Category Archives: Economics

The Irony of “Buy Nothing Day”

There is an event/group on Facebook calling itself “Buy Nothing Day”, in regards to Black Friday. The idea is to, well, not partake in the rampant consumerism that characterizes the day after Thanksgiving. Of course, as should be obvious, the majority of people participating in this event are leftist college students. They rage against the mindless individualism and greedy consumerism of modern day capitalism. The very idea of spending money on cheap foreign products makes them sick.

So, to combat the capitalist machine, they will all refrain from spending money whilst wearing their Che shirts and waving the Communist Manifesto proudly through the air. The irony, of course, is that these capitalist-hating individuals have implicitly rejected today’s dominant leftist economic theory which states that consumer spending is what drives the economy and leads to our high-standard of living. The typical narrative goes something like this: “Consumer spending makes up 70% of our GDP! The only way to get out of the recession is to increase spending, which puts money into businesses, who then ramp of production, which requires them to hire more workers, and suddenly the economy is back on track!” Now, as Dr. Robert Higgs points out here, consumer spending has not been the problem. Consumer spending only fell a few percentage points since the recession began back in 2008. It’s investment that really took the hit.

In more formal economic terms, many economists today (those calling themselves Keynesians) believe the problem with the economy today is that aggregate demand has fallen and, in order to get the economy back on track, aggregate demand has to be boosted. There are two ways this could be done: Government spending, and consumer spending. If consumers would only go out and began spending once again, businesses would hire more people and the economy would right itself. Unfortunately, this doesn’t happen because consumers fear uncertainty, and so begin saving. This increased savings (non-consumption) further depresses the economy. At this point, government is supposed to pick up the extra slack in the economy and spend enough to get businesses hiring again.

If the Keynesian theory is to be believed, “Buy Nothing Day” can only further deteriorate the state of the economy. At any rate, it certainly won’t help. These people’s decision to not consume is going to contribute to lower wages, more unemployment, and further depressed housing prices. Not good, right?

I would argue, however, that there is nothing economically harmful when it comes to “Buy Nothing Day”. Indeed, I don’t believe the problem is with a lack of aggregate demand. Spending does not drive the economy, savings does. One cannot consume oneself into prosperity. Prosperity and rising living standards require that some people putting aside some consumption today in order to consume more tomorrow. If we imagine a man, alone, on an island with some fruit trees, we know that he can either consumer all of the fruit on the trees, or he can consume some of the fruit and plant more fruit trees for the future. If he consumes all of the fruit today he will certainly be well off for a short period of time. Perhaps until the next evening, or so. But after that he will have nothing left to eat until the trees grow more fruit. Clearly, if this man wants to have something to eat for the future he will engage in some non-consumption in order to consume more later.

To the extent that “Buy Nothing Day” leads to less consumption today (savings) and more consumption later, I think it will be a good thing. I doubt it will have much effect on the economy, but in principle it sounds right. The economy needs more savings to finance greater output in the future. The irony with this whole thing, however, is that the people participating in this event are probably the same people calling on the government to spend more money in order to get us out of the recession. Is spending the problem, or is spending the solution? Which is it, guys?

The Problem of Farm Subsidies for the Environmental Movement

“Free-markets” and “environmentalism” aren’t terms normally thrown together in conjunction these days. If you’re well enough in tune with various right-wing and free-market think tanks you will no doubt be aware of institutions like PERC (Property and Environment Research Center) which offer a free-market look at environmental issues. But all in all environmentalism, the green movement, and locovores are usually seen as the domain of the left, not the domain of the right or even those with a libertarian bent.

For that reason I was pleasantly surprised to meet a libertarian the other week who was quite interested in the concept of sustainable farming (in fact, her desire to one day run a sustainable farm influenced her towards libertarianism). A Political Science major at Boise State, she was quite knowledgeable about the ways in which government was, paradoxically, holding back the green movement in favor of large corporate farms.

Sustainable farming is the idea that farming today should leave future generations better off. It emphasizes environmental sustainability, animal welfare, biodiversity (many sustainable farms do not use any chemical pesticides), and so forth. In other words, it’s a popular buzz-word amongst the left and something you would likely hear tossed around casually at one of those hip downtown coffee shops that all the fashionable liberals like to frequent. Not that there’s anything wrong with that, of course. Sustainable farming is certainly a viable alternative to large-scale agribusiness, at least in theory.

