Bastiat's Bastions

Last January, I wrote in this post about how Mubarak’s hold on Egypt was lost, in part, due to food riots, riots over the rising prices of food.  The problem was that the government in Egypt, to placate its citizens, had created programs to keep food prices down, at least to some, creating “program addiction,” a situation that results in uprisings if the program is cut, and that is what happened in Egypt.

The problem with such programs that give something away is that people come to depend on the program, and then, more and more become attracted to the giveaway.  With increasing numbers of people depending on the program, spending goes up and up and the taxpayers are asked to assume a heavier and heavier burden.  The ranks of the dependent swell while the number of those providing the payments shrinks. 

Now it looks as if a similar problem is occurring.  Take a look at this recent report from Andrew Breitbart about the reported gasoline shortages in Egypt.  Prices of gasoline have been held down through the Egyptian government’s subsidies, but such subsidies look to be unaffordable, leaving the government but little choice to end them, meaning prices will rise.  How do you think the Egyptians will respond to a government that causes gasoline prices to double?  The new leaders of Egypt have not yet solidified their power.  Just like Mubarak, they may soon be out of a job.

As you can read in the Breitbart article, the authorities blame speculators and smugglers.  Hmm? Maybe.  What needs to be asked is “why is smuggling going on in the first place?  Could it be that the policy that keeps prices of gasoline at half of the price in a neighboring country CREATES the opportunity for someone clever to buy in one market at a low price and sells in another at a higher price?  Here is an excellent analysis of what is going on with subsidized oil in Indonesia Price differences create profit opportunities for smugglers.  They create even larger opportunities for thieves. 

So, are the smugglers causing the shortages, or are they just taking advantage of a situation that politicians set up to build and maintain support?

What we will see this term is that when it takes government edicts to keep prices low, the amount buyers want becomes high compared to the amount that sellers want to sell—the textbook definition of a shortage.

-MC

A recent study   released by the Tax Foundation and reported by the Pelican Institute (here) states that extended unemployment benefits, which has been part of the stimulus programs passed by Congress, have increased the unemployment rate and slowed our recovery.

Under ordinary conditions, an unemployed individual is eligible for up to 26 weeks of unemployment benefits.  Through several federal extensions, supposedly for stimulus purposes, eligibility for unemployment benefits has been extended to 99 weeks.  President Obama’s “American Jobs Act of 2011” would extend the date for starting their 99 weeks of eligibility.  Notice that these extensions have lengthened eligibility for collecting assistance from half a year to slightly less than two years.  Under three recently passed free trade agreements with South Korea, Panama and Columbia, Democrats added extra weeks of eligibility for unemployment benefits under the guise of “trade adjustment assistance” for those losing jobs because imports from these countries.

What is pointed out in the Tax Foundation’s study, is that the supposed countercyclical nature of unemployment benefits, that benefits rise in bad times and fall during good times, is destroyed by the way that states have financed their portion of the funds to pay these benefits, raising unemployment insurance taxes when their unemployment funds get depleted during sharp recessions and lowering them in better times.

The Pelican Institute’s story includes discussion of what economists have long known, when you increase payment for certain behavior or reduce the costs to individuals for living in certain conditions, that behavior or condition increases.  Dr. Walter Block at Loyola University New Orleans is quoted in the Pelican Institute piece saying “The more you subsidize something, the more of it you get. If the government wanted the unemployment rate to fall, it would find a way to tax unemployment.”

Even Obama’s former economic advisor, Larry Summers, states in the Concise Encyclopedia of Economics:

Empirical evidence shows that two causes are welfare payments and unemployment insurance. These government assistance programs contribute to long-term unemployment in two ways.

First, government assistance increases the measure of unemployment by prompting people who are not working to claim that they are looking for work even when they are not…

The second way government assistance programs contribute to long-term unemployment is by providing an incentive, and the means, not to work. Each unemployed person has a “reservation wage”—the minimum wage he or she insists on getting before accepting a job. Unemployment  insurance and other social assistance programs increase that reservation wage, causing an unemployed person to remain unemployed longer.

Many people while unemployed get job offers or could get, but often at wage rates far less than what they have been accustomed to.  Their “reservation wage,” while falling over time, is sometimes not low enough to accept a low-paying job.

