Cafe Hayek

"If Only People Had Half a Clue as to Why this is Happening!"

My and Karol's dear friend Betsy Albaugh -- founder and owner of Betsy Fisher, the wonderful womens'-clothing store near Dupont Circle -- sent this site to me yesterday.  In her e-mail, Betsy said "If only people had half a clue as to why this is happening...."  Indeed.  The market -- humans' "propensity to truck and barter," property rights, reason, a worldwide division of labor and trade -- is why so many of us can sit in our living rooms, press a few buttons, and, by spending only a tiny fraction of our incomes, acquire marvelous goods from around the world.

Perspective

My latest essay in the Pittsburgh Tribune-Review is (are you sitting down?) on the benefits of free trade.  Here are some passages:

We've all seen a drawing that looks like two very different things depending upon how the viewer looks at it. In one case, for instance, what at first appears to be the craggy face of an old woman suddenly looks like a beautiful woman standing in a sexy pose. If you look for the old woman in the drawing, you see the old woman. If you instead look for the gorgeous babe, you see the gorgeous babe.

Same picture. Same objective reality. Two wholly different sightings.

And so it is in economics. The very same set of facts -- the very same objective reality -- often tells two (or more) very different stories depending upon the attitude and knowledge that the observer has when examining these facts. More imports from abroad and the losses of specific domestic jobs that they typically entail are seen by some as a sign of trouble for the domestic economy. Others see these same facts as a boon -- as the opportunity to get valuable goods and services at lower costs and as releasing scarce domestic labor to produce outputs that would otherwise be too costly to obtain.

.....

When trade is free, even craggy and slothful economies can be transformed into lively and fertile ones. That's my perspective.

Happy 109th, Fritz!

F.A. Hayek was born on this day in 1899.  To mark this occasion, I offer a brief passage from page 104 of Hayek's 1973 book Law, Legislation, and Liberty, Vol. 1: Rules and Order:

Maintaining the overall flow of results in a complex system of production requires great elasticity of the actions of the elements of the system, and it will only be through unforeseeable changes in the particulars that a high degree of predictability of the overall results can be achieved.

Interfering with trade and technological advances in order to protect certain producers from disappointment (and, hence, from the need to adjust to changes) not only makes the economy less productive over time, but also infuses it with greater uncertainty.

Fair Advice

I've never been invited to deliver a commencement address.  And I probably should never be so invited, for I already know the title I would choose: "Don't Change the World."  I would explain that it's okay -- indeed, admirable -- to change the world marginally, incrementally, by engaging in voluntary actions.  But all the "change the world" talk that high-school and college graduates get presumes that change, any change, is desirable -- as if the world is such a decrepit place that nothing about is worth preserving (except, of course, "the environment").  And all this "change the world" talk also tends to presume that doing things politically is the best way to effect worthwhile change.  (Update: Reader Bob Ewing kindly suggests that I add a link to this article of mine that develops this point further.)

Anyway, I digress.....  for the reason I post today is to recommend that you read P.J. O'Rourke's commencement-address-like ruminations.  (HT to Tom Hazlett)  Here's one of my favorite passages:

Life sends the message, "I'd better not be poor. I'd better get rich. I'd better make more money than other people." Meanwhile, politics sends us the message, "Some people make more money than others. Some are rich while others are poor. We'd better close that 'income disparity gap.' It's not fair!"

Well, I am here to advocate for unfairness. I've got a 10-year-old at home. She's always saying, "That's not fair." When she says this, I say, "Honey, you're cute. That's not fair. Your family is pretty well off. That's not fair. You were born in America. That's not fair. Darling, you had better pray to God that things don't start getting fair for you." What we need is more income, even if it means a bigger income disparity gap.

Seeing Past the Chicken Littles

Denver Post columnist David Harsanyi is superb.

Manufacturing and Employment

From Robert Samuelson's column in today's Washington Post:

From 1998 to 2007, total non-farm payroll employment [in the U.S.] rose 12 million, and unemployment averaged only 4.9 percent -- despite the 4 million lost factory jobs. In that period, U.S. manufacturing output rose 22 percent.

Krugman's Peculiar Sense of History

Paul Krugman makes a claim in his column (appearing in today's New York Times) that is both wrong and misleading.

The column features his familiar theme that ordinary Americans are suffering terribly as a result of the decrepit shape of America's current, GOP-ransacked economy.  Krugman's offending statement is the one in bold:

Our [that is, ordinary Americans'] bleakness partly reflects the fact that most Americans are doing considerably worse than the usual economic measures let on. The official unemployment rate may be relatively low — but the percentage of prime-working-age Americans without jobs, which isn’t the same thing, is historically high. [emphasis added]

Sounds ominous.  But what does this figure mean?  The closest statistic that I can identify to "percentage of prime-working-age Americans without jobs" is to start with (one minus) the labor-force-participation rate of Americans aged 25-54.  Then adjust that figure for the unemployment rate of Americans in that age group.

For example, if 90 percent of Americans between the ages of 25-54 are participating in the labor force (that is, either have or are seeking employment), then ten percent of Americans in this age-group are without jobs by choice (some, for example, are stay-at-home parents).  These ten percent of Americans without jobs are not "unemployed," for they are not in the labor force.

Then, to determine the actual number of prime-working-age Americans who are "without jobs," we must add to this 10 percent of Americans, in this age group, who are without jobs because they aren't in the labor force whatever percentage of the remaining 90 percent of Americans aged 25-54 are unemployed.  BUT because there's no reason to suppose that unemployment is hitting workers in this age group today significantly any harder or less hard (relative to workers in other age groups) than in the past -- and because, by Krugman's own admission, today's unemployment rate of 5.1 percent isn't especially high -- we can ignore this unemployment rate for my purposes.