Although one could no doubt argue back and forth about how efficient or realistic organic and sustainable farming really are, that isn’t the point of this post. As my libertarian friend went on to point out, due to the system of agricultural subsidies in the U.S. large, well established farming corporations are continually subsidized by the Department of Agriculture at the expense of smaller farms (many of which practice sustainable farming). As it turns out, the top 10% of the largest farms received close to 75% of all subsidies from 1995-2009. The USDA has shelled out close to a quarter trillion during that time period.

Aside from the fact that these subsidies lead to huge amounts of surplus agricultural products (inefficient use of resources) at taxpayer expense, they also directly destroy the livelihoods of third world farmers the world over. The U.S. Government, through its incredibly dubious “Food for Peace” program, buys this surplus food from U.S. farmers and sends it into third world countries at very low, discounted prices thereby ensuring small indigenous farmers are unable to make a living. The entire system is quite plainly awful.

But back to the subsidy’s effects on the domestic market.  What USDA subsidies do is not only encourage inefficiency through an ex ante declaration of market winners (those farms that get the subsidies), but they also ensure that Joseph Schumpeter’s creative destruction never happens. Creative destruction, remember, is a the idea that capitalism is constantly reinventing itself through the process of competition. Goods and services come and go; old businesses die while new ones are born, and so forth. USDA subsidies have the effect of maintaining large agribusiness while new, innovative farming firms (like those engaged in sustainable farming) flounder because they just cannot compete. It is not only a complete injustice- it is completely wrongheaded from an economic perspective. Not because sustainable farming is better than the traditional large-scale corporate farm, but because we don’t know which one is better. The only way to know is to let the market process work. If those subsidies are never removed, consumers will never know if my libertarian friend’s sustainable farm will be able to better satisfy their demands, as well as help the environment. USDA farm subsidies are neither fair nor efficient.

The Problem is Structural…Again

Over at the NY Times Economix page, the editors point to a new study by the Economic Policy Institute which makes the case that the state of unemployment today is cyclical rather than structural. Cyclical unemployment being the idea that unemployment exists because of a lack of demand in the economy. Structural unemployment, on the other hand, sees unemployment as arising because of a change in the structure of the economy (new products, sectors, and technologies requiring workers to move or learn new skills).

The authors of this study want to argue that the problem is simply one of demand. They recommend increased deficit spending to get the economy moving so that workers will be reemployed generally in the areas they used to work in. This is all fine and good, but only if you think the economy was following some natural trend line from 2001-2008 and the recession was just an event not at all connected to the housing boom that came before it. In other words, the problem isn’t structural if you think the economy was structurally sound during the housing boom years.

Is this is a realistic view? I would say no. One can argue about the causes of the housing bubble (low-interest rates, lax lending standards, global savings glut, etc), but one cannot argue that there was, indeed, a housing bubble.  Paul Krugman rightly points out that

The 2007-9 recession was driven by the collapse of a huge housing bubble, and the resulting financial fallout. The Fed couldn’t cut rates sharply, because they weren’t all that high to begin with; there couldn’t be a housing boom, because housing was already overbuilt.

Obviously houses don’t magically appear out of nowhere. To build houses requires material and labor. If houses are being overbuilt than we can only conclude it happened because resources and labor were diverted from other areas of the economy into the construction and manufacturing sectors. Notice that what was going on there was structural. People who would have worked in other sectors of the economy found themselves looking for employment in those areas of the economy connected to housing (obviously this isn’t the full story because hiring was taking place in plenty of other sectors as well).

Just look at wages and salaries of construction workers during the housing bubble:

That’s a pretty clear upward trend right there. Clearly, wages were being bid up which attracted workers from other sectors. More to the point, however, is the fall in construction jobs since the recession began. Employment in the residential building sector alone peaked at a little over 1 million jobs in 2006 but had fallen to a little over 500,000 jobs this last February. That’s almost a 50% drop. What the authors of this study are advocating for is for all of those people to wind back up in the construction sector, which is only going to happen with another housing bubble (at least for the immediate future).

Additional attempts at increasing aggregate demand through fiscal stimulus will only have the effect of maintaining the pre-recession structure of the economy. Goodness knows the Federal government is still trying its darndest to prop up housing prices. This is a recipe for disaster or, at the very least, a non-recovery that goes on for years to come.

