Cafe Hayek

The Wages of Aggregation

Related to this post by Russ, Mario Rizzo's recent post over at ThinkMarkets is outstanding.

For persons who insist that aggregation at the high level at which it is typically done by textbook Keynesians (such as Krugman) is acceptable, I offer this Krugman piece as Exhibit A for why such aggregation is poisonous to sound economic reasoning.

As Mario points out, wage adjustments are best thought of not as all wages falling (or all wages rising).  There is no lump of L in the economy hired to do some all-purpose task aimed at producing, in combination with a lump of K, a lump of Q to be bought by a lump of spending (C + I + G + [X - M]).

Even if some measure of average wages is falling, some wages fall relative to other wages (meaning, some wages rise relative to others).  And all wages that fall do so relative to the prices of capital goods -- some of which are complementary to labor, others of which are substitutes for labor.

Such changes in the pattern of wages are necessary to allocate labor from less-productive to more-productive tasks.

Moreover, the demands for some forms of labor are elastic over the relevant range of wages -- meaning, that as wages for such labor fall, the increased quantity of this labor demanded by employers results in these employers paying out more in total wages than before the wages fell.  (It would be as if, say, McDonald's cuts the price of the Big Mac by ten percent and the resulting increase in the quantity of Big Macs demanded by buyers is twenty percent.)  If the total spending power of workers as a whole is a function of the total amount of wages paid to workers as a whole, then a fall in wages when demand for labor is elastic over the relevant range of wages means that these wage cuts will contribute to higher consumption spending.

I have more to say about this silly Keynesian take on wages -- more that, time permitting, I might offer in a follow-up post.

Update

The Folly of Price Fixing

Historian Burt Folsom explains how price-fixing helped to further depress America's economy during the 1930s.

The Great Parisian Bike Experiment

A couple of summers ago, Paris embarked on what seemed like a wonderful idea:

The local authority in Paris has deposited 20,000 heavy-duty bicycles in 750 or so special racks around the city and anyone who wants one simply swipes his or her ordinary travel card and pedals off wherever they want to go.

The bike does not have to be returned to the same pick-up point - you can take a bike from a rack near the Eiffel Tower, cycle to the Pantheon and leave it in the nearest Velib stand there.

Mathieu Fierling, the deputy director of the scheme, believes it will suit Parisians and tourists alike.

"We've set things up so that the same card can be used for public transport and for Velib. You can set up a subscription for just one day or for a whole week and the subscription fee is minimal - one euro ($1.38; £0.68) to anyone who wants a one-off go or 29 euros ($40; £20) for a year's subscription."

Seems like a great idea. But as an economist would have predicted, people don't take care of other people's property quite as carefully as they take of their own. There was no deposit involved with the bikes, just a inexpensive user fee. The outcome isn't pretty (HT: Jeff Bliss):

Over half the original fleet of 15,000 specially made bicycles have disappeared, presumed stolen.

They have been used 42 million times since their introduction but vandalism and theft are taking their toll.

The company which runs the scheme, JCDecaux, says it can no longer afford to operate the city-wide network.

Championed by Paris Mayor Bertrand Delanoe, the bikes were part of an attempt to "green" the capital.

Parisians took to them enthusiastically. But the bikes have suffered more than anticipated, company officials have said.

Hung from lamp posts, dumped in the River Seine, torched and broken into pieces, maintaining the network is proving expensive. Some have turned up in eastern Europe and Africa, according to press reports.

Since the scheme's launch, nearly all the original bicycles have been replaced at a cost of 400 euros ($519, £351) each.

It evidently worked better in Lyon, a smaller town. Maybe norms and a different culture restrained people there from abusing the bikes and the system.

Loving the Gouger

From Reason comes the tale of David Strange, the generator man, bringing electricity to people in the wake of ice storms in Kentucky:

Enter David Strange, the enterprising figure the Associated Press calls the "generator man." Strange drove the hills and hollows of backwoods Kentucky delivering and setting up generators to those without power—at a $50 to $100 mark-up over retail. Willing customers included a dialysis patient and a powerless 80-year-old woman dependent on an oxygen system. They called him a "godsend," although Strange prefers "jack of all trades" or even "hustler." To Adam Smith, he would be recognizable as an agent of the invisible hand.

The World's Smallest Violin

Life is tough, isn't it? Circuit City goes broke, a lot of people are out of work, and some people are complaining that the liquidation prices on the Circuit City stuff aren't low enough. (HT:  Mark Anderson):

The news that all merchandise would be discounted 10% to 30% drew throngs of customers to stores across the nation over the three-day weekend. But many shoppers left angry and empty-handed.

"What happened to 30%? Lies!" shouted customer Gabriel Ifrah, 52, at the Circuit City on La Cienega Boulevard in Los Angeles on Monday, where most items were priced at 10% off...

At Circuit City stores Monday, most big-ticket items were marked down only 10%, including digital cameras, large flat-screen televisions, printers and cordless phones. Less pricey items, such as wiring, video games and video game accessories, were priced at 20% or 30% off.

"You have to start somewhere, and we have commitments to a lot of people -- banks, creditors -- who are expecting a certain amount of return, so it's not like we can go out there and go to the deepest discounts right off the bat," said Billy Nichols, senior vice president and director of merchandising at Great American Group, one of four liquidators involved in Circuit City's closeout. "This is a big financial risk for a lot of companies. We have to be economical on our discounts."

Relative Price Adjustments and Aggregate Demand

Some persons understand the role of relative prices -- understand that prices work only if they are permitted to adjust in order to reflect relative scarcities -- understand that the hardships that sometimes accompany such adjustments are the necessary price to pay for the fact that persons yesterday got the once-good jobs and built the once-good businesses that are so painful to lose today.

Other persons, upon encountering an unusually large number of price adjustments occurring simultaneously, worry that catastrophe looms.  To avoid this awful outcome, they demand more demand.  They demand either more money be injected into the economy, or more direct spending by government.  The idea is to raise demands across the board to levels that will make the old prices -- the pre-adjustment prices -- work as they worked before the underlying reality changed.

"If only people spent as much as they spent before, all would be well," these demand-more-demand people imagine.

One of the many blind spots in this view is that it causes its adherents to overlook the underlying changes in reality that sparked the price-adjustments in the first place.  It's dangerous business to ignore this reality by trying to recreate, as a kind of facade, the economic outcomes that prevailed before the underlying reality changes.  It's ultimately futile as a means of restoring vigor to a market economy.

Amity Shlaes in today's Wall Street Journal does a great job explaining some faulty reasoning of those who insist that the problem with economic downturns is inadequate aggregate demand.

Munger on Middlemen

The lastest EconTalk is Mike Munger talking about middlemen. In the first part of the podcast, he tells a wonderful story about the priest in the POW camp during WWII taken from R.A. Radford's 1945 Economica article, "The Economic Organization of a P.O.W. Camp." Here is the gist of the story:

We reached a transit camp in Italy about a fortnight after capture and received 1/4 of a Red Cross food parcel each a week later. At once exchanges, already established, multiplied in volume. Starting with simple direct barter, such as a non-smoker giving a smoker friend his cigarette issue in exchange for a chocolate ration, more complex exchanges soon became an accepted custom. Stories circulated of a padre who started off round the camp with a tin of cheese and five cigarettes and returned to his bed with a complete parcel in addition to his original cheese and cigarettes; the market was not yet perfect. Within a week or two, as the volume of trade grew, rough scales of exchange values came into existence. Sikhs, who had at first exchanged tinned beef for practically any other foodstuff, began to insist on jam and margarine. It was realized that a tin of jam was worth 1/2 lb. of margarine plus something else; that a cigarette issue was worth several chocolates issues, and a tin of diced carrots was worth practically nothing.

