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Where was this kinda stuff when I was hacking my way through school NOT understanding things?

I've been saying this for a while now. As Sheldon Cooper might say, "Feel free to not follow this advice IF you want really expensive urine."

Caplan makes the case for open borders in Vox.

Steven Landsburg offers a little perspective on what economics has to offer humanity.

It is looking a little steep, but I still have over three years for my prediction to be true that 50% of the major, regional newspapers in America will not still be printing by the end of 2018. Megan McArdle gives me some hope. It takes just a few large preprint, insert advertisers to pull the plug on what is left of newspapers. Those who decry it fail to understand the blessings of what Schumpeter called creative destruction.

Well, of course, we need a government panel whose job it is to thwart the creation, expansion, or improvement of hospitals.

Bryan Caplan offers what every high school junior needs to consider about going to college.

Trying To Understand Inflation

Scott Sumner makes the case that economists generally can’t agree on what inflation is, and even when they do, their understanding is at odds with the general population. Let’s explore this a little:

Imagine an economy with one laborer, me, one capital owner, you, two consumers, you and me, and two kinds of goods, apples and oranges. It takes me one hour to produce one apple and one hour to produce one orange. I can only work a maximum of 500 hours in total per year. I get paid one dollar an hour, but you get half of my wages (this makes it easier to introduce a monetary system into this fictional economy rather than having the capital owner retain the product--just assume after production the fruit is co-owned by you and me hence we "buy" it from the coop). Let's start with the price of apples at $1 and the price of oranges at $1. Another way of looking at it is to say the price of an orange is one apple and the price of an apple is one orange.

Fast forward to one year later where apples and oranges begin the year at the same price of $1 each (sticky prices) but then rise to $1.17 for apples and $1.05 for oranges (details how are below), my wage rate is still $1 per hour (sticky wages), but my productivity has increased whereby it only takes me 45 minutes to produce either fruit. In this story how can we meaningfully talk about "inflation"? Prices have risen, but so has productivity. In fact, productivity has potentially increased 33%. And wages are flat for the time being. None of these variables alone really tells the story. John Cochrane might say we’re on to something.

And if a monetary authority (an entity that controls the supply of money such as a central bank) targets "inflation", we start to see big problems. David Beckworth tells it better and more thoroughly than I can.

Picking up on one of Beckworth’s claims, we can see from our hypothetical apples and oranges economy that it will look like the supply of money needs to be loosened when in fact it needs to be tightened to allow total spending in the economy (nominal GDP) to be maintained.

Let's assume in the first year I produce 300 apples and 200 oranges, and then you and I each separately purchase/consume 150 apples and 100 oranges. Total spending in year 1 is $500 (500 fruits at $1 each). 

[here comes the yada, yada, yada...]

In the second year I produce 360 apples and 240 oranges taking just 450 hours to do so thanks to my enhanced productivity which leaves time every day to pretend I'm Rip Van Winkle while on the clock (you'll see below why I would stop working at some point short of maximum output--360 and 240 are somewhat arbitrary numbers). My total wages are $500 still since I'm still getting $1 per hour for 450 hours of labor and 50 hours of napping. You still get half of my wages, but additionally the central bank gives you $100 and me $75 (out of thin air) so as to maintain the monetary authority's desired ~2% inflation target in the face of a 33% rise in productivity* ($175 is about a 35% increase over the $500 monetary base). I have $325 and you have $350. As we attempt to make our purchases of apples and oranges presumably to get at a similar consumption arrangement as before (half of each type of fruit for each of us), we bid up the price of each good somewhat so that the market can clear and in the process we change the consumption arrangement some. Your greater purchasing power allows you to bid up your slightly preferred fruit, apples, a little relative to oranges. The prices settle at $1.17 for apples and $1.05 for oranges (these prices are arbitrary in the example—just one of many ways the math will work out). You walk away with 190 apples and 121 oranges while I get 170 apples and 119 oranges (just one of many possible outcomes). This makes total spending in period 2 $675 [$1.17 x (190+170) + $1.05 x (121+119)].

We can summarize the economic situation: Total spending, "nominal GDP", is up dramatically (35%) while the "real GDP" is only up 20%. The monetary authority wanted only about 2% price inflation but got a 15% level. The economy could potentially be producing 11% more fruit than it is actually producing. The Cantillon Effects of you getting $100 and me only $75 from the central bank may be unrealistic and are not central to the story. I believe there is something to it and it can have distributional effects as it does here (both in the price change and ultimately the quantities of apples and oranges we each get to enjoy). Don’t get lost in this, though; it is not the central theme—rather understand that inflation is a murky subject and policy based on it can have severely adverse consequences.

It was my expectation of the central bank's inflation targeting which led me to shirt instead of producing more--I happened to stop at 360 apples and 240 oranges. The high rate of money supply growth was a negative shock to my purchasing power. I should have seen my $1 per hour going further as the price of apples and oranges came down in nominal-dollar terms, labor-hour terms, and substitute-good terms (apples for oranges and vice versa). If instead of targeting inflation the central-bank targets nominal GDP to rise about 5% such that nominal GDP should be about $525 in year 2, prices will be allowed to fall and my purchasing power because my wages are sticky will be rising; hence I will be incentivized to produce closer to the the economy's full potential. In which case I will be doing a lot less shirking. Year 2 would look more like this: I produce close to 667 total fruit, the money supply increases about 5% rather than 35%, the prices of apples and oranges each fall about 25% (a 33% productivity increase implies a 25% price decrease) but is offset some with the 5% increase in money supply, and the economic distortions are minimized. Happily ever after . . .

