In The Affluent Society, Galbraith asks whether it is the products of most laborer's work or the wages paid to them that have a greater positive social impact. By a strict Pareto analysis where market value is the only measure of worth, it must be the case that the product of the labor is more valuable. Rather than solving the problem, such a result is more of an example of absurdity, casting doubt on the Pareto Optimality concept.
The question can actually be broadened, as it has been by contemporary economists. Professor Randall Wray of UMKC looks at a variety of factors that workers gain from working rather than sitting idle, and argues that the social costs of unemployment are actually grossly underrated. Rather than utilize his analysis, which is not holistic enough for my tastes, I want to develop my own system for estimating the value of employment for the laborer.
Borrowing again and elaborating on arguments developed in The Affluent Society, Generally speaking, a worker will labor for some combination of the following reasons:
1. Pecuniary Compensation (wage, salary, bonuses)
2. Ideology (feelings of the righteousness, charity or necessity of his actions)
3. Fear (punishment awaits those that do not work)
4. Personal Education (Development of skills or specialized knowledge)
5. Conveyance of Status (The worker gains some status that is valuable, such as being considered "experienced" or being considered a brave or good person)
6. Leisure (The task is the preferred alternative to boredom)
Without this broad set of motivating factors, it becomes impossible to understand why some activities become ones that individuals pay for and others become ones that individuals desire to be paid for. These may be negative or positive.
An economy is actually a dynamical system, and so there are two more general considerations. First, that the relative value of each of these factors to an individual will be evaluated by that individual on the basis of net gains/losses from the individual's current position. Secondly, that a set of filters exist which limit the potential applicant pool for any given position. Once again, speaking generally, they are as follows:
1. Status (holding specific titles or claims to experience)
2. Education (having certain skills or knowledge)
3. Geographic proximity (worker and firm must be within a certain radius)
4. Cultural Conformity (being part of a sufficiently similar cultural group, in particular having a common language)
5. Search success (the firm or worker must search each other out and will not always find all matches)
6. Miscellaneous Hiring Filters (personality tests, interview "impressions", arbitrary limits to considered applicants, etc.)
These are not numerical values. They are subsets. The space that is the intersection of all of these constraints contains all the potential qualified applicants. Ideally, firms will then evaluate potential applicants within this space, and perform a cost-benefit analysis, ultimately hiring individuals who promise the greatest positive impact on the firm given their requested wage. But, to capture a real approximation of firm behavior in this respect requires an understanding of the internal politics of firms and empirical data for theories of internal politics to analyze.
The existence of so many constraints on worker pools harms the ability of firms and workers to to find matches that would work well for them. It is appalling, for instance, that so many individuals would happily work as CEOs or Doctors but are effectively prohibited from pursuing such careers. This has led, in once case, to vastly overinflated wages, and in the other case, to shortage.
Regardless of the cause, it is clear that the empirical state of the economy is far from ideal. Not only are many individuals who seek labor not finding it, but many tasks which would be highly enjoyable to a large sector of the population, such as philanthropic work, is not available to individuals. Finally, many people work extremely hard only to make enough for bare survival. Given our natural resource position, this can be due only to gluts in worker pools. Nobody should work only out of fear of poverty, homelessness, or starvation.
Monday, March 15, 2010
Thursday, March 11, 2010
Pigouvian taxes and subsidies
There is a theory in economics that an effective way to reduce the incidence of a bad behavior is to place a tax on it. The reasoning goes that this tax increases the cost of the behavior, thus by the law of supply and demand, the quantity demanded decreases. The use of taxes for the purpose of balancing out externality costs is referred to as a Pigouvian tax.
The implementation of these strategies in the real world tests both the entire regulatory framework and the economic theories. This naturally complicates things - are failures the result of the theory being wrong or merely due to flaws in implementation? Many public policies that seem to have great promise may actually be nothing more than the fiscal equivalent of building a levee on this mile of the river: flooding is prevented here but made worse downstream.
I have been approached on multiple occasions by bicycle advocates who have suggested that better bike policies and funding for bicycles can best be brought about through a campaign against car usage. The reasoning goes that by not funding more roads and by increasing taxes on gasoline, the "cost" of driving increases. By the Pigouvian reasoning, this will lead - nay, force - people to pursue alternative transportation options.
There is certainly some marginal effect, but it will not follow a uniform curve. This marginal effect will be a function of the attractiveness of alternatives, and these alternatives can be quite varied. The temptation is to be lazy, and to assume that some intersection of continuous curves defines the demand functions, meaning that each incremental cost increase of driving would have a similar, incremental decrease in driving. This, of course, is not the whole story, because the reality of the situation depends on the discrete decisions that are made. A small increase may not be enough to actually push a different transportation option into the top spot - people are actually quite uniform in their transportation situations and the biking/public transit system tends to have a more or less uniform cost. Furthermore, an additional "hump" that represents the force of habit may block people from changing habits for savings that are insignificant.