In the podcast, I mention that it's a bit of a puzzle that would make a good exam question. How can a priest, presumably an honest priest, engage in trade and end up with more of not just one good by trading for it and accepting less of something else, but more of EVERYTHING. That means everyone else, en masse, must have less. How did he manage it through voluntary exchange. In fact, he managed to make everyone he traded with better off. Yet, they seem to be poorer for it.

So listen to the podcast and in the comments section to that podcast, try to resolve the paradox of how an honest man can benefit others by leaving them with less than they had before.

The "Mysterious" Great Depression?

This insightful op-ed by West Virginia University banking theorist and historian George Selgin (dispensing the myth of the alleged 'mysteries' of the Great Depression), although written more than a year ago, is especially relevant today.  Here's a key paragraph:

Paradoxically, perhaps, the fact that orthodox economics has a good deal to say about how the Great Depression happened itself suggests that there is after all something puzzling about the Great Depression. What's puzzling is not that the depression happened, given policies that were resorted to, but that such destructive policies secured wide support despite their often readily-predictable, adverse consequences. But to call even such perversity a "mystery" is to be guilty of hyperbole. After all, politicians are rewarded for appearing to "do something," and not for their command of "abstract" theories.

She Earned an F

Here's a letter that I just sent to the Wall Street Journal:

Hillary Clinton wants government to temporarily "freeze rate hikes in adjustable-rate mortgages" ("Let's Keep People In Their Homes," September 25).

The Senator's reasoning is akin to that of weak students who - offering excuses such as "My grandma died" - ask me to change their grades.  I always refuse by saying that grades are like market prices: they reflect an underlying reality.  Were I to change a student's grade arbitrarily, I wouldn't change his actual performance in my class or his command of the material.  I would merely send to the world a false signal about him, and encourage him to rely on such excuses in the future.

As a teacher, I can't make students smarter simply by lying about the grades they've earned.  As a Senator, Ms. Clinton can't make housing more affordable simply by forcing mortgage terms to lie about the reality of high risks and scarce credit that are reflected by unregulated mortgage-interest rates.

Sincerely,
Donald J. Boudreaux

More on Short-Selling

Coyote Blog offers wisdom about short-selling.

Doh!

Let no one accuse politicians and bureaucrats of lacking Homeric courage.  When prices change in ways that disturb the electorate - whether it be gasoline prices rising or corporate share prices falling - the political class springs into action against prices that dare to truthfully reflect less-than-rosy underlying realities.

Like Homer Simpson who routinely deals with problems by closing his eyes and pretending that what he no longer sees no longer exists, government efforts to stop or modify price movements - such as the SEC's unprecedented ban on short-selling - merely blind markets to reality.  The result is immediate relief from unpleasant sights, followed by uncomprehending and harmful stumbling in the resulting darkness.

Optimism Quickly Fading

Like McCain, now I, too, would fire the head of the Securities and Exchange Commission (but for reasons different than those cited by Mr. McCain).

To ban short-selling of stocks is to short-circuit an important mechanism through which people share their knowledge and expectations with others.  Banning a mechanism that better allows share prices to reflect the expectation that the underlying assets are not worth as much as current market prices suggest does nothing to change the underlying reality.  Such a ban merely distorts knowledge of this reality.

My optimism about the future, which as recently as yesterday was real, is truly beginning to fade.  The news about the SEC's ban on short-selling is annoying; this news about a "vast bailout" is distressing.

Markets Anticipate the Future

Here's a letter that I sent today to WAMU, a local DC radio station:

Dear Sir or Madam:

This morning your reporter interviewed a resident of Galveston, Texas, about the effects of hurricane Ike.  The person interviewed said that she went to the gasoline station before Ike hit to "top off" her tank.  But she was angry to find that gasoline prices had jumped 50 cents per gallon from the day before.  "It's ridiculous," this woman opined. "Ike hadn't hit yet!"

Your reporter should have immediately asked this woman: "Well, why were you topping off your tank?  Ike hadn't hit yet."

Gasoline became more scarce -- more precious -- in Galveston the moment Ike's arrival became likely. Gasoline retailers acted in anticipation of the future no more or no less than did motorists (such as your interviewee) who topped off their tanks.

Sincerely,
Donald J. Boudreaux

Bush shows he cares

Hard core free market ideologue and mindless follower of Milton Friedman once again shows his religious support for laissez faire policies. (Sarcasm off).

Hayek in the Classroom

Over the years I have come to appreciate the depth of Hayek's insights, particularly in "The Use of Knowledge in Society," his 1945 American Economic Review paper. But how do you bring these insights into the classroom? How do you get students to understand what Hayek meant when he wrote about price adjustment:

Of course, these adjustments are probably never "perfect" in the sense in which the economist conceives of them in his equilibrium analysis. But I fear that our theoretical habits of approaching the problem with the assumption of more or less perfect knowledge on the part of almost everyone has made us somewhat blind to the true function of the price mechanism and led us to apply rather misleading standards in judging its efficiency. The marvel is that in a case like that of a scarcity of one raw material, without an order being issued, without more than perhaps a handful of people knowing the cause, tens of thousands of people whose identity could not be ascertained by months of investigation, are made to use the material or its products more sparingly; i.e., they move in the right direction. This is enough of a marvel even if, in a constantly changing world, not all will hit it off so perfectly that their profit rates will always be maintained at the same constant or "normal" level.

I have deliberately used the word "marvel" to shock the reader out of the complacency with which we often take the working of this mechanism for granted. I am convinced that if it were the result of deliberate human design, and if the people guided by the price changes understood that their decisions have significance far beyond their immediate aim, this mechanism would have been acclaimed as one of the greatest triumphs of the human mind. Its misfortune is the double one that it is not the product of human design and that the people guided by it usually do not know why they are made to do what they do.

Getting people to really appreciate the marvel of our economy is part of the reason I wrote The Price of Everything. But it is hard for most of us to use a novel in the classroom. We can use it in the class. That is, we can assign it. We can lead a discussion in class on the book. We can give an exam question based on the book. But it is hard to teach a novel in the sense of lecturing on it. It is for me anyway. So I wanted a more traditional way to teach Hayek's insights that would parallel the ideas in my book.

So I came up with this essay, "How Markets Use Knowledge." that tries to integrate supply and demand and Hayek's description of the price system as a marvel. Ironically, it treats the price system as "perfect" but I hope that I have been able to capture in a traditional supply and demand framework, some of what Hayek was getting at . Any and all reactions are welcome and I will revise it based on feedback I get from you and my students when I use it in class this semester.

If you are a teacher, please feel free to use it with your students.

I, 'I, Pencil'

Leonard Read's 1958 essay "I, Pencil" is unmatched among all publications in economics in its success at conveying an immense amount of profound wisdom in a style so accessible and charming.  (By the way, near the beginning of The Price of Everything Russ does a superb job of explaining how an economics professor might introduce this wisdom to students.)