Another way to understand the point is to see these benefits as the opportunity costs of taking a job while still eligible for benefits.  Once one runs out of eligibility, the opportunity costs of taking a job fall considerably and job offers are more likely to be accepted.

The economics Nobel laureate and liberal columnist, Paul Krugman, in his college economics textbook co-authored with his wife, Robin Wells, states

[P]ublic policy designed to help workers who lose their jobs can lead to structural unemployment as an unintended side effect. Most economically advanced countries provide benefits to laid-off workers as a way to tide them over until they find a new job. In the United States, these benefits typically replace only a small fraction of a worker’s income and expire after 26 weeks. In other countries, particularly in Europe, benefits are more generous and last longer. The drawback to this generosity is that it reduces a worker’s incentive to quickly find a new job. Generous unemployment benefits in some European countries are widely believed to be one of the main causes of “Eurosclerosis,” the persistent high unemployment that affects a number of European countries.

Michael Elsby, Bart Hobijn and Aysegul Sahin report in the spring 2010 Brookings Papers on Economic Activity that the extensions in unemployment benefits we have seen from various stimulus programs that have increased the length of eligibility “correspond to between 0.7 and 1.8 percentage points of the 5.5 percentage point increase in the unemployment rate witnessed in the current recession.”  In other words, almost a fourth of the increase in the unemployment rate we have witnessed from the recession and lagging recovery is due to the extensions of unemployment benefits.

We need to be careful in how we structure these benefits and what we do to extend them.  While these benefits to ease the pain of unemployment, such pain killers lead to dependency and make it harder to get “afford” to take a job.

-MC

Here is an ABC News report on GDP growth for this year’s 3rd quarter, the months of July, August and September.  In a month, the 3rd quarter figures will be revised and more data comes in for September.  The report from the government agency that gathers this information, the Bureau of Economic Analysis, is here. This updates a blog post I had earlier this summer.

-MC

Today, I note the passing of Bill Niskanen, who, at the age of 78, died of a stroke this last week (see David Segal’s obituary of Niskanen  in the 10-28-11 New York Times).  Niskanen was not only an important and influential economist, but at 6’4”, he stood tall figuratively as well as literally.  Niskanen earned his undergraduate degree at Harvard and his Ph.D. in Economics from the University of Chicago, studying with Milton Friedman.  He later taught at UCLA and UC Berkeley and had various positions in the Office of Management and Budget and the Defense Department.

Niskanen served as chief economist for Ford until he was fired for being critical of Ford for seeking trade protection from Japanese automakers, noting that the problem of the American auto industry was their reluctance to producing the more fuel-efficient type of cars that Americans wanted to drive and that is was wrong for corporations to ask Washington for special treatment, writing in a Ford memo “A common commitment to refrain from special favors serves the same economic function as a common commitment to refrain from stealing.”

His criticism of Ford cost him his job there.  Niskanen rebounded, though, serving on Reagan’s Council of Economic Advisors, and then becoming the Chairman of the Cato Institute, a free-market think tank in Washington, where he served until 2008.  Though an admirer of Reagan, he was critical of the Reagan administration’s inability to cut government spending, stating that there was really no Reagan revolution.

As a graduate student in the late 1970s and early 1980s, I read many of his works on the economics  of government bureaucracies.   As a fellow member of the Public Choice Society, where Niskanen served as president in the 1990s, I would often see him at annual conferences, and having similar interests, we were often in the audience in the same sessions, if not in each other’s sessions.  In 2005 I was invited by the book review editor of Public Choice to review a book of his, Autocratic, democratic, and optimal government: Fiscal choices and economic outcomes. I saw Niskanen in May of that same year for the last time, as Niskanen presented one of the thirteen papers at the “Political Economy of Terrorism” at George Mason University’s School of Law and Economics where I was privileged to be among the remaining presenters.

Niskanen, ever critical of big government and special favors handed out by big government, especially to businesses, I am sure he saw ideas he could agree with from both the Tea Party and the Occupy movements, though I think he would have disagreed with both on several fronts, too.

Niskanen, while always a thoughtful gentleman in discourse, always stood on principle, committed to free markets, the rule of law and ethical behavior.