Therefore, there is a threshold below which only an insignificant portion of drivers would bother changing their plans. Above this threshold, a large number of drivers would seek to change their plans. And so, the question now arises, "What is the value of incremental driving disincentives both below and above the key threshold?"
Below the threshold, taxes on gasoline and congestion promoting policies amount to little more than regressive taxes. That is to say, the cost is passed through the drivers. Rather than changing their driving habits, it merely leads them to have less wealth available to purchase other goods in the economy. Owing to the dependence of many goods on gasoline transport, these taxes may also be expressed in the cost of goods.
The story is essentially the same above the threshold as well: those who are still driving with high taxes on driving are unlikely to change their behavior simply because driving starts to have a slightly higher cost.
The real effect occurs at the threshold, where the variable is actually sensitive. This is the only area where a case can actually be made that the pigouvian incentive concept is a good idea, because here the tax actually does bring about a reduction in the unwanted behavior. Here, the supply of the chosen alternative goods must be sufficiently flexible to absorb the relatively rapid change in habits that the cost increases bring about. But are public transit and bike networks actually capable of making these sudden changes? Not really. Here again, even at the threshold, the consumers will find they are unable to switch because the existing bike infrastructure is insufficient and the existing mass transit system is already operating at capacity.
A similar argument can be made for subsidies of public transit and bicycle infrastructure: they will be underutilized and fail cost/benefit tests without a complimentary policy of increasing the cost associated with existing behavior.
So, it is sensible to propose a steep tax, and to cut back severely on existing vehicle infrastructure, such that the effect is sufficient to bring incentives across the threshold, only if a comprehensive expansion of public transit and bicycle infrastructure is also implemented in parity.
In reality, the issue of cost pass-through is present in every tax and subsidy scheme. It can have a variety of unintended consequences. Generally, cost driven changes in consumer behavior come in the form of regressive policies. Care should be taken by well intentioned reformers to take the two steps outlined here: first, to find any thresholds in the discrete consumption bundles of actual goods; and second, to find and assess the role of potential bottlenecks in the desired new behavior pattern.
Additionally, there are two more potential problems in the basic implementation of such systems.
First, the shift in behaviors as a result of increasing costs may be unpredictable. Could increases in driving cost drive a portion of people to simply never leave their houses, instead becoming Television and Internet addicts? Could toxic waste disposal fees, instead of leading to reductions in toxic manufacturing processes, lead to the marketing of building material mixtures that contain these toxins (so that they do not need to be disposed)? The regulatory framework, as well as the nature of the goods in question, are the determinants of such results. Thus, taxes may need to be imposed on a large number of goods, and subsidies or other supply expansions may need to be effected on a similar scale.
Secondly, the political cost may be great. A politician in anything but a safe district would have to be incompetent to back a gasoline tax. Even safe politicians may want to vote against a gas tax simply to preserve the stream of automobile lobby dollars. At some point, advocates for social and environmental justice will need to assess the political realities. Though it is a difficult task, compromise will be necessary in all environmental agendas. For real political change, a great deal of consensus, log rolling, and popular awareness are essential.
In conclusion, there are four prerequisites for the use of a pigouvian tax/subsidy scheme:
1. Discrete understanding of the supply/demand for the goods to be taxed and subsidized in terms of the consumption bundles of the consumer demographics.
2. Ability of policies to simultaneously cross both the demand threshold for the good that is to be suppressed and any necessary subsidy to supply of the substitute good.
3. Adequate regulatory structure to ensure that new consumer behavior will actually be as planned. This may require a comprehensive set of many taxes and many subsidies across a large number of goods.
4. A strong political position for the elected officials responsible for the policies that bring about 1-3, as well as an electorate that is highly sympathetic with the cause that such policies represent.
The implementation of these strategies in the real world tests both the entire regulatory framework and the economic theories. This naturally complicates things - are failures the result of the theory being wrong or merely due to flaws in implementation? Many public policies that seem to have great promise may actually be nothing more than the fiscal equivalent of building a levee on this mile of the river: flooding is prevented here but made worse downstream.
I have been approached on multiple occasions by bicycle advocates who have suggested that better bike policies and funding for bicycles can best be brought about through a campaign against car usage. The reasoning goes that by not funding more roads and by increasing taxes on gasoline, the "cost" of driving increases. By the Pigouvian reasoning, this will lead - nay, force - people to pursue alternative transportation options.