My friend Roger Meiners recently created this PowerPoint presentation to accompany his lecture on "I, Pencil."  When Roger sent this presentation to me, he commented that his effort was much easier than Leonard Read's effort of 50 years ago.  "I just used Google to get many of the details and the pictures."

Think about it.  Millions of persons unknown to Roger contributed their skills, knowledge, time, and effort to make it possible for him, in just a few minutes (and at zero marginal pecuniary cost!), to create a PowerPoint presentation that will enable him to deliver a great lecture to his students.  How many people helped to build the computer he worked on?  To construct the cameras that captured the images?  To engineer the PowerPoint software?  To create and maintain search engines on the web?

The answer to each of these questions, and to each of many other similar questions that could be asked about this single, today-very-ordinary task of creating a PowerPoint presentation, is "countless."  In some cases hundreds of thousands of people; in some cases hundreds of millions -- perhaps billions -- of people.

No one knows how to make a PowerPoint presentation.  No one could possibly know all that there is to know about making a PowerPoint presentation.  The creation of such presentations requires the cooperation of uncountably large numbers of people from around the globe.  And yet, like the quotidian pencil, PowerPoint presentations are made and consumed everyday, and at minuscule cost.

That is the power of markets.

Economics Crimes

It is a crime to profit from helping others. (HT: Bill Eilberg) Much better to keep the price low and reduce the incentive for people to help. True, there will be less help. But no crimes. Phew.

Feathers and Rockets?

Here's a letter that I sent a few days ago to the New York Post:

You favorably quote an analyst's assertion that "motorists are getting hosed" because prices at the pump have not fallen enough recently to reflect the latest fall in oil prices ("Oil Drop Brings No Relief to the Pump," August 3).

Despite your seemingly supportive accompanying graph, this assertion is questionable.

First, according to the figures in your own graph, oil prices today are 55 percent higher than in late September of 2007 (the starting date in your graph), while gasoline prices today are 57.7 percent higher.  As evidence of hosing goes, these figures are very weak indeed.

Second, if we take a longer time horizon, evidence of hosing disappears completely.  In 2004, for example, a gallon of gasoline retailed for about $2.00 while a barrel of oil sold for about $33.  Today, oil's price is higher by 275 percent while gasoline's price is higher by only 100 percent.

Sincerely,
Donald J. Boudreaux

Cuts Both Ways

Here's a letter that I sent today to the Baltimore Sun:

Brad Heavner says that "drilling off our coasts would have no significant impact on gasoline prices - not in the short term, not in the long term, not ever" (Letters, August 3).  If so, then Mr. Heavner is mistaken to worry that such drilling would "increase our dependence on oil and produce more global warming pollution," for any such impact would also be insignificant.  An amount of oil that would affect prices only inconsequentially is an amount of oil that would affect global warming and Americans' use of oil only inconsequentially.

And see Ross Kaminsky on this topic.

Obamanomics

Here's a letter that I sent to the Aurora (Illinois) Beacon News:

Barack Obama proposes to deal with rising gasoline prices by giving a $1,000 "emergency rebate" to consumers - a rebate to be paid for by taxing the so-called "windfall profits" of oil producers ("Obama pitches $1,000 energy rebate checks," August 2).

In other words, a critical part of Sen. Obama's strategy for reigning in high gasoline prices is to subsidize gasoline consumption and more heavily tax its production. This plan - which increases the demand for gasoline and reduces its supply - makes as much sense as trying to put out a fire by dowsing it with jet fuel.

Sincerely,
Donald J. Boudreaux

Wal-Mart and Food

A good rule of thumb to follow these days is that any book or article that blames Wal-Mart for some real or imagined evil should not be taken seriously.  The meme "Wal-Mart is a destructive sorcerer spreading poverty and hardship throughout the world" is now so ingrained in the minds of so many Very Smart And Well-Read People that accusations against Wal-Mart are met with too little skepticism and scrutiny.  It's now a ritual to blame Wal-Mart -- and following this ritual, while it might sell books and make the heads of Very Smart And Well-Read People nod, too often signals mental laziness or analytical weakness or both.

The above paragraph was prompted by reading a review in today's New York Times Book Review, as was the following letter:

John T. Edge - reviewing Paul Roberts's apocalyptic book "The End of Food" - quotes Mr. Roberts's claim that today's "food system can only truly be understood as an economic system" ("Nothing to Eat," July 27).  Indeed so. Unfortunately, though, Mr. Roberts is starving for economic understanding.  Predicting that the age of abundant food is ending, he blames not only that timeworn (and mythical) scapegoat 'overpopulation,' but the devil du jour: Wal-Mart.

How does Wal-Mart hasten global hunger?  By continuing "to drive down retail prices to unsustainably low levels."  But when resources become scarcer - or when people working with those resources suspect their increasing scarcity - prices rise, not fall.  Falling prices signal greater abundance.  Whether Wal-Mart is a principal cause of this greater abundance of food or, more likely, a retailer especially skilled at bringing the advantages of greater abundance to its customers, the fact that Wal-Mart continues to lower the prices it charges for food is solid evidence that we can safely ignore Mr. Roberts's chicken-little-like assertions that we're running out of food.

Donald J. Boudreaux

Market Rally

Here's a letter that I sent yesterday to USA Today:

Concerned that oil is nonrenewable, Tim O'Neill wants government to "Rally the nation to find a way to reduce dependence on oil" (Letters, July 25).  This advice, alas, is at best redundant.  The market itself is "rallying the nation" on this front.  Oil's higher price reliably inspires consumers to use less of it and, simultaneously, prompts entrepreneurs to search for alternatives.  And the higher this price rises, the stronger these inspirations become.

Any further "rallying" by government would not only be overkill, it would risk infecting a natural market process with the poison of politics.

The Cost of Gasoline

Is gasoline now more expensive for consumers than it was in the 1970s (as claimed by, among others, the author(s) of this article in the most recent issue of The Economist)?  Adjusting for inflation seems to yield an answer of "yes."  The average retail price of a gallon of 87-octane gasoline in 1979, in the U.S., was 90 cents.  Adjusted for inflation, a gallon of regular gasoline retailed in 1979 at $2.67 reckoned in 2008 dollars -- more than a dollar less than gasoline is retailing for today.

But let's not be too quick to affirm the conclusion that gasoline costs consumers more today than it cost way back then.

While the inflation-adjusted dollar price at the pump for gasoline is indeed higher today than it was during the disco decade, consumers' expense of acquiring gasoline is arguably now lower.  The 1970s were notorious for long queues at filling stations.  These queues meant that consumers back then paid not only with dollars at the pump, but also with hours spent waiting in line (not to mention suffering anxiety over the prospect of being unable to get gasoline at all).

The average price of a gallon of gasoline in 1979 was (in 1979 dollars) 90 cents. So if a worker in 1979, earning that year's average hourly wage of $6.19, spent one hour waiting in line to buy five gallons of gasoline - a standard maximum amount that filling stations would sell to customers during periods of shortage - he would have spent, waiting in queues, $1.24 worth of his time for every gallon he bought.  The total cost per gallon to him would have been $2.14 ($0.90 in cash expense plus $1.24 in time expense).  $2.14 in 1979 was worth about $6.36 of today's dollars -- a cost per gallon much higher than the roughly $4 that we Americans now pay (without having to queue up for the privilege of filling our tanks).