So what am I getting at?  This: Krugman's statement that "the percentage of prime-working-age Americans without jobs, which isn’t the same thing, is historically high" is, as I said above, both wrong and misleading.

Look at Figure 1B on this page from the San Francisco Fed.  (HT Russ.)  It does not show the labor-force-participation rate for all Americans aged 25-54; rather, it breaks down the participation rate for Americans in this age group by sex.

Look at the labor-force-participation rate of men (aged 25-54).  That rate is indeed lower than in the past.  For the full time period reported in this Figure, that rate is indeed at an all-time low.  It peaked in 1953, and has been declining ever since.

Now look at the labor-force-participation rate of women (aged 24-54).  Not surprisingly, it has surged in recent decades, although leveling off a bit since around 1990 and even declining a tiny bit since around 2000.

It's highly unlikely that, given that today prime-working-age women participate in the labor force at rates vastly higher than was true even in, say, 1975, that the percentage of all Americans aged 25-54 who are "without jobs" is today lower than it was thirty or even twenty years ago.

Whatever is the percentage of prime-working-age Americans who are today "without jobs," it surely isn't -- contrary to Krugman's hysterical claim -- "historically high."

One possibility is that Krugman saw these, or similar, data and confused "men aged 25-54" for "all workers aged 25-54."  If so, then he's correct that the percentage of men in this age group "without jobs" is "historically high" (where "history" here is confined by the data that go back no farther than the late 1940s).  But today's "historically high" figure is part of a trend that began during the first year of the presidency of Dwight Eisenhower.  At that time, George W. Bush was seven years old.

(Note also that, although the labor-force participation rate of prime-working-age men has been declining for a half century, the trend is slight.  Even today's "historically" low figure is pretty darn high.)

So, to summarize.  Krugman is simply wrong to assert that the percentage of Americans of prime-working-age without jobs is "historically high" -- and misleading to suggest that, whatever this percentage might be today, that it is evidence of some major economy malady.  A rise in the percentage of prime-working-age persons "without jobs" might just as well reflect greater middle-class prosperity -- resulting in more years of schooling or early retirement -- as it reflects economic hardship (such as workers so discouraged by their futile job searches that they just call such searches to a halt).

BTW, this post from Megan McArdle on labor-force-participation is worth reading.

The Market, Not Nature, Is Bountiful

Robert Kennedy, Jr., recently wrote this letter to the editor of the New York Times expressing his opposition to building hydroelectric dams in Chile.  I sent my own letter in response to Mr. Kennedy's missive:

Robert Kennedy, Jr., might be correct that electricity is best provided in Chile by means other than hydroelectric dams (Letters, April 8). His presumption, however, about the source of prosperity casts doubt on the quality of his argument.

Mr. Kennedy opposes dams because he wants to protect "nature's bounty."  But nature is not bountiful. If it were, human history would be one of prosperity and long, healthy lives rather than one of oppressive poverty and short, miserable lives.  Nature is miserly.  The bounty that Mr. Kennedy presumes comes from nature is, in fact, the relatively recent product of human creativity and industry unleashed by free markets - and now threatened by the mindless worship of nature.

Sincerely,
Donald J. Boudreaux

The Monster That Is Mercantilism

The Washington Times recently published this letter by William Hawkins.  It's proof that the monster that is mercantilism remains alive, kicking, and screaming.

Today's edition of the Washington Times published a letter that I sent in response.  Here it is:

Not only does William Hawkins misunderstand the principle of comparative advantage, but he incorrectly suggests that it is the lone pillar supporting the case for free trade ("Economic theory ignores reality," Letters, Monday).

Adam Smith didn't know about comparative advantage when he wrote "The Wealth of Nations," but his case for free trade remains powerful. Smith explained that free trade expands the size of markets, making possible capital investments and greater specialization of workers.

These investments, along with the improved skills that highly specialized workers learn, increase output and wages. Confining economic activity to the nation keeps the market artificially small and, thereby, reduces opportunities for output-expanding investment and specialization.

Smith also explained a danger that Mr. Hawkins who wants government to pick economic "champions" overlooks: "The statesman who should attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it."

DONALD J. BOUDREAUX

The Challenge is to Create, Not Jobs, but Wealth

Today I sent this letter to the Washington Times:

Like economic alchemists, Senators Clinton and Obama peddle plans to spend billions of taxpayer dollars on various government projects that will create millions of jobs ("Obama's economic plan," February 20).

Creating jobs - creating demand for workers - is no challenge.  Vandals and arsonists do so routinely.  What is a challenge is to create opportunities for workers to earn good incomes while producing real value for others, where value is confidently measured by the amounts that buyers voluntarily pay for what is produced.  As far as I know, Sens. Clinton and Obama (and, for that matter, McCain) have never created a business whose success relied upon producing outputs efficiently and then selling these outputs at prices attractive to consumers.

So why suppose that any of their "plans" to create innovative industries and jobs are anything more than the cheap-to-dream-up fantasies of self-important politicians accustomed to spending other people's money?

