The Parallel Problems of TBTF and Poverty

The dilemma faced by central banks specifically and governments generally when considering corporate bailouts and other “market-saving” activities is very similar to the dilemma faced by those designing poverty-relief programs.

Essentially one wants to go with Bagehot’s Dictum: lend liberally on good collateral charging high interest but don’t bail out insolvency. I argue that this has some application to individuals as well as firms. And it applies not just to a central bank or government but really to anyone in a position to help another.

The general view seems to be that those suffering in relative or absolute poverty fall into one of two conditions: (1) Temporarily on hard times (solvent but for liquidity problems) and (2) Permanently unable to provide for oneself (insolvent due to fundamental problems). This was something in my notes from long ago, but it comes into high relief in the current pandemic crisis.

While I have tremendous and from my perspective very atypical faith in individuals' abilities to make the best choices for themselves and to have the corresponding responsibility for such, I do agree that for some people help is needed. For most people who end up in times of need, it is temporary (case 1). For some (few) it is permanent or for very long stretches and to a very large extent (versions of case 2). The dilemma is probably obvious: Is the person(s) in need going to be ultimately and truly helped by my charity or is it simply going to bailout and enable their poor choices? This is not an easy problem to solve. It is typically filled with emotional noise. There are always extenuating circumstances. Hypothetical narratives are easily constructed to fortify confirmation bias. In short it is fraught. And that is when we start with the presumption that there are real-world examples of case 2.

Under what circumstances would we put businesses into case 2? Presumably never except in the case of a truly public good--a rare thing indeed. Yet government's actions and the moral hazard that results implicitly create an environment where case 2 is common and pervasive. We are inappropriately continuing it with airlines, et al.

So this is why I title this as "parallel problems"--because we are making it as such. We are allowing a powerful group with concentrated benefit to dictate the narrative. We should call their bluff. If they are in case 1, then make the argument for being lent to at appropriate interest putting up appropriate collateral. Find a private source of funding even if that private source needs public backing in these extreme times. If they fail, then they were in fact case 2. That doesn't mean they get bailed out. It means they get extinguished to make room for another entity better suited for role they have failed at.

Harsh? Yes indeed. The market is harsh--by design. It is a feature of creative destruction. There is an old saying that in bear markets, stocks return to their rightful owners. The same can more generally be said of capital and economic downturns.

Who You Gonna Call? An Economist

If you had questions about the conditions of the local restaurant market, you wouldn't ask a chef or a restaurant manager.
If you had questions about the OPEC oil cartel or how it's actions affect the U.S. fracking industry, you wouldn't ask a petroleum engineer.
If you had questions about the affect charter schools have on education outcomes, you wouldn't ask a teacher.
If you had questions about the pricing and payment of medical services, you wouldn't ask a doctor.
If you had questions about fractional reserve banking, you wouldn't ask a banker.

Well, you might ask these people, and they might have brilliant, insightful answers. But if they did, it would be because they were using the tools and skills of economics. You might be better off just asking an economist--especially one with expertise in the specific area of interest.

Drs. Fauci and Birx are very important experts in immunology. Their understanding of infectious disease and their roles in the current crisis are keys to us conquering SARS-COV-2. But asking them when we should open society back up and revive the economy from the self-induced coma is likely asking them to speak outside their depth. I am not saying they are incapable of performing the necessary trade-off analysis, but if they are, it is because they will be employing economics not epidemiology.

Just as we did not prepare properly for a pandemic, just as we did not heed the warning signs as this one approached, just as we did not do the relevant cost-benefit analysis as decisions were hastily made and virally accelerated, I fear we are not willing to reasonably and scientifically consider, plan, and execute the return to normal life.

Reversing the lockdowns and shelter-in-place commandments should require us to consider the following at a deep level:

Benefit of reduced infection going forward minus Cost of change in way of life

What would we like to know includes:

1. R0 - the rate of infection now and going forward (both the average and the distribution of typical people and super-spreaders); Robin Hanson's analysis shows the need for an even deeper level of thought. 
2. How did R0 changed over time both as a result of human action and public policy as well as naturally?
3. How many people were infected and when?
4. How did the various policies impact viral transmission, viral impact (did putting asymptomatic infected people, mostly kids, in intense contact with at-risk people, mostly elderly, cause dangerously strong infections--dose makes the poison?), other health results, etc.?
5. How did the various policies impact our way of life? Just how damaging were the policies and how damaging was the virus?
6. What would we do different? How many lives on net did the actions taken save? How much was overall well being benefited by the actions taken? 
7. How would we do it differently in the future?

At this point we don't really know enough to depict the overall tradeoffs and how the equation above would plot in the graph below.

