Politicians and Incentives

Reading this week's article has reinforced my views as an economist looking at the world. Before thanksgiving break me and and my friend were having a heated debate on practically the same topic, however instead of baptists and bootleggers it was Teachers and Politicians.

The main point of his argument was that politicians were paid too much, which was making more corrupt people think it was a good idea to be a politician. I countered that the wage doesn't matter much since the idea of the special interest groups paying their campaigns or making donations will be enough to create the incentive for them to sway their way as they are human and respond to incentives. His idea was that if we had lower wages for those politicians, the corrupt ones would be disinterested at making the lower wage which would opt out the bad ones. Not a bad idea on paper and i'm sure that others would be tempted to sway to his side of the argument until you think about the other interest group that is bribing the politician. If the politicians are being paid less wouldn't the temptation of giving into the special interest group be stronger since the difference in amount is now larger than before?

Obviously there are a couple of wrong assumptions on my point, first of all we could expect that if politicians were paid an enormously large sum that it would drive the supply of people offering their experience for the job yet the special interest groups could still probably come up with other incentives to deter a politician. But beyond this argument after I made this point he switched it up to the topic of teachers wages and education.

Since teachers are not being paid enough there are not enough good people that have a comparative advantage in teaching that would be willing to take up teaching as a career. Not a bad point right? Well this is kind of linked to the argument above, if you pay them more and fluctuate the market to the wage you want it to be, you will have plenty of teachers however you will have more unemployement for that area of expertise as well since schools would have to pay the teachers a bigger salary and to fix the dilemma of a bigger salary expense, they could just make the classes bigger and cut out some of the teachers to fill the gaps of their budget. Also, increasing the wage might not even bring better teachers. If we assume that easily corruptable people end up in the senate, wouldn't it be as likely to assume that some teachers wouldn't be as good as teaching as others and is there just for the wage? Not saying they are particularly lazy but that they don't have a comparative advantage in teaching as they would in say engineering. Now it is a longshot to say that that those wage differences would be a long shot at best, it would be difficult none the less to prove exactly how good the legislation would do in either case of the politician or the teacher. They all respond to incentives and wages are a good way for us to sway the market but is it really worth it to poke and prod at the market while everything else is set and it is controlled by no one?

Perhaps those wages are set and I just don't happen to know enough about their particular details but I find it peculiar that it all the statements and ideas end up on a supply and demand graph.

I think it is Fair :D

Is It Fair?

I want to be a politician. I used to think if you had good values and a big heart you could become president and single handedly change the fate of the nation. As I grew older this ideolodgy started to show its flaws, by the time I was fourteen I had seen the onset of two wars and the housing bubble burst right in my face. At first I thought that corrupt businessmen were to blame for these hard times, and then later I assumed that in fact the government was out to get me and that all in power were corrupt and inherently evil. These ways of thinking soon left me as I came to understand how people thought, when I started to study philosophy. In my head I saw life as being a flow, a miraculous combination of hundreds of different decisions made by people and people made these decisions on what they thought was best at the time. So I assumed any politician who takes the time to get your vote probably has other incentives than just to benefit his countrymen. Some like the power and prestige, some enjoy the financial benefits associated with the post, and others are people pleasers, out to satisfy the wants of the masses. So I now know I cannot trust any man to govern people unbiasly and not take incentives to do ill that are so heavily propped around him.

My bone worth picking lies in the election process, to be able to give any sort of effective campaign a candidate must raise a boat load of cash. It is ridiculously expensive and the demand for it only serves to raise prices for ad time and marketing strategys. Therefore only the ones with extensive support from the private sector are able to garnish the needed resources to get elected. This system inherently places obligation for that candidate to help his supporters out since they gave him the essential aide to even be in office. This system is flawed.

In Germany they have reasonable restrictions of the amount of spending a person can do on a campaign, and limits airtime for radio and television to try and level the playing field in elections. I like this idea, to have some basic and very loose restrictions to prevent campaigns getting to be worth more than fortune 500 companies and to prevent people from buying up massive amounts of air time to try and outspend opponents. I am not at all a backer of any free trade restrictions but limiting private sector involvement in the voting process I think is fair.

Do you?

The true Story behind Thanksgiving

Because this is Thanksgiving week and Thanksgiving is one of my favorite holidays (despite being French and not celebrating it in my home country) to celebrate in US, I think you will enjoy that short article by Benjamin Powell.

http://www.independent.org/newsroom/article.asp?id=2378

You will appreciate that Thanksgiving is actually a celebrating of markets and the importance of private property rights.

I obviously encourage you to share this with all non-SWEET members!