Sincerely,
Donald J. Boudreaux

A Tribute to Julian Simon

Were he still alive, Julian Simon would have turned 76 yesterday.  Unfortunately, he died in 1998 just four days shy of his 66th birthday.  Here's a tribute that I wrote to Julian, published in today's edition of the Pittsburgh Tribune Review.  And here are some core paragraphs:

Simon's most important contribution was to crystallize and explain an insight that even the best economists before him only glimpsed -- namely, that human beings in free societies are "the ultimate resource." Nothing -- not oil, not land, not gold, not microchips, nothing -- is as valuable to the material well-being of people as is human creativity and effort.

Indeed, there are no resources without human creativity to figure out how to use them and human effort actually to do so. Recognizing the truth of this insight renders silly the familiar term "natural resources."

No resources are "natural."

Take petroleum. What makes it a "resource"? It's certainly not a resource naturally. If it were, American Indians would long ago have put it to good use. But they didn't. I suspect that for Pennsylvania's native population in, say, the year 1300, the dark, thick, smelly stuff that bubbled up in watering holes was regarded as a nuisance.

Petroleum didn't become a resource until human beings creatively figured out how to use it to satisfy some human desires and other human beings figured out how to extract it cost-effectively from the ground.

Or take land. For at least 80 percent of Homo sapiens' time on earth, land was merely something to trod and hunt upon. Land had no special value as a resource until about 10,000 years ago when someone figured out how to cultivate soil and to plant, tend and harvest crops. Only then did land achieve the kind of status and value that we associate with a resource.

The same, of course, is true for magnesium, iron ore, bauxite, feldspar, trees, New York harbor -- you name the "natural resource" and you'll realize that it is a resource only because human beings creatively determined how to use it productively.

An important implication of this realization that humans are "the ultimate resource" is that high and growing population -- in societies with sufficient freedom to allow individuals to experiment and create -- is desirable. If human creativity and effort are not only resources, but also the ultimate resource, surely it's foolish to lament large and growing supplies of it.

Telling Stories

Which of these stories is right?

The Giants will win the Super Bowl. They have the momentum on their side. They have a great pass rush. They will be more relaxed than the Patriots because they don't have the pressure of the perfect season. They'll be able to control the ball with Brandon Jacobs. Manning hasn't thrown an interception in the playoffs.

Or is it this one:

The Patriots are the better team. They have Super Bowl experience. They have the better coach. Their quarterback is better.They will shut down the Giants running game and force Manning to make mistakes.

So which one is better? Neither, of course. They're just stories. But on Monday, one narrative will look convincing and the other will look foolish. But of course there was no way to really know ex ante which story was better. Ex post it will seem obvious. But even ex post, judging the stories or the storyteller is just so much finger-snapping. It's just one data point. Don't be fooled by randomness.

Can a camel understand football?

From the Asbury Park Press:

Forget what the sports analysts are saying. Super Bowl XLII will end in victory for the New York Giants, according to Princess, "Popcorn Park Zoo's famous prognosticating camel," the zoo announced Monday.

Princess had an 11-6 won-loss record for games picked during the season. And "her playoff standings were phenomenal, selecting eight out of 10 winning teams. Last week she accurately predicted the Patriots for the championships, but not the Giants," the zoo press release states.

Each week, Popcorn Park's general manager, John Bergmann, has had the names of two teams playing that weekend written on his hands. Then he offered Princess her favorite snack — graham crackers — in both hands. Whichever hand she nibbled from, that was regarded as her choice in the game.

"I can't explain it, but her predictions, more often than not, are right on the money," Bergmann said. "I'm hoping she's right this time, because I'm a Giants fan."

I think most people understand that the success of Princess is not due to her understanding of football, or her "gut feeling" or her intuition. It's just random. But on Monday morning, some human football "experts" will seem smart and some less so, simply because of one data point, the result of Sunday's game.

 

Which story is better:

The economy is in crisis. The subprime mortgage mess has taken down the housing market and thrown the banking industry into turmoil. The crdeit crunch that is inevitable will soon knock out other industries as well.  The anemic December job numbers (18,000 net jobs created) show are just the beginning of the problem. A recession is imminent or we may already be in one. We have to do something.

Or is it this one:

Yes, housing and banking are struggling. But the rest of the economy is healthy. The December job numbers were atypical. Unemployment claims are down. We don't need a stimulus package.

Who is right? Tomorrow, February 1, the January job numbers will be released. There are hints that they will be very strong. Some people's stories will look wise and others less so, at least for a while. If the numbers are strong, the worriers will find some other data point to wave around.

But I suspect the experts are like Princess, the pigskin prognosticating camel. We are fooled by randomness. We don't really understand the macroeconomy. Certainly not enough to micromanage it.

Stimulie, II

Here is federal tax revenue collected from the income tax on individuals from 2000-2006, reported by the CBO (Tab #3), measured in billions of dollars:

2000    1,004.5
2001    994.3
2002    858.3
2003    793.7
2004    809.0
2005    927.2
2006    1,043.9

Bottom line: revenue in 2006 was still below 2000 in real terms. I'm not sure when the Bush tax cuts first started. The first cuts were passed in 2001 but there was a rebate akin to what's being discussed now--a lump sum retroactive cut, if I remember correctly. Not sure when that happened and when it affected the revenue numbers. But even between 2001 and 2006, real revenue is down.

Here are the numbers for all sources of federal revenue, same CBO report, again, billions of dollars:

2000 2,025.5
2001 1,991.4
2002 1,853.4
2003 1,782.5
2004 1,880.3
2005 2,153.9
2006 2,407.3

That's about a 19% increase from 2000-2006. The GDP price deflator increased about 16% over that time period. So total revenue was roughly flat with a smaller percentage coming from the individual income tax.