-MC

If you look at Bastiat’s writings, you will notice a major theme.  Freer trade improves the lives of people in the society, while protectionism promotes the interests of some at the expense of others in the society.  In this recent article in The National, the prominent Indian economist, Jagdish Bhagwati, repeats Bastiat’s theme of free trade not only increases overall prosperity, but also elevates the well being of the poor by examining the evidence from history.  If you think “oh, free trade ideas from another Republican economist,” think again.  If you go to the Wikipedia entry for Bhagwati, you will see that Bhagwati is a Democrat.

-MC

Contrasting to gas prices seen earlier this month, I saw the lowest gas prices I have seen in a while as I drove to New Orleans tonight.  I saw gas prices around $3.32 in Boutte, and then down to $3.29 by Avondale and then down to as low as $3.19 in Westwego.  I wondered why, but quickly remembered seeing stories like this one from Reuters that the Obama administration has released a part of the US strategic oil reserve and will continue to release oil from our reserves over the next month, as part of an international effort to increase the supply of oil to counter the reductions in supply because of the war in Libya.

How long can we count on these lower prices?  My bet is that these reserves will be used up and prices will be back up long before Gadaffi is forced from office.  And then, we will have high prices and a big hole in our strategic reserves, that we would be wise to replenish.  Then, we will have sold our reserve oil at low prices and will have to replace it at higher prices.  “Sell low, buy high” is the strategy of fools.

-MC

Unless you have been laid up in bed, you are sure to have noticed that the price for gasoline has skyrocketed in the last few days, rising by about $0.25 a gallon here in south Louisiana, or about 8%.  For extra credit only to the first of my students to correctly post the right answer, explain to me, in terms of supply and demand and the factors that affect them, why gasoline prices have gone up so much so fast.

Now, gasoline prices have been trending up a bit over a much longer period, peaking finally in the summer of 2008, and then the price for fuel plummeted. 

Researchers with the International Monetary Fund, the IMF, have noticed a peculiar correlation, as reported here at the Public Radio Program, Market Watch—the very high correlation of the price of oil and the price of fine wine, like the wine from the French wine region on Bordeaux.  These two prices move closely up and down together (see also this Wall Street Journal article ), and not for the reason one might suspect–it is not because of transportation costs, as transportation does not make up as much of the price of expensive wine as it would, say, for cheap wine. 

Again, for extra credit, but only for the first to answer this correctly, explain to me, in terms of supply and demand and the factors that affect them, why oil and wine prices move so closely together, that is, why are they strongly, positively correlated?

-MC

Economists recognize a limit on government spending due to the sources for the spending for those dollars to be spent.  Economists call this limitation the “government budget constraint.”  We recognize that there is a tax to be paid one way or the other, different ways of raising the funds implies different taxes.  Some of these are up front taxes, where we know we are being taxed, while others are hidden taxes that we pay, nonetheless.

Indulge me to some simple math.  Let’s use “G” for Government Spending, ”T” for Taxes, and “D” for Deficit.  The Deficit, D, is, of course, just G-T, so D = G-T.  That part is obvious:  the part of government spending that exceeds the taxes raised to pay for that spending is the deficit (government debt on the other hand, is the deficit accumulated over the years minus the few surpluses we have had).

So, the excess of government spending over above the taxes to pay for that spending is the deficit.  A hallmark of Keynesian economics has been the idea that deficits are ok, that they are even a good thing during recessionary periods.  This approval of deficit spending by the federal government removed the moral constraint to not run deficits that had been in play for years.

Borrowing to pay deficits and taxes on capital and labor

The next question is “how do we pay for this deficit?” Well, of course, we borrow the money–we choose to increase our debt by borrowing from anyone who thinks that we are credit worthy, better risks than others at the interest rate we are paying.   We simply put IOUs (or treasury bills) up for sale. Some of the creditors or buyers of these IOUs are our own citizens, and some are not.

If we only sell our IOUs only to our own citizens, we soon have to lower the price of our IOUs in order to sell more, as there will be a point where the our citizens will start to have to take their funds from investment projects in which they are willing to invest and keep those funds in treasuries, or government IOUs.  While I will not go into the explanation in this post, interest rates and the prices of IOUs go in opposite directions, but here is a sufficient explanation from About.com.