The x-axis runs from maximum virus eradication (all resources thrown at fighting the virus, which is well beyond even the extreme measures we have taken so far) to not changing our lives one bit other than perhaps dealing with infections as they arise including hospitalizations and death. The y-axis is overall societal well being. In the middle is the point of well being that is equal to a world where there was no SARS-COV-2.

Is the trade-off function like one of the solid-line parabolas? Don't get too hung up on the lines I've drawn other than to notice that one is at times above the other. And of course choices we make could allow us to jump from one trade-off frontier to another. But notice the other two stylized functions. Perhaps the virus is so dominant that any effort short of total effort to counter it was a net loser for societal well being (as depicted in the red-dashed line). This is possible but highly unlikely. Yet this in the extreme is the position implied by many in the populace as well as some in power. Alternatively, the virus could be an unfortunate circumstance but not one that at any level deserves us changing our way of life (as depicted in the green-dashed line). This is also possible but highly unlikely. Yet this in the extreme is the position implied by those who might be labeled virus deniers.

We would expect, however, that some type of parabolic function if not one with multiple peaks would properly depict the real world tradeoffs. The devil is in the details, and which function and how we might transform the function to improve our lot is the many-trillion-dollar question. I would like to see it asked more strongly and widely, and I would especially like to see it asked of economists. 

The Defining Debate of Our Time

The most important debate we should be having and must have eventually is under what circumstances, to what extent, and by whose authority shall we "lockdown", "shutdown", "shelter-in-place", "stay home", and otherwise stop allowing others to live life.

I applaud those thinking critically about this. We need more. Here are some examples:

Roman Pancs via The Big Questions

John Cochrane

Arnold Kling

The Reason Roundtable - this is where I really expect a long-term best efforts, and this might finally be The Libertarian Moment.

Emergency Situations Call For Proven Failed Policies

The pandemic of the novel coronavirus (SARS-COV-2) is upon us. But rest assured; our fearless leaders are here to help by making sure we keep reality at bay. I'm talking about an old favorite of head-in-the-sand, wish-it-all-away virtue signalers--price gouging laws (aka, price controls).

Because it worked so well exactly never but makes those who don't like an certainly very bad and difficult (but nevertheless necessary) change feel like something is being done, we shall inflict self harm.

Let's turn this into a partial list of things to remember about price gouging laws:

• Price controls that limit market clearing prices don't change the reality that suddenly and acutely certain goods and services are more scarce--demand has risen while supply is temporarily mostly or entirely fixed.
• They don't allow us to efficiently allocate goods. I hear you cry, "But what pray tell is so great about efficiency in a crisis?!?" Okay, okay, I sneaked in some technical jargon. When economists speak of efficiency, they are sorta saying how can we do the best for the most. We have to get what we have (water, ice, lumber, medical supplies, etc. depending on the disaster) to those who need it most. Most is key. While we always want to satisfy this to the best of our abilities, in a crisis it becomes crucial. What substitutes do we have for allowing prices to gauge who wants/needs it most? We could use:
• First come, first served
• Personal, arbitrary preferences
• Non-price competition (to the beautiful, the rich and powerful, the special interest, etc. go the spoils)
• Government or other authorities trying (honestly trying) to determine who should get what (more on this fantasy world below)
• All other methods listed above have SUBSTANTIAL costs associated with them. And there is very little reason to believe they would outperform the price dimension. They are all subject to manipulation (both malicious and innocent; intentional and accidental). They waste resources including time when resources are especially scarce. They encourage hoarding and black markets (more below). The best they possibly can do is match the outcome price would achieve while avoiding some of the dreaded downsides of allowing prices to rise. But just how bad and realistic are those downsides?
• The downsides to letting prices rise to the new equilibrium levels are hypothetical straw men. If you are worried or distressed by the idea that someone, somewhere will profit off of a bad situation you need to realize that is a reflection of your own envy and a mischaracterization of who actually is in a position to provide goods and services. If you are worried that only "the rich" will be able to get the precious thing(s), then you are ignoring the fact that "the rich" always will have access, ignoring the charitable impulses of most everyone including those with more wealth, and ignoring that your wrongheaded description of "the rich" still leaves "the not rich" without access--store shelves get emptied when prices don't rise properly (see the Art Carden link at the bottom).
• Black markets will spawn and propagate where markets in the light of day are prohibited. If you think you are ending the high prices "problem" by stopping prices in stores, etc. from rising, you are woefully naive. Those same "greedy" people who would otherwise raise their price up to the market-clearing, too-high-for-your-comfort level will simply take the items off the shelves and sell them in the alley at a more reasonable (given the new economic reality) level. And who do you think is buying in the alley? I can assure you, it is not the Boy Scouts.
• Demand is not the only curve that can change. Supply very crucially can and will if we entice it. As also indicated in the next bullet point, one must answer the always important question: "And then what?". Allowing prices to rise sends signals literally worldwide that scream: "HEY, STOP WHAT YOUR DOING! THOSE [goods and services specific to the given situation] ARE DESPERATELY NEEDED ELSEWHERE. Help us reallocate them there. And help us make more of them!" The Mike Munger links at the bottom have a lot on this very important point. In a dire situation I don't just want some (water, medicine, etc.). I want all we can get including that for which it has not yet been economical to access/build/develop. I want the best pharmaceutical firms and minds working on a vaccine today--not just the most altruistic. I want the best doctors out of their personal quarantines and on the front lines--not just the most altruistic or frankly those with lower opportunity costs. If you have a severe, acute, and emergency back injury, you don't want to be paying only enough to entice a chiropractor to help you.
• Think past the first level--there are strong incentives (social and economic) for businesses to not allow prices to fully rise or to themselves supply the charity we would want to make sure those without means can get the goods and services they truly need.
• It is a very bad way of forcing charity as it imposes the cost of charity on those supplying goods and services as well as those who otherwise would have access to those goods and services. Think of the guy who really needs ice for baby formula or a nearby hotel room to keep his job but who showed up later than the guy who didn't need those things so badly but wasn't deterred from taking them because the price wasn't giving him the crucial information that somebody else needs it more who isn't yet here to say so.
• It is immoral as it denies the property right that the owner of the resource has and it disallows her from most easily finding the person who needs it most and it punishes her for having been there in the first place to supply it. In a disaster we want the church to have been built and maintained for Easter Sunday. That is expensive. One way to get that insurance policy against pain in a disaster is to allow those who bear it 99% of the time to reap the reward for having bore it. 
• Lastly, you want to substitute a market process with a government process in a time of desperate need. Do you really, really, really think those in government are in a better position (access to knowledge, incentives and feedback effects, corruption temptations, organizational structure, etc.) than the market to do the job? I would not trust a group of (non-government) people to have the judgement, knowledge, and ethics to dictatorially make the best decisions. Why would that change for those same people if I simply put them into a government system?