I post these numbers in response to a friend (who will be spared identification here) who said the key to keeping the economy on track is to keep the Bush tax cuts in place. He gave two reasons—the tax cuts spurred economic activity that increased tax revenue. And the tax cuts put more money in our hands and less in the government's hands. And because we spend money more wisely than the government, this is a good thing.

But the revenue effect was negative. As to who was spending the money, read on.

There were some good things about the Bush tax cuts—particularly the (temporary) elimination of the estate tax which I view as immoral and possibly discouraging of productivity and creativity. The threat of even higher deficits that they may have created may have kept government spending from being even higher.

But the across-the-board reduction in marginal rates was an illusion. It wasn't really a reduction in taxes. It lowered revenue at the same time that spending was going through the roof. Here are federal outlays in nominal terms, measured in billions, from the same CBO report:

2000 1,789.2
2001 1,863.2
2002 2,011.2
2003 2,160.1
2004 2,293.0
2005 2,472.2
2006 2,655.4

That's a 48.4% increase. between 2000 and 2006.  Again, the GDP price deflator rose about 16% during that time. That's a massive increase in real government spending during a time when tax revenues were essentially flat. To be fair to Bush, you can't blame him for the spending level in 2001. But between 2001 and 2006, it's still a real increase of over 30%. Bush didn't veto a single bill until July of 2006 and that was a stem cell research bill.

So what kind of a tax cut did Bush provide? George Bush (along with Congress) has raised our taxes. Government has gotten bigger. Here is the ratio of federal outlays relative to GDP, the federal government's share of the pie:

1988 21.2
1989 21.2
1990 21.8
1991 22.3
1992 22.1
1993 21.4
1994 21.0
1995 20.7
1996 20.3
1997 19.6
1998 19.2
1999 18.6
2000 18.4
2001 18.5
2002 19.4
2003 20.0
2004 19.9
2005 20.2
2006 20.3

Government's share of the pie has grown dramatically under Bush II. You can argue it was worthwhile. You can argue that he had no choice. (I think you'd be wrong on both counts, but never mind.) But you can't argue that Bush has cut our taxes. Our taxes are higher and they've been shifted into the future via debt.

Notice also that government's share fell during the Clinton years. Yes, I know that's partly because of the Republican Congress. Partly. But it reinforces my view that partisanship is overrated.

George Bush likes to say that he gave us back "our" money because we could spend it more wisely. While I agree with the premise, it was an illusion. There weren't any tax cuts in 2001, 2002 and 2003 that supposedly stimulated the economy or that let us spend the money more wisely than the government. The government spent more of our money, not less.

Spend or save

There's a debate in the comments to this post about whether recipients of tax rebates spend or save them. There's no right answer. It's an empirical question. I was just giving the intuition for why people might save rather than spend a windfall gain, given that most people just presume it will increase spending. I will try and give some more empirical evidence down the the road. Meanwhile, you might find this survey result about the rebates of 2001 of interest:

A poll by the Gallup organization recently asked around 1,000 adults how they would spend their rebate checks. Seventeen percent said they would spend the money,       while 47 percent said they'd use the cash to pay off bills. Thirty-two percent plan to save or invest it.

It's only a survey. But I thought you'd find it interesting.

Stimulie, I

After my commentary on NPR, I spent a lot of time last week talking to bright non-economists about the various proposals to stimulate the economy by giving people money. Most of them presumed that of course giving people money will improve the economy. I realized that most people have trouble with what might be called "macro intuition." So I thought I would start a series of brief observations on why giving people money is unlikely to cause the economy to grow.

Let us begin with the most basic question. If you received a windfall, that is, an unexpected increase in your income, what would you do with it? The right answer is that it depends. If it is a one-time increase, you would respond differently than you would if it were a permanent increase. A one-time increase is more likely to be saved compared to a permanent increase. With a one-time increase, you might use it to pay off current debt. Or you might add it to your savings. Or you might spend some of it and save the rest. Or you might spend all of it.

Would the answer depend on where the money comes from? It would seem to be irrelevant, but it's not. If you are the only person receiving the money, say from an unexpected inheritance, you might respond differently than you would if you knew that everyone was getting a tax reduction.

Let's consider two different situations.

1. Your rich uncle dies who hated you. But he left you money anyway—$1600. What do you do with the money?

2. The government announces a $1600 rebate for all families, financed by borrowing. What do you do with the money?

With the inheritance, you feel a little richer. You might splurge on a fancy weekend in New York. Or you might save all of it. Or something in between. But with the rebate, you are less likely to spend it. Why? Because your taxes (or someone's taxes) are going to go up in the future and that will discourage the feeling that you're wealthier. It's not just a feeling. We as a society aren't any wealthier. To see the importance of this effect, imagine that the government announces that there will be no taxes collected this year. Concerned about a recession, the government is collecting no taxes in order to encourage consumer spending.

Consider a family that because of the magnitude of this tax cut, finds they have an extra $16,000 available rather than a mere $1600. Imagine the husband calling his wife. "Honey, great news. The government isn't going to collect any taxes this year. We have an extra $16,000 to spend. Now we can finally (choose one: take that cruise, replace the minivan, renovate the bathroom)."

The wife replies "Well, if the government isn't going to cut spending (and they're not, because that would offset the stimulus of the tax cut, wouldn't it?), then it's going to have to borrow all the money to cover its spending for this year. The bonds the government sells are going to have to be repaid. We're going to have higher taxes next year and the year after. I think we better put that $16,000 aside to pay for those taxes."

Who wins that argument?

