The Rest of the Story

The last lecture in my six-part series on everyday economic errors releases this upcoming Wednesday. Thanks again to Grove City College for the opportunity.

I kept my talks to around 25 minutes, which means there are lots of objections and/or extensions I didn’t cover. If I had more time, here’s what I might add.

Lecture 1: The most sophisticated comeback to the broken window story is the notion of “idle resources,” or the idea that Bastiat’s parable only applies under conditions of “full employment.” Krugman, for instance, expresses these hydraulic Keynesian ideas in his Depression Economics, which my GCC colleague Shawn Ritenour reviews here. (Trigger warning: Shawn believes demand curves slope downward to the right–see the last paragraph!)

The “idle resources/full employment” retort misses the mark for at least two reasons. First, it evinces a remarkable lack of curiosity about why so many resources become “idle” simultaneously. As Murray Rothbard famously put it, the central question of business cycle theory is: “How is it that…the business world suddenly experiences a massive cluster of severe losses?” (Here at CSOC, we promise not to do too much macro…)

In my opinion, the best answer to that question leans heavily on the fact that capital goods are heterogeneous and multi-specific. For reasons Austrian business cycle theory explains, capital goods can become mal-invested, ill-suited to their current position in the economy’s capital structure. When this is revealed, widespread dislocation results (i.e. seemingly, but not actually, “idle resources”). Arguably, this understanding of the economy’s capital structure, and the associated business cycle theory, is the hallmark of the contemporary Austrian school.

But the idle resources comeback fails for another reason too. As W.H. Hutt argued, “idleness” isn’t really idleness at all. All resources have alternative uses, and who’s to say that withholding a resource from the market isn’t a “use”? In fact, such withholding is precisely what we’d expect in the wake of a depression, as resource owners “search” for where they can best refit into the economy’s shifting capital structure.

Resources are searching. They’re not idle! In what he considered his most difficult paper (I thank Rosolino Candela for this tidbit), Alchian provides micro-foundations for the idea that seemingly “idle resources” are actually hard at work.

Lecture 2: In my opinion, price controls are among the most illuminating topics in Econ 101 because they (indirectly) demonstrate all the problems that unhampered prices are solving, mostly in invisible fashion.

Economists agree rent control is destructive, so they won’t be the ones raising objections here. In addition to the evidence I cited in my talk, Alson et al.’s 1992 survey of AEA economists found that 93% agreed with the following statement: “A ceiling on rents reduces the quantity and quality of housing available.”

Interestingly, even as the minimum wage consensus has disintegrated in the wake of Card and Krueger (1994), economists’ confidence in the destructiveness of rent control seems to have only increased since 1992.

Though I wouldn’t have devoted more time to objections, twenty-five minutes is hardly enough time to explore the near-infinite–and sometimes quite bizarre–margins of adjustment people devise when policy takes price competition off the table.

One important aspect of rent control that I did not discuss is that it “freezes” tenants in their apartments. Renters who got an apartment in Manhattan at rent-controlled prices shortly after WWII clung to those spaces for decades to come. This contributes to an inefficient use of housing space, longer commuting times for those can’t find an apartment in the city, and may even help explain the persistence of rent controls.

Why? Those outside the city limits may want to vote for the repeal of rent control, but their current address means they can’t vote in the crucial municipal elections. Instead, those who benefit from rent control continue to vote for city council members who promise they won’t repeal the rent freeze.

This sort of public choice analysis reminds us that economists aren’t claiming that no one benefits from rent control. Cui bono?

It’s possible to benefit at the expense of landlords and other prospective tenants if the apartment complex doesn’t deteriorate to the point that a tenant would rather have the market rental price and the well-maintained apartment. See here for the complete catalogue of photographs comparing bomb damage with rent control.

For additional material that had to be nixed for time, see Diamond et al.’s recent, interesting work on how rent control worsens inequality. And evidently, Donald Trump can accurately claim: The rent control made me do it!

Lecture 3: My favorite talk. When politicians believe that all supply and demand curves are perfectly inelastic, they’re demonstrating that they don’t understand “margins of adjustment.”

Some runners-up examples I nixed for the sake of time:

  1. Seat-belt laws induce reckless driving.
  2. The Cobra Effect isn’t just about cobras. David Lucas and I describe how rats, pigs, microbes, graveyards, garbage removal, and the battle against homelessness have all been fertile breeding grounds for the “Cobra.”
  3. The stated rationale of license-plate rationing is to reduce air pollution. In 1989 in Mexico City, it accomplished just the opposite.
  4. Curfew laws kill. The stated rationale of curfew laws is to reduce crime. Instead, they remove witnesses from the street, something that Jane Jacobs argued on the basis of commonsense, and which Carr and Doleac have demonstrated empirically for Washington D.C.
  5. A 1972 FDA decree mandated the use of child-proof safety caps on aspirin and certain other drugs. The evidence suggests that this regulation increased the rate of child poisonings from analgesics. Consumers adjusted by leaving the cap off or by transferring the medicine to an easier-to-open container.

