On Cafe Hayek, I found a charming little open letter written to the magazine known as The Economist. Though I’m not a heavy reader of the publication, I have written criticisms of one of their books on economics.
In this case, it seems that The Economist was critical of Hayek’s theory of malinvestments, an idea that is pretty central to the Austrian theory of the business cycle. It is curious that they then say Hayek’s lessons on the price mechanism and the failures of central planning are better lessons to take away. But isn’t this precisely the lesson that Hayek’s theory of malinvestments teaches us?
The Economist article itself deals with “Who is winning the battle of economic ideas in China?” China responded to the 2008 financial crisis with Keynesian-style stimulus packages. Despite their efforts (or perhaps because of them) China’s economy last year was the slowest it’s been since 2009. This has led to an increase in Hayekian thinking among Chinese policymakers. The Economist paints the situation as being of two risks:
- The “Hayekian Risk” of wasted investment. Evidence of this can easily be found in one of China’s numerous “ghost towns,” which were created by government “investment” but there wasn’t the demand to fill them.
- The “Keynesian Risk” of inadequate aggregate demand, and thus lower employment. Keynesians argue that during an economic downturn, aggregate demand won’t meet aggregate supply. Government can then increase aggregate demand through fiscal policy (increased government spending and/or tax cuts) and monetary policy (the central bank lowers interest rates).
The arguments presented against the “Hayekian Risk” seem pretty weak. One is that since cities like Beijing and Shenzen are heavily congested, they could stand improvements in transportation infrastructure. Thus, infrastructure demand will eventually catch up with infrastructure supply, “as long as infrastructure spending remains disciplined.” I’m not sure how increased demand for transportation options in these cities will somehow justify the infrastructure spending in these ghost towns.
A second argument is that some Chinese investment could be looked at as “quasi-consumption,” such as earthquake-proof schools or more comfortable metro. But I’m not sure how it can then be declared that these are no longer malinvestments. If it is the case that Chinese individuals preferred to spend their own money on something other then these things, even if they derive some satisfaction from them, then the spending created inefficiencies that otherwise wouldn’t have happened had these people been allowed to keep their own money.
A third argument goes like this:
…China’s high investment is backed by even higher saving. As a consequence, China does not need its investment to generate high returns in order to pay back external creditors. China has, in effect, already set aside the resources that will be lost if its investments turn sour.
But the fact that the malinvestments occurred with the saved money of the Chinese people rather than the borrowed money of foreigners hardly makes it less of a malinvestment.
The final paragraph, as Cafe Hayek points out, is confused.
This points to a different, better lesson to take from Hayek, who never won his battle against Keynesian stimulus in the 1930s. His later works praising the price mechanism and fretting about economic planning are what turned him into an intellectual star. Mr Wen’s successors will inherit an economy less susceptible to planning and ever more in need of deregulation. The later Hayek is the one China’s policymakers would do well to heed.
According to Hayek, the precise cause for the malinvestment is government manipulation of the price mechanism through central planning!
So, I would advise all to be careful when reading The Economist (as well as any other text dealing with economics). And be especially careful when reading economics blogs. Even this one!
So I’ve debated about whether or not I like Bitcoin. I’ve read pro and con articles about. I’ve read the debates over whether it’s actual money or not. I’ve had mixed feelings all along. But I think I’ve finally come to some conclusions about the issue. If you aren’t already, you should become familiar with Bitcoin before reading this article.
Bitcoin is definitely money from a purely academic standpoint. Money fills three roles: 1) medium of exchange, 2) store of value, 3) unit of account. That Bitcoin fulfills these three roles perfectly is easy to see. Bitcoins are already being exchanged in the market for tangible assets. There are a myriad of online retailers that accept payment in Bitcoin – some ONLY in Bitcoin. The transactions costs (marginal cost of transaction) while trading Bitcoin are so low as to almost be non-existent. So far, Bitcoins have held – and increased in value. #2 on that list of roles is problematic because value is a completely subjective experience. But as long as society or – in the case of Bitcoin – even a sector of society values the money, it will store some value. Finally, Bitcoin has fractional denominations that can be used to account large or small units.