As we drop our price to sell more, our interest expense increases.   So, as we increase the size of our debt with deficits year after year, we also drive up interest expenses for most of the debt we owe, as much of it is in short-term securities.  Since interest payments amount to part of our G, government spending, the deficit goes up at an even faster rate.

Of course, we sell our IOUs not only to our own citizens, but to all those around the world.   By selling them to those outside our borders we are able to raise more funds at the same interest rate as compared to only selling them domestically.  Still, as our debt creeps upward, we have a larger proportion of our spending going to pay the interest on this debt.  Since so much of our current debt obligations are in short-term obligations, new debt from additional deficit spending raises our interest expense on most of our debt.   As more borrowing to finance new deficits begin to push interest rates up as the default risk on these funds increases (just like a lender runs a higher risk of not getting his funds back from someone who owes ten times what they make in a year compared to someone who is now debt free, but once had a mortgage), and so, lenders must get higher rates to take the risk of making the loan.

Interest rates start to edge upward as it becomes more difficult to sell our IOUs.  Higher interest rates mean fewer business investments in machinery, equipment, factories, etc. will be worth making and less of these tools will be available for workers to use.  Less capital per worker means lower productivity for workers and less pay, as workers are ultimately paid because they are productive.  If the worker does not produce as much, the worker cannot be paid as much.

So, increased borrowing is a tax on workers and owners alike, as lower wages for workers and less capital held by owners harms both of these producer groups.  This tax is hidden from immediate view, as it is not obvious that excessive government spending is immediately coming out of their pockets.  The tag line for our blog, “what is seen and what is unseen” becomes important here, as people usually perceive taxes that they get a bill for as a tax, but they don’t see deficits as taxing them.  As Louisiana Sen. Russell Long was noted for saying, voters really mean “Don’t tax me and don’t tax thee, tax the man behind the tree.”  We are the men behind the tree.  Or, when it comes to taxation, as Walt Kelly’s Pogo said “We have met the enemy and he is us.”

Printing money to pay the deficit and the inflation tax

Now one of the tricks that governments have used in the past is to have its central bank (our Federal Reserve) become one of the creditors and buy up these IOUs.  In an earlier day, we would simply have some institution print or coin money.  Increases in the supply of money in an economy usually or eventually results in raising prices, in inflation.  If the increased money supply causes people to reduce their acceptance of the money involve as they expect the money to have a declining value,

The unstable Weimar Republic, the post-WWI German government, did exactly that, resulting in inflation rates that boggle the mind, reaching a rate of 100% every 2 days.  In other words, prices were doubling every two days for a while.

Another way of thinking about that is that a person’s savings in money fell in half every two days.  There is an often-repeated story of someone choosing between a huge prize and a penny payment that doubled every day for a month (30 days—we won’t get greedy here).  Imagine getting a million dollars in 30 days or the penny payment doubling every 30 days.  Here is a little article on that choice.   The doubling penny ends up being $5,368,709.12 in just 30 days.

Now imagine the reverse, where you start off with cash holdings of $5,368,709.12, and you face inflation of 100% every two days.  In only 60 days the buying power of your cash holdings is reduced to a single penny.  In those short 60 days, the government’s inflation policy, turning its debt into money, has taxed away over $5 million of your savings.  “My father was a lawyer,” says Walter Levy, a German-born oil consultant in New York, “and he had taken out an insurance policy in 1903, and every month he had made the payments faithfully. It was a 20-year policy, and when it came due, he cashed it in and bought a single loaf of bread.” (From the PBS series, Commanding Heights )

While everyone may try to rid their portfolios of money assets, it cannot be done for the whole economy, and so, wealth held in dollar assets falls, making us all poorer, but also making the inflation tax even higher.   As people try to protect their portfolios by buying real assets (not money or dollar denominated IOUs), we end up in a game of “who gets stuck with the worthless money.”  We spend that money at a faster and faster rate.  For instance, the German hyperinflation mentioned above led to retailers raising their prices several times a day.  Workers and their spouses soon started demanding to get paid several times a day so that the same marks were going around the economy at faster and faster rates.  A very old and well known relationship in economics is that the price level (think CPI) times the output of real goods and services produced (think real GDP) equals the Money in the system times the speed at which money circulates (something called Velocity).  Or, put another way, the growth rate in the Money Supply times the growth in Velocity divided by the growth in the economy is the growth in prices better known as inflation.  Either more money or faster circulating money will drive up prices if we don’t increase our output.

