Saturday, July 31, 2010

Complex orders

Earlier this month Boyes compared the current administration to that of FDR. He wrote:

I find the parallel between the Obama Administration economic policies and those of the FDR Administration uncanny

Clearly the evolution of state presence in society has accelerated since WW 2 and we see in present deficits and other "fiscal policies" as well as "monetary policies" a willingness to extend state control further into the process of discovery and use of knowledge.

Think Markets has a must read for those undecided about the benefits of increased centralization:

The recent July blog makes two key points

The market system itself is a large and highly interconnected system of exchanges, capable of generating beneficial effects unintended by the participants. The latter’s behavior is nonetheless shaped by feedback from these effects. And it is an open system, subject to and adaptive to changes, including attempts at outside control.

The issue of adaptive reaction (feedback) is an important, perhaps essential, issue to consider when looking at the performance of society. It is in my view an indirect measure of liberty and freedom. Douglass North highlights the role of what he calls adaptive efficiency and it is this flexibility and ability to engage in trial and error that is at the center of a market or spontaneous order.

Adaptive orders, and the US remains one of the most adaptively efficient societies in the world, in spite of the evolution and emergence of an expanding welfare state. Boyes and I share the concern articulated by Pete Peterson and others that the elasticity of our society seems to be near a zenith and the ability of our open access order to adapt to additional outside or central control may be limited. The constraints on state involvement in society seem to be broken in a distressingly cavalier and frequent manner - I view this as the most striking similarity between the Obama and FDR administrations.

Think Markets goes on to point out what is the key recognition that is lacking in public policy discourse today.

The recognition of some social systems as complex arrangements whose beneficial effects are the unintended consequence of people pursuing personal goals is an extremely important but seriously underappreciated scientific discovery.

The Santa Fe Institute is one of a few locus points for the study of and discussion of the Hayekian view of complexity, knowledge and the discover procedure embedded in competition that work together to create opportunity, wealth and freedom in a spontaneous order.

Thursday, July 22, 2010

Keynesian Economists Leave Me Baffled

Alan Blinder has done it again. In his latest WSJ editorial (Obama's Fiscal Priorities Are Right, July 19, 2010) he attempts to argue that Keynesian policy is correct and only fools deny it. He says:

"On one side, you find the deficit hawks, Democrats and Republicans, who have steadfastly opposed any "second stimulus"—partly on the grounds that the federal budget deficit is already too large, and partly on the grounds that the first stimulus failed. I argued on this page last month that the latter is not remotely close to true, but never mind."

And he was absolutely wrong last month. The stimulus has done nothing. Businesses are not spending and not borrowing and definitely not hiring. The only jobs created by the stimulus are Census takers (who not are done) and government bureaucrats. Blinder goes on to argue for extending unemployment insurance even though study after study has demonstrated that such extensions lead to unemployment. Think about it – if you tax something you get less of it and if you subsidize something you get more of it. Subsidizing unemployment gives us more unemployment.

"The hawks have even dug in their heels against extending unemployment insurance benefits at a time when the unemployment rate is 9.5%, or helping states and localities avoid laying off teachers in September. That's pretty anti-Keynesian thinking."

The fact that it is anti-Keynesian thinking makes it correct. Keynes was wrong. Why can’t Blinder realize that when people spend their own money resources are used where they have the highest value; when government spends the people’s money, resources are used inefficiently. It is probably time to lay off teachers and close public schools as they are now constituted. It is a great time to move toward a system of vouchers and private and charter type schools.

Blinder goes on to say: I" argued on this page in May that the right mix of fiscal policies would combine more stimulus in the short run with more budgetary restraint for the long run. And I believe most economists, whether of the left or the right, agree with this prescription, reserving their disagreements for details such as whether to use spending or taxes, and what specific types of each."