There is certainly some marginal effect, but it will not follow a uniform curve. This marginal effect will be a function of the attractiveness of alternatives, and these alternatives can be quite varied. The temptation is to be lazy, and to assume that some intersection of continuous curves defines the demand functions, meaning that each incremental cost increase of driving would have a similar, incremental decrease in driving. This, of course, is not the whole story, because the reality of the situation depends on the discrete decisions that are made. A small increase may not be enough to actually push a different transportation option into the top spot - people are actually quite uniform in their transportation situations and the biking/public transit system tends to have a more or less uniform cost. Furthermore, an additional "hump" that represents the force of habit may block people from changing habits for savings that are insignificant.
Therefore, there is a threshold below which only an insignificant portion of drivers would bother changing their plans. Above this threshold, a large number of drivers would seek to change their plans. And so, the question now arises, "What is the value of incremental driving disincentives both below and above the key threshold?"
Below the threshold, taxes on gasoline and congestion promoting policies amount to little more than regressive taxes. That is to say, the cost is passed through the drivers. Rather than changing their driving habits, it merely leads them to have less wealth available to purchase other goods in the economy. Owing to the dependence of many goods on gasoline transport, these taxes may also be expressed in the cost of goods.
The story is essentially the same above the threshold as well: those who are still driving with high taxes on driving are unlikely to change their behavior simply because driving starts to have a slightly higher cost.
The real effect occurs at the threshold, where the variable is actually sensitive. This is the only area where a case can actually be made that the pigouvian incentive concept is a good idea, because here the tax actually does bring about a reduction in the unwanted behavior. Here, the supply of the chosen alternative goods must be sufficiently flexible to absorb the relatively rapid change in habits that the cost increases bring about. But are public transit and bike networks actually capable of making these sudden changes? Not really. Here again, even at the threshold, the consumers will find they are unable to switch because the existing bike infrastructure is insufficient and the existing mass transit system is already operating at capacity.
A similar argument can be made for subsidies of public transit and bicycle infrastructure: they will be underutilized and fail cost/benefit tests without a complimentary policy of increasing the cost associated with existing behavior.
So, it is sensible to propose a steep tax, and to cut back severely on existing vehicle infrastructure, such that the effect is sufficient to bring incentives across the threshold, only if a comprehensive expansion of public transit and bicycle infrastructure is also implemented in parity.
In reality, the issue of cost pass-through is present in every tax and subsidy scheme. It can have a variety of unintended consequences. Generally, cost driven changes in consumer behavior come in the form of regressive policies. Care should be taken by well intentioned reformers to take the two steps outlined here: first, to find any thresholds in the discrete consumption bundles of actual goods; and second, to find and assess the role of potential bottlenecks in the desired new behavior pattern.
Additionally, there are two more potential problems in the basic implementation of such systems.
First, the shift in behaviors as a result of increasing costs may be unpredictable. Could increases in driving cost drive a portion of people to simply never leave their houses, instead becoming Television and Internet addicts? Could toxic waste disposal fees, instead of leading to reductions in toxic manufacturing processes, lead to the marketing of building material mixtures that contain these toxins (so that they do not need to be disposed)? The regulatory framework, as well as the nature of the goods in question, are the determinants of such results. Thus, taxes may need to be imposed on a large number of goods, and subsidies or other supply expansions may need to be effected on a similar scale.
Secondly, the political cost may be great. A politician in anything but a safe district would have to be incompetent to back a gasoline tax. Even safe politicians may want to vote against a gas tax simply to preserve the stream of automobile lobby dollars. At some point, advocates for social and environmental justice will need to assess the political realities. Though it is a difficult task, compromise will be necessary in all environmental agendas. For real political change, a great deal of consensus, log rolling, and popular awareness are essential.
In conclusion, there are four prerequisites for the use of a pigouvian tax/subsidy scheme:
1. Discrete understanding of the supply/demand for the goods to be taxed and subsidized in terms of the consumption bundles of the consumer demographics.
2. Ability of policies to simultaneously cross both the demand threshold for the good that is to be suppressed and any necessary subsidy to supply of the substitute good.
3. Adequate regulatory structure to ensure that new consumer behavior will actually be as planned. This may require a comprehensive set of many taxes and many subsidies across a large number of goods.
4. A strong political position for the elected officials responsible for the policies that bring about 1-3, as well as an electorate that is highly sympathetic with the cause that such policies represent.
Wednesday, February 24, 2010
Duties
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.
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.
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)
Furthermore:
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:
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.
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)
Furthermore:
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
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.