But what is Bitcoin, really? Can it be trusted? Bitcoin comes into existence through a “mining” process that requires users to solve complex mathematical puzzles and equations. It is programmed such that no more than a certain amount of Bitcoins will ever exist, and their production is rather slow and decentralized. Decentralized and a slow rate of inflation to a finite level is something that most libertarians would hail as a vast improvement over the central bankster monopoly. But there is one common factor that both Bitcoin and US Dollars share. They are both backed only by the subjective valuation of users. That is, they are both fiat currencies.
The utility of fiat currency is limited to only the purpose of serving as money. There is no intrinsic value in Bitcoin, and no other use for it. This is a double edged sword. When a currency is “backed” or made of a commodity, it has value beyond (though not necessarily directly tied to) the face value of the money itself. This is completely unnecessary to fulfill any of the functions of money, but it has it’s perks – not the least of which is a built in hedge.
I don’t hate Bitcoin, but I just can’t justify the switch. For my money, a non-fiat decentralized currency is the ticket. There are a lot of open currency movements out there now. The people over at AOCS have done a good job at standardizing coins to be minted privately for private trade. Those currencies fulfill the roles of money just as well as Bitcoin, but have the added benefit of intrinsic value. Beyond that, the supply will not be finite over time. A metallic currency standard with decentralized minting will allow for low levels of inflation into the infinite future, adjusting in accordance with supply and demand for the currency.
In the end, I believe there is room for both. If I were counseling a friend, I would tell them to invest in AOCS or some other decentralized commodity currency rather than Bitcoin. But I wouldn’t begrudge anyone who prefer Bitcoin either. If the evils of the Fed and other Central banks are to be combated, it will take the decentralized effort of all the movements. And with the uncertainty of the integrity of the dollar going forward, I highly recommend that you do something, however small, to hedge against it.
Many people think that there is a limit to the benefits of technology; that at some point, improved technology will only displace workers and make people worse off. This idea sounds somewhat plausible on its face. Even some economics professors, such as the one in the video above, endorse it.
This idea is not new. Both Frederic Bastiat and Henry Hazlitt destroyed this fallacy many decades ago. Even I wrote about it recently. Let’s address some of the ideas in the video and see if we can’t gain a better understanding of productivity.
@00:50 Peter Schiff, Austrian economist and owner of Euro-Pacific Capital, says something that seems almost comedic in response to the question of whether we should be worried about robots taking our jobs: “Well, hopefully they take some of our jobs!” But isn’t this a bad thing? Not if we define means and ends. I imagine very few people, if any, think of their jobs as ends in themselves; rather, their end is earning an income (producing) so that they can use it to purchase goods and services that they desire. The job is simply a means to that end. Yet the fallacy that automation is bad because it destroys jobs partly results from treating a job as the end itself. Fair enough. But what will those positions have been displaced by automation do? More below.
@01:03 Schiff states that automation frees up labor for other uses. This might be more obvious when we think of it at an individual level, considering our own tasks and time. We use washing machines so we don’t have to use washboards, dishwashers so we don’t have to wash by hand, email so we don’t have to handwrite (as well as stamp and address envelopes, among other things), lawnmowers so we don’t have to cut by hand, etc. All of these things free up our time for other work or leisure. We don’t want it to be the case that we have to do more work for the same amount of productivity. This same consideration applies to the whole economy.
@02:05 The host says that he will choose to go through the toll booth with a human toll collector or through the checkout line with a human at the register rather than the automated ones, even though it takes up more of his time, in order to save jobs. Again, the problem with this is that he is treating work as an end in itself. We can see the silliness of this by looking at some places in Latin America, where there are toll roads in which the entire revenue from the toll goes to the toll booth operator! His labor serves no purpose and adds no value. His efforts would be worth more doing anything someone would be willing to voluntarily pay him to do. His labor can be used elsewhere. The same goes for the toll collectors and check out workers mentioned above: money used to pay toll booth operators cannot be used to pay for road repairs and labor used in checkout lines can’t be used to restock shelves, corral shopping carts, clean spills, etc. This is pointed out to the host @02:39, where Schiff says that the time he wasted in line could be used for something more productive. But he doesn’t seem to get it.