Reading Recommendation and other recommendations

Given the discussion that took place, I would like to recommend at least a short interesting book regarding Intellectual Property Rights and Cyberspace. The book is David Koepsell and it's entitled: The Ontology of Cyberspace: Law, Philosophy, and the Future of Intellectual Property (2003). It's available via Amazon.

It's not an economic analysis of Intellectual property but it's interesting.

Also I would like to recommend the ECONTALK podcast entitled FREE and discussed by Chris Anderson: http://www.econtalk.org/archives/2008/05/chris_anderson_1.html.

Obviously, when we say free, we are talking about explicit monetary costs. We are not talking about opportunity and implicit costs.

Internet Censorship

For the past few days congress has taken it upon themselves to discuss the possible internet censorship and immediate shut down of all sources of the internet where you can download software, music, movies, etc. for free. After looking over the process and arguments for both sides that they have been mulling over, reading this week's article was quite refreshing. I also happen to agree with the conclusion of the thoughts that through technological advance eventually there would be a lot less theft. Yet when it comes down to it people would rather see the theft in jail or pay a large fine rather than making the developers think of a better idea while still being legal. Pandora is a great example of how the idea of downloading music has changed. You don't have to constantly pay attention to it, there is no downloading involved, other artists are also included so you can branch out your music you like, and it's free. Okay you do have to listen to an advertisement for every 5 songs you listen to but nothing too long to complain about. If you upgrade and pay for a year it will be cheaper than 4 albums and you have all the music you want that can be played through your car stereo and any smart phone.

This to me is the sort of future the internet should hold concerning downloading. Not where developers try to sue these sites, but try to encourage others to do similar things as to offer services that seem free but come at some sort of expense. Netflix is another great example, however with a little more effort they could put more movies online to stream. I'm just very excited to see what sort of sites pop up in the future with the ideas of making it more available to the customer at a lower cost/free with some advertising.

Taxation via the Market

Freedom of choice is a tax levied upon those who are unable to adapt in a dynamic spontaneous society. In a competitive market consumers must weigh various costs and benefits of goods and services in order to make buying decisions. However, it can be assumed that there are individuals less able to make such decisions. These individuals will make decisions that hurt themselves simply because they are ill informed or they simply lack the mental capacity of others around them.

As an example one could look upon the mentally handicapped, but instead, look upon an individual that is perhaps not well educated or trained and viewed by local society as responsible albeit lesser. Going to the example from the reading, one can look upon the example of music piracy: An individual could download music illegally from a torrent or peer to peer service, or they could purchase the music in either the form of a CD or a secure download from a service like iTunes. The options could be weighed as such: pirate the music for no monetary cost while risking malware, legal repercussions and potential lack of quality, or purchase the music from a 'legal' provider and run the risk of loss of data or pesky DRM software. Typically individuals with higher disposable income will choose to purchase their music and not risk flying their Jolly-Rodger high. While the inverse would also tend to be true. But, neither the pirates nor the straitlacers seem to be 'winning'. Pirates have slow computers and strailacers spend near thousands of dollars on their music collections. perhaps the real 'winners' are the individuals who are truly good at pirating. no monetary cost, high quality vinyl rips with little to no risk when downloading. These blackbearded audiophiles will go to great lengths to 'steal' their favorite music but will purchase concert tickets, and other memorabilia provided by their favorite artists.

Perhaps what the 'invisible hand' is trying to sell is not individual songs but rather popularity of music. A song is a piece of art but trying to monetize its use is rightly difficult. The best use of the song is marketing the artist. Author Neil Gaiman once believed that piracy was wrong, but when he released a free PDF copy of one of his books he noticed that the sales of that book and his other work greatly increased. The cost of a good is stratified, the cost of stealing, the cost of purchasing and the low cost of being an effective consumer.

Those who are effective consumers and can purchase a good or service at its lowest opportunity cost are using the tax of the market placed upon pirates and buyers, or those with lesser purchasing capabilities. These are the dynamic innovators. Even though their actions may incur costs upon others they breed innovation and competition lowing the aggregate costs for all.

Napster and ITunes

Dr. Roberts discusses the economic consequences of leaving Napster unmolested by the legal system.  His argument is that in the long run the market will correct for the lacuna of enforcement.  The market did produce a viable alternative to Napster, ITunes.  If you can remember, using Napster almost guaranteed downloading malware onto the hard drive of your computer.  After so many trips to the Geek Squad, (where you have a sneaky suspicion that they are not really doing anything to help anyway), you have to buy another computer.  ITunes allowed the user to purchase not only just a single song at the relative diminutive price of $.99 but allowed you to purchase a song in the full knowledge that you would not be downloading some foreign spyware, virus, or malware onto your computer.  I would posit that a good portion of our society likes to obey the law, and when given a safe, viable alternative, they will use a legal market to obtain goods over an illegal one.  The illegal one, Napster, even if left unprosecuted came with the additional cost of malware, which depending on your computer savvy skills could mean a trip to Best Buy to purchase a new computer.   