Saturday, January 30, 2010
Value theories
Historically, currency had its value pegged to the value of the collateral that backed the currency. Thus, a paper bill was typically representative of some quantity of specie (precious metals or coins made of precious metal) held in a bank. Much of early economic theory was dedicated to the justification and promotion of this fact. Thus, the idea arose that the value of a unit of currency was based on what it represented - be it a share of a valuable object, a quantity of labor, etc. Thus, the argument goes, an expansion in currency available leads inevitably to a decrease in its value, as more units of currency exist for each unit of the backing object.
This classical line of reasoning has been hard to shake despite the fact that it was never justified in a scientific way. Observations that people think of currency in this way is evidence only of a body of beliefs, not a revelation of universal law. Moreover, currency and the specie that backs it are both currencies of sort. Many thinkers make the (rather sad) error of believing that a block of precious metal has value in and of itself. Precious metals are not used for anything other than as wealth holding assets, and it has always been the common belief in their value - arbitrarily decided by historical events - and nothing more, that creates the value itself.
The false theory of currency value as proportion of backing object value results from two big mistakes in the classical line of reasoning relating to currency value.
1. The classical line of reasoning ignores the possibility of underutilized resources.
2. The classical line of reasoning ignores the fundamental role that uncertainty plays in currency value.
Both of these points are made by Keynes in his General Theory, but I would like to expand on them here in my own direction. Incidentally, both of these are tied to a fundamental problem in economics: the failure of equilibrium models to rigorously represent equilibria as related rates.
First, the case of underutilized resources can be directly highlighted by a few examples:
Suppose that a king wishes to expand his treasury, and devises a brilliant strategy for quickly growing his gold-mining industry. He prints new bills of currency, backed by no matching specie, and enters into contracts with mining firms whereby they will provide him with a portion of the specie that they find, such that it directly matches the quantity needed to back the currency issued. Assuming that the results of the venture meet the king's expected value and that there is a high unemployment rate, how will this affect the value of the currency?
Looking first at time of initial issuance - one can expect demand to rise for machinery and chemicals used in the mining process. This change will then ripple into the spending habits of the producers of these components. The increased revenue of these "component firms" will, due to the assumption of surplus labor, primarily become increased plant capacity and profits for the firm owners. These owners will bid up investments of various types (including real estate), and may spend marginally more on luxury goods.
Having a larger paid labor pool will also have an effect - laborers may increase their food consumption, primarily by demanding greater food variety, but for the most part, increased income will be spent on goods and services. Landlords will see lower vacancy rates as laborers cohabitate less, prompting an increase in rental rates.
Generally, an increase in prices across the board represents a decrease in the value of the currency. However, in the case of currency issue, these increases are the response of suppliers to the increase in quantity demand. In many cases, the supply of a good is sufficiently elastic that only the quantity produced increases. In only a few situations is there a bottleneck such that the supply of a given good cannot increase easily, and it is in this case that a price increase will occur.
To calculate the initial stimulus effect of such an action by a Government, an economist should ask two things: 1)Are the natural resources that will see increased demand readily available for use? 2)Is the economy significantly below full employment? If the answer to both of these questions is "yes", then the vast majority of the quantity demand increase will be expressed in terms of increased output. If the answer to either question is "no", the vast majority of quantity demand increase will be expressed in terms of increased prices.
Next, let us turn to the point when the mining firms begin to transfer precious metals back into the King's treasury. It is hard to see how this could have any effect whatsoever. Other than the labor utilized for the actual movement, inspection, storage, and safeguarding of the specie, no actual changes take place. The King now simply has more of a valuable asset, which is kept out of circulation, and which he will be able to use to meet future obligations if necessary.
Theories that predominated during the time when currency was directly backed by assets most likely had a profound effect on the decisions of the speculative class. When exchange rates were fixed, speculation often surrounded the values of currencies. In any speculative atmosphere, the ideas and decisions of the herd were the primary determinant of changes in prices paid by speculators. Therefore, so long as a sufficient portion of speculators believed in a given economic rule, the market would behave in a way that allowed economists to draw statistical evidence for that rule from the market. The egoes of the wealthy had a further impact on the development of the discipline, in that they believed their own wealth stemmed not from the collective effect of an otherwise arbitrary belief, but from actual knowledge. It is the wealthy that control University endowments, and they want the world to know that they are people of virtue.
Uncertainty also plays a key role in currency value. I invite the reader to imagine an economy in which individuals do not have uncertainty. Note that risk should be treated as a type of uncertainty. The cognition of an individual who does not have uncertainty is really omniscience. Such a person does not respond in a nash equilibrium fashion because he is able to coordinate with others effortlessly. Furthermore, the psychological predisposition of the individual toward equality would be an overriding factor in his economic relationships. Specialized knowledge disappears, and thus workers are no longer differentiable from each other. The only (economically significant) differences between individuals in such a scheme is their preferences and their property.