@03:10 The host goes to Laurence Kotlikoff, professor of economics at Boston University, saying that he doesn’t know where the jobs lost at the toll booth are going to reappear. Kotlikoff concurs; he doesn’t know either! But is this a problem? The assumption that we have to know is related to F.A. Hayek’s work regarding the economic knowledge problem. There are so many economic “facts” (prices, preferences, etc.) that it is impossible for any centralized decision-making body, even if it had access to all of these facts, to effectively make use of them. Not only that, they are constantly changing. However, when economic actors (who collectively have such knowledge, though it is dispersed among them) are allowed to act, they are able to make use of this knowledge. We don’t have to know exactly what job opportunities will arise for former toll booth operators in order to state that there are unlimited wants and therefore no set number of jobs.
@03:20 (On a bit of an unrelated note) Professor Kotlikoff criticizes Schiff for “the copious use of the word ‘we.’” This, in fact, can be a problem in economics, such as when economists say that the national debt isn’t that big of a problem because “we owe it to ourselves.” However, even if it were the case that Treasury bonds were held fully by Americans (instead of foreigners or the Federal Reserve), “we” is different than “ourselves.” When the bonds come due, it will be “ourselves” who are getting the proceeds, and “we” who are paying for it. Those not owning Treasury debt will be worse off. But I don’t think the use of “we” by Schiff is entirely inappropriate in this situation, since all consumers of whatever is now being produced through automation enjoy lower prices. Those being displaced may have to suffer the pain of finding another job, but their purchasing power is now greater because of lower prices.
@03:30 Kotlikoff talks about skewed income distribution, youth being less skilled than older workers (and therefore being more likely to be displaced by automation), and youth having less income to invest in the economy. However, it is not clear that skewed income distribution is caused by automation, nor is it the case that low-skilled jobs being replaced by automation is automatically a bad thing (indeed, switching from low-skilled jobs to other low-skilled jobs is easier than switching from high-skilled jobs in one industry to a different industry. As well, if it’s a low-skilled job in the first place, the workers in it might not have been gaining any skills that would eventually make them more productive anyway). And Kotlikoff can’t really be concerned about there being less capital to invest in the economy since it is pretty clear that if automation replaces labor, there will be more freed up capital to invest.
@03:57 But Kotlikoff has mathematical models that show that automation can be bad for the economy. I guess mathematical models trump logic. I also question the internal reasoning of his paper itself, as somehow there is less capital accumulation with automation. How is that possible?
@06:20 After Schiff points out something very important but seems to be ignored in this discussion, the benefits to the consumer, the host doesn’t want to get into the “free market fundamentalist” argument. Nice.
@13:45 Kotlikoff talks about his taxi driver, who used to be a welder but was displaced by automation, and will eventually be replaced by driverless cars. His life will forever be worse, apparently. The idea that he benefits at all as a consumer is totally ignored. Kotlikoff also has the assumption that technology concentrates wealth, but has no evidence for it beyond the fact that some people gain more from it than others.
@19:50 The host assumes the conclusion: that automation shrinks the labor market (or more accurately the demand for labor). When a panelist points out that employment in Amazon distribution increased after brick-and-mortar bookstores closed, he responds that Amazon couldn’t have absorbed all of those who are displaced and therefore they have no job. As explained above, this is a non sequitur. Just because we don’t know where they went doesn’t mean they now have no job. We’ve all heard or read stories in the media talking about people losing their jobs. How often do they report about people finding other jobs?
@21:49 Kotlikoff pulls out the ultimate trump card: “Peter, you’re not an economist and it’s pretty clear.” Why even have a debate?
To conclude, I think we can take the following lessons. One reason the Austrian approach to economics is so powerful is that it treats the study of action seriously. Humans do purposeful actions. As such, they have ends that they achieve through certain means. As seen above, this is important as so not to confuse jobs with actual ends and will keep us from falling for certain fallacies. Secondly, Hazlitt’s One Lesson consisted of seeing the unseen. In this case, what we see with automation is that jobs are displaced. What is unseen is that prices go down, capital is freed up for further investment, labor is free to move to more highly valued uses, and the standard of living rises. Third is the important concept of knowledge in economics. It’s only when we look at the economy as something that needs to be managed by a central power that we see the unknown as scary. But when we understand that knowledge is dispersed and the only way it can be made use of is when people are free to act as they see fit, then we see that not only is central planning unnecessary, it is disastrous.