*The key here is that the central bank doesn’t completely understand the increase in productivity, and it realistically wouldn’t. In a more realistic, fluid economy what they would see would be falling prices or at least downward price pressure for apples and oranges. Productivity gains would equally be disguised as underemployment (after all, I am napping). The feedback loop keeps telling them to fight deflation—i.e., increase the money supply.

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Two short videos lead us off. Work is a means not an ends. The world we live in is wonderful; be happy.

I want to go to there.

I want to go to then.

Tradesports is back, baby. Can't keep a good man down for long it seems.

I'd like for us to think hard for a moment about hard-boiled eggs. Next, please quit trying to make me feel guilty about foie gras.

Turning now to the item du jure in economics: Thomas Piketty's "Capital in the Twenty-First Century". There will be more soon, much more (including something about how, oops eeps, looks like his data may have had spreadsheet issues). For now just a few points with which I heartily agree: Landsburg says income inequality is something to celebrate. Cass Sunstein takes an Alfred E. Neuman approach to the issues Piketty raises (note, I do NOT heartily agree with the FDR conclusion at the bottom of the piece). But let me recast Sunstein's argument a little more clearly.

For those who reflexively agree with Piketty’s worldview, a question.

In which world would you rather live:

1. A world (starting from where we are today) in which the rich however defined (e.g., top 5%, top 1%, top .01%) see their wealth grow at 5% per year while the rest of society sees its wealth grow at 2% per year, or
2. A world (starting from where we are today) in which everyone sees their wealth grow at 1% per year?

How you answer this question says a lot about how personal envy ranks for you versus your love for others. I am not saying this is the choice we face. I am saying if it were, which would you choose?

Russ Roberts offers a great, short lesson in economics specifically regarding GDP and government expenditure. A snippet:

Here's the fallacy. Suppose I want to know your income for the year. I ask you and you tell me you made $50,000 in salary. Another way I can get to that number is to add up everything you spent money on--food, rent, clothing, entertainment, savings and so on. As long as I count everything, I get to the same number, $50,000.

Suppose I find out you spent $5000 on entertainment. It would be very wrong to say that without that spending, your income would only have been $45,000.

Read and understand this post from Scott Sumner, and you will have a better grasp on current monetary macroeconomics than quite a large portion of the economics-commentary professional class.

Climate Alert! A really small change might happen to the Earth in 100 years. So, panic now? No.

Scott Lincicome at Cato discusses two trade policies that make domestic gasoline prices higher than they would otherwise be.

Here is a sports-statistics lesson applicable and important in a wide range of fields from medicine to business: "...the complexity of a stat should not be its selling point. If a stat tells you something, but you can't act on it, it's no good." read the whole thing.

Not good at investing? Blame your caveman ancestors. Hint: Your problem is you don't and are not built to understand risk well.

Information technology and networks are all busted (HT: Barry Ritholtz). Have a nice day . . . for the record, I'm not as jaded and pessimistic as this piece, but I think there is much truth here.

Can't Stop The Gods From Engineering

Well, we can all breathe a sigh of relief. The momentum won't end. At least that is the story now that Oklahoma City Mayor Mick Cornett has won re-election. His main opponent, City Councilman Ed Shadid, was apparently threatening to thwart that progress. And he continues to I guess by leading an initiative drive to bring back up for a vote both the >$250,000,000 new OKC convention center and the nearly permanent 1% sales tax associated with the city's long-term MAPS projects.

I'm not here to tout Shadid. The point I wish to make is a larger one. The winner of the mayor's race, Cornett, is seen and self proclaimed as the torchbearer for what I call the Coalition to Spend Other People's Money on Bright and Shiny Things. Shadid is one of the more high-profile challengers to this the received wisdom. But let's put the politicians aside and discuss the issue at hand. That issue is simply one of two questions:

1. Should we force people through taxes to pay for things they don't seem to want?
2. Why do we have to use taxes and government spending to express the people's desire?

I believe the first question is the correct framework of the issue. The supporters of MAPS have to believe the second is. I am presuming the people don't want these things because if they did, their wanting them would be sufficient to cause someone in the market to provide them without government involvement. Conversely, the supporters presume that the people* do want these things, but are unable to express that desire through the market. Let's assume the issue is framed properly by the second question, which means the challenge to the supporters is "show me the market failure!" Which really amounts to "show me the externality!"

Here is why. We've got lots and lots and lots of evidence that the market generally works at delivering the goods (the goods people want). That puts the burden of proof firmly on those who wish to make the case for the second question. Why is the market not able to connect demand and supply in this case? Ultimately that gets to what economists call externalities--positive externalities in this case. For some reason it must be that the benefits that would come from these projects cannot be sufficiently realized by those who would be the suppliers of these projects in the free market. But is a convention center really like clean air? There are lots of private suppliers of convention centers. What makes the OKC market so unique that convention centers become a public good?

Looking back to the funding into what is today Chesapeake Arena where the OKC Thunder play, why would private investors not be rewarded enough to build and improve such a facility? A self-serving, non-peer reviewed economic impact analysis is not relevant to this question. I understand how bright and shiny bright and shiny things are. This is a question of a cost/benefit analysis--both parts of which are critical to making a good investment decision. If only someone impartial studied these things . . .

Good public policy is shaped by setting aside what emotionally feels good for what critically is in the best interest of the public. Figuring that out is hard, but it is especially hard if you never look. See beyond the seen. Until the coalition can answer the second question effectively, I have to presume that the first question is the one to ask--the answer to which seems obvious.


*There is a BIG underlying assumption here that what is in the general (majority) interest of the public is expressed through the voting process and that that interest is a desirable end to impose on all of the people. It is not hard to poke holes in this assumption. If thirty people are trying to decide on what movie to go see where they all have to see the same movie, having fifteen of them vote on the movie will leave some of the voters dissatisfied and likely will leave some of the non voters dissatisfied too.