This thought experiment highlights another aspect of economic life that is seldom mentioned: its ethical connotation as revealed by our impressions. I invite the reader to contemplate the following examples:
Considering our ethical impluses and our way of evaluating our own economic position, a society of omnipotent individuals will have a certain political equilibrium. Currency will not be necessary because the actions of each individual will be known to all. Each person will understand the full configuration space of individual action combinations and their consequences. Labor would be divided between individuals only on the basis of their preferences. Nobody would want to see the basic needs of others go unmet, and will balance this desire against selfish interests. Labor could not be divided between workers and management because management is completely unnecessary - the only possibility is the existence of a capitalist class who own the means of production, but even this is unlikely given that these capitalists would face perfectly coordinated resistance by the rest of the society and collective bargaining by their workers.
Individuals also have foreknowledge of all their future consumption needs. Therefore, individuals would be able to enter into contracts with each other for the direct exchange of goods between current and future dates. For example, I may work in a machine shop for an hour, with the understanding that this earns me a loaf of bread from the baker. The baker would understand how this settles some contract he is involved in, or establishes a future compensation for him.
Currency is really an effort at approximation of this system of contracts. Approximation is necessary because of the incompleteness of individual knowledge. This incompleteness is synonymous with uncertainty. Uncertainty has three principal effects:
1) The use of risks and estimates
2) Creation of search costs that establish a value for information.
3) Existence of liquidity
Returning now to an example of a theoretical "normal human" economy, if the total quantity of currency in circulation is X, during any given time period somewhat less than every unit in X (X-a) will change hands at least once. Of the exchanges that take place, some will be at a price that has not been actively reevaluated. When reevaluations do take place, the price-setter must generally plan for a price that will not need to be raised (or lowered) again for some time, meaning the change will be in greater proportion than what is initially required, and often will occur later than expected. In other words, price changes and rebalances do not freely propagate across economies, but actually move at a certain estimable rate. Furthermore, price changes may not be made at all if the cost threshold for change and accompanying discounting rate of the costs are not met. Therefore, even if the economy is at capacity when the currency supply is changed, the question is not merely by how much but for whom the change is taking place.
A tax can be seen as a transfer of currency from one group to another. It is paired with government services that are funded by the tax, and these services are, in turn, expressible as monetary savings for the individuals who benefit from these services. Often, the Government can provide services more optimally than the private sector. We may, in accordance with our ethical prerogatives, denote certain services as providing a greater contribution to quality of life than others. So long as tax policy shifts the balance of goods and services provided toward those that provide a greater benefit to quality of life, it is justified.
Returning to the concept of the money supply in contrast to the effective money supply, suppose that the money supply is expanded or contracted in some fashion. The economic effect of this change is wholly dependent on who receives the currency. Let us rank the individuals within a society based on (1) their propensity to spend an additional dollar received and (2) their propensity to take each dollar reduction in income from spending rather than savings. These two variables are bound to have some degree of covariance, but that is beside the point. Imagine a scale going from zero (will not spend) to one (will spend) for these measures. Then each individual will occupy a point on this scale. Savings are only reintegrated into the economy as loans. Thus, private debt is a function of the total level of savings. Payments on debt lead to income concentrations in the hands of debt holders. Thus, either price levels must fall, income levels must increase, or debt levels must increase for individuals to maintain their consumption levels over time. When left alone, the trend seems to be toward a glut of savings in the hands of the ultra rich, a lack of viable investments, and a inevitable drop in the price and employment level.
An injection of additional currency targeted to the least likely to consume will lead only to an increase in loan issuance. If the loans market is saturated, it will lead to a direct increase in savings and no overall change in the economy (X and a increase in parity).
An injection of additional currency targeted to the most likely to consume will lead to an increase in consumption levels. This will mean that the effective quantity of money has directly increased. Prices may rise, but they will not rise in a greater portion than income, as this additional currency is first expressed through income. However, the added currency will eventually reach the hands of those least likely to consume and it will "fall out" of the market in this fashion (X increases but a stays constant).
A tax placed on those least likely to consume will lead to a decrease in loan issuance, or to no change if the loans market is saturated. The direct decrease in savings will precipitate no change to the actual economy because the effective supply of money has not been changed (X and a decrease in parity)
A tax placed on those most likely to consume will lead to a direct contraction in the economy. It will precipitate a reduction in the effective money supply and would be very harmful to the economy (X decreases but a stays constant).