The wife, don't you think. So if a $16,000 tax rebate isn't going to stimulate spending, why would a $1600 rebate? Because people won't realize that they're going to have higher taxes in the future?

And as will see in future posts, even if it is different, it still isn't clear that it will stimulate the economy.

Stimulus

Here is my commentary from NPR's All Things Considered on why a stimulus package is unlikely to stimulate. The link will take you to my newly designed site where I am archiving all my essays and related material.

Future Jobs

The following letter of mine is published in today's edition of the New York Times:

To the Editor:

Bob Herbert quotes the observation by Andrew L. Stern, president of the Service Employees International Union, that Americans today “cannot see where the jobs of the future are that will allow their kids to have a better life than they had.” Mr. Stern adds, “And they’re not wrong.”

But when could Americans of any generation foresee future jobs? Did the blacksmith in 1890 foresee jobs in the auto industry? Did the corner grocer in 1940 foresee his son prospering as a regional manager for Wal-Mart?

Did the telegram-deliverer in 1950 foresee his child designing software for cellphones? Did the local pharmacist in 1960 foresee his daughter’s job as a biomedical engineer?

Our inability today to see the details of the future is no more worrisome than was the same inability of our grandparents. 

Donald J. Boudreaux
Fairfax, Va., Dec. 22, 2007
The writer is chairman of the economics department, George Mason University.

Does It Matter that Other People Save? Yes. Does the Nationality of these Savers Matter? No

Arnold Kling insightfully points out that among the distinguishing features of economics as it is taught and researched here at George Mason University is that we resist the temptation to treat abstract collectives as acting, relevant beings.  The typical GMU economist doesn’t believe that just because a group of people are conventionally called by a certain name – “Americans,” or “Ukrainians,” or “Taiwanese” – that such a designation carries much economic relevance.

Nowhere is the need to “lose the we” more important than in discussions and analyses of international trade – and in particular in discussions and analyses of the so-called “trade deficit.”

Nearly every American is part of the economy that can, without risking too much misunderstanding, be called the American economy -- or, alternatively, the global economy.  But also part of this economy are foreigners who sell their goods and services to Americans – so too are foreigners who buy American-made goods and services – so too are foreigners who invest in dollar-denominated assets.

It’s easy to confuse Americans getting poorer with the American economy getting worse.  The latter does not necessarily follow from the former.

Suppose that 100 percent of Americans are irresponsible spendthrifts – something like the teenager who, upon receiving his first paycheck, spends it all on beer and rock concerts.  Clearly, unless this teenager changes his habits, prosperity beyond the norm will not come his way.  But if American institutions – work habits, trustworthiness, laws, structure of government, and so on – remain attractive to investors, then capital will continue to be invested in America.  New jobs will become available, jobs offering higher and higher pay.  New products and services will be produced, and their qualities will generally rise and prices generally fall over time – becoming more and more affordable even to spendthrift Americans.

Of course, in this scenario all investments will come from non-Americans – from foreigners who, being more prudent and patient than Americans, save and invest part of their current earnings in the economy of which Americans are part.  This economy thrives even if (in this unrealistically extreme example) no American enjoys the fruits that come from owning assets deployed in a vibrant economy.

Americans thrive more than they would thrive if foreigners didn’t invest in America (or if foreigners invested less in America).

Here’s good news for all of us who live in the United States: as long as lots of people are willing to invest in the U.S. economy, we will enjoy benefits over time even if each of us Americans is a spendthrift.  It should make no difference to me or to you if those people who do invest in the United States have passports issued by Uncle Sam or have passports issued by some other government.  If you are a spendthrift, you will not, of course, benefit from this thriving economy as much as you would if you became one of the savers and investors.  But whatever is your own personal rate of saving and success at investing, your material prosperity will be higher the greater is the willingness of other people – including foreigners – to invest in the American economy.

Put differently, if you become the only American willing to save and invest, and if foreigners (for whatever reason) stop investing in the American economy, you will likely be much worse off over time than you would be if you continue your spendthrift ways and foreigners continue their saving and investing-in-America ways.

Marvelous Arrangement

One fact of arithmetic that ceaselessly impresses me is that the number of different ways to arrange, in a single dimension, a mere 20 items is much larger than is the number of seconds in ten billion years.  (I first encountered this fact in something written by Paul Romer, and was reminded of it by something written by Virginia Postrel.)  This simple yet startling arithmetical ditty contains important lessons about economics -- some of which I explore in my latest column for the Pittsburgh Tribune-Review.

My conclusion is this:

Private property ensures that resource arrangements will not be random. Each resource owner chooses a course of action only if it promises rewards to the owner that exceed the rewards promised by all other available courses of action.

For each consumer, this means spending money on those items that best satisfy his individual tastes. For each producer, this means finding those uses that promise the highest profit. Because profit in free markets comes from satisfying as many consumers as possible, each producer is forever on the lookout for better ways to use his resources to satisfy consumers.

Because private property gives to each resource owner (including people who own just their own labor) both the power to reject unattractive offers and incentives to use his resources in ways that generally do much to help others, the result is a system of peaceful, productive, mutual accommodation.

F.A. Hayek called this result a "marvel." It's a breathtakingly complex and productive arrangement of countless resources. This arrangement emerges and evolves over time as the result of billions of individual, daily, small decisions made by persons seeking to better employ their resources and labor in ways that other people find helpful.

Although unplanned, this order is governed by a strict logic -- that of mutual accommodation -- a logic contained only in the institution of private property.