                The internet brings up a host of legal and economic questions.  How much government intervention do we want in the cyber realm?  Is the market a viable option to the capacious amount of illegal activity in the cyber realm? 

fees and taxes, they are all the same

Fees, Taxes, They Are All The Same

Externalities are very common to an individual, and even more so to a college student. Every college student pays certain fees that support all sorts of different campus functions like student recreation centers and waste recycling. These functions were established under the premise that they will provide benefits to students and that is why the students are required to pay for them. The issue with this is that not all of the students use these services or ever wanted to, meaning they are required to pay for goods and services that they have not reaped the benefits from.

This is to me a negative externality, since the cost is shouldered by the entire student body and the entire student body does not partake in these activities. That means that those students who do not take advantage of the goods and services they are made to pay for suffer, since they received essentially nothing for the money they were required to pay. This negative externality is odd because it is a direct cost that is mandatory, but use of the product or service is not used. Since usually a negative externality is seen as a transaction that has costs borne by a third party, many do not think of negative externalities of mandatory fees.

These fees act like taxes, and to an extent they are. Taxes are placed on peoples within the governing body’s jurisdiction to pay for the services and products that the government provides them with. Since there is no guarantee that these will be utilized by all of the people who pay their taxes, the people who cannot or do not use them are essentially throwing their money away.

To some their utility function might make them feel happy about paying taxes and some might even be so generous as to gain utility from paying for services they know will only be used by others. But even if this is so, it does not account for the fact that many are unaware of how much they are actually paying to support things they do not consume. It is this unawareness that plays to the favor of those that do use the product. Since they are able to share the costs with people who are not consuming the product, they are able to pay a much lower price than what they would actually pay if only consumers of the product were to bear the cost.

This is a double edged externality sword. The positive externality of the uneducated tax payer paying for goods and services they do not use it that the consumer of said goods is able to gain the benefits they provide at a lower cost to themselves. On the other hand, since the cost is shared by consumers and non-consumers alike the non-consuming tax payer suffers a loss. This phenomenon is seen in all sorts of governing, and explains why programs that only allow some to receive benefits while others are excluded are in essence defunct. Things like welfare are not fair at all to the majority of tax payers who are not allowed to reap the benefits of these programs because they do not meet the criteria to do so.

The hopes behind this are that if everyone helps pay for a service (even those who don’t use it), those who use the service will be able to gain enough from it to make it worthwhile. The fallacy behind this is that if people are made to pay for something they don’t want or use then it is not mutually beneficial and in a sense destroys wealth. In the few situations where other positive externalities come into play to make up for the loss suffered by the non-users (things like roads, fire departments, and public safety) then they can be economically feasible. All programs in government should be this way, to provide overall more benefits to the governed than costs, and when they do not it will only serve to destroy wealth.

I feel that the vast majority of people don't stop and think about how amazing it is that we can go to the store and find what we need. The fact that we can go onto the internet and buy literally anything is straight-up mind blowing. I wish more people would respect how markets work.

There was a recent discussion in the blogosphere on this topic. David Henderson asked his blog readers who was the modern day Bastiat. Bastiat was a French economist who is famous for many insights regarding the benefits of trade and markets. Center-left blogger Karl Smith voted for Paul Krugman while others thought that Russ Roberts, Thomas Sowell or Steve Landsburg was the modern day Bastiat. It was an interesting discourse with some of economics most interesting people interjecting their views. I would encourage you to check this out.

One of my favorite lines came from the hard-hitting and awesome Don Boudreaux--


Krugman spends the bulk of his time today, when writing for the general public, assuring the general public that its economically untutored instincts are correct.

And another thought,

Adam Smith may or may not have been referring to God with his "invisible hand" simile, but I can understand how humans turn to a deity to explain such phenomena. Many people seem to hold "the market" in a religious like reverence that I find interesting.

I may be mistaken but there seems to be a positive relation between traditional Christian values and some degree of respect for markets. If you are a religious person are you more likely to support "the market" than someone who is not?

Peace yo

What I Believe.

I was once asked by a child of three, what is god? This question had never been asked of me and for the first time I wondered. The answer I gave the child was that god is the unseemly order behind things, the “something from nothing”, basically when you could not rationally explain why something worked out the way it did that is god. Then I grew older, I went through many changes in mind and body and when I was a junior in high school I was again asked by my first professor, what is god?