For the reasons just outlined, the policy of the US government of backing its deficit spending with bond issues is silly (actually I think of it as grand theft of taxpayer dollars). The government can simply issue additional quantities of currency and should not be concerned with balancing its books. Rather, it should pay attention to the macroeconomic effect of its actions and work to bring unemployment down.
This classical line of reasoning has been hard to shake despite the fact that it was never justified in a scientific way. Observations that people think of currency in this way is evidence only of a body of beliefs, not a revelation of universal law. Moreover, currency and the specie that backs it are both currencies of sort. Many thinkers make the (rather sad) error of believing that a block of precious metal has value in and of itself. Precious metals are not used for anything other than as wealth holding assets, and it has always been the common belief in their value - arbitrarily decided by historical events - and nothing more, that creates the value itself.
The false theory of currency value as proportion of backing object value results from two big mistakes in the classical line of reasoning relating to currency value.
1. The classical line of reasoning ignores the possibility of underutilized resources.
2. The classical line of reasoning ignores the fundamental role that uncertainty plays in currency value.
Both of these points are made by Keynes in his General Theory, but I would like to expand on them here in my own direction. Incidentally, both of these are tied to a fundamental problem in economics: the failure of equilibrium models to rigorously represent equilibria as related rates.
First, the case of underutilized resources can be directly highlighted by a few examples:
Suppose that a king wishes to expand his treasury, and devises a brilliant strategy for quickly growing his gold-mining industry. He prints new bills of currency, backed by no matching specie, and enters into contracts with mining firms whereby they will provide him with a portion of the specie that they find, such that it directly matches the quantity needed to back the currency issued. Assuming that the results of the venture meet the king's expected value and that there is a high unemployment rate, how will this affect the value of the currency?
Looking first at time of initial issuance - one can expect demand to rise for machinery and chemicals used in the mining process. This change will then ripple into the spending habits of the producers of these components. The increased revenue of these "component firms" will, due to the assumption of surplus labor, primarily become increased plant capacity and profits for the firm owners. These owners will bid up investments of various types (including real estate), and may spend marginally more on luxury goods.
Having a larger paid labor pool will also have an effect - laborers may increase their food consumption, primarily by demanding greater food variety, but for the most part, increased income will be spent on goods and services. Landlords will see lower vacancy rates as laborers cohabitate less, prompting an increase in rental rates.
Generally, an increase in prices across the board represents a decrease in the value of the currency. However, in the case of currency issue, these increases are the response of suppliers to the increase in quantity demand. In many cases, the supply of a good is sufficiently elastic that only the quantity produced increases. In only a few situations is there a bottleneck such that the supply of a given good cannot increase easily, and it is in this case that a price increase will occur.
To calculate the initial stimulus effect of such an action by a Government, an economist should ask two things: 1)Are the natural resources that will see increased demand readily available for use? 2)Is the economy significantly below full employment? If the answer to both of these questions is "yes", then the vast majority of the quantity demand increase will be expressed in terms of increased output. If the answer to either question is "no", the vast majority of quantity demand increase will be expressed in terms of increased prices.
Next, let us turn to the point when the mining firms begin to transfer precious metals back into the King's treasury. It is hard to see how this could have any effect whatsoever. Other than the labor utilized for the actual movement, inspection, storage, and safeguarding of the specie, no actual changes take place. The King now simply has more of a valuable asset, which is kept out of circulation, and which he will be able to use to meet future obligations if necessary.
Theories that predominated during the time when currency was directly backed by assets most likely had a profound effect on the decisions of the speculative class. When exchange rates were fixed, speculation often surrounded the values of currencies. In any speculative atmosphere, the ideas and decisions of the herd were the primary determinant of changes in prices paid by speculators. Therefore, so long as a sufficient portion of speculators believed in a given economic rule, the market would behave in a way that allowed economists to draw statistical evidence for that rule from the market. The egoes of the wealthy had a further impact on the development of the discipline, in that they believed their own wealth stemmed not from the collective effect of an otherwise arbitrary belief, but from actual knowledge. It is the wealthy that control University endowments, and they want the world to know that they are people of virtue.
Uncertainty also plays a key role in currency value. I invite the reader to imagine an economy in which individuals do not have uncertainty. Note that risk should be treated as a type of uncertainty. The cognition of an individual who does not have uncertainty is really omniscience. Such a person does not respond in a nash equilibrium fashion because he is able to coordinate with others effortlessly. Furthermore, the psychological predisposition of the individual toward equality would be an overriding factor in his economic relationships. Specialized knowledge disappears, and thus workers are no longer differentiable from each other. The only (economically significant) differences between individuals in such a scheme is their preferences and their property.