Creating Value

There are two kinds of people in the world.  Members of the first group think of jobs as being rather like boxes, each of which has a monetary figure on it as well as a set of levers inside.  A job-holder occupies a box, yanks on the box's levers, and in return receives pay in the amount of the prescribed monetary figure.  Lucky workers are those who land in boxes paying big money and whose levers are easy to manipulate; unlucky workers are those who find themselves in boxes paying little money and whose levers are difficult to manipulate.

The second group of people in the world understand that real jobs are a matter of creating value for buyers.  The greater the amount of value I create for others, the better -- or, at least, the higher-paying -- is my job.  In markets, your job isn't a box that you get assigned to; your job is an opportunity to perform, to help improve the lives of others and, in return, to persuade these others to help you improve your life.

And one of the most important of these performances is corporate management -- the ability to coordinate large amounts of resources, time, and workers in ways that create large amounts of value for others and that makes it easier for those of us with less vision and administrative ability to find jobs that maximize the value that each of us, individually, creates for others.

Charles Koch, CEO of Koch Industries -- and author of the just-released The Science of Success -- is one of our era's great entrepreneurs and managers.  (He is also a stalwart supporter of economic education and classical-liberal values.)  Washington Times columnist Richard Rahn has this nice overview of Charles Koch and his book.

The System Is the Solution

Here's my latest column in the Pittsburgh Tribune-Review.  In it, I argue that people's propensities -- as uncovered by behavioral economics -- to behave "irrationally" from time to time do not mean that the market will fail to perform well.

Economic Change

John Baden writes about how life has changed in Montana:

From the Civil War until Earth Day, only approximate benchmarks, our region had a coherent culture, economy, and politics. The glue holding them together was commodity exploitation and conversion. The folks who mattered in community life manipulated real stuff, cows and trees and water and grain, not symbols and electrons. People dealt with the furniture of the world and cheating was easily exposed. Folks were interdependent, knew it, and acted accordingly. That’s what’s gone.

Now things really are different. Ever more people’s incomes are independent of their locations. And ever more folks want to live in places with Bozeman’s qualities. Consider growth in America. The locational advantages of Cleveland, Baltimore, and Detroit are gone -- all have lost population. What’s booming? Bellingham, Boise, Bend, and Billings all are growing rapidly.

It's a nice piece on coping with change. The whole thing is here.

The Capitalist Peace

In the forthcoming January 2007 issue of the American Journal of Political Science, Columbia University political scientist Erik Gartzke has a gem of an article.  Its title is  "The Capitalist Peace."  (It isn't yet available on-line.)  In this paper, Gartzke refines the argument that he presented in the Economic Freedom of the World: 2005 Annual Report, co-authored with James Gwartney and Robert Lawson.

Here's the abstract from Gartzke's forthcoming paper:

It is widely accepted that democracies are less conflict prone, if only with other democracies. Debate persists, however, about the causes underlying liberal peace. This paper offers a contrarian account based on liberal political economy. Economic development, free markets, and similar interstate interests all anticipate a lessening of militarized disputes or wars. This paper shows that this “capitalist peace” subsumes the effect of regime type in standard statistical tests of the democratic peace.

Economies are Long-Run Processes

Paul Krugman, among others, has warned that today's economy is scarily different from economies in the past.  His reasoning, as explained in this June 16, 2006, column in the New York Times, is this:

In fact, the distinctive feature of the current economic expansion -- the reason most Americans are unhappy with the state of the economy, in spite of good numbers for the gross domestic product and explosive growth in corporate profits -- is the disconnect between rising worker productivity and stagnant wages.

I've never bought the implication that productivity is really disconnected from workers' compensation.  Capital is too fluid and the American labor market too competitive for such a "disconnect" to be lasting.  The fact that such a "disconnect" shows up in economic reports reveals more about the shortcomings of inferring long-term trends from the happenings during arbitrary (and ususually short) time periods such as "month," "quarter," or "year."

Now today's Boston Gbobe has this report, entitled "Pay outpaces productivity: inflation feared."  And here's a letter that I sent to the Globe in response:

Dear Editor:

For months we've been warned that the current economic recovery differs ominously from past recoveries because worker pay now is rising more slowly than worker productivity.  But in today's paper we read that "Growth in productivity - the key ingredient for rising living standards - skidded to a standstill in the late summer while workers' wages and benefits shot up at the fastest clip in more than two decades" ("Pay outpaces productivity: inflation feared," Nov. 3).  In other words, workers' pay is catching up with their productivity, just as economics predicts.

Economies are long-run processes; they should be evaluated as such.  What happens in any arbitrary time period - a month, a quarter, or even a year - typically is too filled with short-run distortions and lags to present a reliable picture of an economy's long-run trajectory.

Sincerely,
Donald J. Boudreaux

By the way, just as we have no real reason to fear that wages will not keep pace with worker productivity, we also -- for a variety of reasons -- have no reason to fear that rising wages will cause higher inflation.

High-Status Publication

My colleague Dan Klein is the founder of the on-line journal Econ Journal Watch ("EJW").  It's an outstanding publication.  The September 2006 issue is just released; here's a link.

I especially look forward to reading Dan's own piece (co-authored by GMU economics PhD student Andrew Kashdan) on Robert Frank's argument that higher tax rates can help reduce wasteful jockeying for status.  And I look forward equally to reading Bob Frank's reply, also in this issue.