Of course, the results of any calculation of the sort that I perform above are sensitive to the assumptions used (such as my assumptions of one-hour queuing time per gasoline purchase, and a five-gallon per purchase limit; by the way, you can find here a brief account of the 12 hours that my father and I shared in waiting in a queue to buy five gallons of gasoline during the summer of 1979).

The important pont is that, no matter how you slice it, the full price that Americans paid for gasoline during the many shortages of the 1970s was higher than the simple money prices they paid at the pump.

(HT to Hans Eicholz for drawing my attention to the article in The Economist.)

Inconsistent McCain

Here's a letter that I sent today to the Wall Street Journal:

John McCain credits the recent fall in oil prices to President Bush's announced support for more off-shore drilling and, hence, to the fact that the future supply of oil likely will be higher than previously thought. ("McCain Credits Bush For Drop in Oil Price," July 23).  Sen. McCain also blames the preceding run-up in oil prices on unjustified speculation.

Sen. McCain can't have it both ways.  Oil prices either chiefly reflect the underlying reality of supply and demand or they don't.  If baseless speculation caused oil's price to rise to heights unjustified by supply and demand - if speculators are financial sorcerers who detach prices at will from underlying economic realities - how does a presidential announcement signaling higher future supplies cause lower prices?  On the other hand, if a more promising prospect of greater off-shore drilling really is responsible for pushing oil prices downward (which I think more likely), why would Sen. McCain ever have blamed high oil prices on evil speculators rather than on the underlying conditions of supply and demand?

Note that I'm not saying here that speculators cannot drive prices to heights (or depress prices to depths) that are, on some reasonable calculation, inconsistent with the underlying conditions of supply and demand.  I concede the reality of bubbles, both positive and negative.  My point is that McCain is playing politics (duh!) to scream "evil speculators" when oil prices are rising and then announce "supply and demand" when oil prices are falling.

Skepticism about prices

Arnold writes:

Russ Roberts' not-yet-released novel The Price of Everything starts out by making the economic case for the snow shovel pricing mechanism. My wife read and enjoyed the novel (which is more than can be said for any of my own books, so I think Russ should be optimistic about his book's prospects). But afterwards, she was still skeptical, wondering if Russ and I are right, why don't more people think the way we do?

That is, if prices are so great at rationing scarcity, why don't people feel better about them?

It's a good question. A couple of possible answers.

1. We're (economists) wrong. High prices in a crisis are awful. We should rely on the benevolence of strangers rather than their self-interest.

2. People don't understand economics and the full effects of prices. They only see the transfer from buyer to seller and wish it were otherwise--that is, they wish they could have the good and pay the everyday, non-crisis price. They also tend to ignore the long-term incentive effects.

3. People understand economics, but are hardwired or culturally affected to be skeptical of transfers during a crisis.

I'm partial to number two. But three could be part of it, too. There are certainly many settings where we are averse to rationing via price--the family for example. We may carry those feelings into other situations as Hayek suggested.

Nonsense on Speculation

An especially clear example of the confusion that economically illiterate people suffer when thinking about speculation is this column today by Dick Morris and Eileen Mc Gann.  The core offending passage is here:

If there is any doubt that it is speculation, not the supply and demand for oil, that is driving up the price, look at this week's history of oil prices. After Bush announced that he was rescinding his father's executive order and permitting off shore drilling and after OPEC announced a weakening of oil demand, the futures market price dropped $15 per barrel. No new oil gushed through the system. The speculators just switched their bets from up to down.

Market prices reflect future as well as current conditions.  Just as, say, General Motor's share price would rise today if that company announced a major breakthrough in fuel-conservation technology - rise even though this technology might not find its way into GM's engines until years from now - so too does new information on greater supplies of oil tomorrow push today's oil prices down.

And it's good that this price adjustment happens today because such information means that oil is less scarce than previously thought.  Because there's more oil than previously thought available in the future, people need not be as careful today in consuming it. "Speculators" play a vital role in causing today's prices to reflect future conditions and, hence, in causing consumers and producers today to act in ways that are consistent with future reality.

Morris's and Mc Gann's supposition that the price of oil should be determined only by today's physical flows of oil -- and that supply and demand reflect only such immediate-run realities -- is wholly mistaken.

(HT Rudy Schober)

Pageant of Ignorance

Here's a letter that I sent on Monday to the Washington Post:

Re Robert Novak's "Oil Paranoia" (July 14): We humans have a long and embarrassing history of blaming devils for distressing aspects of reality that we don't understand.   Droughts, floods, plagues, and erupting volcanoes have all been ascribed to the machinations of unseen super-powerful entities – as ill-defined as they are ill-intentioned – who manipulate a reality to which they are immune but to which we mortals must inevitably bend.

Today's witch hunt for speculators who allegedly are driving oil prices to heights unconnected with the realities of supply and demand is just the latest entry in this pageant of ignorance.

Sincerely,
Donald J. Boudreaux

Carnival of Contemptibles

Jonah Goldberg's column in today's New York Post is excellent.  Here's a snippet:

Never mind that there's no evidence "speculators" - i.e. commodity traders - are doing anything to increase the price of oil. They aren't hoarding it; no one's cornering the market. The speculators make money when the price goes down, and they make money when it goes up. In short, they don't care if oil prices are high or low as long as they guessed correctly.

That may be the most infuriating part of all this. The speculators don't want high oil prices - but Washington does.

The US government has barred billions of barrels of oil from coming to the market by declaring huge petroleum reserves off-limits to drilling. Uncle Sam stores vast amounts in the Strategic Petroleum Reserve for a rainy day now called "election season." Government drives up pump prices with gas taxes and regulations against increasing refinery capacity.

Oil Speculation

This email arrived in my inbox this morning from United Airlines:

   

Dear Mr. Russell Roberts,

Last week, crude oil hit an all-time high of $146, and the skyrocketing cost of fuel is impacting our customers, our employees, the communities we serve, and the economy as a whole. United, and the majority of other major U.S. airlines, are asking our most loyal customers to join us in pushing for legislation to add more transparency and disclosure in the oil markets. Please see the attached open letter from the leaders of the U.S. airline industry.

   

An Open letter to All Airline Customers:

Our country is facing a possible sharp economic downturn because of skyrocketing oil and fuel prices, but by pulling together, we can all do something to help now.

For airlines, ultra-expensive fuel means thousands of lost jobs and severe reductions in air service to both large and small communities. To the broader economy, oil prices mean slower activity and widespread economic pain. This pain can be alleviated, and that is why we are taking the extraordinary step of writing this joint letter to our customers. Since high oil prices are partly a response to normal market forces, the nation needs to focus on increased energy supplies and conservation. However, there is another side to this story because normal market forces are being dangerously amplified by poorly regulated market speculation.

Twenty years ago, 21 percent of oil contracts were purchased by speculators who trade oil on paper with no intention of ever taking delivery. Today, oil speculators purchase 66 percent of all oil futures contracts, and that reflects just the transactions that are known. Speculators buy up large amounts of oil and then sell it to each other again and again. A barrel of oil may trade 20-plus times before it is delivered and used; the price goes up with each trade and consumers pick up the final tab. Some market experts estimate that current prices reflect as much as $30 to $60 per barrel in unnecessary speculative costs.