This thought experiment highlights another aspect of economic life that is seldom mentioned: its ethical connotation as revealed by our impressions. I invite the reader to contemplate the following examples:
- A convicted murderer (about whose guilt there is no doubt) is released from prison due to a legal error by the prosecution. He purchases a lottery ticket and wins the jackpot, becoming a multimillionaire.
- A woman who works hard her entire life, saving a small amount of money from each paycheck, invests her money in a mutual fund that loses more than half of its value in the course of a year.
- A man witnesses a stranger help a blind person across a busy intersection and buys him a drink.
- A student who earns straight A's has her allowance increased.
- The city council passes a tax increase that affects only a single business owner.
- The city council passes a tax increase that includes an exemption that only a single business owner can take advantage of.
Considering our ethical impluses and our way of evaluating our own economic position, a society of omnipotent individuals will have a certain political equilibrium. Currency will not be necessary because the actions of each individual will be known to all. Each person will understand the full configuration space of individual action combinations and their consequences. Labor would be divided between individuals only on the basis of their preferences. Nobody would want to see the basic needs of others go unmet, and will balance this desire against selfish interests. Labor could not be divided between workers and management because management is completely unnecessary - the only possibility is the existence of a capitalist class who own the means of production, but even this is unlikely given that these capitalists would face perfectly coordinated resistance by the rest of the society and collective bargaining by their workers.
Individuals also have foreknowledge of all their future consumption needs. Therefore, individuals would be able to enter into contracts with each other for the direct exchange of goods between current and future dates. For example, I may work in a machine shop for an hour, with the understanding that this earns me a loaf of bread from the baker. The baker would understand how this settles some contract he is involved in, or establishes a future compensation for him.
Currency is really an effort at approximation of this system of contracts. Approximation is necessary because of the incompleteness of individual knowledge. This incompleteness is synonymous with uncertainty. Uncertainty has three principal effects:
1) The use of risks and estimates
2) Creation of search costs that establish a value for information.
3) Existence of liquidity
Returning now to an example of a theoretical "normal human" economy, if the total quantity of currency in circulation is X, during any given time period somewhat less than every unit in X (X-a) will change hands at least once. Of the exchanges that take place, some will be at a price that has not been actively reevaluated. When reevaluations do take place, the price-setter must generally plan for a price that will not need to be raised (or lowered) again for some time, meaning the change will be in greater proportion than what is initially required, and often will occur later than expected. In other words, price changes and rebalances do not freely propagate across economies, but actually move at a certain estimable rate. Furthermore, price changes may not be made at all if the cost threshold for change and accompanying discounting rate of the costs are not met. Therefore, even if the economy is at capacity when the currency supply is changed, the question is not merely by how much but for whom the change is taking place.
A tax can be seen as a transfer of currency from one group to another. It is paired with government services that are funded by the tax, and these services are, in turn, expressible as monetary savings for the individuals who benefit from these services. Often, the Government can provide services more optimally than the private sector. We may, in accordance with our ethical prerogatives, denote certain services as providing a greater contribution to quality of life than others. So long as tax policy shifts the balance of goods and services provided toward those that provide a greater benefit to quality of life, it is justified.
Returning to the concept of the money supply in contrast to the effective money supply, suppose that the money supply is expanded or contracted in some fashion. The economic effect of this change is wholly dependent on who receives the currency. Let us rank the individuals within a society based on (1) their propensity to spend an additional dollar received and (2) their propensity to take each dollar reduction in income from spending rather than savings. These two variables are bound to have some degree of covariance, but that is beside the point. Imagine a scale going from zero (will not spend) to one (will spend) for these measures. Then each individual will occupy a point on this scale. Savings are only reintegrated into the economy as loans. Thus, private debt is a function of the total level of savings. Payments on debt lead to income concentrations in the hands of debt holders. Thus, either price levels must fall, income levels must increase, or debt levels must increase for individuals to maintain their consumption levels over time. When left alone, the trend seems to be toward a glut of savings in the hands of the ultra rich, a lack of viable investments, and a inevitable drop in the price and employment level.
An injection of additional currency targeted to the least likely to consume will lead only to an increase in loan issuance. If the loans market is saturated, it will lead to a direct increase in savings and no overall change in the economy (X and a increase in parity).
An injection of additional currency targeted to the most likely to consume will lead to an increase in consumption levels. This will mean that the effective quantity of money has directly increased. Prices may rise, but they will not rise in a greater portion than income, as this additional currency is first expressed through income. However, the added currency will eventually reach the hands of those least likely to consume and it will "fall out" of the market in this fashion (X increases but a stays constant).