Links to more thorough sources:

Art Carden
Mike Munger

Munger on Econtalk

Choose Your Own Adventure - Voter Edition

Choose one of the following ideological menu items by candidate:

Welcome to big-government democracy. Democracy is better than the rest, but the strong-state version has big shortcomings that are widely underappreciated. This is not an argument against voting. Let's assume that your vote counts; in fact, let's assume it is the only vote that does. If we assume a strong, powerful government that will be called upon to play a role in most affairs, we are doomed to a world filled with disappointment. This is true even for you, the sole voter. Surely this, a small sampling of each candidate's views, has conflicts with your own preferences. If not, let me present you with a longer list to certainly reveal disagreement.

Beyond you there is the rest of us. If we can find someone for each of the four candidates whose interests align at least in the strongly opposes and strongly supports positions, we will therefore have the ingredients for at least three disappointed people. But the problem is deeper than that. Each issue above is but a category unto itself filled with a myriad of nuanced issues. I would imagine the three candidates who strongly support government involvement in education have important differences in how they would effectuate that desire.

It should be clear from this alone that the will of the people is a silly myth. Voting doesn't count in two fundamental ways: (1) in any typical election you can be reasonably certain your vote will not determine the outcome, and (2) even if your vote did determine the outcome, you could be reasonably certain that outcome would be disappointing.

If all you do is vote, the best you can hope for is a political climate that is conducive to the changes you want and resistant to the changes you oppose. In that sense it is like standing in an open field as a storm approaches hoping that lightning does not strike you.

Rather than just vote, I recommend thoughtful advocacy, approachable engagement (pick your battles but be prepared and respectful enough to kindly offer your disagreements), a willingness and ability to change your mind, but also a fundamental resistance to the power and growth of the state. The more we ask the government to do, the more we demand to be disappointed. 

Highly Linkable

It has been too long since I shared things worth reading...

Scott Sumner explains just how rigged it all is in America, and how despite this the American free market still keeps making it better.

The difference between science and Science! begins with some simple yet important facts--take chemistry for example.

How long until smart phone phobia is behind us? Someday it will be fodder for the Pessimists Archive.

Better post this take down of Elizabeth Warren by Tyler Cowen before her candidacy (thankfully) fully flames out.

A Radical Idea

I'm going to propose something that is completely crazy. . . Hear me out on this.

I think we should get the government completely out of the manufacturing and distribution of automobiles. We should fully and completely privatize autos.

I know, I know, this sounds crazy. But I truly think that the free market can best provide automobiles for people.

