longest ‘low price’ periods in recent memory.

It is conceivable that for most people this claim is nonsense.  After all, if they believe greed results in price gouging, how then can greed drive prices down?  The answer to this question is found in the law of supply and demand and in the outcomes of the dynamics of the Prisoner’s Dilemma.

The fastest way to drive up oil prices is to lower the supply relative to the demand.  The law of supply and demand is a well-known principle but one whose full implications are often difficult to understand.  One such point is that rising prices to do not imply rising profits.  Other factors, such as market share and rising production costs, are reflected in the costs as well.  In the particular case of gasoline prices, market share is the key feature.

Currently, there is more oil on the world stage than at any other point in recent times.  So the ‘logical’ question to ask is why don’t the greedy oil producers simply cut production thereby lowering the supply.  Lower supply with current demand equals higher prices equals higher profits.

This logic is flawed since it implies that all the oil producers are in perfect collusion with each other and that their collusion is so solid that each member will be content with the profit-sharing plan they all agreed to (predicated, of course, that they have actually entered into an agreement at all).  Since the going in position is that the producers are greedy – here defined to mean that they will attempt to maximize their profits – one has to grant the strong possibility that one or more of them will betray the others when the order to lower production comes.  Betrayal will mean that oil production will remain high and prices low, so that the net effect to the consumer is negligible; but to the producer who betrays first, their profits will soar as their market share increases.  Since total profit is determined by profit per unit and the number of unit sold, the betrayer can increase his profit without lowering production, providing the other producers don’t think the same way.

But the other oil producers aren’t saps and they can work this out just as well as their fellow co-conspirators.  So they all ‘betray’ the cartel and either keep their production steady or increase it, regardless of whatever they may say to each other.  The overall effect is that greed keeps oil supplies high and prices low.  This outcome is a direct consequence of free market forces and is good for the consumer.

So the next time you go to the pump and fill up your tank on $1.95/gallon gasoline, take a moment to thank a greedy oil producer for their greed.

Well the Thanksgiving holiday is again upon us with its yearly promise of turkey, football, and absolutely absurd number of Black Friday commercials.  And once again, the actual story of the first Thanksgiving is lost in the constant background noise of consumption originating from our loving media who are quite happy to submerge sensible thinking underneath the constant drumbeat of buy, buy, buy.

As I’ve written elsewhere, the real story of the Pilgrims is one more deeply rooted in what modern economists would call game theory and behavioral psychologists the equity theory of motivation.  The story starts with the contractual agreement that the Pilgrims entered into in order to have their voyage to the New World funded.  That agreement required them to share the production and support of the new colony communally.  This forced socialism led to almost complete disaster and scarcity was the order of the day.  Only after they abandoned shared farming and allocated individual plots of land for each family did they thrive rather than just survive.

In his account of the Plymouth Colony, Governor William Bradford cites the various interpersonal frictions caused by how one colonist viewed another.  The old felt that they didn’t get the respect they deserved when forced to work the same ‘mean’ chores as the young.  The strong felt indentured by the weak who could not work as hard.  Bradford goes on to chide the vanity of Plato for recommending the abolishment of property rights and the establishment of a commonwealth.

What Bradford observed first hand is that people measure their happiness in relation to what others do.  When standing on his own, each Pilgrim felt entitled to his bounty, took satisfaction in his attainments, and lowered his resentment to his neighbors.  Bradford is perhaps the first adherent to equity theory.

Now despite what passes for common knowledge in certain circles, the same type of concerns that dominated that early colonial life in the 1620s are also at play in our technically advanced world nearly 400 years removed.  The saga of Gravity Payments shows clearly how unearned attainments by some can be viewed as an insult or even a threat by others.

But what brought all of this much closer to home was the recent departure of a co-worker to greener pastures.  I had the privilege before he left of being able to sit down to speak frankly with him about the reasons he was leaving.  His primary reason for calling it quits was the fact that he viewed his effort as being unrewarded in relation to his peers.  He didn’t quite phrase it as concisely as that but that was the gist of it.  From his point-of-view, his efforts were undervalued by a management who couldn’t actually articulate their set of expectations.

Of course, no one should be rewarded simply for working hard; regardless of the effort put forth, a worker must produce.  But likewise a business can’t simply hope that by promoting some workers over others that the entire work force will be able to infer a set of expectations.  Management must be able to articulate what they prize and be able to give clear rules by which the employees can measure their own output in relation to their peers.  Fairness is a central concept in human behavior and it governs how people perceive an activity as worthwhile or worthless.  By stating a set of objectively measured criteria for promotion, businesses can expect to keep a larger percentage of the work force willing to stay and work, even for lesser wages.  It is when the management of a business is thought to be arbitrary and capricious that friction ensues with departures following shortly.

Unfortunately, the business my friend was leaving seems not to have learned this message.  His departure is one of many in the past year and more are likely.  It seems that the Pilgrims story still has a lot to teach us if only we would listen.

In his 1988 book Innumeracy, the mathematician John Allen Paulos explores the inability of many people, some highly educated some not, to grasp what large numbers really mean.  The book was something of a best-seller and is often discussed within certain intellectual and academic circles but its influence seems to be short-reached based on the fact that people still seem to be innumerate.

This failure is particular troublesome when the large numbers are associated with probability and statistics, and even more bothersome when the large numbers are about money and the statistics are about who holds what in terms of wealth.

A recent example of this kind of sloppy thinking is found in the following video, which went viral recently

As Neil Cavuto, the host of the show, pointed out to Keely Mullen, the organizer of the Million Student March, the central question here is not one of judgement but of numbers.  Society can decide politically where it stands on her three core demands for free public college, the cancellation of student debt, and an across the board $15 dollar/hour minimum wage.  The economics question is how to pay for it.