A tax placed on those least likely to consume will lead to a decrease in loan issuance, or to no change if the loans market is saturated. The direct decrease in savings will precipitate no change to the actual economy because the effective supply of money has not been changed (X and a decrease in parity)
A tax placed on those most likely to consume will lead to a direct contraction in the economy. It will precipitate a reduction in the effective money supply and would be very harmful to the economy (X decreases but a stays constant).
For the reasons just outlined, the policy of the US government of backing its deficit spending with bond issues is silly (actually I think of it as grand theft of taxpayer dollars). The government can simply issue additional quantities of currency and should not be concerned with balancing its books. Rather, it should pay attention to the macroeconomic effect of its actions and work to bring unemployment down.
Thursday, January 28, 2010
The Opinion game - variations on a voting game
In my own personal throwback to the 1970's, when these kind of things were all the rage, I have thought up a game, with a few variations, that I believe can be of use in the modeling of opinions formed by groups.
This game is played with one player. There is a stack of identically backed tiles, each having a color on the reverse side, one of m possible colors. In each round, a new tile is revealed, and the player must pick a color.
They are awarded points on the following basis:
+1 point if they pick a color that is shown on the greatest number of tiles revealed thus far
-4 points if they changed their color from last round (no penalty for this in the first round)
Naturally, the behavior of the player will depend on the distribution of tiles. If the tiles are chosen ahead of time from an equally distributed lot, they will behave differently than if each tile's color is an independent random event.
Because the analysis is easier when each tile is independent, I will focus on this case. If there are 2 possible colors - say red and blue - the minimum number of rounds that must pass before a rational player has an incentive to change his or her opinion is 8. This follows from the following argument and example (WOLOG):
Round 1:
Red tile revealed
Pick red
Round 2:
Blue tile revealed
Pick red (tied numbers; the "change cost" can be avoided)
Round 3:
Blue tile revealed
Pick red (at this point nine more rounds must be played for the expected value of changing to exceed 0)
Round 4:
Blue tile revealed
Pick blue (at this point, only 4 more rounds must be played for this choice to pay off)
Rounds 5 - 8:
regardless of tile revealed, player picks blue (see assertion 2)
Conclusions -
Studies of communication tend to emphasize the "deeply entrenched" nature of our opinions. This game confirms that if there is a social cost to changing an individual's opinion (such as alienation from your like-minded bretheren), a very large preponderance of evidence may be necessary to counterbalance this loss. Considering our number of choices in daily life, and the marginal benefits (if any) that abstract knowledge poses for the individual, it is no wonder that people tend to believe crazy things.
This game is played with one player. There is a stack of identically backed tiles, each having a color on the reverse side, one of m possible colors. In each round, a new tile is revealed, and the player must pick a color.
They are awarded points on the following basis:
+1 point if they pick a color that is shown on the greatest number of tiles revealed thus far
-4 points if they changed their color from last round (no penalty for this in the first round)
Naturally, the behavior of the player will depend on the distribution of tiles. If the tiles are chosen ahead of time from an equally distributed lot, they will behave differently than if each tile's color is an independent random event.
Because the analysis is easier when each tile is independent, I will focus on this case. If there are 2 possible colors - say red and blue - the minimum number of rounds that must pass before a rational player has an incentive to change his or her opinion is 8. This follows from the following argument and example (WOLOG):
- We may limit ourselves to the simple case where one red tile is revealed then all blue tiles after that.
- It never makes sense to change one's mind within four rounds of the last round
- If red is behind by p tiles, the total expected payout of changing is derivable from the binomial distribution as follows: let n be the number of rounds remaining; the payout is a function of the path traveled to the final distribution. There are 2^n paths; we care about the difference between this outcome and the continuation of the red choice, thus equality of red and blue tiles is worth 0. Each path decomposes into previously calculated paths.
Round 1:
Red tile revealed
Pick red
Round 2:
Blue tile revealed
Pick red (tied numbers; the "change cost" can be avoided)
Round 3:
Blue tile revealed
Pick red (at this point nine more rounds must be played for the expected value of changing to exceed 0)
Round 4:
Blue tile revealed
Pick blue (at this point, only 4 more rounds must be played for this choice to pay off)
Rounds 5 - 8:
regardless of tile revealed, player picks blue (see assertion 2)
Conclusions -
Studies of communication tend to emphasize the "deeply entrenched" nature of our opinions. This game confirms that if there is a social cost to changing an individual's opinion (such as alienation from your like-minded bretheren), a very large preponderance of evidence may be necessary to counterbalance this loss. Considering our number of choices in daily life, and the marginal benefits (if any) that abstract knowledge poses for the individual, it is no wonder that people tend to believe crazy things.
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