Oh, I hear your complaint, "But Steve, you're crazy. Many people cannot afford cars." As hard as might be to conceive, I believe the free market could do a much, much better job. I also think that we should give people the trust and respect and dignity by expecting that they can actually make the best choices for themselves and their families. 

It is my firm conviction that if we completely got the government out of the business of making and allocating cars, say over a five-year period, that we would get cars at a third the price if not better. After accounting for quality improvements and specialization of needs met, we might see prices effectively a tenth of what they are today.

Imagine a world where cars are not one size fits all. Imagine that we have various sized trucks and sport utility vehicles. Imagine we have sports cars and family cars; we have cars that are small and highly fuel-efficient. All this would be possible if we would let the free market help people figure out what is best for them. 

And yes I hear the objection: some people simply would not be able or be willing to get themselves an automobile. I hear the concern that some people won't make great choices in this regard. For those people we can come up with other solutions. But there is no reason to totally sacrifice all of our well-being just to try to address the very nuanced and isolated problems of particular cases.

For those people that simply can't or won't provide for their own automobile needs, we can provide a bus service; we can provide funds for taxi and ridesharing; we can help organize carpools.  We see the free market work so splendidly in so many other regards. We don't question its ability to provide for our needs in so many countless ways.

Just imagine if you will some alternate universe where we had a public school system. Imagine in this crazy world we decided that because some people won't make the best choices for their children and some people very truly cannot on their own come up with the resources to get their children's educational needs met, that we force everyone to pay for a government-run, public school system. Imagine how inefficient that would be. Imagine how large the cracks would be in that one-size-fits-all world.

Even if we allowed private school alternatives, we would still be mightily restraining the free market by forcing resources into this public school system. It would also be subject to powerful political influences that would shape the school in ways that were at best suboptimal and at worst abject failure. It is easy for us to see how having the government run education would not in any way address the needs of the most needy. It is easy to conceive of how there would be very large disparities in education between the Haves and the Have Nots that couldn't be rectified and corrected because the market process would be thwarted.

All I ask is that you think about this clearly and realize the same is true of automobiles.

P.S., Thanks to Don Boudreaux and Bryan Caplan for the inspiration.

An Idea Ahead of Its Time Is a Bad Idea

Is Alexandria Ocasio-Cortez (AOC) simply way ahead of her time? 

If someone came back from the future to tell us that in her time (our future) fossil fuels had been successfully banned (first nationally and then worldwide), this would have to be taken as exceptionally good news. 

At the same time if we were to implement a first national and then worldwide ban on fossil fuels today, it would be colossally bad news.  

It is overwhelmingly likely that a ban on fossil fuels sometime in the future can only happen in a remarkably wealthy world. Ironically it will be built on the back of the use of fossil fuels that we will be wealthy enough to eventually ban them.

Religious leaders like AOC don't understand the subtle yet critical difference between our legitimate aspirations and our binding realities.

Politicians follow rather than lead. Perhaps we should be grateful for this when it holds true.

On the Matter of Carts and Horses

I want to be wealthy.

The wealthy take fabulous vacations, drive expensive sports cars, and surround themselves with luxury.

Therefore, I am going to New York for a week at The Plaza. While there, I will do some amazing shopping; eat at Tavern on the Green, The Russian Tea Room, et al.; and take in some fabulous theater. Upon my return, I am buying a Ferrari.

Of course . . . it doesn’t work that way.

Will someone please tell local governments that? Please? Please? Please? Please?

Government Shouldn't Run Healthcare, Etc. -- Round Basketball Court Edition

Driving by watching this park develop years ago it surprised me as I noticed this circular pavement being built not knowing what it was going to be.



When basketball goals went up I became irritated and was reminded of this irritation again every day as a drove by. Anyone who plays or watches basketball knows this is not what a basketball court looks like or how it is played. In fact it is dangerous. Not just because anyone who has played much basketball builds a muscle memory of the court being rectangular with corners extending to a baseline, but simply because the natural flow of play will take people off of the edge of this circular court.

Of course, this is not something to go to the mattresses over. As frustrating as it is, this incorrectly built basketball court is not the problem; it is just a symptom.

The problem is that even though a strong public goods case can be made for local government’s role in parks, government is ill-suited to successfully provide parks. It is not for lack of good intentions and not even necessarily for lack of good, intelligent people. Rather it is because of a lack of good incentives or perhaps more accurately a good incentive structure.

Government doesn’t have the right feedback loop. Government actors do not have the tools they need to course correct as they make decisions. It doesn’t matter that it won’t be the same people who designed and built this park trying to run healthcare or trying to guide the financial system or trying to fight wars or trying to [insert whatever grandiose project you want government to do]. And it does not matter that there will be enormously greater resources devoted to the grandiose project; in fact that probably makes it worse.