After writing and re-writing an introduction to this post, I couldn’t come up with a good fit. So I’ll just drop the bomb on you all at once. Here it is:
Gun control legislation is racist.
“No way!” you might think, “we’re protecting people – especially minorities from the additional carnage involved with gun violence.” Maybe so, but probably not – I’ll let someone else argue that point. There’s an interesting article reviewing (briefly) the history of gun control and race/labor relations here. How can gun control possibly be racist? Apparently some notable minorities (like Danny Glover) actually believe just the opposite – that open access to firearms is racist and that the purpose of the Second Amendment was to allow whites to keep slaves. Now that’s pure hogwash, and I’m not even going to address that either. There’s an important and overlooked aspect of gun control and the way the government handles these laws that paints a picture.
What exactly would an assault rifle or high capacity magazine “ban” mean? It’s not really what most people think it is. Most people believe that fully automatic weapons, along with silencers, explosives and similar items are illegal. That’s simply not the case. You can read the official laws here, or read my brief version:
Currently, owning a machine-gun (fully automatic weapon), a silencer, etc is not illegal on a federal level (individual state policies vary). The process to obtain something outside the realm of what is available “over-the-counter,” vs. what it takes to own a hunting rifle usually entails a long, tedious paper trail, and is mired by bureaucratic procedure. It also includes an additional tax payed directly to the government for each item purchased. But to be sure, you (at least most of you) can own even fully automatic weapons, etc…. as long as you are willing to pay the price and follow the bureaucratic procedure. This is how the institutional racism enters.
I should not have to argue that a smaller percentage of minorities reach upper-middle class or above status in society than exist in society at-large. That is, the ratio of non-white people to white people is much smaller as the income and wealth scale increases. Additionally, the ratio of non-white people to white people increases as we look at criminal convictions. Please note: I’m not advocating that this is good, simply making a statement of fact. Actually, I believe we have a lot of institutional racism in our society that makes this so.
Very simply: because of these factors, fewer non-whites than whites by ratio own machine guns, silencers, etc. Not only is the process to obtain one of these weapons tedious, it requires additional payments of a $200 tax for each item, additional transfer fees, and severe scrutiny. Currently, it’s mostly rich white guys that own these kinds of items. Largely, these people are rich, white, male firearm collectors or firearm dealers.
So what happens if President Obama gets his wish and “bans” assault weapons (including semi-automatics and high capacity magazines)? Even fewer minorities will have access to these items. Unfortunately for these minority groups, the racism is built into the system. Passing stricter gun control laws disproportionately impacts racial groups negatively. Owning firearms to ensure freedom from oppression is essential – especially for minority groups. They ought to have just as free and open access to them as anyone else. In many ways, it is more important for them to own these items than for the rest of us.
Political strategists are completely overlooking this issue. If I were the NRA, I would be asking all of my non-white members to write their congressional delegates and light up their phones with this issue. This is an issue that needs to be seen in the light. We cannot allow institutional racism to prosper in America. Let freedom ring for all groups, races and classes of people – and let that freedom be protected by the second amendment!
I have received a lot of positive feedback from my original post about buying a home. Recently I have been asked a few questions about real estate as an investment vehicle in a couple of different ways. 1) What about the advantage of owning a home later in life, when income is fixed and living expenses (food, fuel, energy, health care) are rising? and 2) What about rental properties?
These are both tough questions to answer because, as usual, it is highly dependent on the situation. Owning a home later in life is undoubtedly a good thing. While living on some kind of a fixed income, it is nice to know that housing (as a service) is taken care of. To fully answer this question, however, there are several things to consider. First, how does the cost of owning vs renting compare, year over year? Second, what is the real rate of return on retirement investments other than the primary residence? Third, what kind of housing are we talking about? There are certainly more considerations, but these are the most important. Asking these questions will determine what your opportunity cost of buying a home is. Let’s look at each of these elements individually.