And here the innumeracy comes rushing to the front and crashing down on her.  All she could say in defense of her program is that she doesn’t believe Cavuto when he says that confiscating the wealth of the rich would not be enough to pay for her core demands.  She couldn’t argue with his points.

At the heart of the discussion was the concept of ‘who pays for this all’.  Here her poor understanding of large numbers has harmed her.  The basic numbers are:

• The total wealth in the US held by households and nonprofits is approximately $82 Trillion dollars
• The wealthiest 1% holds, on average, 35.86% of the wealth
• Student debt is 1.2 trillion dollars
• The average US cost for public colleges is $9410/year
• The number of students enrolled in higher education is 17.5 million students

Now let’s do some trivial analysis; analysis that any fifth grader should be able to do, let alone a college educated activist.  First let’s calculate the wealth held by the one percent by multiplying the percentage wealth held by the total wealth.  This value comes out to be 29 trillion dollars of wealth.  It is a misleading number but we’ll come back to that.  Next let’s estimate the total cost for public college.  A reasonable estimate is that about 2/3 of the student population attends public college resulting in a yearly cost of around 110 billion dollars.  So, on the surface, if we make the one percent cough-up their fair share there should be ample money to meet the first two demands.

Just for giggles, let’s assume their fair share is 100%.  How long can we run the system?  Well 29 trillion take away 1.2 trillion for student loan forgiveness leaves just under 28 trillion of with which to pay for free college.  At 100 billion a year, that gives us about 255 years of free college.  So what if the system eventually runs out we will all be cozily dead and by that time (255 years into the future) we may not need college – we can just learn like they did in the matrix.

At the very minimum, Keely could have thrown these numbers into Cavuto’s face.  Had she done so, he no doubt would have pointed out the difference between wealth and fungible wealth.  To understand the difference, let’s consider how that 29 trillion held by the one percent is put to use.

For the sake of argument, let’s assume that all 29 trillion were placed in a simple savings account and then ask what purpose does that money serve?  Clearly the bank will loan it out for some businesses to get started, or loan it to a family to buy a house, and so on.  So we can’t simply take the money out of the bank and spend it on colleges with no consequences.  True the money is in the economy either way, but only in certain cases is it used to produce while in other ways its movement results in nothing.

In reality, that 29 trillion is tied up in lots of ways and earmarking it for one function will hurt people who depend on it for other functions.  The pros and cons of such a movement is what economics is all about. If we can only tap a tenth of that wealth, then the free-college system can only sustain itself for 25 years; hardly long enough for Keely's own children to attend for free. But what about the fact that the one percent will earn more? Well if we confiscate their money what incentive do they have to accumulate vast wealth again? Why not just be a normal working class dude like the rest of us, with all their needs take care of (but by whom?)?

Of course, a more profitable use of Keely’s time would have been to rail against the following two statistics.

• The cost of college has grown four times faster than inflation
• The amount of wealth held by the one percent has fluctuated only about 2% (1 standard deviation) up or down in the last 35 years

So what she should really be marching about with her 999,999 fellow students (or is that number too large?) is the fact that higher education is a bubble market – it consumes lots of money and produces far too many students for whom the numbers simply don’t add up.

One of the most rich and interesting components of economics is associated with the management of Risk and Knowledge.  As Taylor puts it in his textbook Principles of Economics: Economics and the Economy

This interplay between knowledge and risk (I prefer the term knowledge over information as the former implies a judgment that the latter lacks) is profound.  Management of risk in the face of what the future holds for securities is at the heart of hedge funds and derivatives.

Similarly, the issuance of insurance policies and the premiums by which they are underwritten is based on actuarial science where probabilities and impacts lead to expected outcomes and costs.

Interest required of a borrower is also linked to the risk that borrower represents in repayment and thus the interest rate is set accordingly – both in personal loans and in the offering or corporate bonds and stocks.

Naturally, we expect that a legitimate function of government is to ensure as free a flow of information as possible and we rightly view the pursuit of violators as a function of the courts.  Just ask Martha Stewart about insider trading or Ford about the Pinto.

With the advent of the internet, it was natural to expect that there would be better flows of information now that most everyone was ‘wired’.  Certainly CNet Reviews and Angie’s List seem to provide a forum for consumers to trade information on their experiences thus allowing others to gather knowledge and to make more informed decisions.

However, all is not well in paradise.  An increasingly larger number of companies are making ‘gag orders’ a part of the implicit contract between seller and buyer, with often draconian punishment awaiting a buyer who has the temerity to place a bad review on Yelp or to speak unfavorably on Facebook.

These gag orders are the digital equivalent to insider trading.  They are designed to keep information in the hands of a few and away from the buying public at large in the hope that, with less information, the public will make ill-informed and unknowledgeable choices.

And so it was with a some delight that I heard that Senator John Thune was providing Yelp Help by sponsoring S.2044 - Consumer Review Freedom Act of 2015.

Under this act, consumers will be protected from the bullying gag clauses by declaring such clauses, usually hidden in the terms of service (talk about a lack of information), invalid, thereby ending the punishment that would accompany honest reviews.  Gone would be stories of customers placing bad reviews on Yelp and then finding that they owe $3500 in fines for a dispute over $20 of merchandise.   Businesses would still retain rights to sue for libel for any grossly inaccurate reviews.  So kudos to what seems to be a sensible law that moves us one step closer to the ideal of a free flow of information.