The Fundamental Importance of Economic Freedom

The release today of the new Economic Freedom of the World: 2006 Annual Report -- by Jim Gwartney, Bob Lawson, and Bill Easterly, and published jointly by the Cato Institute and the Fraser Institute -- prompts me to revisit, today at Tech Central Station, one of my favorite themes: economic freedom is more fundamental than technology in raising living standards.

Interview with Milton Friedman

The second part of my interview with Milton Friedman is up at EconTalk.

The edited transcript of both podcasts is here.

Bubble Standard

Today's New York Times column by Paul Krugman befuddles me, for a variety of reasons.

One reason stands out, however: Krugman's choice of a benchmark against which to measure the sufficiency of today's investment spending.  Here's what Krugman writes today:

The key point is that the forces that caused a recession five years ago never went away. Business spending hasn’t really recovered from the slump it went into after the technology bubble burst: nonresidential investment as a share of G.D.P., though up a bit from its low point, is still far below its levels in the late 1990’s.

And here's what Krugman wrote in the New York Times on September 2, 2001:

During the years of booming stock prices, which were closely linked to euphoria about the ''new economy,'' businesses invested frantically, sinking vast sums into information technology. Now, of course, many of those businesses realize that they invested far too much.

If the late 1990s were cursed by an investment bubble -- and I agree with Krugman that they indeed were so cursed -- why should investment levels from those years be the benchmark against which we measure investment today?

Everything is Relative

Jagdish Bhagwati believes that the invisible hand of the market is feebler and less dextrous than I believe it to be.  Nevertheless, he recognizes the important point that the relevant comparison is not of the invisible-hand's actual performance to some imaginary ideal performance.  Instead, the relevant comparison is of the invisible-hand's actual performance to the actual performance of the visible hand of government.  As Bhagwati observes, "the invisible hand may be frail, but the visible hand is crippled."

[This quotation is found of page 31 of Bhagwati's book Free Trade Today (Princeton University Press, 2002).]

My Haut Explanation

In the middle of this post I made the rather trite observation that the most desirable jobs are in the service sector:

Service-sector jobs are the most desirable. Until his retirement, my dad had a manufacturing job: he worked as a welder in a shipyard. Like most parents, his dream was for his children to become doctors or lawyers and the like -- that is, he longed for his children to work in the service sector.  Ever hear a parent say “I want my boy to grow up to be a pipe-fitter!” or “My dream is for little Suzy one day to operate her very own sewing machine in a clothing factory!”?

Responding to this paragraph, Bill Waddell (in the comments section) mistakes my meaning when he says:

As a matter of fact, there are quite a few people who would be proud to see their sons grow up to be pipefitters. Machinists, welders and electricians too. They would be proud to see their son not only become a pipefitter, but to own his own truck and be an independent pipefitting contractor. Same with Suzie and her sewing machine. They would like Suzie to become so good that she someday owns a couple of sewing machines and has a small sewing business. It is decent, honorable work, despite your pompous drivel.

I can only wonder how full of his own superiority a man must be to flush a toilet a time or two, take a shower and have a drink of water, then sit down to write clever throw away lines insulting the people whose pride in their chosen line of work made that possible. You cannot possibly fathom the fact that the pipefitters who make your life comfortable would be ashamed to have their kids grow up to be academic snobs.

Let me be clear.  I never said -- and I never believed -- that my father would have not been proud of me had I become a pipefitter or a welder or a garbage man rather than a college professor.  Nor did I say -- and nor do I believe -- that such jobs are contemptible or shameful.

A parent's love and respect, and a person's worth, are determined by far, far more than employment and income.

Likewise, the attractiveness of a job is determined by far more than the salary it pays or the social status that it affords.

No serious person doubts the truth of these points.  Nor does any serious person question the fact that nearly everything that any of us does in modern society is made possible by the creativity and labor of countless people -- some paid highly and holding prestigious jobs; many others paid modestly or even very little and holding jobs that bring their holders no status recognition.  And of course I understand that the house that my family and I live in could never have been built, and would not today operate, without the labor of plumbers, electricians, carpenters, operators of earth-moving equipment, and on and on and on.  I challenge anyone to find anything in any of my writings that can fairly be interpreted as an insult to such workers.

My point was the (again) quite trivial one that the careers that most people aspire to -- and the careers that most parents hope that their children will enter -- are not jobs in the construction industry or in the manufacturing sector.  They are, instead, jobs in the service sector -- jobs such as physician, lawyer, accountant, architect.

Like most folks, I understand why most people aspire to such jobs rather than to jobs in a shipyard or in an assembly plant.  (From 1975 through 1981, I worked each summer in a shipyard.  It's unpleasant, difficult, dirty, and dangerous work that doesn't pay particularly well by modern American standards.)  Perhaps those parents (such as mine) who would prefer that their children become physicians or lawyers or accountants or even college professors (rather than become manual laborers) are crass, shallow, and ungrateful materialists.  But I venture to suggest that such parents outnumber those who would prefer that their children work in an assembly plant rather than become white-collar professionals.

So whether or not I'm a snob -- whether I'm coldly insensitive or not to the workers who keep my toilets flushing and my automobile in one piece -- the fact remains that the jobs that most people want, and that most parents want for their children, are jobs in the mindlessly derided service sector.

Some Easy Predictions

Here's my latest in the Pittsburgh Tribune-Review.  I hope -- although I don't dare predict -- that you'll enjoy reading it.

Samuelson on Prices

Commenting on this post, Jaroslav Borovicka says:

Well, Samuelson simply uncritically took over data which were cooked up by the Soviet statistical office (or, better, by the political leadership). This data was of course dreamt up to the extreme, but you see some pressures to "polish" GDP data in the western economies as well - even today.