How does the cost of owning vs renting compare, year over year? In my previous post, I indicated that the true cost of ownership is typically higher than just the cost of the mortgage payment, taxes, and insurance. Often times this difference is significant enough to make a difference. What if, instead of spending the difference on the purchase of a home, it was invested in something else or saved? It is quite likely that by saving the difference, one could feasibly save up enough for a large down-payment in the span of a few years, or even a full payment on a home by retirement age. The caveat here is that mortgage payments are level while rent usually increases along with the price level to some extent. That can be a huge advantage over the long-term. If buying a home makes sense for you (as noted in my previous post), then by all means. But again, you should plan on living in it for a long time, make a large down payment, get a 15-year fixed rate loan, and allot only up to what you can very safely afford per month. Additionally, consider whether you want the big house And you must consider how your retirement might look if you could earn interest on money invested elsewhere.
Another thing to consider is what kind of lifestyle you want now vs. later. It might be nice, while you are young, to have a well manicured lawn in the suburbs, with room enough for the kids to play, etc. But when you begin to age, will you want to have to manicure the lawn? Will you want all that space? Many people move later in life and “downsize” their abode. Assuming this is a possibility, the sale of the first home may actually prove to have lost you money over other investments, and would leave you worse off than if the money had been invested.
So what’s the bottom line? I don’t know. Again, I can’t tell you or anyone else what to do. I can just provide you with some tools that might help you analyze your own situation, and make a sound decision for the future. As for me – I’m looking for the right piece of property and the right time. It’ll be a few years – after grad school and a few years of debt repayment and saving.
When it comes to rental properties, this is much simpler. If it’s possible to rent the property out and cover at least 120% of the payment, it’s probably not a bad idea. If not, I wouldn’t go for it. Less than 120% won’t allow you to save for maintenance expenses.
I hope this answers the questions, and helps any of you who are in the position to make this decision. If you have any questions, please comment, or e-mail me.
As you may have noticed, I am not Aaron, but I hope to be as informative and entertaining as he is. You can read about me here. You can contact me here. You can check out my blog here. Thanks for reading!
While at a bookstore in the Siam Paragon in Bangkok, I came across a series of books published by the popular British magazine, The Economist. They had books on banking and finance and even their namesake, economics. I decided to open the latter to a random page and found a piece about the concept of the fiscal multiplier (which can be read here). The idea behind it is that government spending can have a multiplying effect on GDP. This particular writing within the book was on why economists disagree on the degree of the multiplier, and even whether there is a multiplier at all. What they can agree on is that when the economy us at full productivity, that is, when all available resources are being used, the multiplier equals one, meaning it has no effect. However, when the economy is at less than full capacity (when some resources are idle) then government spending brings some of those resources into employment, meaning the multiplier is greater than one.
This seems to make sense. Factories that are running and employed people seem to be more productive than idle factories and idle hands. But is this necessarily the case?
The question that The Economist‘s analysis seems to be neglecting is why resources are idle in the first place. This is directly related to another pertinent question: if government spending uses these resources in a productive manner, why aren’t private owners doing the same thing themselves?
Let us say that during a boom phase of a business cycle, entrepreneurs speculate that hovercrafts are going to be especially popular and decide to build factories and invest in machinery to produce such hovercrafts. But they find out after the bust phase that there isn’t enough demand for their hovercrafts to cover the costs of their production. One of the things they could do is decide to cut their losses and sell the factories at a price corresponding to the demand of hovercrafts (and perhaps sell some of their machinery for parts or scrap metal). Another thing they can do is let it sit idle, perhaps expecting that after a time that demand for hovercrafts will increase and production of them will be profitable.
In this scenario, the answer to the question of why resources are idle is that it is more profitable (or rather, there is a smaller loss), to have them sit idle than use them to produce goods. Using government spending to cover the losses from production makes people worse off because resources are being diverted from more highly valued uses (whatever taxpayers would have spent their money on had they been allowed to keep it) to lower valued uses (hovercrafts). It is during these bust phases that entrepreneurs who have malinvested (that is, invested resources into unprofitable projects) have to divert those resources into more profitable projects. This takes time and there might be idle resources (including unemployment) in the interim. However, subsidizing unprofitable projects causes this process to take even longer.