All this said, I don’t think it’s analytically helpful to attribute all public policy outcomes we don’t like to “unintended consequences.” To do so would be to deny an enormous body of public choice literature, which has illuminated the role rent-seeking plays in explaining law.

Unions don’t lobby for minimum wage increases out of ignorance–but from knowledge–of the consequences. More political economy / historical research could profitably investigate which interventions are the result of “true believers” generating “secondary consequences” (Hazlitt’s preferred term) and which are the result of special interest victories (also generating secondary consequences).

Lecture 4: Maybe the most controversial lecture to laymen. Something just feels wrong about the compensation package multinational corporations pay to the world’s poorest people. Yet, if economists are wrong about voluntary exchange being mutually beneficial, they are wrong about nearly everything. Additionally, this sort of thinking fails to remember that all of mankind used to labor in sweatshop conditions (or worse). The puzzle is prosperity, not poverty.

In my lecture, I hint at a few questions that I didn’t have time to answer there. Here are the answers that I promised economics can provide.

  1. “Why don’t workers in the underdeveloped world command higher wages?” Productivity determines wages. Competition between employers tends to bid wages up to their (discounted) marginal revenue product. To deny this process is to assert that employers intentionally leave “money on the table.” Employers even have a profit incentive to find the “mix” of compensation that workers prefer, where the “mix” includes pecuniary rewards, nicer working conditions, more vacation days, etc…Finding the optimal mix saves employers’ money.
  2. Ok, what determines “productivity”? Primarily the extent of capital accumulation which a country’s workers enjoy. When workers have more and better capital goods to work with, their per capita is output is higher, which increases the demand for their labor. Why then is capital accumulation lacking in certain parts of the world? Largely due to predatory governments, which aggress against private property rights, reducing the incentive to save and invest. Well-behaved governments, defined as governments which protect private property rights, are the exception–not the rule–both historically and now.
  3. “Why can’t large manufacturing companies pay their workers more than they do?” Large companies pay workers in the developing world roughly what they’re worth (it’s a process, not something that holds instantaneously). If they paid them more, they’d earn losses on the those marginally overpaid workers. If they paid them less, that’d invite additional investment in the underdeveloped world to seize those profits. This investment would include a scramble to earn profits by employing these underpaid workers. That’s not what we see empirically. The lion’s share of international business investment does not occur in the underdeveloped world, precisely for the reason I discussed in the last paragraph.
  4. “I don’t like your definition of exploitation.” The alternative to my definition would seem to be something more expansive, something sufficiently expansive to condemn all voluntary exchange and the division of labor itself. On a broader conception, grocery stores exploit our lack of food, clothing stores our lack of clothes, etc…Of course, you’re free to remove yourself from association with others and live as a hermit. Nothing stops you but the cost!

Another question I’ve received: Is agriculture really more dangerous than manufacturing? Yes. First, the “indirect” evidence suggests this is the case. People flocked from the fields to the factories beginning in the Industrial Revolution, a tendency which continues to the present day. They did / do it for the combination of higher wages, shorter hours, and safer working conditions.

More directly, the International Labour Organisation estimates that agricultural workers suffer 250 million injuries a year, and that the fatality rate among these injuries tends to far outstrip rates found in other industries. Ben Powell reports that the injury rates for children working in agriculture are higher than for those working in manufacturing. As the ILO rightly summarizes it: “Agriculture is one of the most hazardous occupations worldwide,” (p. 7).

What about my claim that the rate of economic development has been increasing worldwide? See evidence from Ben Powell’s book on how the length of the “sweatshop phase” of developing countries has been falling. And the evidence suggests that we have the fashionable-to-hate Age of Milton Friedman to thank. (Even Amartya Sen says something like: “When someone uses the word ‘neoliberal,’ I have no idea what they mean, but I do know they don’t like me!”)

Lecture 5: If labor econ corrects a disproportionate share of economic fallacies, international econ is a close runner-up. Indeed, perhaps lecture 4 is controversial because it sits right at the intersection of labor and international econ.

As I explicitly note, my talk is about why international trade raises living standards for all parties in the long run, ceteris paribus. I intentionally did not address other arguments for tariffs, such as the idea that they facilitate national defense. The argument is that tariffs can protect crucial war-time industries, in the event that these goods are supplied by our enemies. A closely-related argument maintains that tariffs might help us survive pandemics.