Of course, Samuelson himself now understands just how kooky were the data that he used to estimate Soviet growth rates.  Here's Samuelson writing in the February 2005 issue of the Economic Journal; it's an obituary for Abram Bergson:

Abram Bergson was a realist par excellence.  He applied generous reasoned discounts to the statistical growth claims of the Stalinist and post-Stalinist statisticians.  And yet, after the dozen post-Gorbachev years of communist dissolution, the emerging evidence suggests to me -- and I think to 'Honest Abe' as he was known at Harvard -- that the Soviet system was even less productive in most sectors than the international almanacs had estimated.  Why?  Plain Machiavellian lying?  No doubt there was some of that as all our experts did recognize.

More important, I suggest after much reflection, is the fact that what are called 'prices' in a controlled society have little true relationship to relative scarcities and technical trade-off costs.  From copious non-meaningful statistical inputs will have to come quite non-meaningful statistical estimates. [P. F132]

Indeed.  That's pretty much what Mises and Hayek argued in the 1920s, '30s, and '40s: prices that don't emerge from voluntary exchange of property rights aren't really prices; they don't incorporate and convey the information that must be acted upon by economic agents in order for lasting prosperity to be created.  But not only will elimination of market pricing make statistical estimates of the performance of that economy meaningless, it will inevitably bring an economy to ruin.  It's not clear to me from Samuelson's recent concession that socialist 'prices' make for poor statistics that he grasps the deeper point that real, market prices are necessary for economic prosperity.

Hayek's Method

Hayek passed away fourteen years ago today.  I help to celebrate his long life well-lived with this essay at Tech Central Station.

A Simple Rule for a Complex World

"'Let the market handle it! Let the market handle it!' Don't you tire of muttering this simplistic formula?" So ended an e-mail that I received from a reader.

It's true that all of us sometimes are tempted to avoid thinking hard about complex issues and, instead, to fall back lazily upon simplistic mantras. We should guard against this weakness, in ourselves and in others.

At the same time, though, we shouldn't confuse consistency with simplicity. The two are different. Just because I instruct my eight-year-old son to be always truthful does not mean that I'm a simpleton offering simplistic advice; it means, instead, that truthfulness is a virtue that should be pursued consistently -- even if in a handful of instances my son might be made better off by telling a lie.

I admit that my proposed solution for many public-policy problems is to say "Let the market handle it." But this response is neither naive nor lazy. It's realistic. It reflects my understanding that almost any problem you name -- rebuilding the Katrina-ravaged Gulf Coast, providing excellent education for children, reducing traffic congestion on highways -- is most likely to be dealt with efficiently, fairly and effectively by the market rather than by government.

Saying "Let the market handle it" is to reject a one-size-fits-all, centralized rule of experts. It is to endorse an unfathomably complex arrangement for dealing with the issue at hand. Recommending the market over government intervention is to recognize that neither he who recommends the market nor anyone else possesses sufficient information and knowledge to determine, or even to foresee, what particular methods are best for dealing with the problem.

To recommend the market, in fact, is to recommend letting millions of creative people, each with different perspectives and different bits of knowledge and insights, each voluntarily contribute his own ideas and efforts toward dealing with the problem. It is to recommend not a single solution but, instead, a decentralized process that calls forth many competing experiments and, then, discovers the solutions that work best under the circumstances.

To recommend the market is to understand, or at least to cooperate with, the wisdom of James Buchanan's important insight that "order is defined in the process of its emergence."  It is to understand, at some level, Vernon Smith's awareness that "ecological rationality" is greater than individual or "constructivist" rationality.

This process is flexible and it encourages creativity. It also denies to anyone the power to unilaterally impose his own vision on others.

In brief, to advise "Let the market handle it" is a shorthand way of saying, "I have no simplistic plan for dealing with this problem; indeed, I reject all simplistic plans. Only a competitive, decentralized institution interlaced with dependable feedback loops -- the market -- can be relied upon to discover and implement a sufficiently detailed way to handle the problem in question."

None of this is to say that getting the government out of the way is sufficient to create peace and prosperity. Markets require a rule of law to ensure that, among other blessings, property rights are secure and exchangeable. At their best, governments can help to protect our rights. Markets also require a culture in which commerce flourishes.

Unfortunately, no recipe exists to create the legal institutions and commercial culture required by capitalism. If these prerequisites are absent, there can be no market to handle any problem. So saying "Let the market handle it" is not the same as saying "All will be just dandy if only the government gets out of the way."

But when these prerequisite institutions are mostly in place, as they are in the United States and other developed countries, markets are amazingly creative and reliable. Calling on markets to deal with problems is then the wisest course.

Alas, though, foolishness frequently triumphs over wisdom. People too often suppose that large social problems can be solved only by deciding ahead of time which particular group of people and procedures hold the key to the solution.

While declaring "Let the government handle it" comes across as a solution, it's no such thing. Instead, it is merely a sign of a simple and baseless faith -- a simple and baseless faith that people invested with power will not abuse it; that political appointees possess or will find better answers than will millions of people pursuing solutions in their own ways, and staking their own resources and reputations on their efforts; that only those 'solutions' that are spelled out in statutes and regulations and that have officials paid to implement them are true solutions.

So yes, show me a problem and I'll likely respond "Let the market handle it." I'll respond this way because I know that not only is my own meager knowledge and effort never up to the task of solving big problems but that not even the Einsteins or Krugmans or Bushes amongst us can know the best solution to any social problem.

Solutions to complex soci