By then I had a better answer, I had refined god down to everything. By everything I meant that all things came about due to random happenstance, a moment in time where things could have gone awry but did not. I was marveled by things where there was no human hand, yet peaceful balance existed. Things like ecosystems, the water cycle, evolution, or metabolisms. Millions of actions and reactions that happened with no person directing them, a symphony with no conductor. This to me is what I firmly believed god to be.

Finally I achieved the graduation of high school, and was college bound. I was sitting in my economics class and I was presented with the idea of an invisible hand that seemed to guided cultures and civilizations forward through mutual self-interest. This blew my mind, here I was seeing the same thing that I called and knew as god being explored and presented in how human’s decisions are made. It was astounding how much logical sense it made, things work out because people want what they think is best. They aren’t always perfect solutions that make all parties involved totally satisfied, but statistically it has improved nearly all aspects of human life by having better thing happen then bad.

What struck me most was that I chose to worship this concept before I even knew it was a part of economics. I trust that this spontaneous order that appears is not a giant bearded man in the clouds. When I tell someone that the lord works in mysterious ways and that he always has a plan I mean it. I trust but do not understand, and that is where my faith lies. I trust that the invisible hand is there, and I understand it won’t always be working in my personal self-interest. That is also why I love it.

Brave new world

There is a lot of talk today about what amounts to protectionist ideas. We need to "protect" such and such sector from unfair competition. What this amounts to is the majority should fork over a few dollars more to help out a special minority in such and such sector. The result is a trade war in which everyone loses, even the protected industries because in the end they are consumers as well.

We've also learned about fair trade policies and I see this soon being applied here at home for buying local. The result is basically incentivizing people to perform a task at which they have no comparative advantage in. I don't mean farmer's markets are necessarily bad but I do see a pressure group growing that wishes to use government power to mandate the grown local economy. This could come in the form of school lunches being mandated to provide healthy, local diets for children. If these steps were to be implemented there would be a loss for local economies as money was poured into not the most efficient goods but the most protected goods.

The Paradox of Buy Local

            Russ Roberts and Don Boudreaux’s podcast on the economics of buy local is a timely discussion about a topic we were recently discussing in our math economics class.  One of my classmates who works as a researcher at the University has been tasked with analyzing the costs and benefits of purchasing ‘locally’ produced goods and services for the sustainable village.  The discussion turned to the arbitrary nature and misguided reasoning behind the ‘buy local’ movement.  What value is there in buying a good or service at a higher monetary price?  We live in an international system, nothing stays local.  As soon as I buy a slice of pizza from the local store, the owner most likely places their money in the safety and security of bank.  Even if it is a local bank, the bank invests in funds that surely are not local[1].  The reason I buy pizza at the local pizza joint versus the chain, is because I enjoy their product and prefer it to the chain’s pizza.  There is of course a limit to the additional price I would pay and some threshold of price for which I would not pizza at all.

            If at an individual level, the ‘buy local’ ethos provides a certain level of self-righteous misinformed utility, then more power to them.  They then in effect pay for the extra utility received by buying local even though they could have bought a similar good at a lower price at one of those “big evil box stores”.  I loved the podcast because Roberts and Boudreaux discuss how self-subsistence is the road to poverty - it is through exchange that value is added and the standard of living is raised.  My favorite part was when they pointed out that if you wanted to live a subsistence lifestyle, there was nothing stopping you from going to buy some tract of land and giving it go.  I for one would not choose such a route, but to each their own, even if it is foolish path.

---

[1] Point brought up by our instructor, Greg.

Division of Labour, Comparative Advantage & Trade

I have read a lot of interesting posts regard this week topic. I am late again because I was out of town to give a talk. Anyway, the division of labour discussion traditionally precedes the discussion on trade and comparative advantage.

As Adam Smith explained in his pin factory example, when people specialize, their productivity increases over time because they are getting better at what they are doing. On the other hand, if you don't specialize in a specific task or activity, your productivity won't increase as much because to do so you need to get better at everything you are doing. Assembly lines in the automobile industry illustrate perfectly that case. If each individual had to build the entire car, automobile manufacturers will never be able to assemble as many cars. It is because each individual is specialized in a specific task that they can build as many cars.

Specialization leads to increase in productivity gains because with experience you learn how to do things better and faster.

The question that follows any discussion about division of labour is what are we going to specialize into? The answer comes from David Ricardo: we will specialize in activities where we have a comparative advantage.

