Wednesday, February 24, 2010


Ultimately, ethical imperatives must be absolute in nature. That is to say, it is invalid to use a relative measure to determine the morality of an action, unless that relative measure is used as an inference to some absolute state of affairs.

Suppose a person were to assert that "college students have a duty to get good grades". This imperative would be invalid if grades were rated on a curve such that some students must get bad grades. However, many people actually intend this statement merely as a surrogate for the statement that "college students should study hard and learn the materials to the best of their ability", with the assumption that some will inevitably not study hard and be the same students who do poorly.

Additionally, the assertion that "only the best alternative among good alternatives is morally acceptable" is nonsensical, as it represents a double evaluation. If an alternative can be seen as good, then it cannot follow that it is also not good. Typically, examples that fit this definition suffer from a lack of sufficient parsing, stringing together series of actions into a single object. It may actually be possible to define actions in such a way that better alternatives do not exist, by looking at each decision point as a separate action in which only one choice is the good one.

Monday, February 22, 2010

Trade: Dangers and instabilities

The political and media game in the midst of this Second Great Depression is sadly fixated on real estate and banking. Certainly, these sectors have played a role in the collapse that we have experienced, but it is wrong to attribute the full force and persistence of our malaise on just these sectors. At the very core of the economic problem, it is not currencies that are to blame. Balances of income and expenditure between various regions of the globe and sectors of the economy are what actually determine things like unemployment rates and other numbers of political importance. Additionally, the degree of achievable prosperity is constrained by the rate at which key natural resources are exploited. These two determinants of economic outcomes are aspects of economic geography and market structure.

A firm that follows a neoclassical business strategy will seek to maximize production efficiency by minimizing costs per dollar value of finished goods. Such profit maximizing philosophies are clearly the norm among large scale businesses. This model takes both workers and consumers as essentially being factors of production. The final product of the firm, in the mind of the firm's owner, is not the product for sale but the income stream that firm profits bring to him.

This maximization is best achieved through locating of factories where the necessary natural resources can be plentifully obtained and where costs of labor are low. The degree to which real estate costs affect this calculation seems to be minimal, in part because low cost of labor tends to correlate with low cost of real estate. Delivery of natural resources to the factory and a means of moving finished goods to port are the required infrastructure developments and these are also expressed in the production cost. Low shipping and transport costs (primarily the low cost of shipping on large tanker ships) make the possible market for goods global in scope, making distance to consumer largely irrelevant in all cases except for goods that are perishable. Therefore, manufacturing for non-perishable goods will tend to be concentrated where costs of production are lowest.

Regions that offer ideal locations are invariably those that have both persistent poverty and a well organized government capable of and interested in providing the necessary infrastructure to the factory. The goods produced will be sold on a global scale, directly to nations which are not ideal locations for new factories.

All factories eventually become depreciated to the point of needing to be shut down. Therefore, new economic growth is not a prerequisite for the relocation of these factories to more optimal regions. Rather, over time, industry in general will naturally move into those regions.

Firms in these factories' host countries will have revenue in the goods importing country's currency, but pay their workers in the local currency. Therefore, they must exchange most of the imported currency for local currency. With a floating exchange rate, this is merely the sale of that currency on the market. The imported currency's value is equal to that of the goods it can purchase - that is the value of manufactured goods offered by the goods-importing country.

If a simple system of comparative advantage emerged from this relationship, two effects would result. First, the goods-importing country would experience relatively fewer working hours and relatively lower prices for goods when compared to wages (higher standard of living) than the exporting country. Secondly, over time the exporting country's higher level of savings and lower unemployment would reduce poverty to the point that wages would be bid up, while the importing country's lower (or negative) level of savings and higher unemployment would cause wages to be bid down, effectively leading to a trend toward equilibrium (or, more likely, an equilibrium-centered oscillation) and a progressive reduction in the level of wage differences between the two countries.

This simple system of comparative advantage is complicated by three factors. New technology that is developed will tend to dramatically slow the trend toward equilibrium. Shifting balances of trade with other countries will create chaotic effects that contribute a high degree of uncertainty to the analysis of eventual effect. Finally, changes in output levels will alter the purchasing power of consumers in both countries and lead to a non-unique equilibrium.