The national defense argument is lacking, not because it doesn’t identify a possible scenario, but because the relevant alternative is worse. Advocates of this view assume that government possesses both the knowledge and the incentives to protect the “right” industries. Both of these are heroic assumptions.

First, consider knowledge. As Don Boudreaux speculates, it’s easy to see how 1960’s governments might have identified the typewriter industry as critical to prosecuting a war. Imagine trying to win a war sans the ability to communicate. But encouraging the typewriter industry amounts to suppressing other emergent and innovative means of communicating–like the laptop. National security would undoubtedly be worse if the military relied on typewriter technology in 2021.

Now, consider incentives. In 1984, the president of the Footwear Industry of America made the following plea to the Armed Services Committee of Congress: “In the event of a war or other national emergency, it is highly unlikely that the domestic footwear industry could provide sufficient footwear for the military and civilian population. We won’t be able to wait for ships to deliver shoes from Taiwan or Korea or Brazil or Eastern Europe…Improper footwear can lead to needless casualties and turn sure victory into possible defeat.” Rumor is he even said it with a straight face.

Of course, it’s difficult to imagine any good that’s not “essential” to successful war-making. And once government announces its intention to protect such industries, who wouldn’t be lining up to receive protection? Once they do, the logic of “concentrated benefits, dispersed costs” kicks in, and what non-arbitrary, logical stopping point is there short of national autarky? (To answer that question, you’d need to overcome the knowledge problem of the previous paragraph…)

Let’s also not forget that trade reduces the likelihood of trade in the first place. See Coyne and Pelillo for a review of some evidence.

What about when other countries don’t “play fair”? It turns out that the case for free trade is unilateral. No country on earth “plays fair” if that phrase means the country is free of interventions, which distort relative prices and therefore production decisions. But from “our” perspective, it still makes sense to take the other country’s interventions as exogenous to our production decisions.

Whether cheap steel is due to “genuine” production superiority or from subsidies, it still frees up “our” laborers to enter alternative lines of production. Our consumers/producers are better off due to the cheap imports, which leave more money in their pockets.

Lecture 6: There are far-reaching implications of the fact that markets are regulated by profit and loss. When I present this idea in class, the most common objections fail to realize just how much behavior the profit-and-loss system constrains.

No only does the profit-and-loss system mitigate the impulse to defraud and discriminate, as I discuss in my final talk, it also imposes a non-arbitrary “stopping point” for all production processes.

Why don’t we produce more medicine, more books, more chocolate? Because we’d have to withdraw scarce capital goods from production processes that create more value to do so. This argument applies to your “favorite” goods–goods you just feel the world should have more of. (It also has dramatic implications for the tenuous theory of “public goods,” but that’s a story for another time…)

Additionally, this argument also has important implications for the confused literature on entry barriers. Fashionable entry barriers like economies of scale or brand loyalty are merely evidence of the constraining power of the profit-and-loss system to channel resources to where they’re most highly valued. See more here.

Of course, the biggest implication of understanding profit and loss is that incentives aren’t the Achilles Heel of socialism. Socialism doesn’t “work,” even if all men are angels. New Soviet Man, seeking only his fellow comrade’s maximum welfare, wouldn’t know what to produce or how to produce it. (Evidently, there was also New Soviet Woman).

As Mises put it in Socialism, profit and loss calculation, “…provides a guide amid the bewildering throng of economic possibilities…Without it, all production by lengthy and roundabout processes would be so many steps in the dark…And then we have a socialist community which must cross the whole ocean of possible and imaginable economic permutations without the compass of economic calculation,” ([1922], 1951, pp. 117, 122).

To read more about economic calculation, there’s no better place to start than Mises’ 1920 Economic Calculation in the Socialist Commonwealth.

One additional question I received concerns the story Klein and Leffler develop in their insightful, 1981 paper. In their story, producers offer “hostages” to consumers in the form of sunk investments, usually taking the form of specific assets or advertising. Producers will never recoup these investments if they renege on their commitment to high quality.

For this mechanism to guarantee quality, must consumers be walking around with a a sophisticated understanding of the Klein/Leffler model in their heads? No.

Klein and Leffler anticipate this question, writing: “We obviously do not want to claim that consumers ‘know’ this theory in the sense that they can verbalize it but only that they behave in such a way as if they recognize the forces at work. They may, for example, know from past experience that when a particular type of investment is present such as advertising they are much less likely to be deceived. Therefore, survivorship of crude decision rules over time may produce consumer behavior very similar to what would be predicted by this model without the existence of explicit ‘knowledge’ of the forces we have examined,” (p. 634).

Leave a Reply