We see store owners and farmers raising prices and seldom think that it is really the government and the central bank behind these price increases, making inflation amount to an invisible tax eroding away at the cash savings we worked years to build up.

I should point out that economists recognition of a government budget constraint, that we are taxed one way or the other for all of our spending is noted in the acronym “TANSTAAFL,” standing for “There Ain’t No Such Thing as a Free Lunch,” coined by Robert Heinlein in his science fiction book, “The Moon is a Harsh Mistress.” Still earlier, David Ricardo noted the equivalence of taxing and borrowing in his 1820 “Essay on the Funding System.”

Why Do Deficits Matter?

If we are taxed one way or the other as has been shown, why do deficits matter, why should we care about deficits and running up big national debts?

Well, just as Ricardo noted the monetary equivalence between borrowing and taxing to pay for some large government expense, such as a war (Ricardo’s example), Ricardo also suggested ways that these were not the same, noting that people often fail to perceive the full costs of government spending when it is financed by borrowing, noting what has been called by one of my professors, James Buchanan, “Fiscal Illusion.”  The problem is that the taxpayer-voter seldom notices the perpetual interest payment the government must make as the same as the immediate tax increase to avoid a deficit.

Another way of putting this is that not all taxes are seen as such.  People seldom connect the inflation that they face because of government services that they receive while refusing to pay higher taxes.   People also do not notice that they have less equipment and tools at work and fewer sellers in each industry because investments were not made at some earlier time because interest rates were too high.

Taxes out of their own pockets are seen and kept to a minimum, while government benefits they get are seen and kept to a maximum.  On the other hand, stealth taxes on capital and on money holdings are not seen as payments for their government benefits or the reductions in taxes for which they themselves are liable.

So, voters ask for lower taxes and higher benefits, more spending, and their representatives oblige.  The cost of government is perceived as being very low.  When we do not see the full cost of something, we usually ask for more, just as the consumer who does not pay for the environmental costs of the products they consumer want more to be produced.

Deficits matter because they misrepresent the true costs of decisions to voters.  Voters who benefit from the spending vote for it, as it is clear that they benefit.  Voters who pay the inflation tax or the capital tax (higher interest rates) do not perceive their liabilities and do not try to block passage.  The most popular legislation, then, raises deficits.  Fiscal Illusion that plagues us, especially when we employ deficit financing of government spending, makes continued deficits more likely, as voters, more than Twist, find it easy to ask for “More, please.”

-MC

As anyone who pays attention to the news realizes that in recent months, Julian Assange, the genius behind WikiLeaks , has released thousands of secret documents on the internet, and has been the subject of an international manhunt.  His release of documents is often compared to the release of the Pentagon Papers by Daniel Ellsberg to the New York Times in 1971.

What you may not realize is that Daniel Ellsberg was something of a genius, too.  Ellsberg was a military analyst and used game theory in analyzing diplomatic rhetoric, especially the use of blackmail.  Here is a paper he gave before his Pentagon Papers release, which is really a rehash of a paper he gave in 1959.

I must give a big thanks to Donald A. Coffin, Associate Professor of Economics at Indiana University Northwest, for distributing Ellsberg’s paper to a listserv for teachers of economics.

-MC

In this article from the U.K. newspaper, The Telegraph, Ambrose Evans-Pritchard writes about how increasing food prices and food scarcity, while not causing the tumult in Tunisia and Egypt, may have triggered recent riots and revolution in those countries, the straw that broke the camel’s back, so to speak.

When prices for major necessities, such as food, begin to rise sharply, people become very desperate.  While not taking the sting out of rising prices, it does help to understand what lies at the root of price changes and what social purpose prices serve, how prices both help us to conserve the food we do have and give food producers the incentive to produce more food.  International trade in food also gives merchants the incentive to move food from low scarcity to high scarcity realms, to get food to where it is most wanted and least available.

Bastiat’s compatriots in England, Bright and Cobden, worked furiously to rid the U.K. of is corn laws, which made it difficult to import food, a factor that made the Irish Potato Famine more severe.

Learning about the social role of prices and exchange really is important.

-MC