Mises on Transportation Subsidies

One of the primary claims of left-libertarians such as Roderick Long and Kevin Carson is that the state has supported the proliferation of large-scale organizations through subsidies such as the building of public roads, the interstate highway system, and so forth. According to them, firms are larger and more concentrated than they would be relative to a market where transportation subsidies did not exist.

How do transportation subsidies lead to overall larger firm sizes? The primary point is that transportation costs are, in effect, socialized (or dispersed) whereas the benefits tend to be concentrated on those who use the roads the most. In other words, although the roads are open to everyone, firms that have a geographically large market (such as Wal-Mart) are paying roughly the same as everyone else but actually using the roads more. Big-box retailer’s business model is dependent on long haul trucking, which is dependent on government subsidies to the roads.

The net effect of this is to increase the overall size of firms larger than they would otherwise be. The reason is simple: Were it not for transportation subsidies, the markets these firms compete in would probably be much smaller, and much more local. Without transportation being subsidized, a business model based on a market the size of (say) most of the United States would not be feasible.

At any rate, the reason I brought this up was because of a Mises Daily that I read this morning. It’s called, “The Problem of External Costs and External Economies” (written by Mises), and deals with external economies and government subsidies. One part caught my attention, and relates to what I’ve been talking about. Mises writes about the effort of governments to build railroads and other types of infrastructure to specific rural areas in an attempt to allow rural food producers a chance at a larger market. The reason the government has to engage in this sort of activity in the first place is because private investors are unwilling to put up the funds to develop a private railroad system. If it was profitable to do so a private railroad could be financed, allowing these farms to ship food to wherever it needs to go. In these sorts of areas the costs of production are higher than in other parts of the country, because the agriculture is taking place on submarginal land. Mises writes that…

If the government, yielding to the demands of the interested pressure groups, builds the railroad and runs it at a deficit, it certainly benefits the owners of farm land in those poor districts of the country. As a part of the costs that the shipping of their products requires is borne by the treasury, they find it easier to compete with those tilling more fertile land to whom such aid is denied.

This is essentially the exact same situation Carson has been writing about. This isn’t a direct subsidy to those out-of-the-way producers of food, but an indirect subsidy that allows submarginal land to compete with marginal land when, without government help, it would not have been able to. Likewise, big-box retailers and other firms that have geographically large markets are able to compete where they would not have been able to without government transportation subsidies.

So, although this doesn’t really add anything crucial to the debate over how much transportation subsidies effect the overall size of firms, I think it’s interesting Mises seems to have weighed in on it a good many years before today’s left-libertarians.

The Problem is Structural…

Martin Wolf, a British journalist, recently commented on the Austrian Business Cycle Theory (ABCT) at his Financial Times blog entitled the Martin Wolf Exchange. While he acknowledges that much of what the Austrians say could very well be correct, he disagrees with their view that markets should be allowed to liquidate without government intervention.

But Austrians also say – as their predecessors said in the 1930s – that the right response is to let everything rotten be liquidated, while continuing to balance the budget as the economy implodes. I find this unconvincing.

The problem here is that while he may agree with Austrians that fractional-reserve banking could be inherently unstable, he misses the real heart of the theory: malinvestments within the capital structure. During the boom stage of the business cycle capital is misallocated into sectors of the economy it otherwise would not have been were it not for the artificially low interest rates that misled entrepreneurs. Roger Garrison, in his book Time and Money, says

…credit expansion sets into motion a process of capital restructuring that is at odds with the unchanged preferences [of consumers] and is ultimately ill-fated.

The problem, then, is structural. It is a structural problem within the production process that ultimately leads to the bust. Now, I realize most mainstream economic theories typically think of capital as a homogeneous “k” where a “structure of production” is ultimately meaningless. But just for a moment take the ABCT on its own terms. If the problem is ultimately structural and not simply a lack of effective aggregate demand than it becomes immediately apparent why government attempts to boost aggregate demand will end in failure. Increasing aggregate demand is not going to help the production process straighten out its  structural problems. In fact, it will probably exasperate it.