Over seventy years ago, Congress established regulations to control excessive, largely unchecked market speculation and manipulation. However, over the past two decades, these regulatory limits have been weakened or removed. We believe that restoring and enforcing these limits, along with several other modest measures, will provide more disclosure, transparency and sound market oversight. Together, these reforms will help cool the over-heated oil market and permit the economy to prosper.

The nation needs to pull together to reform the oil markets and solve this growing problem.

We need your help. Get more information and contact Congress by visiting www.StopOilSpeculationNow.com.

This was followed by facsimile signatures of the CEOs of AirTran Airways, Alaska Airlines, American Airlines, Continental Airlines, Delta Air Lines, Hawaiian Airlines, JetBlue Airways, Midwest Airlines, Northwest Airlines, Southwest Airlines, United Airlines, and US Airways.

Three thoughts. First, blaming speculators for high prices has always seemed to me like blaming the thermometer for how hot it is. Second, airlines speculate all the time on oil prices. I assume they hedge against future price increases. Notice that in this plea, they distinguish between paper speculators and "real" speculators as if that matters. Third, is it not strange that of all the policies that the airlines could advocate to bring down gas prices (more drilling, a change in environmental regulations, etc,) they choose this one?

The cynic in me says that the airlines must think it's good PR to look like they're fighting for lower prices and attacking speculators is about as riskless an approach you could choose.

Passover, Coke, and Ethanol

During Passover, traditional Jews from Eastern Europe have a custom of avoiding corn along with flour and bread and other forbidden foods. The idea is that corn can be used to make corn bread which might lead to confusion about what someone is eating.

As a result of this custom, Coca Cola does a run of kosher for Passover Coke that uses sugar rather than corn syrup. Some years back, Coke switched away from sugar and started using corn syrup as a sweetener. Part of the reason is that sugar in the United States is artificially expensive because of our despicable sugar quota system that benefits a handful of wealthy sugar beet and sugar cane farmers at the expense of the rest of us.

Supposedly there are Coke aficionados, purists, who prefer the taste of Coke with sugar to Coke with corn syrup. These folks find solace in either Mexican Coke which is still sweetened with sugar or kosher for Passover Coke. These purists stock up either when they are in Mexico or in April when kosher for Passover Coke is available. But there is a limit to how much you can stockpile--presumably in addition to inventory costs of money and space, after a while, the Coke just isn't fresh enough. I assume purists also care about freshness.

Well there is good news on the horizon for Coke purists. Now that the price of corn is being artificially raised by the ethanol mandates of the U.S. government, I suspect that Coke will go back to using sugar if they haven't already. Dear readers, if you come across anything on this switchover, please let me know.

Politicians Make My Eyes Tear Up

From today's Wall Street Journal:

As it happens, though, there's a useful case-study in the relationship between futures markets and commodity prices: onions. Congress might want to brush up on the results of its prior antispeculation mania before it causes more trouble.

In 1958, Congress officially banned all futures trading in the fresh onion market. Growers blamed "moneyed interests" at the Chicago Mercantile Exchange for major price movements, which could sink so low that the sack would be worth more than the onions inside, then drive back up during other seasons or even month to month. Championed by a rookie Republican Congressman named Gerald Ford, the Onion Futures Act was the first (and only) time that futures trading in a specific commodity was prohibited, and the law is still on the books.

But even after the nefarious middlemen had been curbed, cash onion prices remained highly volatile. In a classic 1963 paper, Stanford economics professor Roger Gray examined the historical behavior of onion prices before and after the ban and showed how the futures market had actually served to stabilize prices.

The fresh onion market is highly seasonal. This leads to natural and sometimes large adjustments in prices as the harvest draws near and existing inventories are updated. Speculators became the fall guys for these market forces. But in reality, the Chicago futures exchange made it possible to mitigate the effects of the harvest surplus and other shifts in supply and demand.

To this day, fresh onion prices still cycle through extreme peaks and troughs. According to the USDA, the hundredweight price stood at $10.40 in October 2006 and climbed to $55.20 by April, as bad weather reduced crop yields. Then it crashed due to overproduction, falling to $4.22 by October 2007. In April of this year, it rebounded to $13.30.

Futures trading can't drive up spot prices because the value of futures contracts agreed to by sellers expecting prices to fall must equal the value of contracts agreed to by buyers expecting prices to rise. Again, it merely offers commodity producers and consumers the opportunity to lock in the future price of goods, helping to protect against the risks of future price movements.

Supply and Demand Applied to Body Organs

In this post I argue that liberalizing the market for transplantable body organs -- that is, allowing adults to sell their body organs at unregulated prices -- will save lives.  In particular, I argue that

If organ sales were liberalized, the availability of organs would rise and their prices would fall. Transplant surgery would become more affordable and, thus, more lives - not only of the rich but of all classes - would be improved and saved.

An angry bear, commenting on this post, disagrees; he writes:

The organ is now donated and cost nothing, zero.

Consequently it does not contribute to the expense of the surgery.

But you argue that paying for something that is now free will lower the cost of the surgery.

Care to explain how this works?

And they let you teach economics to the children of Virginia.

I offered this response in the comments:

This claim is mistaken. Because the prohibition on organ sales keeps the quantity supplied of organs lower than it would otherwise be, it artificially limits the supply of transplant surgery, thus driving up the price of transplant surgery.

More organs means higher supply of transplant surgery and, thus, a lower price of transplant surgery.

Think of it this way: suppose a regulation were enforced that prohibited people from selling shoelaces. Such laces could be given away, but never sold. Would the price of shoes-with-shoelaces rise or fall? The naive answer is fall - because an essential input to shoes-with-shoelaces is formally priced at zero.

But the correct answer is that the price of shoes-with-shoelaces would rise, because the supply of shoes-with-shoelaces would fall. Therefore, by ending the regulation prohibiting the sale of shoelaces, the price of shoes-with-shoelaces would fall (because of the resulting increase in the supply of shoes-with-shoelaces).

One can look at the issue even more straightforwardly, but from a slightly different perspective, by asking: what would happen to the price of cars if automobile producers were prevented from selling their cars at prices higher than $0.  If you think that the price of cars would not rise, you fail.

In this post from October 22, 2004, I explain further:

What's Truly Sick

Here's a letter that I sent today to the Wall Street Journal:

Louise Benson says that allowing people to sell their transplantable body organs would result in poor people being "enticed by the money" to become suppliers; she thinks this outcome would be "sick" (Letters, May 31).  Ignore Dr. Benson's questionable presumption that her personal cultural aesthete should trump the freedom of other adults to make such choices.  Focus instead on the economics.  If organ sales were liberalized, the availability of organs would rise and their prices would fall. Transplant surgery would become more affordable and, thus, more lives - not only of the rich but of all classes - would be improved and saved.

What's truly sick is government's continued prohibition of organ sales.

Sincerely,
Donald J. Boudreaux

By the way, my GMU colleague Lloyd Cohen (who teaches in the law school) writes insightfully about organ donations.  Many of his papers can be found here at his website.

