Economics

Economics and Moral Hazard

Another first rate video from the Econ 101 series of the Center for Freedom and Prosperity.  This video exlores the concept of moral hazard in economics.  A moral hazard occurs in economics when one of the parties to a transaction is  insulated from bad effects if the transaction goes south.  This will cause that party to behave more recklessly than if the full impact of the failure of the transaction were felt.  Government bailouts of course establish a precedent that if a big business suffers a loss, that the government might bail it out.  No doubt many of our major financial institutions have learned the lesson that if a financial fiasco is large enough, Uncle Sucker will come to the rescue, and put the taxpayers on the hook for another few trillion that they can’t repay.  Moral hazard indeed!

A Story in Graphs

Once upon a time there was a country — it had its problems as any nation does, but it did well enough. Its people prided themselves on working hard, and they were comparatively well off: less so than the UK, more so than Spain and Italy.

They’d had the good fortune to have none of their infrastructure destroyed during World War II, and after the war they experienced a boom as an exporter. Things slowed, however, in the late 60s and early 70s. Some said this was because the rest of the world got better at growing their own food and manufacturing their own goods. Others said it was because they allowed too much immigration. Some said it was because the welfare programs they created in the 60s ate away at the motivation to work hard.  Others said it was because unions became weak. Whatever the reason, their average income in inflation adjusted terms grew much more slowly than it had, and there was a good deal of discontentment and disagreement as to what to do about it all and who was at fault. Here’s a graph of their average family income in inflation-adjusted US Dollars.

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Progressives Are Not Cynical Enough About Business

One thing my study of economics has taught me is that businesses will tend to act in whatever way they think will bring them the most profit. There may be rare exceptions, and of course businessmen often have mixed motives. But the overall tendency in this direction is very strong.

My guess is that if you surveyed people, many more self-described progressives would say that they agreed with the statement than self-described conservatives. Indeed, progressives often criticize conservatives and libertarians for being insufficiently attuned to the rapacious self-interest motivating businessmen.

Yet oddly enough, it seems to me that one of the main problems with progressive thought is that they don’t take the idea that businesses act to maximize profit seriously enough. For a group that claims to have a low opinion of businessmen, progressives have a strange habit of advocating policies that will only work on the supposition that businesses won’t act to maximize profit, and then react with shock when they proceed to do so.

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Quick Econ Thoughts on Licensing

This was going to be a comment on Blackadder’s post which has turned into a discussion on licensing and whether it raises prices, but since I only have time to write out one thought process today I thought I’d turn it into a post.

Most folks outside economics see licensing as a way of legally certifying duties and providing a means of redress when incompetence occurs. Not only does a plumber who consistently allows sewer gases to enter a home get sanctioned civilly, he can be sanctioned by license loss and prevented from harming other households.

Let’s try two examples on our theoretical plumber here:

1) Say that we have a local economy in which licensing is not mandatory. If I want some plumbing done, I have several options: I could open up the phone book, call around, and hire the absolute cheapest guy who says he’s willing to give plumbing a job. He may do a terrible job, and set sewage to run through my ice maker.

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What the Left Cannot Supply, the Right Will Not Demand

Recently I’ve been toying with the idea of doing a series of posts looking at the recent survey purporting to know a lack of economic knowledge on the Left, with one post for each of the eight questions on the survey. As I look at the list of questions, however, a clear theme emerges, namely that liberals tend to think that the price of a good or service isn’t much affected by the supply of that good or service or visa versa. According to the survey, liberals tend to think that restricting the supply of housing doesn’t increase the price of housing (question 1), that restricting the supply of doctors (through licensing) doesn’t increase the price of doctors (question 2), and that price floors won’t decrease the supply of either rental space (question 4) or jobs (question 8).

Coincidentally, I’m currently reading a (surprisingly good) book by Paul Krugman, in which he argues that conservatives tend to minimize or dismiss the part changes in demand have on getting us into or out of recessions. Naturally this got me thinking whether one of the things separating left from right in this country is a difference in the importance of supply and demand in economic phenomenon. For the above issues, at least, liberals seem to be ready to discount the importance of supply, whereas conservatives underestimate the importance of demand.

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Left=Economic Illiteracy?

Great minds think alike.  I had prepared a post on this subject and I see that Darwin already has posted on the same topic.  Normally I would simply trash my post, but this time I think our readers might find it amusing to see our different takes on this topic.

Everyone loves a pop quiz right, especially on economics!   Here are eight questions.   Possible answers are :   1) strongly agree; 2) somewhat agree; 3) somewhat disagree; 4) strongly disagree; 5) are not sure.

Here are the questions:

 1) Mandatory licensing of professional services increases the prices of those services.

 2) Overall, the standard of living is higher today than it was 30 years ago.

 3) Rent control leads to housing shortages. 

 4) A company with the largest market share is a monopoly.

 5) Third World workers working for American companies overseas are being exploited.

 6) Free trade leads to unemployment.

7) Minimum wage laws raise unemployment.