I do not think most economists agree with his argument. I think many would argue that what you do in the long run affects the short run. People realize that increased “stimulus” means increased taxes in the future. So people decide not to spend now knowing that they have to pay more taxes in the future. This idea is called the Ricardo effect. So with a government spending multiplier of .4, as compared to a private spending multiplier of 2.0, taking money from people (now or in the anticipated future) retards the economy rather than stimulates it.

Then Blinder introduces the classic Keynesian thesis that: " …….not all dollars are created equal. To take a very relevant example, consider three different ways to add a dollar to the budget deficit: increase unemployment benefits by $1, give a $1 tax cut to someone earning $50,000 a year, or give a $1 tax cut to someone earning $5 million a year."

While the immediate impacts on the budget are identical, the near-term spending impacts are not. The unemployed worker struggling to make ends meet will likely spend the entire dollar right away. The $50,000 earner probably will spend the lion's share of it, saving just a bit—that's what most Americans do. But the $5,000,000 earner probably will save most of the new-found dollar.
So according to Blinder and Keynesians savings is bad. It does not create jobs. But how are jobs created? Investors must offer funds to entrepreneurs to create businesses, to create jobs. Taking money from the entrepreneurs and investors to give to the unemployed worker reduces jobs and hinders recovery.
I used to think, and even wrote in my textbooks, that economists don’t really disagree. It is just over some normative policy issues that economists disagree about and these are relatively few. But after reading Blinder and Krugman and the Obama Administration economists, I know that there is serious disagreement among economists.

Monday, July 19, 2010

Bad to Worse

I find the parallel between the Obama Administration economic policies and those of the FDR Administration uncanny and very scary. The recently passed Financial Reform bill is anything but reform -- it is a potential disaster. What with significantly higher taxes coming on line in January, this bill makes it more difficult to carry out business in the United States. It is estimated that this bill is several hundred times more onerous and difficult to understand than was SOX and the average cost of complying with SOX is close to a million dollars a year.

The bill restricts and outright bans certain uses of hedging instruments.Without the use of hedges, hundreds of companies will simply move their operations to those countries that they previously simply hedged currency fluctuations for. How does a soy farmer hedge the potential of drastically lower soy prices? Under this reform measure, it is not allowed to.

Cristina Romer told us that unemployment would not exceed 8 percent. She based that on a government spending multiplier of 1.5 or so. Robert Barro has demonstrated that the government spending multiplier is significantly less than one. That only makes sense. Who best can choose how to spending money, the person who earns the money or the government? Resources are allocated to their highest valued use only by individuals spending their own money. Government does not care about efficiency.

If the Obama Administration policies are not reversed, the U.S. will follow Japan's recent history of lost decades; the U.S. will remain mired in very slow growth for some time. I am not optimistic that the policies will be reversed. Each time a Republican candidate for some office wins under the guise of cutting government, fights with unions and trial lawyers leave the candidate compromising principles. Government Christy in New Jersey just did that with his cap on property taxes. Two term governor of North Carolina has done that and is now susceptible to lsoing the seat to a Democrat. Will the Tea Party remain adamant about cutting spending if the economy remains in the doldrums in 2012 or 2014? I don't think so.

Tuesday, July 13, 2010

Bourbon before Breakfast

I just finished reading Jeffrey Tucker's set of essays titled "Bourbone before Breakfast: Living Outside the Statist Quo". I recommend it to anyone. It is witty, well written, and essentially libertarian. There are a few essays devoted to Tucker's personal likes and dislikes, but overall it rails at increased government intervention in our private lives. One of my favorite essays was on Mark Twain. I had not realized that Twain was so anti government. Clemens wrote:
"The mania for giving the government power to meddle with the private affairs of cities and citizens is likely to cause endless trouble .. and there is great danger that our people will lose that independence of thought and action which is the cause of much of our greatness, and sink into the help lessness of the Frenchman or German who expects his government to feed himwhen hungry, to clothe him when naked .. and in time to regulate every act of humanity from the cradle to the tomb, including the manner in which he may seek future permission to paradise.
Twain's letter to Enterprise on January 1866.