New technologies that are available tend to originate through the research of wealthy countries that have the resources to spend on comprehensive education systems and research funding. These technologies become a market good that is exported from the goods-importing countries and slow the rate of convergence toward the equilibrium described above. This effect has the following characteristics: first, firms must save up or receive loans in order to make the costly technology purchases and implement them. This leads to a financial market that mediates (with occasional speculation bubbles) the collection of currency in the goods-importing country's denomination. Firms are unlikely to take loans in their local currency and attempt to then save up imported currency because this time consuming process has a large opportunity cost and may involve costly interest payments as well.

These new technologies will bring about three types of improvement for the firm that implements them: 1. Labor usage reduction; 2. Natural resource usage reduction; 3. Greater market share. For this reason, new technologies can accelerate the rate at which markets become monopolized, and can actually lead to lower levels of employment within markets.

Additionally, this process will affect both economies in different ways at the macro level. For the goods-importing country, the tech industry will sustain higher levels of employment. This will sustain higher goods importation rates for longer. For the goods-exporting country, the higher rates of market monopolization and lower employment levels that technologies bring will actually slow the rate of poverty reduction. Thus, the trend toward equilibrium is slowed by technology. Both of these factors, however, will eventually dissipate unless new technologies are introduced at a constant rate, or if a technology development industry develops in the exporter country. Because new technologies are actually developed erratically, markets will tend to spurt toward equilibrium, then stall, then spurt again, rather than moving smoothly. This can lead to oscillatory effects that prevent the existence of steady states.

The comparative advantage equilibrium is further complicated by the effects of the comparative advantage of other countries. If natural resource costs increase, or if exports to another sector increase or decrease, the labor and natural resource markets will transmit these effects throughout the market, affecting the balance of trade between all trading partners. The demonstration of oscillatory effects in complex equilibrium systems is a topic of high mathematical sophistication, but oscillating reactions have been discovered in chemistry, a discipline in which the units are approximately 21 orders of magnitude finer and therefore statistically better behaved than an economy.

Finally, the simple model is inaccurate in part because drops in exports, caused either by a loss of relative currency value of the importing nation or a drop in incomes due to higher unemployment, typically leads to an increase in unemployment or decreases in wages in the exporting country. This effect implies that increases in measured comparative advantage can lead directly to a diminished economic outcome.

Taking these things into consideration, where does our current economic position fit into this model? Likely, the United States and most of Europe have survived the past decade only by taking a technology provider role. As China and India and other major exporters develop science and technology programs of their own, what we have to offer in exchange for the constant stream of cheap goods becomes increasingly limited. The uses for US dollars correspondingly diminishes. Most likely for geopolitical reasons, the Chinese government has artificially stimulated demand for US dollars by buying US treasury debts. This has lessened the loss to Chinese manufacturing to some degree. Similar activity by other exporter countries all over the world, concerned with preventing collapse of their industries, has propped up the exchange values of importer country currencies. This has, in turn, prevented oil prices from going up. Ultimately, though, these measures will reach their limit. This is not unlike the catastrophic collapse of the globalized markets in the first great depression, but in our case, the supply of oil is not as plentiful nor can it be readily expanded, making the situation dire.

The root cause of this problem is really the false steady state model that seems to dominate economic thought. This model typically takes aggregates as stable objects and firms as permanent fixtures. In reality, firms are not permanent fixtures. Rather, they have a finite but indeterminate lifespan. Employment results from specific tasks that are undertaken by the firm during its lifespan. The natural trend in economies is toward wealth concentrations and high productivity. This inevitably leads to low employment and low quality of life. This is where the "equilibrium" rests. In truth, there is no guarantee that a job will last for the 30 years that our tradition defines as a career. Nor is there a guarantee that a person will be able to live off of the wage they are paid. Nor is there a guarantee that housing will exist for each citizen. And amid all of these human concerns, the environment will be exploited to the point of complete destruction, permanently reducing the possible quality of life for all future generations, over and over again.