8)  Restrictions on housing development make housing less affordable. Continue reading

Ideology and Economic Knowledge

Prof Daniel Klein of had a brief piece in the WSJ this week talking about how people’s economic knowledge or ignorance breaks down by ideological lines.

Zogby researcher Zeljka Buturovic and I considered the 4,835 respondents’ (all American adults) answers to eight survey questions about basic economics. We also asked the respondents about their political leanings: progressive/very liberal; liberal; moderate; conservative; very conservative; and libertarian.

Rather than focusing on whether respondents answered a question correctly, we instead looked at whether they answered incorrectly. A response was counted as incorrect only if it was flatly unenlightened.

Consider one of the economic propositions in the December 2008 poll: “Restrictions on housing development make housing less affordable.” People were asked if they: 1) strongly agree; 2) somewhat agree; 3) somewhat disagree; 4) strongly disagree; 5) are not sure.

Basic economics acknowledges that whatever redeeming features a restriction may have, it increases the cost of production and exchange, making goods and services less affordable. There may be exceptions to the general case, but they would be atypical.

Therefore, we counted as incorrect responses of “somewhat disagree” and “strongly disagree.” This treatment gives leeway for those who think the question is ambiguous or half right and half wrong. They would likely answer “not sure,” which we do not count as incorrect.

In this case, percentage of conservatives answering incorrectly was 22.3%, very conservatives 17.6% and libertarians 15.7%. But the percentage of progressive/very liberals answering incorrectly was 67.6% and liberals 60.1%. The pattern was not an anomaly.
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Pope Speaks About Economics Again, "It's the Natural Law, Stupid"

After calling for Catholics to be liberated from their pet ideologies, Pope Benedict is helping flesh out a moral economic vision that puts the standard Left- socialism/Right- Free Markets debate into the dust bin for faithful Catholics.  The bottom-line seems obvious to me- you can’t demonize government and you can’t demonize business- both bring difficulties into play- over-regulation can harm economic development, but lack of regulation can lead to corporate dominance which is a problem when one considers that corporations typically are upfront about being in existence to pad their investor’s bank accounts, not being much concerned with the universal common good. Our Pope clarifies the inherent morality(read Natural Law) in the economy in this article from one of my favorite web sites Zenit.org:

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Set Me Free (From Ideologies) Part 2

 

To follow up on my first installment of “Set Me Free (From Ideologies), I am going to draw again from the rich well of Pope Benedict’s powerful encyclical Caritas In Veritate.  In this case it would seem that in paragraph #25 the Pope is sounding kinda liberal if we would attempt to fit the views expressed into one or another of our American political ideologies. Continue reading

Ash over Europe, Wilting Flowers and Produce in Kenya


Economics may be the “dismal science”, but I find this kind of story about the interconnectedness of the world endlessly fascinating. With flights restricted throughout the UK and Northern Europe because of the volcanic eruption, vegetable and flower growers in Kenya find themselves with mountains of produce with no market.

If farmers in Africa’s Great Rift Valley ever doubted that they were intricately tied into the global economy, they know now that they are. Because of a volcanic eruption more than 5,000 miles away, Kenyan horticulture, which as the top foreign exchange earner is a critical piece of the national economy, is losing $3 million a day and shedding jobs.

The pickers are not picking. The washers are not washing. Temporary workers have been told to go home because refrigerated warehouses at the airport are stuffed with ripening fruit, vegetables and flowers, and there is no room for more until planes can take away the produce. Already, millions of roses, lilies and carnations have wilted. Continue reading

Service Economy

One often hears polemics against the fact that our country is now dominated by the “service economy”. It is one of those phrases that gives a strong impression, yet is oddly difficult to pin down.

If I may be indulged in an open-ended post:

1) How would you define the “service economy”? (with examples)

2) Is the service economy new, or merely expanded/changed, versus what you would consider a more traditional time? (Whether that is 100 years ago or 500 years ago.)

3) Is it a problem that the service economy is so large, and if so why?

From Sweat-shop Workers to Business Owners

The Oregonian features an article on how Chinese workers who spent years working in factories for American brands like Nike and Columbia Sportswear have become a major source of business startups and wealth in China’s rural interior.

WUHU, China — Years after activists accused Nike and other Western brands of running Third World sweatshops, the issue has taken a surprising turn.

The path of discovery winds from coastal factory floors far into China’s interior, past women knee-deep in streams pounding laundry. It continues down a dusty village lane to a startling sight: arrays of gleaming three-story houses with balconies, balustrades and even Greek columns rising from rice paddies.

It turns out that factory workers — not the activists labeled “preachy” by one expert, and not the Nike executives so wounded by criticism — get the last laugh. Villagers who “went out,” as Chinese say, for what critics described as dead-end manufacturing jobs are sending money back and returning with savings, building houses and starting businesses.

Workers who stitched shoes for Nike Inc. and apparel for Columbia Sportswear Co., both based near Beaverton, are fueling a wave of prosperity in rural China. The boom has a solid feel, with villagers paying cash for houses.