PS. Note that I am only discussing the economic efficiency facet of this debate wholly ignoring the important ethical argument about if it is right to tax some people (largely lower income/lower wealth people who have a harder time escaping the sales tax) for the benefit of some people.

The Regulator's Dilemma

Imagine two rooms: one is a group of consumers and one is a group of producers. For now the rooms are completely isolated from one another. As they are labeled, these two groups will interact in trade.

Now imagine a regulator whose job is to, well, to do something. The regulator has imperfect information but is guided by a few beliefs about the job to be done. The first is a belief that the job exists somewhere along the dimension of necessity, which extends from anti-necessary to necessary. At the extreme of necessary the regulatory job is required for a good outcome. Anti-necessary is not the same as unnecessary; rather it means the job of regulation is in fact destructive—that the execution of the regulatory job brings a clear net harm.

The second belief is about where the need exists. Is it the consumers or the producers who need "help"? Let's call this dimension need.

The third belief is that he as the regulator will do a good job of fulfilling the regulatory mission. Let's call this dimension effectiveness. This dimension obviously extends from positive to negative meaning he does a good job or a bad job regulating.

The regulator has limited resources in addition to imperfect information. He must make tradeoffs. The interaction of where his beliefs land on the three-dimensional grid of necessity, need, and effectiveness will determine how he approaches the job of regulator (of course, it may not just be his beliefs that guide that decision, but he is a good proxy for the fact that something guides those beliefs).

For example he can concentrate his efforts on the group of consumers. In this case he surveys the room of consumers with the underlying belief that 'there are people in this room who can't be trusted to make good decisions even if there is no fraud involved. I must protect those idiots from themselves.' Call this option 1.

Alternatively he can concentrate on the producers thinking 'there are people in this room who can't be trusted to act ethically. I must stop those crooks.' Call this option 2.

And of course there is the more likely option that he divides his efforts between both groups. Call this option 3.

Here are my thoughts:

• We unfortunately tend to view the job of regulation and regulators as highly necessary and highly effective. This means they punch hard and with impunity. The only thing left to decide is where they punch.
• Option 1 can be a realistic point of view or it can be a disgusting point of view. People do make poor choices—all the time, every day. But the magnitude of those poor choices matters. So does the incentive arrangement—who is in the best position to benefit from a good choice and hurt but learn from a bad choice. At the extreme this point of view relies on a paternalistic philosophy that assumes the best way to make decisions is through a poorly incentivized and poorly informed regulator. Free market processes are highly superior to a regulator if option 1 is our focus for regulation.
• Option 2 is the best case that can be made for regulation. There will be fraud and with it real blood. But again the role of the regulator can and should be limited here. The regulator can be a blunt and poor instrument for discovering and preventing fraud in all its forms including unintentional harm. Liability law via common law and contract law (both emergent processes) can be equal or better regulators than a pure regulator himself.
• Option 3 is where most regulation tends to land from the SEC to the FDA. And think about how the more dynamic real world plays out. The rooms aren’t actually isolated from one another nor are the groups mutually exclusive. Everyone is in one big room wearing multiple labels. The imperfectly informed regulator is going to look for the help of the relatively informed producers to help guide his attempts at helping consumers. He is asking people, some of whom are crooks and many of whom have ulterior motives, to structure and enforce option 1. He will also look to define fraud from the point of view of the “victim”. The relatively injured consumers (who will self-select among those who have suffered a harm—happy people don’t complain) will help guide the regulator. He is asking people, some of whom are notoriously making bad decisions but not bearing the full burden of those choices, to structure and enforce option 2. This is a formula for regulation that is anti-necessary, ineffective at all the wrong times, and fulfilling mythical needs.

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Gun rights are dead. Long live gun rights! Caplan offers some great insight into the Briggs-Tabarrok Effect, a study which shows that gun access doesn't lead to more violence but does lead to more suicide. The points Caplan makes are right in line with the concept that magnitude matters.

As you sit down for Thanksgiving dinner this week and Uncle Fred begins ranting about how, "The dollar has lost 97% of its value! When I was your age, I was older!You're gonna carve the turkey with that? That's not a knife; this is a knife..." You can confidently dispute at least part of his claims.

The government picking winners and losers wouldn't be quite as infuriating if it came at a decent cost.

Landsburg makes a great case for the magnitude of tragedies that happened ~50 years ago today. And Boudreaux supports the argument thoroughly.

"Failure is always an option." -- A great point among many made in this post. (HT: Russ Roberts)

Instead of a carbon tax, how about a carbon subsidy? That is not the point of this post; rather the point is don't be so presumably sure about the sign attached to the externality.

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The more I read about pirates the less I think the Jack Sparrow saga is based on true events. (HT: Tyler Cowen)

What do you mean the cost of health care is going up?!?

But surely there aren't simple, compromise solutions that while they may not be first best, are second best and far and away better than the Obamamess?

Finally, here is a great summary of what market "efficiency" is really all about. One of many money quotes:

Efficiency implies that professional managers should do no better than monkeys with darts. This prediction too bears out in the data. It too could have come out the other way. It should have come out the other way! In any other field of human endeavor, seasoned professionals systematically outperform amateurs.

We need more teacher pay inequality

A recent conversation with a relative who I am quite sure is a very good teacher got me thinking about the conventional wisdom regarding teacher pay--specifically, that teachers are underpaid.

While I feel strongly about this particular teacher's abilities, I do not feel as strongly that she is "underpaid" despite being in a position of relative low pay when considering hours and effort that go into her job. Likewise, I don't think she herself necessarily believes she is "underpaid", though that would be a common and understandable instinctive feeling. If I have to guess, I would say she is indeed underpaid, but as you will see that is not a guess I can arrive at lightly nor can I have much confidence in it.