On Women and Assets

Here are two letters sent today to USA Today:

You suggest that women are less likely than men to seek political office because women have fewer political role models, and because "no one urges them to run"  ("Our view on women in politics: Reluctant to take the plunge," May 29).  I offer a different reason: women are more decent than men.

Fewer women than men itch to lord it over others.  Also, women are less willing than men to perform the countless asinine stunts and soul-shriveling pandering necessary to win political office.

Sincerely,
Donald J. Boudreaux

And

Re your editorial "One bright sign emerges in a gloomy housing market" (May 29) and the general dismay about falling real-estate prices and rising gasoline prices: What principle of economics suggests that markets are working well when the price of one asset (say, housing) rises, but not when the price of another asset (say, petroleum) rises?  What principle of ethics dictates that owners of one asset (say, housing) are entitled to capital gains and to enjoy these gains however large they might be, but that owners of another asset (say, petroleum) are not so entitled to their gains?

Finally, what moral precept advises us, in the case of petroleum products, to sympathize with buyers and demonize sellers, and in the case of housing, to ignore buyers and sympathize with sellers?

Sincerely,
Donald J. Boudreaux

Why prices rise

Steve Mufson at the Washington Post is bewitched, bothered, and bewildered about why oil prices keep rising. The headline:

Skyrocketing Oil Prices Stump Experts

The article begins:

Confused about oil prices? So are the experts.

Executives from the giant oil companies say it's partly the fault of "speculators" or financial players. Key financial players say it's really a question of limited supply and expanding global demand. Some members of Congress accuse the Organization of the Petroleum Exporting Countries for bottling up some of its production capacity. And OPEC blames speculators, wasteful U.S. consumers and feckless U.S. policy.

Almost everyone points at China's growing appetite for fuel.

Whatever the causes, one of the most dizzying runs in the history of oil prices picked up pace yesterday -- again -- as crude oil prices jumped to settle at more than $133 a barrel, up $4.19 in one day, 18 percent so far this month and more than one-third so far this year. Prices climbed even higher in late electronic trading.

After a few paragraphs explaining the impacts of the higher prices, the Post quotes an expert who does have a theory:

But the bigger question is: What has been driving the doubling of prices over the past year even as U.S. demand has stagnated and global output has continued without any major new disruption?

"The basic story that has brought oil from $20 to $130 dollars is that world demand is growing robustly when world supply is not," argued Jeffrey Rubin, chief economist of CIBC World Markets. "As a result, we need ever-higher world oil prices to kill demand in the [industrialized countries], which is exactly what's happening."

While U.S. demand has leveled off, Rubin said, demand in China is growing at a 12 percent rate, more than the 8 percent rate he forecast. While the extra increase in China is probably because of short-term factors, such as the earthquake or hoarding by the government in preparation for the Olympics, Rubin said even the lower rate would keep world demand growing briskly.

Hmmm. Seems pretty straightforward, doesn't it? Rubin doesn't seem stumped. I'm not sure why this article was written. I think the author wants one reason. China. Speculation. Greed. (Or more accurately, an increase in greed.) But the simplest explanation is that world demand is growing briskly and world supply is not as responsive.

If we want low gas prices, we should lower the costs of exploration and refining. If lowering those costs has environmental costs you don't like, stop complaining and get on your bicycle.

There is always a substitute

Economists usually argue that as oil gets more expensive, there is an incentive to discover new technologies and to switch to existing technologies that are only financially viable when oil prices rise. This innovation would fall into the latter class. (HT: Gil Arno)

The Price of Everything at Amazon

My new book, The Price of Everything: A Parable of Possibility and Prosperity is now available for pre-order at Amazon for the lovely low price of $16.47 in hardcover. Scheduled arrival is August 4. Here's the blurb:

Stanford University student and Cuban American tennis prodigy Ramon Fernandez is outraged when a nearby mega-store hikes its prices the night of an earthquake. He crosses paths with provost and economics professor Ruth Lieber when he plans a campus protest against the price-gouging retailer--which is also a major donor to the university. Ruth begins a dialogue with Ramon about prices, prosperity, and innovation and their role in our daily lives. Is Ruth trying to limit the damage from Ramon's protest? Or does she have something altogether different in mind?

As Ramon is thrust into the national spotlight by events beyond the Stanford campus, he learns there's more to price hikes than meets the eye, and he is forced to reconsider everything he thought he knew. What is the source of America's high standard of living? What drives entrepreneurs and innovation? What upholds the hidden order that allows us to choose our careers and pursue our passions with so little conflict? How does economic order emerge without anyone being in charge? Ruth gives Ramon and the reader a new appreciation for how our economy works and the wondrous role that the price of everything plays in everyday life.

The Price of Everything is a captivating story about economic growth and the unseen forces that create and sustain economic harmony all around us.

    Here are the back cover quotes:

Nassim Nicholas Taleb, author of "The Black Swan: The Impact of the Highly Improbable" : A remarkable use of parables and dialogues to convey economic intuitions. This should be mandatory reading for anyone who wants to understand this branch of applied philosophy we call economics.

Vernon Smith, Nobel Prize-winning economist : This is a great story about human, social, and economic betterment brought about by the forces of spontaneous coordination. It's also about justice and there's a warm ending. Read and enjoy.

Paul Romer, Stanford University : The Price of Everything illuminates the astonishing economic world we live in. This book could change your life--reading it will give you a sense of wonder about the everyday marvels that are all around us.

Deirdre N. McCloskey, author of "The Bourgeois Virtues" : The Price of Everything is sensationally good fiction and sensationally good economics.

   

I hope you like it.

Better than free

In my conversation with Chris Anderson, he mentioned in passing that free was as cheap as things can get. I answered that no, you can actually go lower than free. You can pay people to use your product, what is essentially a negative price, better than charging zero. Someone must have been listening. From the WSJ:

Microsoft Corp. hopes to make gains on Google Inc. in the lucrative business of Internet search through a new service that pays consumers who buy items they find through the software company's search service, according to people familiar with the company's plan.

The Redmond, Wash., software maker is rolling out a service called "Live Search cashback" that gives consumers money back on certain purchase of products found through Microsoft's live.com Web search service, the people said.

In Defense of Usury

Especially in light of the renewed efforts to regulate the terms that credit-card issuers are allowed to offer to borrowers, Jeremy Bentham's short little classic Defence of Usury is well worth reading.  Below is a germane passage.  Writing of a potential borrower whose circumstances put him in desperate need of money, Bentham says

A man is in one of these situations, suppose, in which it would be for his advantage to borrow. But his circumstances are such, that it would not be worth any body's while to lend him, at the highest rate which it is proposed the law should allow; in short, he cannot get it at that rate. If he thought he could get it at that rate, most surely he would not give a higher: he may be trusted for that: for by the supposition he has nothing defective in his understanding. But the fact is, he cannot get it at that lower rate. At a higher rate, however, he could get it: and at that rate, though higher, it would be worth his while to get it: so he judges, who has nothing to hinder him from judging right; who has every motive and every means for forming a right judgment; who has every motive and every means for informing himself of the circumstances, upon which rectitude of judgment, in the case in question, depends. The legislator, who knows nothing, nor can know any thing, of any one of all these circumstances, who knows nothing at all about the matter, comes and says to him—"It signifies nothing; you shall not have the money: for it would be doing you a mischief to let you borrow it upon such terms."—And this out of prudence and loving-kindness!—There may be worse cruelty: but can there be greater folly?