“No one would take out a mortgage to build a house,” said Wang Jianguo, 37, who returned after a factory injury in a distant province to the area near Wuhu, west of Shanghai. “You wouldn’t feel secure living in a house you didn’t own.”
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It's Not Subversion, It's The System

I ran across this Boston Globe article about a Boston College professor who believes she has successfully identified a new form of civil disobedience, or as she terms it “economic disobedience.”

The interview changed the way Dodson talked with other supervisors and managers of low-income workers, and she began to find that many of them felt the same discomfort as the grocery store manager. And many went a step further, finding ways to undermine the system and slip their workers extra money, food, or time needed to care for sick children. She was surprised how widespread these acts were. In her new book, “The Moral Underground: How Ordinary Americans Subvert an Unfair Economy,” she called such behavior “economic disobedience.”

I’m perplexed as to why Prof. Dodson is so surprised by this. Continue reading

Sweatshop Economics Must Not Continue

I don’t believe any good Catholic would say they are happy with the situation of so many sweatshops operating in China et al.  The problem is what to do (or not do) about it.  I am giving my students a research project premised on a single sentence- “How can I avoid buying sweatshop products?”.  We are simultaneously studying the good Pope Benedict XVI’s “Caritas In Veritate”- specifically paragraphs #21, 22, 25, 27, 35, 36, 37, 38, 40, 41, 44, 48, 49, 51, 60, 63, 64, 65, 75, and 76. You can follow along at home!

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On Certification Instead of Regulation

What started as a “Ha, do you libertarians endorse this?” dare by Mike of Rortybomb has turned into a somewhat interesting discussion between him and Megan McArdle about to what extent it’s possible to protect people who are not good at understanding complex financial products (the elderly, or people who just aren’t good at understanding complicated service agreements) from being victimized by banks without in the process hurting the people you’re trying to help. This as the new credit card legislation is going into effect, trying to crack down on banks which raise interest rates quickly if you’re late paying, have hidden fees, or move due dates around (theoretically in an attempt to keep people from paying on time.)

Mike suggests that banks should be required to offer a “plain vanilla option” of products such as credit cards or checking accounts.

And that solution would be mandating financial services to provide Vanilla Option financial products. Boring, low-reward trap-fee products you’d probably have to pay a yearly fee for.

So much of our financial services are predicated on tricks and traps but also have a lot of benefits. You get free checking, but if you overdraft you lose more than you gained. Now with a vanilla option, you could pay more upfront to not take the risk of losing later. This is banking how it used to be, boring. And this is exactly the kind of product that people with weak cognition would want to have available. Someone approaching older age, but before getting there, could opt for the “extra boring” financial services package. People buy renter’s insurance; some might view a yearly-fee on their checking account or credit card as a “trap insurance.”

Megan doesn’t think the idea would be very successful: Continue reading

Difference and Equality

Individualism is one of those terms which a great many people use in a great many different ways, so it has been with interest that I’ve been reading Individualism and Economic Order by F. A. Hayek. The book is a collection of essays dealing the individualism, its definition and its place in the economic order.

From the first essay, “Individualism: True and False” comes an interesting thought:

Here I may perhaps mention that only because men are in fact unequal can we treat them equally. If all men were completely equal in their gifts and inclinations, we should have to treat them differently in order to achieve any sort of social organization. Fortunately, they are not equal; and it is only owing to this that the differentiation of functions needs not be determined by the arbitrary decision of some organizing will but that, after creating formal equality of the rules applying in the same manner to all, we can leave each individual to find his own level.

There is all the difference in the world between treating people equally and attempting to make them equal. While the first is the condition of a free society, the second means, as De Tocqueville described it, “a new form of servitude.”
(Individualism and the Economic Order p. 14-15)

This strikes me as touching on the sense in which classical liberals in the tradition of Burke and Smith can still be considered “conservative” in the old sense of the term. Although Burke is commonly accepted by those who argue that classical liberalism is not “truly conservative” as being conservative in his outlook because of his reaction to the French Revolution, he was (like Smith) Whig, though they were Old Whigs, not True Whigs or Country Whigs. Prior to the French Revolution, Burke had been generally supportive of the cause of the colonists in the American Revolution.

Taking Hayek’s point, classical liberals in the tradition of Burke and Smith do not reject the necessary hierarchy of society. Nor do they embrace sudden, transformative social change. As such, they can certainly be seen as conservative. However, they do seek sufficient freedom within society to allow people to “find their own level”, believing that there is a natural hierarchy of ability which will thus result in an ordered society, and a more desirable one than one in which hierarchy comes strictly from birth and rank.

In this sense, the freedom of a classical liberal society creates social order, and a more stable one than the sort that an ancien regime conservatism maintains. Indeed, arguably, at this point in history, it is only this Whig-ish conservatism which is commonly found within society. Ancien regime conservatism has virtually died out.

Entirely different are notions of politics or the human person in which it is held which all people are truly and fully equal — in ability and inclination as well as in human dignity. Such systems would indeed seem to lead quickly to a most undesirable oppression.

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