Here are my thoughts:

A status of being low paid is only meaningful in a relative sense. However, a status of underpaid is also a relative status, but the two are not congruent. Underpaid is a deeper sense of relative--kind of a second derivative in a manner of thinking. To be low paid simply means having a lower absolute level of income in some comparison. To make that comparison more meaningful one should seek a good apples-to-apples arrangement. Obviously comparing a $40,000 a year job to a 10,000 Euro per month job doesn't tell us much. We get more information in comparing a $20 per statutory hour job with a $30 per statutory hour job, but we don't get a whole lot more. Most professionals including many teachers put in time beyond the standard work day.

Suppose we could get a standardized denominator of effort hours (we can't just use hours because an hour spent scanning people in at the local gym is not the same as an hour spent fighting a fire). How meaningful would that comparison of pay then be? The answer is "a lot more meaningful but still significantly short of deep economic significance". Certainly that information would help guide a lot of career decisions, but it still doesn't tell us if someone is underpaid. To get that comparison, we need to know if a particular person should make more. The person should make more (technically speaking, command a greater share of society's resources) if the value of her teaching (resource she creates) is worth more than the total pay she receives (resources she uses). Our best bet to know this answer (and this is a loose use of the term know since we actually can only hope to have a really good guess) is through a market process--and you thought I was going to say government omniscience.

Notice that the market answer is usually the standard to judge the righteousness of outcomes not because we define optimal resource allocation as the outcome the market creates but because we believe (with really good reason) that under the right conditions the market will elicit optimal resource allocations. Those right conditions are when markets are deep, cheap, and esteemed (lots of knowledgeable buyers and sellers with low transactions costs where property rights are firm, clear, and respected). We need a substantial degree of all of these to describe a market as a free market. The free market is not God. The free market is our way of discovering how a benevolent, omniscient dictator (a god-like super creature) would allocate resources.

But the education market is not conducted under very favorable conditions to elicit good allocations. Transactions costs are high and knowledge is expensive. Government separates buyer and seller insulating sellers from the discipline the market would otherwise provide*. We can probably expect a few outcomes from this as it relates to teacher pay. Pay differentials will become compressed where bad teachers are overpaid and good teachers are underpaid. Resource allocation communication and decisions will be further polluted pushing good teachers out of the profession or encouraging them to shirk while inducing bad teachers to enter the profession.

Because of this, I am led to believe that my relative is indeed likely underpaid (I have a lot of inside information about how good a teacher she is). However, (and now isn't this ironic?) for the same reason I believe she is underpaid, I cannot have much confidence in this judgment. That is at the heart of the problem with heavily government-influenced markets--they obfuscate knowledge inhibiting the communication process the market wants to provide.


*Nature abhors a vacuum and the market abhors bad resource allocation. In this sense the market naturally works toward being a free market. It is because of this positive feedback loop, a virtuous cycle, that markets are so powerfully good.

Did we really expect Big Bird to be good at running the world's largest health insurer?

In 2009 in the midst of an economic and financial crisis, the President of the United States chose to direct his administration's efforts toward solving the problems of health insurance as he saw them. For some reason he believed massively increasing third-party payment (a condition that we have no evidence and no theory to suggest should work) was the key solution along with price controls, production quotas, and government-provided alternatives. There were lots of reasons to believe this would not work out well, but the generally overlooked one was the world's largest mega-conglomerate has a horrible track record of getting from intentions to effective and efficient execution.

The virtues of Obama's intentions were well disputed. Arguments were also strongly and sufficiently offered against the effect these policy changes would bring about. But few, Megan McArdle the exception, predicted the websites wouldn't work. Yet we shouldn't be surprised. All reasonable philosophies of political economy leave room for the failure of democratic governance. Coming from a libertarian, free-market philosophy, I believe these schemes are destined to fail because government lacks the proper incentives. But others coming from a progressive philosophy should expect that sinister Republicans, conservatives, tea-partiers, et al. will thwart the efforts of the enlightened. It only becomes utopian nonsense when after the supposed thwarting the defense of failure is "It would have worked if it weren't for you meddling kids."

The website failure is a demonstrative microcosm for why Obamacare is doomed. These aren't glitches, this is a canary in the coal mine.

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As politicians seemingly fiddle as we begin to dance on the ceiling, it is important to realize it is going to be okay. This actually is business as usual--it is just not usually so obviously unproductive. Wasting resources (through an unfettered process of spending money) apparently looks to the media and much of the public as productive progress. It is not. Arguing about the terms under which the money spending process will continue apparently does not look as productive. It is not that different.

Hey, guy who sells ethanol. Is it a good idea to create and foster a monopolistic environment in which you can operate?

Ethanol guy: "Yes!"

Everybody else: "Hell no, are you kidding!?!"

Casey Mulligan makes a strong case about just how high and damaging tax rates are today including as a result of Obamacare. Grumpy says he may be underestimating how bad it is.

Here is the long (and excellent) and the short on why Fama was an excellent choice to share the Noble Memorial Prize in Economics as announced today. Shiller and Hansen are also fine choices in my opinion. It is just that I believe Fama casts a big longer and a bit stronger shadow.

A low-hanging fruit rant

Re: The Great Stagnation

I've been thinking about low-hanging fruit from changes in political economy. I mean this as a constructive group of points, ideas, questions  . . . I don't mean to go off on a rant here, but nevertheless . . .