Monday, July 12, 2010

The Economy

The economy today resembles that in 1933 and it is due to the uncertainty created by the Obama Administration policies. Robert Higgs referred to the situation as regime uncertainty. In essence, neither individuals nor business are certain that their private property will not be confiscated -- tax rates are due to increase the end of this year -- a VAT is being seriously considered -- Democrats are strategizing over how to implement their policies of confiscation during the lame duck session following the November elections. No one wants to invest in this environment. Mortgage rates are at a many decades low and yet people are not buying houses. Banks are earning more money keeping deposits at the Fed than they would be lending, so lending is very low. The economy can not improve in this environment. What is needed is a dramatic cut in taxes, particularly corporate taxes. Moreover, the Democrat policies of the last year and a half need to be reversed or at least stopped. The huge spending increases by government do not stimulate the economy; they mean future higher taxes, future high inflation, or bankruptcy. These are not views that lead to increased private investment and spending.

How can Paul Krugman continue calling for increased government spending? It is beyond me.

Thursday, July 8, 2010

Business Roundtable

The CEO of Verizon, president of the Business Roundtable, recently proclaimed that the group, which had supported Obamacare in order to gain favorable treatment from the Obama Administration, was disappointed and surprised at the treatment its members had received from the Administration. How many are surprised at this development? Surely not many. So why would high level executives be surprised?

Monday, July 5, 2010

Online classes from the Mises Institute

The New Deal: History, Economics and Law

History H110 — with Tom Woods
COST: $255

This course taught by historian Thomas Woods runs from September 6 through November 1, 2010. It examines the critical period of American history from the stock market crash of 1929 to the end of World War II, focusing on domestic affairs. Topics include: the 1920s boom and bust, the Hoover record in light of recent scholarship, the New Deal programs and agencies, the evolution of the Supreme Court, international parallels, political and intellectual opposition to FDR, and the economic consequences of World War II. Readings include primary documents, works by contemporaries, and recent scholarship and commentary.

Weekly Topics:

The 1920s boom and bust
The Hoover record
The New Deal programs and agencies
The evolution of the Supreme Court
International parallels
Political and intellectual opposition to FDR
Economic consequences of World War II

Friday, July 2, 2010

Responses to Journalist Questions

I received an inquiry from a journalist in Tehran, Iran, about several issues. This is my response.

1- The case, as it's usually presented, is that the globalized economy is a good thing that will secure jobs, allow us to remain competitive, and make the economic situation of a country better. Isn't there some wrong to that as we saw an economic crisis in US spread all over the globalized economies?

Free trade and free markets have been proven to be the greatest source for wealth creation, for raising standards of living and human development, and increasing liberty. When people engage in voluntary trade they are doing so because they expect it will make them better off. When trade is coercive or is restricted then people do not get what t hey want at the price they are willing and able to pay. Instead, they get lower quality goods at a higher price and often do not get what they want.

The recent global crisis occurred because of government intervention. Government interventions in the US housing market, regulations on capital flows and banking around the world all led to an attitude that failure is not possible – governments will bail out firms that fail. And, indeed, that is what occurred.
Now, be sure that not all economists agree on what the problem with the financial crisis was and is. It is often claimed by economists that there is essential agreement in the profession on almost everything. Well, if that was ever the case, it is not now. There are free market economists, Keynesian economists, Austrian economists, and even Marxists.

You can see the division among economists in the following remark by Paul Samuelson.
“And today we see how utterly mistaken was the Milton Friedman notion that a market system can regulate itself. We see how silly the Ronald Reagan slogan was that government is the problem, not the solution. This prevailing ideology of the last few decades has now been reversed. Everyone understands now, on the contrary, that there can be no solution without government.”

The market system is generally the most efficient allocation system—it best satisfies people’s wants and needs and raises their standards of living. Without anyone dictating what buyers and sellers do, the market determines a price for each traded good at which the quantities that people are willing and able to sell are equal to the quantities that people are willing and able to buy. Day in and day out, the market system induces people to employ their talents and resources where they have the highest value. People do not have to be fooled, cajoled, or forced to do their parts in the market system. Instead, they pursue their own self-interests and, in so doing, generate the most good for society.