But, for all of this to be efficient, we need to have free trade. Without free trade, there is no reason to specialize and the division of labour won't happen. As Adam Smith explains, the division of labour is limited by the extent of the market. The bigger the market, the greater the specialization. This is why we have so much specialization because we are in a global market. However, it is important to understand that this can only be effective only if we have free trade and open immigration. Mises called David Ricardo's law of comparative advantage, the law of association. Division of labour, specialization, comparative advantage, and free trade allow individuals to associate themselves with other individuals. Mises's point was also that by depending of each other has a result of the division of labour, people, instead of engaging in plunder and violent behavior, were engaging in trade and at peace with other because both parties benefit from the trade.

Similarly, one has to keep in mind that comparative advantage in one activity is not frozen over time forever. As more and more people participate in trade, who has a comparative advantage will evolve over time and people who had a comparative advantage in one activity might find themselves no longer having it. But this doesn't mean they don't have a comparative advantage in another productive and profitable activity. Note that usually when somebody comes along and can make something cheaper everybody benefits because it frees resources allowing people to use these resources to produce other goods and services that might be more costly to make but now can be made because some resources have been freed. As the division of labour and trade grow, the human conditions are improving for everybody. Only people who refuse to embrace the division of labour and free trade suffer.

Russ Roberts makes a great point when it concludes:

"This is the story of American economic life in the 20th century. Innovation and expanded trade reduce the number of Americans necessary to produce what we want. Yet the number of jobs doesn't fall. The number of jobs grows steadily with population and the desire to work. As innovation and trade reduce the number of people working in agriculture or manufacturing, that frees up capital and human skills to make other things, things we couldn't have if we lived in a static world, the antibiotics and iPods and cell phones and heart valves and MRI machines and flat screen TVs. Banal things and glorious things. Things that entertain and things that extend our lifespan. Our skills and the skills of the next generation can turn to creating and making those things.

Not everything we do well is worth doing. And even the things worth doing now are not necessarily worth doing tomorrow. Self-sufficiency is the road to poverty. Innovation and trade are the road to prosperity."

I can't wait till all the jobz haz outsourceD

Imagine a future where all the jobs currently done in our country are outsourced. It's impossible to think of what jobs our citizens would perform if we outsourced even advanced positions such as lawyers and doctors. Countries move from subsistence to manufacturing to service. Whats after service? More service? What would the world look like if we really had better things to do than produce our own doctors and lawyers? We would be producing some pretty crazy s***.

People's always be moanin bout the outsourze. But I say live and let die. Protectionary strategies only hurt us in the long run by postponing new innovations. Some may lose their jobs but those jobs will eventually be replaced by new opportunities in the market. Each new opportunity leads us further and further away from subsistence living.

This does present a problem for some people in the "short" term. I put short in quotes because who can say what a short time period is for society. How much initial unemployment, that occurs when markets shift and new industries arise, is worth the long term efficiency? Perhaps the government should help the unemployed gain new skills. I like to think, however, that if new skills are demanded, training will be supplied and workers will be supplied, if the price is right. But how can we know? We can't perform a test. As I learn more and more about economics I move away from government intervention, socialism, social safety nets etc. I see how the market allocates resources more efficiently than it can be engineered. When I see instances where people loose out I accept it using the rationalization that government or any other form of planning wouldn't produce any better outcome in the long run. But in the long run we're all dead, so that argument only goes so far (no pun intended). Essentially I've become a proponent of laissez faire, yet history shows that politicians on a platform of laissez faire produce policies that are consistently not laissez faire. The poor are left alone while those with enough clout to lobby get funding, or special favors. I cringe at my next statement, but that's not fair. To put it in more economic friendly words, if you are protecting "the rich" but not "the poor" you are distorting the market just as much as if you were providing everyone with free health care and a sandwich.

Most economists who have any grasp on reality realize the impossibility of a pure free market. Perhaps we should also dismiss laissez faire politics for the same reason. Those with money have power. Those with power distort the market through coercion. In America this is done by "buying" a little bit of the coercive force that the government has monopoly on through lobbyists and special interests. Therefore the market will never be "left alone," those with established market power, whether it be from money or otherwise, will always have the hand of those with political power in their pockets. Not because politicians are crooked (which they are), but because they are rational (which they aren't, jk) and are doing what's in their self interest.

So when we argue against government policies that provide funding to the poor it may be a good thing to keep in mind that the rich aren't on their own either. The market is already distorted. Some intervention may be needed to help move toward a level playing field.

This is essentially the point Howard Zinn makes in his book Declaration of Independence. He says we should do this because its "fair" (a dirty word). I say we should do this because it helps bring closer to level an ever changing and ever skewed playing field. Because we trade off economic growth (whatever that is) when we regulate or intervene on someone's behalf, the decision is always murky. Who knows which policy is better in "the long run?"