There still seems to be low-hanging fruit when we look at certain aspects of government policy. Tax code simplification and ending the war on drugs are two great examples. Immigration expansion and school competition (where tax dollars follow parental choices) would be two others. I'm not saying these would be or should be politically a snap--obviously they are not--but consider simplifying the tax code:

• Where are the environmentalists on simplification of the tax code? Why can't we free up these resources (labor is the huge one and as we know our precious time is the one resource environmentalists tend to disregard, but still)? 
• Why can't we get liberal, conservative, libertarian, Democrat, Republican, et al. to agree on this? It can be as progressive as you like. Let me concede to your desire for an intrusive, expansive, colossal government. Just don't make me use a spoon to dig your ditch.
• How can we not defeat the vested interest on this issue? If your business plan depends on tax policy (tax lawyers and accountants, MLPs (to a degree), some charities, realtors, et al.), you are not adding value to society. 
• The bootleggers and Baptists on preventing tax code simplification would be those who want to punish others aligned with those who want to advance their own special, vested interest. I'm not sure which group is the bootlegger.

My point is that these changes would be affect massive improvement to society. The magnitudes are strong. There are still low-hanging fruit if we will just pluck them. 

Recycling my mind

You may remember that here at MM we are always looking for ways to change our minds. In fact, it is an ongoing resolution. Well, we may have found my jewel of the Nile for this year.

I referenced this recycling conversation in my last blog post. I highly encourage you to read all the essays and followup conversation. Mike Munger makes what is for me the first rational point I've ever encountered theoretically supporting mandatory recycling programs. Recycling is an economics and business issue. It is about optimal use of resources. The problem might be that we have too little of it. Why? Because the incentives might be messed up. How? Because we want them to be. I don't mean choose them to be in some sinister, corporate-cronyism sort of way (although there is plenty of that in the larger political economy of recycling). I mean truly want them to be . . . to a degree and as an unintended consequence.

The intention is to make landfills artificially cheap by subsidizing them so that illegal and undesirable dumping is minimized. As a result the relative incentive to recycle is lower than it should be as compared to landfilling. In his response essay Steven Landsburg raises very good and strong concerns about what that actually implies for a recycling effort. Remember, I said theoretical case for mandatory recycling. It is in seeing now a theoretical defense of mandatory recycling (or preferably some less coercive means of encouraging recycling) that I have changed my mind. To that point and in his last response in "The Conversation" Munger makes a very Coasian/Hayekian point about how we need to shift the incentives (Coase would emphasize property rights here) but that he doesn't know, a la Hayek, what that solution(s) will actually be. I agree very much with that thought process.

Another very important point raised throughout the issue is how the moral crusade for recycling is quite an awful thing. It magnifies and worsens all that is bad about excessive recycling, and most mandatory recycling is excessive. A little neglected in the issue is the simplistic but problematic solution of fighting the subsidy come incentive problem with an additional subsidy--this time for recycling. That would be the road to a farm bill for waste/recycling. You think I hate mandatory recycling now . . .

Escape from New York

I've returned from a jam-packed trip to NYC that was part business and part pleasure. I always find it hard to leave New York without feeling that leaving is a mistake. It is such an amazing place. Very few places on Earth can boast the same wide-range of risk/return opportunity sets. Here are some thoughts:

• To my impression, by a wide margin no other American city is as much an international city. This is an underappreciated quality.
• It is a shame people tend to be too uncreative to appreciate experiences that are not "tourist traps". 
• The success of the city, largely a reflection and exacerbation of the success of American free enterprise, disguises and minimizes the drag of being in the People's Democratic Republic of Bloomberg [insert any prominent former or future mayor as well]. It is hard to see the forest of unintended consequences when dealing so directly with the trees of real-world problems. Viewed in this lens, it becomes easier to excuse the frequent acquiescence to bureaucratic and technocratic power.
• If your only impression of life in NYC was from television sitcoms, you would be missing 75% of it. If it were only from movies, I'd say you are still missing 50%, and most of that corresponds to the prior missing 75%. 
• Goldman Sachs, the business portion of my adventure, is a first-class organization. I am often a critic of the revolving door between government regulators of GS and executive positions at GS along with other regulatory capture issues. Being in the heart of the dragon, one sees clearly how that cozy relationship maintains harmony. Literally, the janitors at GS exude more confidence and professionalism than I've seen among bank presidents. Uniformly both in informal conversations and formal presentations, every representative of GS was quite impressive--not cocky or arrogant, but definitely assured of themselves and their organization and certainly serious. They can and do laugh (when appropriate), but I am certain they physically lack the ability to giggle. 
• I appreciate Goldman for having me as a guest at what was a very good conference filled with good information and entertainment. I now have more respect for them as a money manager, and it is with more confidence that I consider investments with them for my clients. 
• Here is a random thought I had during the conference: Does corporate paternalism and generosity breed acceptance for governmental paternalism? This is similar to the forest/trees thought referenced above. People in these companies are very well taken care of with all ancillary needs provided or sourced, they are used to showing ID cards and having limited access within their firm and even on their floor or in their business group, they work in "safe" environments insulated from the "chaotic" world outside, etc. 
• Depending on your perceptive sensitivity to any given behavior, you can get the feeling that "everyone" in NYC matches that given behavior. For example, everybody jogs. Of course, everyone doesn't. But it is easy to be misled being that there are countless examples of any behavior, activity, etc. to be found. That is one thing >60,000 people per square mile will get you. This goes a long way to explain misconceptions visitors come away with.
• Being in the beautiful jungle of so many choices, a thought I have had previously occurred to me again. A key to happiness is being easy to please. If you can see the good in things (be optimistic) and if you can refrain from pickiness (see things as highly substitutable), you can greatly expand your happiness. In economic terms, the flatter your indifference curves and the looser your budget constraint, the greater your utility potential. 
• Nearby our hotel was a Whole Foods grocery. We have a Whole Foods store in Oklahoma City, but the store in NYC, as a microcosm of so much else, is quite different from the store in OKC. The selection was larger in scope and scale, and the services included delivery for a flat $10 fee. No such delivery option is available in OKC. Discussing this with my wife dovetailed with other grocery economics discussions we have had. We've thought before about the intrinsic differences among stores like Whole Foods and Central Market versus Safeway and the local Crest Market versus Sam's Club and Costco. Not to get too far off on tangents, but this thought problem brings up the difficulty of finding a comparable basket of goods for inflation as well as other comparisons. Back to the central idea, what are people getting out of food shopping? The joy of bargain hunting (optimizing $/calorie) versus the joy of elegant shopping (optimizing the experience per se) could be generalized extremes along what seems a reasonable dimension of quality/quantity tradeoffs (optimizing selection and discovery). At what point is the only physical grocery shopping we do that done as an entertainment (elegant shopping) with the remainder done online including preprogrammed? 
• Enough random thoughts. Here are some pictures from a great trip. Enjoy!