Highly Linkable - "progress" report edition

Let us begin with all the answers: The Cato Handbook for Policy Makers - it reads like stereo instructions for solving public policy problems.

Tyler Cowen has a new book, The Complacent Class, this short video is a good introduction. He suggests you can turn the book into winning advice. And perhaps it offers a unique explanation of Trump.

More from Cowen: Let he who cannot assimilate cast the first stone.

The Trump Rally? Scott Sumner cautions against the conventional view.

Dollars, Taxes: It is that time of year again. One of the promised blessings of President Trump is tax reform. Unfortunately, but perhaps not surprisingly, the version we will get is anything but ideal. Cowen explains. And Scott Sumner points out what economists know about taxes that the general public doesn't.

Do we need a national health policy? Steven Landsburg strongly suggests the question is silly on its face and requires more and different thought than what is generally offered.

One area of public policy Trump is offering no progress on is Social Security along with its ~$11 TRILLION of unfunded liability (i.e., debt in addition to the official national debt). Regardless of the chances, Bob Murphy has thought through a first-step solution to be considered before the inevitable changes to the benefit formula: Let people opt out. 

Speaking of letting people make decisions for themselves (and why shouldn't we given that they are in the best position to make good decisions as it concerns themselves), a surprising thing happened to an Ivy-league professor when she did a study of check-cashing businesses by working at one. She changed her mind about the business's virtues. (HT: David Henderson)

Scott Alexander kindly suggests some groups of people who we don't have to hate.

Highly Linkable - Pure Economics Edition

We continue catching up on links with three on economics. Every one of these contains a large degree of counter-conventional wisdom. Something for which I am a sucker.

First is John Cochrane being interviewed by Russ Roberts on Economic Growth and Changing the Policy Debate. I very much like the way Cochrane's perspective and approach to this topic is hopeful, straightforward, and wise.

And I could say the same about George Selgin's strong rebuttal to the conventional wisdom that the fed has been holding down interest rates.

Mike Munger challenges the assumptions many might make about how a free-market thinker would approach an issue of business interest versus a group that technically doesn't own an interest--I say "technically" and probably should say "by being robbed".

The Devil is in the Details

I have been thinking about taxes recently and actually had a couple of potential posts noodling around in my mind and my notes for the past few months. Good thing I waited. No, you didn't miss news of hell freezing over and a sensible tax code being adopted in the U.S. But you did miss me stumbling through what John Cochrane very simply Nadia Comaneci'd.

My notes on the potential posts began with: "I propose a major tax compromise: slightly higher taxes now in exchange for dramatic tax simplification. We take the existing tax code today and replace it wholesale with a consumption tax. We'll have the debate/fight at a later time about how big the tax burden should be, which is really a debate about how big the government should be. For now let's just remove the deadweight loss that comes from the complexity and the cronyism of the tax code."

Here is the full post from The Grumpy One's webpage. Allow me to extract a few key sentences:

Left and right agree that the U.S. tax code is a mess.

The first goal of taxation is to raise needed government revenue with minimum economic damage. That means lower marginal rates—the additional tax people pay for each extra dollar earned—and a broader base of income subject to tax. It also means a massively simpler tax code.  

... A simple code would allow people and businesses to spend more time and resources on productive activities and less on attorneys and accountants, or on lobbyists seeking special deals and subsidies. And a simple code is much more clearly fair. Americans now suspect that people with clever lawyers are avoiding much taxation, which is corrosive to compliance and driving populist outrage across the political spectrum.

... the government should tax consumption, not wages, income or wealth.

Wise politicians often bundle dissimilar goals to attract a majority. But when bundling leads to paralysis, progress comes by separating the issues. Thus, we should agree to first reform the structure of the tax code, leaving the rates blank. We will then separately debate rates, and the consequent overall revenue and progressivity.

Scott Sumner heaped rightful praise on the piece while noting a few considerations. I had similar thoughts. Again from my notes: "The many complications of any tax scheme: defining consumption goods versus investment assets, not penalizing transactions (you want to tax activity as it is more traceable and definable, but you don't want to do so in a way that stifles or distorts gains from trade), not inadvertently taxing capital (capital is ideas; when you tax textbooks, you are effectively taxing capital; when you tax computer sales you are taxing both Minecraft users and the 'next Minecraft' creator), etc."

Some additional thoughts: It is important to understand that ultimately ALL taxes are consumption taxes. The only difference is how efficient they are. When you tax savings, you are taxing future consumption (encouraging current consumption, which is shameful). And this taxation is usually on income that has already been taxed, but that isn't the central reason it is despicable. To savings taxes (including investment and corporate and capital gains, etc.) I say, "You're Despicable!" because that taxation compounds making the tax disincentive for savings worse the longer it is deferred (i.e., saved).