The Division of Labor

The Division of Labor:

This here’s a very interesting concept. The division of labor is not necessarily in regards to those who can do a job the best but in interest of time. For example, your boss might be better at your job than you, and have a much more intimate insight in the company, yet out of the interest of time he hires out positions to other people in order so that he can handle all that needs to be done on the business end, such as management and similar matters. A person can only do so much.

This becomes quite interesting when looking into the possibility of total self-reliance. We all know throughout history that societies which tried to do this ended up with significantly less wealth and prosperity than societies that chose otherwise. Although in theory a society could potentially be controlled in such a manner as to make this plausible, the reality plays out quite differently. The bureaucratic division of labor, I feel, is incapable of meeting the demands of the fluctuations of the market and there’s no way for people to seek their comparative advantage and contribute most to the general good if they aren’t free to follow their own path.

The reading made a good case, where the United States government chose not to bail out Chrysler in the face of competition with Ford and yet they did with Honda. The continued assistance, interference, of the government allowed the company to become somewhat complacent and simply weren’t able to become competitive. It was a division of labor in a sense. Nobody was forcing employees of Chrysler to be forcibly kept around to manufacture cars but on a cooperate level the government said that it was Chrysler’s business to make cars and thus, in a way, chose their comparative advantage for them. Their sub-par products were to be favored in point of fact because it was “good policy” to have Chrysler running according to the example.

Favors and the value of trade

Favors are a very odd thing. There is no physical value to them and as such for even an accountant's stand point it is very difficult to interpret what is considered a large or small favor to owe someone. Trading like this can be very difficult as you can tell from the next example. Lance (my friend) and I got into a strange argument about favors. Silly I know but after the reading this week I found my self caught in a web of trading. I was arguing how tired I am of him using my headphones all the time and I barely use them. I paid for them, i'm receiving no benefit or wealth from this trade as he goes about using them.

He countered with, "Well I bought the food for the gecko this week, I don't see why i'm in any debt to you". This is where the web of favors become complicated. Favors can be easily traded, but are very hard to determine the non-monetary value of a favor. Does getting up early in the morning to pick someone up from the airport cost more than paying for a meal at a nice restaurant (imagine that the expenses equal on both sides); which one costs more and who's in the bigger favor debt to repay the other?

Although they may be difficult to classify and are different for each individual, they are just simply amazing. Think of all the favors you have done in the past for anyone. You weren't expecting them to just hand you some change or a few dollars in order to repay the favor. They repaid you in kind with a similar favor they thought you would appreciate. If you were to pay for your friend's dinner and then in turn they give you a mint as repayment (to make this clearer, if they also stated something along the lines "Hey thanks for buying dinner!") would you not be willing to trade favors or be as friendly to that person?

Businesses often use these sort of favors known as accounts receivable. Basically saying we know how much the expenses are and we will pay you, you just have to trust us (rather than signing a legal note saying they will instead). Without using any court system they developed a reasonable state of trade where both businesses generate wealth by trading with each other on the terms of a favor; and like in real life, if that trust is misplaced that company will never do business again with the other. Of all the trades I can think of that would be the most intricate, versatile, and most difficult to appraise would be the relation of favors to others.

Quite Disastrous

Quite Disastrous

When I think of the words division of labor, I harken back to my days as a child when my father would make a duty roster for all of us kids to follow. Each of us had different jobs on different days to be what he called “Fair”. As an economist I now know that this method is lunacy and madness. Because I was horrible at doing the laundry, and my sisters were horrible at doing the dishes, when it was our respective turns the dishes would turn out dirty and the laundry would be faded and wrinkled. If my father understood basic economical concepts such as comparative advantage and efficiency then he would know that allowing us to trade jobs as we saw fit would be in everyone’s best interest. I would be able to do the dishes and make them impeccable, while the laundry would be cleaned and pressed in half the time. This was not to be so, our dissatisfaction with our jobs was atrocious and it gave an incentive to just avoid doing the jobs we hated so much.

When I observe people grouping into areas of labor that they are best suited to I call that division of labor. The spontaneous act of self-interest to pursue ones comparative advantage is what drives this division and truly determines who should be doing what. When someone intervenes and tries to command the division of labor I believe this is dangerous and can upset the process of pursuing comparative advantages. Since it is through the time saved when capitalizing on comparative advantage that improves the standard of living, controlling the division of labor is going to diminish the overall standard of living by default. Since no one has the informational capabilities to understand another’s true comparative advantages then it makes sense that no human could ever accurately depict the needs of labor.

Just as my father, places like communist Russia and colonial India they made the mistake of trying to control the division of labor and suffered. Do not make the mistake of controlling a process which you do not comprehend or fully understand, the repercussions can be quite disastrous.