When it comes to justifying economic development initiatives and incentives, public officials and those seeking favorable treatment from state and local government generally find it easy. And the most common drumbeat is “Jobs! Jobs! Jobs!” But I’ve noticed a trend where it seems the economic profession’s criticisms are affecting a positive change. Alas, I believe the change is chimerical.

We now hear the champions of economic development talking the talk that “not all economic development is created equal” and “there are some developments that are just not worth the price”. But I think this is a sales pitch to quiet the dissent without actually making a change. The mantra is still JOBS!, but now we hear of “primary” or more desirable jobs versus “secondary” or less desirable jobs. The definition of these two alleged distinct types of jobs shows some fundamental misunderstandings of economic analysis.

Here is the idea. Suppose you are an economic planner representing a regionally large, nationally small but important city. Oklahoma City is a good example. Two prospective firms are each considering a new location in one of a few cities, and Oklahoma City has made the short list for both firms. You know what each wants, say it is a ten-year tax break that amounts to $5,000,000, but the problem is because your city operates under strict balanced budget accounting, you are only authorized to give up to $5,000,000 in tax incentives away. That amount may go up or down in a year, but for now that is all you can agree to. Both firms want it, and you know with high certainty that either firm will take it and choose your city but without it the firms will go elsewhere. You want the jobs (because, after all, it is JOBS!); so you must decide to which firm to extend the incentive.

• Firm A is a call center that will have 100 employees who will take calls from around the world to solve computer technology problems for a fee.
• Firm B is a high-end automotive mechanic service employing 100 who will compete with local dealerships to offer high quality auto repair. The customers base is expected to be nearly 100% local.

The average wage and distribution of wages is the same between the two firms.

To the economic planner Firm A is offering “primary” jobs while Firm B is offering “secondary” jobs. Never mind the fact that jobs are not a good but a cost—there is a reason people aspire to retirement and Garfield hates Mondays. Firm A is “bringing in wealth” by exporting the service calls and importing the customers’ payment for service. Firm B is “moving around wealth” by selling auto repair for payment all within the locality. The preference is intuitive since in Firm A’s case revenue is flowing into the city rather than just revolving around the city as with Firm B. But the intuition here is a deeply flawed economic analysis. It stems from fundamentally misunderstanding the economics of exchange.

When a firm adds value to society, it does so by using less resources than it provides. The measure of this is profit. But profit in the case of both firms flows to the owners who may or may not reside in your community. Because you as economic developer are trying to grow quality jobs, you must consider which jobs are more desirable--remember, you only can give the incentive to one firm. Firm A gives up call center services exporting them outside of the community in exchange for money from outside the community which is partially used to pay the 100 employees' wages. Firm B gives up auto repair services for money all of which remains in the community. Firm B is retaining all of the benefit within the community while Firm A is sending away half of the benefit.

To make this clearer we should remove the monetary component, which serves to muddy the analysis. Ultimately, money is a proxy for what it can buy. At its essence exchange is still a bartering process; it's just that half of the barter is anything you want it to be (anything money can buy--so not love, Dr. McDreamy). Let's replace money with food. Perhaps now we can see it clearly: Firm A is sending computer services out of the community in exchange for food while Firm B is facilitating people within the community exchanging auto services for food. Both exchanges are mutually beneficial to the parties involved. But if you are going to prefer the local society over the society at large since you're the local economic developer, then you should prefer Firm B because that firm is retaining all the benefits (goods and services along with gains from trade) within the community.

Taxes are the price we pay to live in an insane society

It's that time of year again. Time for all Americans to take Uncle Sam's annual insanity quiz: if you can get through the tax forms and still think it all makes sense, congratulations, you're nuts! Notice that I'm not even criticizing tax rates or tax burdens for being too high. At this point I'm only complaining that the process is bat guano crazy.

There are lots of ways to raise as much revenue as we raise today while being immensely more efficient not to mention being fairer. We don't even have to give up all those wonderful special interest giveaways. There are plenty of ways to subsidize them and incentivize behavior otherwise to support all the various things without which society would break down--like jobs for tax preparers, mortgage interest rebates, 366-day stock holdings, and trains running to nowhere. Or would straightforward, simple subsidies be too obviously indefensible?

Regardless, here are my top alternatives to our current tax nightmare (each would be a wholesale replacement of all that befuddles us today):

• A value-added tax (VAT) applicable to all goods and services--no exceptions.
• A final goods and services sales tax as described here.
• A total compensation payroll tax (this means all wages and benefits including education/training, equity including stock options, and health insurance, et al. would be taxable benefits).