The folly of those who persist, as is supposed, without reason, in not taking advice, has been much expatiated upon. But the folly of those who persist, without reason, in forcing their advice upon others, has been but little dwelt upon, though it is, perhaps, the more frequent, and the more flagrant of the two. It is not often that one man is a better judge for another, than that other is for himself, even in cases where the adviser will take the trouble to make himself master of as many of the materials for judging, as are within the reach of the person to be advised. But the legislator is not, can not be, in the possession of any one of these materials.—What private, can be equal to such public folly?

Price Controls and the Reign of Terror

In their 1975 book The Age of Napoleon, Will and Ariel Durant argue that the Reign of Terror during the French revolution was sparked, in part, by price controls.

The economy itself was a battlefield.  The price controls established on May 4 and September 29 [1793] were being defeated by the ingenuity of greed.  The urban poor approved the maxima; the peasants and the merchants opposed them, and increasingly refused to grow or distribute the price-limited foods; the city stores, receiving less and less produce from market or field, could satisfy only the foremost few in the queues that daily formed at their doors.  Fear of famine ran through Paris and the towns....

On August 30 a deputy pronounced the magic word: Let Terror be the order of the day.  On September 5 a crowd from the sections, calling for "war on tyrants, hoarders, and aristocrats," marched on the headquarters of the Commune in the Hotel de Ville.  The mayor, Jean-Guillaume Pache, and the city procurator, Pierre Chaumette, went with their delegation to the Convention and voiced their demand for a revolutionary army to tour France with a portable guillotine, arrest every Girondin, and compel every peasant to surrender his hoarded produce or be executed on the spot [pp. 62-63].

Joe Kennedy II Wants More Regulation of the Oil Industry

Joseph Kennedy II knows neither the relevant history nor economics.  Here's a letter that I sent today to the Wall Street Journal in response to Kennedy's essay that appeared yesterday in that paper.

Joseph Kennedy argues for more government regulation of the oil industry ("We Need a New Bargain With Big Oil," March 22).  His argument, however, is suffused with ineffective anecdotes (such as the untearful tale of the "young mother, who had to move in with her mother to keep her children warm and healthy") - with mistaken history (Teddy Roosevelt's attack on Standard Oil was for "the good of the nation" only if the nation was served by breaking up a firm that steadily pushed the price of kerosene down) - with naivete about government (Mr. Kennedy assumes that all those additional powers that he demands for government will be exercised by apolitical geniuses) - and with bad economics (his assertion that private firms have no right to charge "whatever they want" reveals his failure to understand that prices convey vital information and incentives to producers as well as to consumers).

So why, exactly, did you publish Mr. Kennedy's uninformed and ill-reasoned essay?

Sincerely,
Donald J. Boudreaux

Feedback, knowledge and the division of labor

Arnold Kling over at EconLog tells the poignant story of worrying about his father's health care. Anyone who has had a loved one in the hospital can relate. There are a lot of smart and caring people involved in the treatment, yet no one is overseeing the process and noting the interactions between this specialist and that one. No one is watching the heart rate zealously. The overworked nurse under pressure from another patient fails to note something crucial on the chart. Lots of cooks but no one's in charge. Usually a family member has to play that role, a family member who more often than not doesn't have the time for the full-time assignment and more than often not doesn't have the expertise other than to ask a lot of questions.

Economists talk about the power of specialization and the division of labor. Economists talk about how well things can work when no one's in charge. In the hospital though, it appears not to work as well as it might. Lauren in the comments to Arnold's post asks the right questions:

For which kinds of economic entities does division of labor break down? Why is it that sometimes having no one individual in charge is the economic ideal that is coordinated by the invisible hand, and other times not?

One answer is that maybe it works better in the hospital than it looks. Would we really want our parents in the hospital to be treated by a generalist? There are enormous amounts of knowledge and technology being brought to bear in curing people in a modern hospital.

But it clearly could be so much better than it is. We want the benefits of specialization without the costs, the same way we get them in other areas of our lives. What we want is someone to coordinate the process, someone other than ourselves to look out for the hammer-nail problem. All the specialists I've known are people with a hammer. Everything looks like a nail. The surgeon wants to cut. The oncologist want to give chemo. Beside the interaction problem, you want to make sure you don't have a specialist blinded by too much specific knowledge who fails to see the bigger picture

So why do we need someone in charge in the hospital but not in the graphite industry? In the graphite industry, there are plenty of pencils, tennis rackets and fishing rods and the dozens (thousands?) of products that use graphite. We don't need a graphite czar to make sure there's enough graphite to go around. All the specialists that contribute to those products don't get out of control. Their interactions don't get ignored. As Hayek pointed out, the knowledge gets coordinated without a coordinator. Why does it work there but not in the hospital?

The simple answer is that the price system and profit motive interact in the graphite industry causing the whole thing to work smoothly without it being anyone's intention. The prices and the profit motive lead to feedback and accountability. There are a whole bunch of people with the incentive and the information to make the system work well.

The simple answer is right. But it cannot explain why other organizations work well without prices and profits. Within a firm and within a family, resources and decisions get made without prices and often without profits. The answer (as Coase understood and as Lauren notes in her comment) is that in these organizations, the savings in transaction costs overcomes the loss of feedback and information benefits from using prices. But there are still incentives. There still is a residual claimant who bears the costs of failure and the benefits of success—the boss or the parent. Love motivates the parent. Bonuses and keeping your job motivate the boss.

So why doesn't a hospital work better? The answer I think, is that the level of specialization in medicine has emerged from a process that has very few incentives to make sure that the level of specialization is as productive as it should be. There are very few informational feedback loops. Very little accountability. Sure, if a surgeon leaves a scalpel in your chest cavity and sews you back up, the surgeon bears a cost. And as a result, it doesn't happen very often. But the kind of errors that Arnold worries about, the kind of errors that I've worried about with my Dad in the hospital (and the kind I've seen made) are the ones that have little or no consequence to anyone other than the patient.

These errors are built into the system. When a drug leads to unexpected side effects because the right questions weren't asked, when an opportunity for a safer treatment is missed, when an aggressive treatment for one illness weakens the immune system and leads to other problems, who can you blame? Who bears a cost other than the patient?

You can blame the hospital of course, whatever that means, but the costs to the human beings who work in the hospital are small. There are no feedback loops within the hospital to reward generalists who look for the costs of specializations. And the reason there are not is because the patient is not the customer. The patient is not paying the bill. The financial incentives that do exist are coming from Medicare and Medicaid and the insurance companies. The normal feedback loops that protect the customer from error and greed and simple stupidity are missing. In a way, it's amazing it works as well as it does. It works as well as it does presumably because most doctors and nurses do care about the lives in their hands. But it's imperfect and could be much better.

And because there isn't a residual claimant within the hospital, it is left to the wife or the husband or the parent or the child of the patient to represent the patient's interests in the face of the decentralized incentives presented by the hospital and its specialists. Ironically, the monitoring and feedback comes from the family, another organization that is usually not using monetary incentives to improve performance. But the love works pretty well.