Firms acquire resources and then organize and coordinate the resources to create and offer for sale various goods and services. The value that consumers place on these goods and services must be more than the value they place on the individual resources alone or else the firm will cease to exist. When a firm’s goods and services have more value than the opportunity cost of the resources used to create and sell the goods and services, then rivals will begin to compete with that firm. In other words, when economic profit is negative, the firm will cease to exist; when economic profit is positive, the sharks will attack. Rivals will enter and compete. People will get the goods and services they want at the lowest possible prices and resources will be used where their value is highest.

A free, competitive market is usually illustrated as a simple downward sloping demand curve and an upward sloping supply curve. The price and quantity at which the curves intersect represent the result of competition, the price that is the lowest possible and the quantity that people want and are able to pay for. This price and quantity result from resources being used where they are most valued. If another department store could match Nordstrom’s products and service but do so at a lower price, consumers would abandon Nordstrom and shop at the other store. This would drive Nordstrom’s profits down until they were at the normal or zero economic profit level. If iPods can be replaced with another company’s MP3 at lower prices and/or higher quality, then Apple’s profit will be driven to the normal level. Thus, the intersection of demand and supply is the point where consumers are currently happy with what they are getting and prices are as low as possible.

When competition is limited and entry restricted, then the picture changes. With total entry restrictions, the entire market is converted into a single firm, the monopolist (or a cartel of firms acting as a monopolist). The firm maximizes profit by restricting quantity and raising price. If government intervenes in the fre market price and or quantity is distorted from the competitive outcome and either "too much" or "too little " is produced and consumed. Resources are misallocated. Intervening or interfering with free competitive markets harms society.
But even so, it is argued, a free market causes too many problems. For instance ,if a free market is hit by a sudden reduction in demand caused by any number of things, such as speculative activities, unexpected resource changes, or some other crisis, the free market adjusts to the demand reduction by firms exiting business and price and quantity being reduced. The free market adjusts by price dropping until the demand and supply curves intersect again.

Here is the theoretical crux of the argument between free market economists and Keynesians – the speed with which the market adjusts to changes. Critics of the free market argue that the adjustment from the first equilibrium to the second takes too much time. Markets just take too long.

A slow adjustment of the market means resources will be unemployed and inventories will stock up on shelves for awhile. If demand decreases but price and quantity do not immediately follow, then a surplus will occur. If this market is wheat, then a surplus of wheat will exist; wheat will lie dying in the field. If this market is cars, then excess inventories of cars exist; cars will be piling up on dealer lots. But most importantly to market interventionists, if this market is the labor market, then there is a surplus of labor; unemployment rises.

John Maynard Keynes, the leading economist of the 1930s, captured this criticism of free markets with the following statement:"The long run is a misleading guide to current affairs. In the long run we are all dead." Tract on Monetary Reform (1923) Ch. 3.

Free market economists argue that intervening in free markets will make matters worse than just letting the free market adjust. Under this view, when something like the Great Depression occurred in 1930 or when the financial collapse in 2006-08 occurred, the free market response would be to do nothing - because in the long run the markets would solve the problem, the price of labor would fall, more firms would hire, people would return to work, and the economy would return to full employment.
Keynes said this was madness - in the depth of a recession, why not try to do something about it, rather than leave it to 'market forces'. In the long run the recession may end but the long run could be 10, 15 or more years. Keynes wanted to try and solve the depression now rather than wait for 10 or 15 years or however, long the 'longrun' was.

This viewpoint is the basis of many of the arguments between free market economists and the Keynesian or non-free market economists. "It simply takes too long for the market to work things out. People, central planners, and governments can do it better."