In order to lift the masses out of squalor, a government must be able to occupy a strong negotiating position. The guarantee of high employment is not really possible unless productivity is artificially reduced, a deliberate endorsement of waste. However, high quality of life is possible through rigorous efforts at wealth redistribution and rules limiting working hours (such as shorter work weeks). But regardless of the solution proposed, the actual production of goods cannot occur outside of the jurisdiction of the government, so that reasonable regulations can be imposed. For this reason, and this reason alone, foreign trade ought be severely confined. But if a thinking person looks in detail at its actual effect, it is also clear that it is undesirable for other reasons.

Thursday, February 11, 2010

The Infatuation with Elegance

Economics, as an institution, is one that has tended to have an infatuation with elegance, a notion that simple solutions will emerge from the proper approach, and that the layman's instinct to roll up his sleeves and fixate on minutae is a sign of simplemindedness. This tendency is most pronounced in the political gestures made by the prestigious minds at the forefront of the modern day's many schools of economic thought. They propose that an economy can be improved by some radical change to monetary policy, by a restructuring of the tax system, or by general policies of laissez-faire. Ironically, it takes but the smallest bit of critical thought to dispel this illusion, and to reveal the incredible complexity necessary in even the most rudimentary of public policies. It is not that these minds have an inability or unwillingness to think critically; rather, their very academic careers depend upon their continued championing of the school of thought to which their thesis represents an oath of allegiance.

Wealth is taken often to mean the total monetary value of an individual's assets. If this is the case, then the distribution of wealth alone can hardly be taken as an indicator of the general quality of life. Let us use a simple example, that of the production of bread, from overwintered wheat grains ready to be sown in the spring, to the point of consumption at the table. It is clear that one must look at details: what portion is the cost of a loaf of bread of a laborer's daily wage, and is this state of affairs inclined, without further intervention, to improve or to become more severe, threatening the laborer with starvation? Here again, it is not enough to simply look at the possible, to assess the amount of labor spent in baking the loaf - though a certain level of productivity is necessary for a given quality of life it is not a sufficient condition. Productivity gains can in theory be distributed in any way the firm owner wants between price reductions, cuts in number of labor hours, and expansions of the production level. If any part of the supply chain cannot expand to meet increased demand for its factor goods, prices will not tend to fall and output will not tend to increase, thus unemployment becomes inevitable. In some situations, prices may also rise.

It is also not the case that the combination of different industries, each with a certain level of complexity, is confined by a law of interrelation that limits the total effect to some predictable bounds. Though it is true that as new industries are added, complimentary pairing can arise that compensate for some supply issues, a survey of major economies today reveals a few "bottleneck" resources that can each prevent a smooth expansion of supply levels in every industry. Few industries can go without gasoline in the distribution of goods. Nor can industries go without at least one of electricity, water, fertile land, available real estate, healthy ecosystems, or a general public willing to be fleeced.

One must ask, what about technological advancement? But here, the general trend of history indicates that technology is correlated with increases in resource consumption rather than reductions. In any event, a fundamentally unpredictable thing such as technology cannot make the supply of essential goods more predictable. If, in theory, the economy can become predominantly information oriented, and a permanent, abundant supply of electricity can be secured, the massive production and replacement of electronic gadgets would remain a source of both uncertainty and toxic waste.

We can now turn to the specific limits of monetary measures in the prediction of economic conditions. The welfare of person A is wholly uncorrelated with the wealth of person B, so long as person A and person B consume the same goods and negotiate for the same prices on these goods. In fact, if person B has a great deal of wealth, he may even get a better deal on some goods than person A, simply because his wealth will open doors for him. Inevitably, though, person B will not consume the same goods that person A does, nor will he negotiate for the same prices.