Grow the Pie

Grow the Pie

What does comparative advantage mean to me as an individual? It is easy to think of it on a large scale, such as the comparative advantage of a certain region or the collective comparative advantages of a nation or people, But what about at the personal level? Where does comparative advantage have an effect on my life?

The answers to these questions are complicated, but with simple logic one can come to understand their pertinence. I understand comparative advantage as the ability to produce something with relatively the smallest opportunity cost compared to anyone you have the ability to trade with. With this in mind I wonder where my comparative advantage lies. Can I have many comparative advantages?

The answer is yes; a person can have many comparative advantages and usually has several. This is what allows us to trade an exchange in our benefit; if we could not make something at a lower base level cost than someone else then there would be no reason to trade at all. Mutually beneficial trade hinges on the hope that whatever you are exchanging will be worth less to you than what you receive. With comparative advantage, this means that you can produce something of obvious value at such a low cost to yourself that it becomes advantageous to produce for exchange purposes. Since people values change continually then it would be smart to have many things you can produce at a comparatively low cost to ensure you always have something to exchange for what you want. This makes the total wealth of each of us bigger by default, growing out metaphorical economical pie.

For myself, I look at this also in the labor exchange. People exchange labor for wages, ergo they produce labor and in return they are given money. If I can produce labor for a lower cost to myself than others it is in my best interest, and also in society’s best interest, if I produce that labor in exchange for acceptable wages. But also it is up to me to determine the worth of my labor to make sure that the exchange is profitable. This is why I would choose a job close to my home at 10$ an hour over a job far away from my home at 12$ an hour. This is because the opportunity cost is much higher to travel farther from my home and over time makes the ten dollar an hour job more economical.

All in all, the individual effects of comparative advantage are the ability to gain through mutually beneficial trade, the mechanisms used to determine the cost of producing labor in exchange for wages, and a way to benefit society by producing goods at low costs. When someone actively pursues their comparative advantages it benefits not only them, but also those who they trade with by saving them the time needed to produce that good or service themselves. It is this essential function of a market place that allows the economic pie to grow, whereas participating in things that are not ones comparative advantage would shrink that delicious pie. Since I work, and I would like to gain wealth throughout my life, I think it is definitely in my best interest to pursue my unique comparative advantages.

Fear of spontaneous order

We've all heard the game, six degrees of Kevin Bacon, where players try and find a connection between a seeming-less unrelated actor and Bacon in as few moves as possible. Something tells me if I took the workers names who created the computer I'm working on now I could probably connect everyone in the world in less than five moves. We are so interdependent that the idea that one component of the computer is made in China, another in California, using minerals mined in South Africa, doesn't really mean anything to us, it's just the norm.

I've always wondered if people who think such a system needs or must be centrally controlled wondered how all these people knew just when to make the computer and have it ready in the Apple store the day they arrived even before they even decided on buying it. Even a graduate of public education (no offense I'm one myself) would see the fallacy in such a belief. Of course, the computer was built without anyone in particular in mind because the actual beginnings of it began years ago in the production line. So what is so scary about this?

The "order" stems from rational self interest. When humans act in their long term self interest along with other such individuals we see order come about through market interactions. The inherent argument for central control of this process is the classic "lifeboat what ifs". What if so and so doesn't act in his long term interest and decides to poison the food his country exports or what if a leader in the Middle East decides to stop exporting oil to the U.S. They're always these ridiculous what ifs and despite this the market will correct the error made by the moron not acting in his long term self interest and they are punished. Can they happen, yes, is it a fatal error for the perpetrator? Yes.

The point is this process does not need to be steered the market will handle it.

The Law of Comparative Advantage, Migration, Outsourcing, and Wealth

The law of comparative advantages was originally explained by David Ricardo. People, firms, cities, regions, nations will specialize where they will have a comparative advantage (comparative advantage being defined as the activity where you have the lowest opportunity cost) and trade what they produce against goods and services produced by people specialized in the production of goods and services where they have other comparative advantages. What Ricardo explained is that when you allow people to specialize where they have their comparative advantages and freely trade, the overall amount of goods and services produced increase and everybody is better off (not necessarily equally better off but better off). In itself this model is very powerful but it is not a static model. It implies that you have to allow people to freely exercise their comparative advantage where their skills are being demanded (free immigration). If you don't allow this, businesses trying to hire people with skills for which they have a comparative advantage will relocate their operations (outsourcing). In other words, for that model to work, either you have a free labor movement or you have free movement of capital goods to where the labor skills you are seeking are. We call this the LAW of comparative advantages because this law is universal (applies everywhere, anywhere, at anytime).