Let us make the concept even more simple. The government could just hire people to dig holes and then fill them back up. The diggers could then spend that money on actual goods, thereby “increasing demand.” But who really paid for the diggers? It was the people who were producing goods that consumers actually want; the same people from whom the diggers bought their goods. So where does this leave us? Well, the producers are left worse off because they are being taxed in exchange for paying people to dig and fill holes. If not for the government spending, producers would have greater demand for labor and employ these diggers. The diggers would then be bakers, brewers, blacksmiths, carpenters, or whatever was in demand, thereby adding to the overall wealth of society. Through the government program, they are made into leaches. This same rationale can be applied to the Keynesian favorite of war “goods,” since they rarely serve any consumer’s ends and simply blow up. But what if, instead of digging holes (or making things that blow up), they produce more useful things, like infrastructure? Since much “infrastructure” is monopolized by the government, there are no market prices which means it is impossible to tell whether such a project was the most highly valued use of labor and resources (unless it is something like a bridge to nowhere; such is obviously unprofitable). [For more on this subject, see chapter 4 of Hazlitt.]
What can we conclude about The Economist article? Paradoxically, they have an oversimplified view of productivity (that is, the use of resources is better than the non-use of resources, even if that use happens to be wasteful) which leads them to create complicated models of what the multiplier will be under certain conditions. Keynesian theory overemphasizes consumption, seeing saving as undesirable and not something that necessarily precedes investment spending, and treats capital as homogeneous (which is silly since machinery that produces hovercrafts can’t costlessly and instantaneously be converted to produce copies of The General Theory). It seems to me that they would be better served by going back and looking at first principles, rather than endlessly debate about the accuracy of their econometric regressions.
I recently had an exchange on Facebook with a friend who was promoting a piece about how the gov’t should once again raise the minimum wage. Frustrated, I noted that when the minimum wage rises, unemployment increases, creating fewer jobs overall, and often hurting those it intends to help. Here’s a previous piece on just how. ”But wait!” says the friend, “the article’s author shows how the unemployment rate has not been affected in the last few years by raises in minimum wage! How do you know so much?”
Okay, okay. Here’s the deal. We have to remember how employment/unemployment rates are calculated. First, it’s really a ratio. We estimate the total size of the labor force – everyone working and unemployed. Then we estimate the number of unemployed and divide by the total labor force. Seems easy enough. So to make things simple, here’s an example of how the “unemployment rate” can be VERY misleading.
Let’s assume that the total labor force is (for simplicity) made of 1,000 people. The total number of unemployed is 50. 50/1,000 = 0.05 or 5%. Now, let’s say we raise the minimum wage by $1.50. By doing so, it’s now unprofitable to employ a man who was employed at the previous minimum who, despite a severe brain injury (or has the misfortune of being young), provided valuable service. Let’s assume there are 10 people in the labor force like this. Hey, it’s 10 people, though, right!? What happens to these people in regard to the statistic?
We now have ten people who were previously employed, but are now unable to find work. Maybe, like our friend with the brain injury, some of the now unemployed can claim government benefits and no longer have to/need to work. If they can’t find work and stop searching, or go on benefits like disability, they are not employed, but also not searching for work. So the employment market looks like this: Total labor force – 990, unemployed – 50. So 50/990 = 0.0505 or 5.05%. HOLY SMOKES! By raising the minimum wage, we just lowered the unemployment rate by 1/20th of a percentage point! See how that works?
The marginally employed will be the young, the infirm and disabled, or those who probably most need the employment. By raising the minimum wage beyond what they are worth paying, we deprive them of the employment they need, and of their dignity. Just look at the rate of employment of 16-20 yr olds. It’s very high – and that only includes the ones who haven’t stopped looking for work. Look at the rising rate of disability claims. The employment rate isn’t getting better, the total labor force is shrinking (as I’ve noted), and continually getting worse.
The employment numbers in America are smoke and mirrors, and I’m not buying the charade. What lies ahead? The Wiedemer brothers suggest that unemployment above 50% is possible. If you aren’t prepared for a 50% probability you could lose your job in the next five years or so, now’s the time to get ready.
As for my friend, he may or may not believe me, but I hope you do. We cannot continue to be manipulated by the “official story” fed to us by the government.
Minimum wage laws are costly for the unemployed