The whole mess reminds me of this:

Today also marks the infamous 2-year anniversary of Black Friday as it is known in the poker community. That is the day that a US Attorney unsealed an indictment against Internet poker companies sloppily labeling online poker a crime, a baseless charge that was later dropped, and shutting down effectively all online poker in the United States. As the cases against those charged with money laundering and bank fraud continue to play out and millions of dollars in player funds sit in limbo, it is not at all surprising that a government-created, quasi-black market attracted shady characters and suboptimal market outcomes. The Poker Players Alliance continues the fight for freedom.

Honey, I shrunk the bank.

As a continuation of the on-going discussion I have with colleagues, one sends me this link to a WSJ article by Dallas Fed Chief Richard Fisher and his executive VP Harvey Rosenblum on "How to Shrink the 'Too-Big-to-Fail' Banks". My comments were:


I generally like it—a step toward less government involvement and less social insurance of profit-seeking firms. But there is a bit of hand waving over the third tier in their proposal:

Third, we recommend that the largest financial holding companies be restructured so that every one of their corporate entities is subject to a speedy bankruptcy process, and in the case of banking entities themselves, that they be of a size that is "too small to save." Addressing institutional size is vital to maintaining a credible threat of failure, thereby providing a convincing case that policy has truly changed.

Easier said than done in defining how small a bank would need to be. They need more specifics here; otherwise, the cronyism is in the details.

A TBTF TARP exchange

Over the past two weeks I've been having an on-going conversation with a colleague at work debating the virtue of TARP back in the fall of 2008. While the colleague agrees with me on virtually all points related to the problems with Too Big Too Fail (TBTF), the government's role in creating the financial crisis, the problems with the responses, etc., he disagrees that TARP could/should have been avoided. He tends to see it as TARP or catastrophe  Because I thought it was interesting, I've included here some of our exchange as conducted over email. Some names have been changed to protect the innocent.

From me:

I see the case against TARP as follows:

•  The common pro-TARP narrative is basically fiction.

• We were not at the edge of doom (at least there is next to no evidence for this view)

• It was not approved as originally sold nor implemented as approved

• TARP rewarded through bailout those who had made very poor economic decisions.

• TARP did not and could not ease credit conditions nor bring liquidity to the system. That responsibility was The Fed’s and if they had done their job, the recession would have been a bump rather than a crater, and the financial crisis would have been short lived if nonexistent. The financial crisis was 80% an effect but only 20% a cause.

• TARP was an avoidable mistake in that there was ample time to come up with alternative solutions even if we assume the basic premises supporting TARP’s passage.

• There were weeks before the first TARP bill and between the initial failure and eventual passage.

• There were alternative ideas and other methods to buy time such as suspension of mark-to-market accounting, bankruptcy options including “speed bankruptcy” whereby equity is wiped out and creditors become the new equity holders, et al.

His response (in red):

I see the case against TARP as follows:

•  The common pro-TARP narrative is basically fiction. DISAGREE

• We were not at the edge of doom (at least there is next to no evidence for this view)  DISAGREE (DEPENDS WHAT DOOM MEANS)

• It was not approved as originally sold nor implemented as approved  AGREE

• TARP rewarded through bailout those who had made very poor economic decisions.  AGREE

• TARP did not and could not ease credit conditions nor bring liquidity to the system. That responsibility was The Fed’s and if they had done their job, the recession would have been a bump rather than a crater, and the financial crisis would have been short lived if nonexistent. The financial crisis was 80% an effect but only 20% a cause.  DISAGREE WITH THE FIRST SENTENCE (AT LEAST THE FIRST PART), AGREE WITH THE SECOND SENTENCE AND UNSURE AS TO THE THIRD.

• TARP was an avoidable mistake in that there was ample time to come up with alternative solutions even if we assume the basic premises supporting TARP’s passage. AGREE

• There were weeks before the first TARP bill and between the initial failure and eventual passage.  

• There were alternative ideas and other methods to buy time such as suspension of mark-to-market accounting, bankruptcy options including “speed bankruptcy” whereby equity is wiped out and creditors become the new equity holders, et al.

So we’re in agreement, then, to separate investment banking from “traditional” banking....

My response:

I think you have to separate “doom” for the big, problem banks and “doom” for us all. They are and were not the same.

That applies as well to the credit easing part. Did it ease credit between the problem banks (banks as a broad term where financial institution is more appropriate)? Possibly this was helped by TARP, but even that is debatable. It is not clear that TARP made anyone more willing to lend to those bad banks.

Are you unsure of my 80/20 probabilities or unsure about what I mean in general. I believe the monetary contraction beginning in 2007 created the financial crisis largely. That is what I mean by 80/20 effect/cause. I am not firmly committed to exactly 80/20 . . . I know you know that.

I see little to no help in separating “investment” and “traditional” banking. If any financial institution gets into trouble, we did and will bail them out. If you can wall them off and credibly commit that we will only bailout the banks that fit a specific description (maybe only those who qualify for and pay into the FDIC), then maybe I could come around. But that is a second-best solution at best with lots of potential for major downfall.

He then asked me under what circumstances would I condone or authorize a bailout. I emailed my response:

quick answer to the "who would I bailout" question

On a personal level, I would bailout my kid. But think of [a person] who obviously has severe financial problems. Assuming the bailout(s) from her father are just simply money gifted, they don’t really help her. They only kick the can down the road. Bailing out the kid doesn't really count as a solution.

In the same guise, bailouts in the larger world only address one part of bigger problems. To the extent our problems are magnified by past behavior and bailouts (moral hazard), the problem only grows bigger. In the continuum of the economy we end up favoring one group (those living now who supposedly benefit from the bailouts) at the expense of another group (the future who has to deal with the next bigger problem and who has to pay the debt incurred along the way).