I have read a few posts about a very passionate exchange about non-Alaskans taking jobs from Alaskans (I wasn't there so I can only assume the discussion might have been about immigration). Assuming this is to say that Alaskan's labor and non-Alaskan labor are perfect substitute but research shows that, for example, in the case of immigration, that this is not the case. In other words, non-Alaskans tend to get jobs where they have a comparative advantage allowing Alaskans to occupy activities where they have a comparative advantage, which traditionally higher paid. In the short run, it might be true to some Alaskans lose jobs but in the long run there is no evidence that immigrants (or labor migration) displace "native" jobs or depress wages. Neither is there any evidence that proves that immigrants depress wages. Actually, if any else happens, in the long run, native wages increase because they specialize in activities with higher salaries.

The topic of the post is obviously not immigration even though it's part of the discussion. But I want to remind all students what Bastiat wrote in What is Seen and What is Not Seen: the difference between a good and a bad economist is that bad economists tend to focus on the short run, on what's immediately observable while good economists will look both at short run and long run effects because sometimes short run costs actually produce long term benefits.

When it comes to immigration and outsourcing, many see costs but those are short run costs. In the long run, both produce long term benefits. Outsourcing might displace jobs in the short run but in the long run, they produce lower costs of production which benefit to consumers in the long run including the people who lost their jobs as a result of outsourcing.

PS: I apologize for my late posts recently but I have both moved to a new apartment and hosted an IHS week-end seminar on my campus the same week.

Outsourcing and the Coercive Nature of the Market

It seems like part of the dilemma with outsourcing is that locally, at face value, it is easy to see it as a form of negative market coercion.

Let us say that thousands of local jobs are lost in a specific industry do to outsourcing (although tens of thousands of jobs may be gained overseas). Thousands of individuals who thought that they were working within their comparative advantage, are forced through market coercion to reevaluate their comparative advantage, and quite possibly to find a completely new livelihood and specialization. But changing one’s specialization isn’t exactly like flipping a switch, it requires time and sacrifice to develop new skills. For individuals who have worked within a specific industry for twenty years, I imagine that this level of change may be terrifying. They brought themselves up to a certain standard of living through prior sacrifice and specialization, and there is no guarantee that they will find a way to maintain this current quality of life. In all likelihood, their quality of life will fall in the short run. They may even be forced to do work they don't want to do while they are figuring out what their new comparative advantage is.

This isn’t meant to be a slap against outsourcing, in fact, I agree with the principles behind it. If we look at some semblance of the whole picture, we will find that the local and global economies benefit immensely from outsourcing in the short and long run. Nevertheless, I sympathize with individuals who are having trouble coping with the change it undeniably brings.

The Economic Problem that Society Faces

If we can agree that the economic problem of society is mainly one of rapid adaptation to changes in the particular circumstances of time and place, it would seem to follow that the ultimate decisions must be left to the people who are familiar with these circumstances, who know directly of the relevant changes and of the resources immediately available to meet them. (Friedrich Hayek's "The Use of Knowledge in Society")

Dr. Roberts discusses how the particulars of time and place are foundational to the division of labor and specialization that will be produced by an individual at any time.  The quote above from Hayek, with an earnest eloquence that only Hayek could of produced, provides a succinct and cogent description of the perennial economic problem that society faces and the accompanying solution – decentralization and freedom.  Individuals, when provided the freedom to innovate will generally work to solve their own problems.  At our last SWEET meeting, there was an emotive and specious discussion about how to ‘plan’ a better Alaska; how to stop allowing non-Alaskan workers from coming in and “stealing” jobs from Alaskans. 

Let us assay this topic in light of this week’s readings.  Did Dr. Roberts advocate intervention when the specifics of his island parable changed for the “worse” for one of the couples?  No, the situation changed and given time, the inhabitants of the island would adapt, without the heavy hand of a governmental authority to intervene.  One can jeremiad the change, but we must recognize that with change, innovation, or policy changes there will be people who will be made comparatively worse off and those that will become comparatively better off.  We should not look to an authority to foist upon us some “solution” but to the alacrity, innovation and creation of the individual.   “Alaskans” may resent that a person from the Outside comes to Alaska to work and then leaves, but isn’t this just trade?  An individual sells his or her labor on the open market; the skills and needs of a particular job at a particular time and place will be filled to a qualified worker who is willing to accept the wage rate offered.  Does holding an Alaskan driver’s license make a person qualified outright for employment? Probably not.   An employer will find a qualified individual that they can obtain at the lowest cost, this means that sometimes jobs will go to Alaskan’s, sometimes they will go to migrant workers, and sometimes they will go to an out of state worker. 

What role if any should the state hold in labor market in light of recent reading?  Is it the role of government to assure a living for every man and woman over 16?