The counter to this argument is that while we might be dead in the long run, our children and grandchildren won’t be. So we should do what is best for the economy in the long run and that is leave markets alone. By intervening in free markets, inefficiencies arise that slow the growth of the economy and harm future generations. In the end, intervening in the functioning of free markets just makes the situation worse and creates additional problems.

There is more to the story than this. The Keynesian solution does not even help in the short run. The GreatDepression lasted 13 or so years; the great recession of 1921 lasted two years. The difference was that the Keynesian solution was tried in the Great Depression. In 1920, nothing was done; the free market adjusted. In 2008 the free market was interfered with in a huge way with bailout, takovers, cram downs, huge expansoins of the money supply and other Keynesian policies. How effective have those Keynesian policies been to date?

Ignoring the long run is impossible. People care what happens to their children and grandchildren and the long run to someone, say Pratt, is much longer than it is to me. As a good friend of mine states, I don't even buy green bananas any more. The intergenerational robbery that has gone on with the Keynesian policies is perhaps the theft of the century.

2- Some people feel that after communism collapse, free-market capitalism may be next. Do you think it is the case or capitalism adapt itself with the new conditions and sustain its life?

The long winded answer to question 1 should provide you my answer to this question. No, capitalism will not collapse or fail. What may fail is crony capitalism or big government capitalism. In other words, in those nations where a move toward greater economic freedom is made, success will follow. In other nations, where government is growing as a share of the economy, failure will result. Compare for instance the growth of the US economy to the growth of European economies. From the 1950s to the 1990s the US economy grew at about 3.5 percent per year while the European economies were half that. The projection of future growth for the US is at most 2 percent per year. Increasing government means decreasing economic growth. Comparing 3.5 percent per year growth to 1.5 per year growth means that the size of the economy will double in about 20 years versus about 50 years.

3- Before the recent crisis US was called the motor of the world economy? Do you think it is yet?

The US is still the driver in the world economy but the share of world GDP created by the US is declining. As US government continues to grow, the importance of the US dollar and the US economy will shrink.

4- What is your prediction of the world economy situation at 2050? Which country would be the biggest economy at 2050? Where would be the center of the world economy: the West or East?

There is no way I would venture to forecast the economic situation in 2050. I can tell you with certainty, that the nations that create and protect private property rights, that enhance and secure economic freedom, will be the successful nations. Those that allow government to grow beyond 15 to 20 % of GDP but with a private sector and some private property rights will grow very slowly or decline over time. Those without economic freedom and private property rights will collapse. As a stab in the forecast arena consider the following:

China will either recede into a shell with its totalitarian government without economic freedom or will emerge as a different country by 2050. It could be hugely successful or could return to dire straights. There is inevitably a clash between economic freedom and communist government. India will struggle but will continue to pull more people out of poverty than has ever been done in history. India’s economic freedom must continue increasing and secure private property rights must increase.

The European Union will disintegrate. Most European nations will flounder as their social welfare system grows and private sector output fails to pay for entitlements. It is likely that well before 2050 the European nations will dissolve into class and civil warfare.

The newly free nations of Europe and Asia will likely succeed as freedom and private property rights propel them. In Latin America, the jury is out. Those nations such as Venezuela will collapse. Chile is likely to continue growing. Some other nations may follow Chile’s success.

Accordingto "The Closing of the Muslim Mind" by Robert R. Reilly, unless
a revision in Islam can occur, economic freedom and private property rights -- the necessary conditions for eocnomic growth -- will not occur. According to Reilly, the Wahabi and Sunni nations will collapse without the oil revenues. I don't kow whether Shia and Sunni view matters significantly differently to allow success to Shia nations while Sunni decline. The Wahabi and Sunni nations now have wealth only because of oil. If nations are able to secure other sources of oil and turn to other sources of power, the oil producing nations that do not accept freedom and private property rights will fail. Similarly, without oil revenues and without enhancing private property rights and economic freedom, Russia is not likely to succeed. Another factor in old European nations and Russia is that demographics are against them. Without replacement population growth from within either the countries shrink or immigrants replace resident population.