But the patient who is unrepresented for whatever reason, who must rely on the system itself to keep an eye on the treatment regimen is at a greater risk than the patient whose wife is a doctor or better yet, a loving doctor or better yet, a loving doctor who is at her husband's side 24/7 until he comes home safely.

It's a flawed system that will stay that way until the incentives change. In the meanwhile, my heart and prayers go out to Arnold and his Dad and to anyone with a loved one at a distance going through a medical challenge.

The Wages of Misunderstanding

Paul Krugman circa 1996 understood the point of this letter (below) that I sent yesterday to the New York Times.  Paul Krugman circa 2007 apparently doesn't:

Opposed to free trade, David Raines asks "How can it be good for workers to be subjected to competition from low-wage countries?" (Letters, December 27).  This question reveals a common misunderstanding.

Worker compensation in America is high because American workers are made highly productive by the great amounts of capital they work with.  (And by the way, America is rich in capital, in part, because she consistently runs capital-account surpluses - i.e., "trade deficits.")  Where wages are low, it is because workers in those places have little capital to work with and, therefore, are not very productive.

G.M. and Toyota continue to sell cars even though bicycles - a competing means of transportation, but one far less productive than cars - fetch much lower prices.  For the same reason, with free trade American workers will continue to sell their labor for high wages even though many workers abroad fetch much lower wages.

Sincerely,
Donald J. Boudreaux

Incentives vs. preaching

This Communist propaganda poster is worth many more than a thousand words (HT: Chris Fisher):

Miracles Performed Beneath Marble Domes

Rep. Bill Sali (R-Idaho) understands economic processes.  Here's his smack-down of minimum-wage legislation.  (HT to Amit Varma at India Uncut.)

"Your Call Is Very Important to Us"

I ruminate today, in the Christian Science Monitor, on spending time waiting on hold.

If This Is Monopoly In Action, Bring It On

Today I sent this letter to the Gray Lady:

You allege that Intel is guilty of "abuse of market power to protect [its] monopoly" ("F.T.C. Goes AWOL," October 29).  Sounds terrible - until we read that Intel's offense is to offer "big discounts and rebates to computer makers who minimize the use of processors made by rival Advanced Micro Devices." In other words, to keep customers, Intel keeps its prices low.

Monopolists raise prices; firms facing competition do not.  Intel keeps its prices low, meaning that it behaves competitively.  Yes, Intel's pricing practices make life more difficult for AMD and other rivals, but that's what competition is supposed to do.

Sincerely,
Donald J. Boudreaux

Rating Postal Rates

One of my students at George Mason University recently asked about my thoughts on the U.S. Postal Service's government-granted monopoly on the delivery of first-class mail.  I told him that I see no justification for that monopoly privilege -- that, if I could, I would eliminate it immediately.

"But postal rates aren't outrageous," he challenged (in good and appropriately skeptical spirit, I add).  "Wouldn't a true monopoly charge much higher rates?"

This question recalled to mind the very first letter that I published in the New York Times, back in 1994.  (It is co-authored with my good friend, the University of Georgia's George Selgin.)

It has been suggested that, because the nominal price of first-class postage is about where it was in the late 18th century, Americans who complain about the proposal to increase postal rates are merely whining wimps who are lacking in historical perspective.

However, the real price of transportation (a key input in postal service) has plummeted over the last 200 years. In 1799 it took 53 days for an Army courier to travel from Detroit to Pittsburgh.

Today the same trip can conveniently be made in minutes. Likewise, the productive efficiency of the United States is vastly greater now than it was even a few decades ago.

Given the plunge in transportation costs, joined with other technological improvements and a large increase in the scale of postal activity, the price of postage should have fallen dramatically.

Americans do not oppose postal-rate increases because of their ignorance of history. 

Rather, opposition to these increases grows from the correct perception that a legally protected monopolist such as the United States Postal Service can keep prices higher, and service inferior, to what these would be under competition.

Regardless of how today's postal rates compare with rates in the past, opening the delivery of first-class mail to competition would lower rates still further while improving service.

DONALD J. BOUDREAUX
G. A. SELGIN
Clemson, S.C., March 24, 1994

The writers are, respectively, an associate professor of legal studies at Clemson University and an assistant professor of economics at the University of Georgia, Athens.

Good luck, BLS

The iPod will be six years old next month. The newly released iPod Classic with 160 GB of memory is $50 cheaper than the original iPod, holds 40 TIMES more songs and also plays color videos and displays photos. It is smaller, lighter and has a better battery. I wonder how the BLS takes account of the quality differences when measuring the price index and inflation.

Cape Cod Traffic

In a comment on a recent post of Don's about Cape Cod, Spencer asks about my prediction about Cape Cod traffic. He is referring to this article I wrote in the Boston Globe last November where I predicted that the $62 million project to eliminate congestion at the entrance to the Cape was likely to fail. Here is what I wrote:

Getting rid of the rotary can't solve the traffic problem because it doesn't change the underlying cause of the congestion: the relative scarcity of sand and surf next to magnificent dunes.

A lot of wonderful scarce things are expensive. Think box seats at Fenway on a perfect night in June, Van Gogh's paintings, or a condo overlooking Central Park.

But sitting on the beach at Cape Cod is wonderful and scarce and relatively cheap -- cheap measured by the out-of-pocket costs of a day trip. So more people want to enjoy the Cape than there is room for them on the Cape's roads and beaches. Removing a rotary makes that problem worse, not better. It removes one of the costs of enjoying those beaches. So other costs emerge in response, though no one wants it that way.

Next July or August, there will be a new bottleneck. I'm not sure where it will be, but I'm confident it will be there. The only question is how bad it will be.

The first test of the so-called Sagamore flyover came on Memorial Day. The Globe reported:

For thousands of visitors, going to  Cape Cod   over Memorial Day weekend was much easier and more pleasant than heading home.

The new $60 million flyover, which erased the hated rotary at the base of the Sagamore Bridge, smoothed Cape-bound travel on Friday and Saturday. But drivers returning from the Cape Monday found themselves in a worse-than-usual traffic nightmare, with backups that stretched as far  as 17 miles to Yarmouth at midafternoon.

To avoid a repeat this summer, state transportation officials said yesterday they plan to install electronic signs urging vacationers to stagger their departure from the Cape as well as their arrival. Officials said they will also look at possible changes to the roadways around Exit 1, where Route 6A merges into Route 6 at the base of the bridge.

Evidently, there are still problems as this article a week and a half ago from South Coast Today illustrates:

For Gov. Dukakis, a recent trip to the Cape reiterated the need for the rail line when he and his wife sat in heavy traffic before and after crossing the Sagamore Bridge.

Money that went into the $62 million flyover project would have been better spent on rail lines, he said.

When something valuable (experiencing Cape Cod) is underpriced, it will inevitably be overused and congestion will ration access. Something that appears to be an engineering problem (an inefficient traffic rotary) is really an economics problem.

Two reports don't prove a prediction. I'd love to see some real data on whether delays are more common or less. Anybody out there have any info? Diligent observers can go here on Fridays and Sundays and make their own estimates of whether traffic is free-flowing. Meanwhile, here's a story from December 2003 that called it a $35 million project. I guess it's hard to keep costs down in Massachusetts.