If structured properly, the disruptive effects of taxes on consumption can be minimized. If not, they can be quite dramatic and quite limiting. Of course, the current incumbent is not a high hurdle to surpass on this last point. Consider this very conservative estimate of the gains from simplification:

Let's assume the estimates of man-hours devoted to tax preparation and compliance of 3.2 billion (many estimate it is closer to 6 billion) are way off. Let's assume it is only 1 billion man-hours. Let's further assume away any other costs (capital investment distortions, rent seeking, labor tied up in compliance/avoidance work (lawyers, accountants, internal corporate departments, etc.), enforcement, etc.). Let's finally assume we can only reduce the man-hours by half (500 million). The average U.S. wage is about $25 per hour. Just this conservative estimate yields a wealth gain of about $12.5 billion dollars every year.

PS. Will tax cheating (intentionally under-reporting tax liability) or perhaps more likely tax fraud (filling fraudulent returns to garner other taxpayers' refunds) force us to simplify the tax code? Will they force us to remove Milton Friedman's unfortunate innovation (no refunds, no fraud)? Will they force a rethinking about identity verification at least in regards to the government (even less anonymity)?

Highly Linkable

Let's start with a trip out of town. Got your playlist ready? Sherman, to the Way Back Machine!

Read Jeffrey Tucker's sensible, thoughtful perspective on terrorism and its two great horrors.

Speaking of terrorism, here comes Adam to ruin everything. (HT: KPC)

A top candidate for the most disruptive technological breakthrough of the the next two decades is driverless (or less human driven) cars. The Atlantic has a good discussion of the two approaches driving this disruption.

Scott Sumner summarizes much of what is misunderstood in thinking about monetary economics. This is a bit wonkish, but keep in mind this: getting monetary policy correct is very probably VASTLY more important for your well-being than who wins the next presidential election. The combination of [insert the major candidate you are most opposed to] and good monetary policy is >>> [insert your favorite major candidate] and bad monetary policy. It is not even close.

The Market is a beautiful wonder, and the benefits of free exchange are truly immense. Consider as Cato at Liberty's Chelsea German points out discussing Andy George's projects how expensive a suit or perhaps a simple sandwich would be if we didn't have market exchange. When we limit The Market, we should do so with careful concern and minimal impact.

Assuming we cannot find a strongly compelling reason to prohibit an exchange, a good rule is: If you may do it for free, you may do it for money as Jason Brennan and Peter Jaworski point out. This would include some outcomes that we might at first glance find troublesome but upon further inspection would analyze to be quite beneficial (albeit counterintuitive) as Liberty Street Economics points out when considering payday lending.

One of the key ways the market works its magic is through the price system. An effective market needs an effective price system. It is a remarkable method of capturing cost. Substitutes for that system are quite inferior as in the case Arnold Kling points out discussing locavorism.

Connect The Dots

Test your ability to think like an economist by finding the link between these two stories:

Ice storm creates demand for chainsaws across Oklahoma City metro area

AG Urges Oklahomans To Look Out For Scams During Ice Storm Clean-Up

If you need a hint, look to this.

Highly linkable

I'm back from the dead . . . been watching from the hollow moon, as they say.

Detroit is beautiful and mesmerizing. Chicago is pretty damn awesome. The whole series (Little Big World) is hypnotically good.

Angus Deaton won the economics Nobel. Alex Tabarrok sums up his work nicely.

It is (past) time to recycle our thinking on recycling.

Just like so many of us want to believe recycling works, many want to believe in alternative medicine. Too bad some of those believers were in government.

Closing out a trifecta of wishing that things were not as they are, Steve Landsburg shows more folly in minimum wage policy.

And here is something way too few know or believe.

Highly Linkable

Never eat a bad meal again says Todd Kliman. And don't miss this link in the article.

Scott Sumner on NYC's regressive property taxes and the residential building worth as much as many cities' entire residential markets.

Perhaps they should try rent control? Oh yeah, that is acutely harmful for the poor as well as Megan McArdle points out. In other news local area hospitals are considering blood letting as a cure for cancer.

Of course, public schools play a big role in distorting property values. The performance at NYC's private charter school Success Academy may bring some changes to that.

Think you understand Richter? Think again.

Highly Linkable - economics, et al. edition

The eagle has landed--at Jardins du Trocadéro?

We want to believe, Charles Murray included, that we can raise our children's IQ, but the case against it keeps growing.

BI has 9 more math facts people have a hard time accepting.

Speaking of mathematics, Steven Landsburg has two wonderful passages on the recent passing of math colossus Alexander Grothendieck (read here then here).

Speaking of passings, economics giant Gordon Tullock died earlier this month. Tyler Cowen had a nice, short tribute. Perhaps more than anyone, Tullock taught us that the correct comparison to market failure is government failure.