If one charts the flow of money within an economy, one will find that it is constantly flowing from individuals to businesses, then from businesses to banks, and from banks back into businesses, who return a portion of it to individuals in their wages. Assume that times are prosperous and every sector is flourishing. Here, a few inequalities generally apply. Businesses must collect more from individuals (revenue) than they give out in wages and loan payments (we may leave out business to business transactions such as costs of services and utilities, as we are looking at businesses in aggregate; furthermore wages includes dividend payouts). Similarly, banks must collect more in loan payments than they give out in new loans and wages. Investors must collect more in dividends than they pay in loan payments. Finally, individual incomes (wages) must exceed loan payments and payments to businesses if individuals are to become more wealthy.

This is described symbolically as follows

I.Business > W.Business + L.Businesses
I.Banks > N.Loans + W.Banks
W.Business + W.Banks > I.Business + L.Individuals

Additionally, Loan payments by businesses plus loan payments by individuals is the sum of bank income. Thus,

I.Banks = L.Businesses + L.Individuals

But can this linear system be satisfied with positive values? Let us check:

Start by subbing out I.Banks:

I.Business > W.Business + L.Businesses
L.Businesses + L.Individuals > N.Loans + W.Banks

=> I.Business - W.Business > L.Business
L.Business > N.Loans + W.Banks - L.Individuals
=> I.Business - W.Business > N.Loans + W.Banks - L.Individuals (1)

W.Business + W.Banks > I.Business + L.Individuals
is equivalent to:
W.Banks - L.Individual > I.Business - W.Business (2)

(1) composed with (2) gives:
=> W.Banks - L.Individual > N.Loans + W.Banks - L.Individual

Which is equivalent to:
0 > N. Loans

Thus, the system cannot be all positive. In particular, new loan issues must be negative! In the real world, businesses and individuals actually accept new loans to offset various costs, meaning that many operate at a loss, hedging on better times ahead. However, these inequalities indicate that some sector is always going to lose out.

Indeed, these inequalities indicate that loans are being paid back in times of prosperity, such that eventually the banking system withers away and ceases to exist. Perhaps the banking system is a structural object, never intended to occupy a central place in economic life, but present only due to the persistent imperfections in the market. It is likely, then, that prosperity can be better insured through a policy of tight regulation of banking, and perhaps its confinement to single state charters or being an entirely government run enterprise.

Returning to the nice consumer pair A and B, what types of goods is the person B inclined to purchase? B will purchase the following:
  • Similar basic necessities to A
  • Real estate - B will bid up real estate that A is considering purchasing and lead to higher rental rates if A is renting
  • Land for its natural resources (This will benefit A if it expands economic growth, harm A if it causes environmental damage or the reverse if purchased for sake of squatting or conservation).
  • Luxury goods that do not appreciably increase B's quality of life but may compete for scarce resources and/or get A a better job.
  • Political favors, generally to give B an unfair advantage in the market place
  • Charitable donations
  • Investments in existing businesses (various effects, from good things like reduction of banking to bad things like monopolization)
  • New starting businesses
This last point, though, warrants some expansion. If a society has a coherent standard of civic virtue, B may develop his business for the sake of having a business. If he has ties to his community he may be content to run without a profit or with little profit (honest competition) simply because he will be cognizant of the benefits he is giving to the community. However, if the structure of industries is generally too concentrated (e.g. in megacorporations, box stores, etc.), B may not have any such opportunities. Furthermore, the society may be organized in such a way that genuine communities may be impossible (e.g. sprawling suburbs with no coherent design) or his culture may spend disproportionate amounts of time engaged in antisocial behavior (e.g. watching television or blogging).

Of course, having large amounts of money is different than having a high income. Assume the money supply in an economy expands in the following fashion: the dollars are distributed in an equal fraction to each member of the economy. Then any person who makes X more than the average income must have a total of Q individuals who make Y less than the average, such that X = Y*Q. In fact, net income within the economy (changes in dollar wealth) is equal only to the total amount of new money added to the money supply. Thus, unless prices drop as income becomes concentrated, the quality of life of those at the bottom tends to fall.

So on and so on, myriad details form a web of economic exchanges that has many dimensions and caveats. The interdisciplinary nature of proper analysis in this field ensures that those who focus primarily on mathematical models will not grasp the nuances necessary to make accurate predictions.