Would I bailout Illinois, California, Europe? What does it mean to bail them out? Make others pay for their mistakes (promises that now can’t be kept)? I would not. No bailouts. Workouts, yes. Bailouts, no.

TARP was a bailout. Very far from a workout. I just can’t see the existence of TARP in the vacuum of this or nothing. That doesn't make sense to me.

A very long (and good in my opinion) discussion followed a few days later where another colleague was pulled in. I enjoyed the two-versus-one debate as the other colleague opposes my negative view on TARP as well. If anything, this colleague is even more convinced that it was the end of days but for TARP. Neither colleague likes TARP, they just don't see that there were other solutions available. When all we can muster is cronyism, we have fantastically failed. I see TARP as the creation of corrupt interests with the backing of plainly unimaginative, pitifully ignorant, and foolishly panicking leaders--leaders in name only as they were devoid of leadership.

Obama's confusion about "wise" investment

In his latest State of the Union address, President Obama referred to investing, investors, or investment 13 times. Here are a few of those references:

So let's set party interests aside, and work to pass a budget that replaces reckless cuts with smart savings and wise investments in our future.

It's not a bigger government we need, but a smarter government that sets priorities and invests in broad-based growth.

If we want to make the best products, we also have to invest in the best ideas.

Unfortunately, making wise investments isn't as easy as asking Mr. Obama how many licks it takes to get to the cash-flow center of a public equity fund. The track record of government investment is abysmally poor. And we shouldn't expect it not to be. The government lacks the vital characteristics necessary for successful investment decision making. Most importantly the necessary incentives are not only absent; they are in reverse. Government does not have a profit motive properly aligned with success (consider this the front-end of good investment incentives)--that is not to say that individuals and groups within government lack a profit motive. Government also does not have the correct feedback system whereby success is rewarded and failure is punished. Consider this the back-end of good incentives, and this is the reversed incentive part. Government tends to reward failure at the expense of success.

Another vital component largely and effectively absent from government is talented investors. Rather than attracting and nurturing creative, entrepreneurial innovators and risk takers, government tends to attract and nurture assembly-line bureaucrats and rent seekers.

Government is the wrong process for "wise" investment. Obama doesn't seem to understand this. His administration's malinvestments into solar, et al. are clear evidence of this. Aside from the fraud, there is a key problem with these types of investment. For the investment to be wise, it isn't sufficient to know what the actual technology of the future will be. As very difficult as that part of the task is, an equally challenging feature is getting the timing right.

Being too early to invest in even the right technology can still destroy resources; i.e., not be a wise investment. Imagine travelling in time to 1980 to invest in teaching HTML coding, manufacturing Boeing 787s or Airbus 380s, or building contemporary Whole Foods grocery stores in mid-western cities.

A famous investor adage is, "In the end I was right, I my timing was just too early." Another is that, "The market can stay irrational longer than you can remain solvent." We seem to be testing those two adages via government "investment" at an alarming rate.

I'll take Intellectual Reconciliation for $1000, Alex.

A reader sent me this screenshot of a Ron Paul Facebook post from today:

This is one of the few areas where Ron Paul and I part ways. I'm not sure relative to me if he is too pessimistic about the power of the market to overcome government failure or if I am too optimistic about the limits of government as a destructive force. Possibly some combination is the truth. We are both definitely believers in the market as a force of good and the government as a force of destruction (beyond extremely limited government). For the long-term, however, I would tend to agree with his take presuming no significant changes to the current trajectory of government growth and power. The unsustainability of the current path would imply downward corrections.

I am certainly reading between the lines on his post and perhaps making some errors when doing so.

James Buchanan, RIP and ATRA

This past week we lost an intellectual giant, James Buchanan, whose contributions were and are still under appreciated. Among other contributions, Buchanan helped discover and bring to a fuller light facts that should have been obvious: political actors are subject self interest and incentives just like everyone else and government failure is as much if not more a fact of life as is market failure.

See these excellent appreciations of the Mr. Buchanan's life work:
     From Alex Tabarrok
     From Steve Horwitz
     From Arnold Kling
     From Don Boudreaux
     and From the WSJ editorial page

It is a bit fitting unfortunately that Buchanan's death would come so closely to the passage of the American Tax Relief Act of 2012 (ATRA)--the resolution to the so called tax portion of the Fiscal Cliff. This disgusting example of political corruption would have been well understood by Buchanan. The act contains nothing resembling fiscal responsibility or improvement. It is a giveaway to the special interest of the tax lobby (tax preparers, tax advisors, estate lawyers, et al.) and other corporate special interest. It leaves us with a tax code more punishing on work and savings, more complicated, more encouraging of the rich to spend and use rather than save and share, more taxing on all taxpayers as everyone's income tax burden has increased (not just but especially those making more than a couple hundred thousand in a particular year--the $450,000 is a fiction), and more likely to bring us fiscal problems down the road. But it should have all been of no surprise to any of us; I was not surprised. The whole thing reminds me of this exchange:

Muriel Blandings: You remember Bunny Funkhouser, dear, that clever young interior decorator that we met at the Collins' cocktail party.

Jim Blandings: You mean that young man with the open-toed sandals? What about him? 

Muriel Blandings: Well, you know how long we've said we've got to do something about fixing up this apartment. Well, a couple of weeks ago, he called, and I asked him to come over, and he had some simply wonderful ideas, and I didn't want to bother you with sketches and estimates until I knew whether we could afford it. So I sent them over to Bill. 

Jim Blandings: How much? 

Muriel Blandings: What's the point in asking how much until you know what you're going to get?

Jim Blandings: I've seen Bunny Funkhouser. I *know* what I'm going to get. 

RIP, James Buchanan. We still have a lot to learn from you.