Leaving the somber topics, here is some good news. Be sure to check out the "Browse Data" tab at the top.

In more good news, the health/wealth benefits of self-driving cars have enormous promise. Not to be a Debbie Downer, but here is a predicted summary headline of the near future (the second sentence is the scary one) :

Family of four dies in fiery crash as self driving car refused to recognize and decelerate as it quickly approached a crowded intersection. Regulators question technology that saves over 30,000 lives per year. 

Continuing on a theme of counter-intuitive thinking (from one of my favorite counter-intuitive thinkers), the workers of Amazon (commendably) want foremen who push them hard.

I agree with Noah Smith that we need to rethink how economics is taught to MBAs (and so many others).

We could start with this simple, true, and so often misunderstood economic lesson from Scott Sumner.

This one on antidepressants is long, but interesting and thought provoking. (HT: Bryan Caplan)

Can You Buy Economic Growth?

When you pose the question in that form, the answer should be obvious. Yet time and again we see well intended but mistaken people attempting to get something for nothing. Let’s take a hypothetical example that we see in real life quite often: a city offering a business economic incentives to invest in that city.

In this example we’ll assume the following:

1. That Company XYZ is looking to create a new research facility.
2. That the facility will be staffed with 20 new employees (not being relocated from elsewhere in Company XYZ's organization) who will earn on average $100,000 per year in total salary and benefits after taxes. $2,000,000 in NEW JOBS!
3. That Company XYZ will build a brand new facility on what is currently raw land well within the heart of the city in which it ultimately chooses to locate.
4. That the facility will be built by a local construction firm resulting in a $1,000,000 net profit to the construction firm.

It has narrowed the search down to Oklahoma City and Wichita, Kansas. From Company XYZ’s point of view and analysis the cities are essentially identical, but rather than flip a coin to determine the winning city, it will conduct a game where both cities compete to attract the investment.

The game involves both city governments coming up with incentives to entice Company XYZ, which essentially means each government taking resources from its citizens to give to Company XYZ’s shareholders. The first important point to make is that economically this is at best a zero-sum game and at worst a negative-sum game—at best the economic result is a breakeven; at worst (and likely) the game destroys resources. What is gained by Company XYZ’s shareholders is lost by citizens of the “winning” city. And IF there are economic gains to being the winning city, those gains are foregone by the losing city; hence, playing the game does not change the economic pie of the total economy. It is likely a negative-sum game because playing the game is not free. It takes resources to at the very least organize an incentive plan, tax the citizens to pay for it (or seize their land), and distribute the lucre incentive package to Company XYZ.

However, being the self-centered people advocates for the game playing must believe them to be, both cities* care only about its own economic gains. Thus, each will evaluate the game outcome only on the basis of how it affects its own city’s economy. Since I live in Oklahoma City, I will present it from the perspective of “us” being OKC.

So are there economic gains to be had? Well, let’s start with the construction of the facility. There is a $1,000,000 profit to be had there. Being the winning city is worth at least $1,000,000. In terms of aggregate economic gains for each city, we don’t care that the gain will go to a single construction firm (a concentrated benefit) at the expense of taxpayers in general paying for whatever incentive package is created (a diffused cost). We might care about the distributional effects (are we taking from poorer taxpayers to give to the richer construction firm?) and we should care that the construction firm might encourage an incentive package worth more than $1,000,000 (an effect of the concentrated benefit/diffused cost**). But the economic gains imply we should spend up to $1,000,000 to get the facility.

Of course, Wichita has the same incentive. How will this play out? It is likely the incentive package will be bid up until all the gain (or more) goes back to Company XYZ—the winning incentive package will be $1,000,000 (or higher). I hear your protest, "But wait, aren't there other economic gains? What about the 20 $100,000 jobs? Giving up the $1,000,000 related to the construction seems a small price for $2,000,000 in NEW jobs." Okay, let’s look at jobs.

Remember that jobs are a means, not an end in themselves. The economic gains from a new job is illusory. If we assume the 20 employees come out of the local economy, we have to consider that they came from somewhere. The personal gain to each is the difference between what they had before and what they have now in the new job (i.e., what total wages and benefits they were expecting to make before compared to the new job’s $100,000). Even if they were unemployed, it is bad economic reasoning to assume their gain is $100,000 annually. We need to compare their next-best alternative, which surely was not zero income for life. It may have been government assistance and family support, but it was more likely the prospects of another job very similar to the $100,000 one at Company XYZ. Why is this so?

Effectively workers compete for the new jobs by offering to work for less than competing workers.*** This competitive process tends to eliminate candidates starting with those who have the most to gain from the new job. In a moderately large economy the eventual candidate pool will be those who would only slightly benefit from taking the new job. Therefore, regardless of what they were doing previously, it is highly likely that the new jobs are only marginally better for the workers who get them.