I should point out that if Wolf’s concern is for the general population most effected during the “liquidation period” than I can see no serious objection within Austrian economics to providing some sort of short-term safety net. Of course many Austrian economists would object to a government safety net out of hand, but that would be more as “libertarians” than “Austrian economists”. While there are good economic reasons for being wary of the long-term effects of unemployment insurance and other safety nets, used sparingly I can’t see this as halting, in any meaningful sense, the capital restructuring necessary for the economy to get back on its feet.

The Evolution of Markets

Last March, the journal Science published a fascinating study by researchers from around the globe entitled, “Markets, Religion, Community Size, and the Evolution of Fairness and Punishment,” which sets out to research the ways in which large-scale human societies are able to foster trade and cooperation. Obviously, we haven’t always lived in large, interconnected groups of people like we do now. Once upon a time humans lived in small, closely related groups that were held together by the innate bonds of kinship. But getting from small groups of related people to large interconnected societies has always puzzled sociobiological researchers.

Sadly, the full journal article is only available to subscribers so I haven’t been able to read the full thing. This article, from USAToday, seems to be a pretty good summary. The abstract of the study says this

Large-scale societies in which strangers regularly engage in mutually beneficial transactions are puzzling. The evolutionary mechanisms associated with kinship and reciprocity, which underpin much of primate sociality, do not readily extend to large unrelated groups. Theory suggests that the evolution of such societies may have required norms and institutions that sustain fairness in ephemeral exchanges. If that is true, then engagement in larger-scale institutions, such as markets and world religions, should be associated with greater fairness, and larger communities should punish unfairness more. Using three behavioral experiments administered across 15 diverse populations, we show that market integration (measured as the percentage of purchased calories) positively covaries with fairness while community size positively covaries with punishment. Participation in a world religion is associated with fairness, although not across all measures. These results suggest that modern prosociality is not solely the product of an innate psychology, but also reflects norms and institutions that have emerged over the course of human history.

Russ Roberts, the host of the great economic podcast EconTalk and professor of economics at George Mason University, never tires of defining economics as the study of incentives, and I think this is exactly what this study is talking about. What they are really examining is the incentives that led small groups of people to interact and cooperate with other small groups of people, rather than just fighting them in all out tribal warfare. As Hans-Hermann Hoppe explains in his paper “On the Origin of Private Property and the Family“, the hunter-gatherer societies were essentially parasitic. They took from the land but never produced anything. Once these resources were depleted these societies had to either wait for the replenishment of vegetation and animal herds or migrate. Migration worked for a time, but, the supply of land being fixed as it is, there came a point in which human societies simply could not escape each other and it came down to either warring over land or hunkering down and cooperating.

The question, then, is how to cooperate and trade with groups of people you would normally consider enemies. Ludwig Von Mises, in Human Action, describes the tendency for humans to cooperate,

If and as far as labor under the division of labor is more productive than isolated labor, and if and as far as man is able to realize this fact, human action itself tends toward cooperation and association; man becomes a social being not in sacrificing his own concerns for the sake of a mythical Moloch, society, but in aiming at an improvement in his own welfare.

What Mises is saying here is that as the opportunity cost of not trading rises relative to remaining in small, splintered groups people will begin to trade. They begin to trade by establishing norms and rules (that could be explicit or implicit) in order to facilitate trade.  As the paper notes, groups of people that do engage in trade show greater amounts of fairness towards strangers than those that do not. This can be explained by the concept of “social capital” which compares human relationships analogously to  financial transactions. The sociologist James Coleman describes social capital in terms of credit slips. When person A does something for person B it establishes a mutual relationship and the concept of credit slips describe the “debt” person B then holds for person A. Social capital is the trust and obligations that people hold toward one another.

People went from war to peaceful exchange via “growing” their social capital by engaging in trade. Although many today are apt to see trade and competition as “cutthroat” and somehow inherently hostile, trade is actually an action which establishes people as allies rather than enemies because each party knows the trade is mutually advantageous (A and B engage in trade because they desire what the other party has and if they didn’t the trade would not happen). Fairness is a natural outcome of the creation of social capital.

When economists say markets can overcome this problem or that problem it may make more sense to bring it down to the individual level. People solve problems when there are good reasons, and strong incentives, for doing so. Often times critics of the market conceive of the market as some abstract, homogeneous institution rather than the nexus that ties human action together. When we think in terms of individuals it becomes easier to understand why markets can solve problems- because people do. This study demonstrates just one of the numerous ways in which this is true.