To be generous, let’s assume the new workers all come from another city—might as well assume Wichita while we’re picking on them. Don’t these new entrants into the local OKC economy represent economic gains in the form of growth? Yes, they do.**** And we can roughly approximate the gross gains to OKC's economy as being $2,000,000 per year. The net gain will be somewhat smaller as these new entrants use city resources, etc. Let’s ignore those costs, though, and just stick with the $2,000,000 figure. Again we are back to the courtship competition between the two cities where each will pay Company XYZ the equivalent of $2,000,000 per year to be the winner.

Let’s tally winners and losers:

WINNERS	LOSERS
Company XYZ (it captured all the gains to be had from the winning city)	Both cities (they each used resources campaigning; the winning city gave up all the economic gains to Company XYZ)
People in the winning city who now have new neighbors	People in the cities from which the relocating employees left
Construction firm
Employees (but only marginally)

This analysis used precise assumptions about profits and jobs that are unrealistic. In reality these facts would not be known with certainty and would almost certainly be very out of analytical reach for the city governments. They are ill-equipped and ill-incentivized to discover and estimate these facts well. Notice we didn't talk about cronyism or corruption. We ignored any fanciful, magic multipliers that would imply a $2,000,000 new job infusion would create more than $2,000,000 in economic gains. The burden of proof is on those who would refute this analysis. Wanting it to be different is not the same as it being different. Quit basing economic and political decisions on hopes, good intentions, and "great" leaders performing miracles behind the curtain.

*Here is the first flaw in this line of argument advocates make. Cities don’t have cares or opinions. Only people within cities have cares, and those cares are not uniform or identical.

**See the late Gordon Tullock and public choice economics.

*** The transition mechanism for this is indirect; so don’t get caught up in the fact that you have never witnessed it directly. It is a market-driven process largely unseen to market participants just as the price of my iPhone accounts for the use of expensive elements like praseodymium, gadolinium, and terbium even though I didn't know those even existed until reading an article about rare elements in iPhones—and I still don’t know and don’t need to know what they do.

****I am assuming the cities want (there I go again) economic growth. It is not at all clear that all members of each city desire this. In fact a lot of behavior, from zoning laws to grumpy complaining to moving just outside of the city, demonstrates that people are not that keen on economic growth.

The Trouble With Not Working For Profit

Arnold Kling writes:

For-profit firms ultimately are accountable to customers, while nonprofit enterprises are only accountable to donors. As a result, consumers are consistently over-charged and ill-served in sectors that are dominated by nonprofits....

The intention heuristic is to evaluate at an action, person, or institution in terms of its stated intention: if the intention is good, then it is good. Instead, we ought to evaluate outcomes. If you do that, then you will find that the small-business sector produces more socially desirable outcomes than the large nonprofit sector....

We should not elevate nonprofits to a higher pedestal than that of for-profit firms. We should stop telling our children that working for a nonprofit is in any way morally superior to working for a profit-seeking enterprise.

Read the whole thing. Over the years reading Kling has served to strengthen my position against a favored status for nonprofit organizations. While Rand gave me a moral position to question their status altogether, this is a more economically founded reasoning that I believe many more will find persuasive.

Borrowing from Kling, my view is that not-for-profit firms should only exist where for-profit firms won't but should--where there is a true, absolute positive externality and little to no internalizable benefits. If the positive externality is strongly believed to be real but there is also a profitable firm(s) operating in that space, then simply subsidize the for-profit firms to get more of what is desired.

A big problem with nonprofits is that they tend to live on past the point when they should. We seem to have an urge to keep inefficient, undesirable nonprofit entities in existence. Part of the problem is the intuitive but incorrect viewpoint that because they don't generate profits, nonprofits need extra help. But a larger part is simply that nonprofits lack the feedback mechanism that for profits have that reveals when resources are being wasted. This poor incentive structure is at work throughout these organizations from the day-to-day operations up through to the overall mission.

Another important difference is that for-profits must pay taxes while nonprofits do not pay taxes giving them an advantage that has deadweight loss implications. This has a vicious-cycle effect to it as the conferred advantage favors the firms not using resources most prudently. Since they can distribute the profits to the owners (presumably when reinvestment would not be in the owners and hence society's best interest), for-profits have built-in incentives to use resources well. Nonprofits must reinvest their profits (proceeds in excess of cost) into their operations even if this is not desirable (further investment would be wasted resources).

A firm should not be advantaged in practice or in esteem because of how it uses the fruits of its endeavors. A rose by any other name would smell as sweet--so too, a profit for any ultimate use.