Category Archive: Economics
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To earn a profit, businesses must increase your “consumer surplus” by giving you better products or charging you less money. Watch more with Dan Russell
Russell, Dan. “Consumer Surplus” YouTube. YouTube, 22 June 2017. Web. https://www.youtube.com/watch?v=mOzgmveDdKo
Comments Off on Does the market make us good? Does socialism?
Wouldn’t we all prefer to live in an economy that brought out the best in us? Socialists often argue that their ideal system is more moral than the selfish greed of market life. But some of the best defenses of the free market argue that it in fact encourages virtuous behavior.[i]
It’s in everyone’s interest to be honest and hardworking, for example, since news of one’s not being so can easily spread throughout the marketplace and harm one’s ability to make money.[ii]
Other defenders of the free market, however, argue that while the free market depends on a culture of virtue, it cannot provide the sole foundation for that culture. Instead, virtue must come primarily from outside the marketplace, from institutions whose primary purpose lies beyond economic productivity. The most important advocate of this view was 20th-century economist Wilhelm Röpke.[iii]
Röpke defended the free market, but he did not think that the free market left to itself could produce the conditions favorable to its perpetuation. Instead, he argued that a free market order could not grow and flourish without the fertile soil of a sound moral fabric.
The Free Market Encourages Social Morality
Röpke understood that the free market, at least to some extent, encourages morality and that the free market is clearly superior to a socialist economy: “In ‘capitalism’ we have a freedom of moral choice, and no one is forced to be a scoundrel. But this is precisely what we are forced to be in a collectivist social and economic system” because people there are forced “to act against their own nature,” he writes.[iv]
Why? Röpke explained that “if the collectivist economy is to function, it needs heroes or saints, and since there are none, it leads straight to the police state.” In all socialist economies or modern welfare states, moreover, the allegedly higher morality behind social programs is propped up by “police and penalties [that] enforce compliance with economic commands.”[v]
As a result, heavy tax burdens paid under threat of force make people unable to care for those closest to them as much as they may like, therefore effectively legislating what people in many cases would judge to be immoral. By contrast, only under political and economic freedom do people have the ability to be good, for to be good, an action must be committed freely.
Local Institutions: A Superior Way to Encourage Morality
An even more reliable source of virtue than the market, however, are local institutions whose primary purpose is not the exchange of goods and services. Ropke argues that social factors such as family, religion, and tradition provide the economy with an indispensable “bourgeois foundation” in which people exercise virtues such as
individual effort and responsibility, absolute norms and values, independence based upon ownership, prudence and daring, calculating and saving, responsibility for planning one’s own life … firm moral discipline, respect for the value of money, the courage to grapple on one’s own with life and its uncertainties, a sense of the natural order of things, and a firm scale of values.”[vi]
Such local institutions have as part of their primary purpose the inculcation of virtue and the enjoyment of higher-order goods, and they teach people “a firm scale of values” that reminds us that the creation of wealth and the spending of money are lower-order goods. In other words, the free market is a positive good that can nevertheless do little to show us the meaning of life.
Disregarding this truth, Röpke believed, tended to make the pursuit of material well-being drift into the demand for immediate material enjoyment, the economic manifestation of which was a Keynesian “unconcern for the future” that regards it as “a virtue to contract debts and foolishness to save.”[vii] Placing too much of a burden on the free market to provide us with the source of our social morality paradoxically undermines the perpetuation of sound economics and the free market itself.
To summarize, the free market does encourage some level of social morality, while collectivist economic systems undermine it. Yet Röpke argued, correctly I think, that we cannot rely primarily on the free market — and certainly not on the free market alone — to produce the social morality the market itself needs to thrive.
[i] McCloskey is the best contemporary advocate of this thesis. See, for example, Deirdre McCloskey, The Bourgeois Virtues: Ethics for an Age of Commerce (University of Chicago Press, 2006); Deirdre McCloskey, “Avarice, Prudence, and the Bourgeois Virtues,” in Having: Property and Possession in Religious and Social Life, edited by William Schweiker and Charles Mathews (Eerdmans Publishing, 2004), 312–336; and Donald McCloskey, “Bourgeois Virtue,” American Scholar, Vol. 63, No. 2: 177–191.
[ii] McCloskey, “Bourgeois Virtue,” 182.
[iii] Röpke was a German economist who fled the Nazi regime first to Istanbul and then to Switzerland, where his writings would provide the intellectual groundwork of the wirtschaftswunder — the German economic miracle that saw West Germany move rapidly out of the destruction of total war to being the most robust economy in Europe in only a few decades. He was present at the first meeting of the Mont Pelerin Society along with such great thinkers as Friedrich Hayek and Milton Friedman.
[iv] Wilhelm Röpke, A Humane Economy: The Social Framework of the Free Market (ISI Books, 1998), 121.
[v] Ibid., 120.
[vi] Ibid., 98.
[vii] Ibid., 100.
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Alexis de Tocqueville feared that Americans would willingly give up freedom for a “soft despotism.” Full interview here.
Comments Off on Why we can’t break up with our stuff — yet
Fifty years from now, people will look back on the turn of the century and wonder about us. They will wonder why we were so wasteful, so selfish. Why we had closets, garages, and rental storage units, all under lock and key so we could keep other people from using the stuff that we weren’t using, either.
I can’t brag that I’m not part of the problem. I have a shiny, black BMW 330i with a six-speed transmission. The BMW has its own special shrine, with a door that magically — well, electronically — opens when I approach. My car takes up quite a bit of space. In fact, it “lives” better, in a clean, well-lit garage, than at least a quarter of the world’s human population.
Sometimes I drive it to work, where I park it on a very expensive piece of real estate called a parking lot. I’ve taught at Duke a long time, so I have the “parking spot of God,” near the buildings.
I drive my car about 45 minutes a day, four days a week, less when I’m traveling, as I often am. I’m writing this article in Sydney, Australia, and my car is sitting, unused, in a parking lot at the airport, behind barbed wire. When I’m in town, I also use my car for errands — I might use it another five hours a week. That’s 163 hours a week that the car is unused, and while it is unused, it actually takes up two parking spaces, in the sense that both my garage and work parking are reserved for me alone.
Why We Own Too Much Stuff
One of my grad school advisers was Douglass North, who won a Nobel Prize in 1993 for arguing that transaction costs were the central concept in modern economics. It doesn’t matter what the question is; the answer is transaction costs.
If you want to make a trade, you have to spend time and other resources finding the right person to trade with and then arranging and enforcing the exchange. That cost is the transaction cost.
Why do I pay to store my car rather than let other people use it and collect rent? Transaction costs. Why don’t more people hitchhike? Transaction costs. Why, more generally, do we own things rather than rent them? The answer, as Doug North said, is transaction costs.
But we are living in the beginning of a pivotal era that will transform our relationship to “stuff” (we’ll need less of it) and to each other (we’ll share more). For all of human history until about 1995, the desire to reduce transaction costs was tied to the desire to sell a particular product. Now, entrepreneurs are combining three things — mobile platforms, software apps, and internet connections — to sell reductions in transaction costs with no product attached. And that combination will change everything.
You already know about Uber, of course. If I have a car and a few minutes, and you need a ride, it’s unlikely we could solve the transaction costs problem on our own. We’d face problems of triangulation (finding each other), transfer (arranging the delivery of the service and negotiating payment), and trust (being sure I won’t rob you and you won’t assault me, though Uber hasn’t been flawless in that regard). Those three categories — triangulation, transfer, and trust — are the reasons that we own so much stuff and pay to store it all.
But there is an enormous and largely unused amount of excess capacity in the system now, just waiting for a reduction in transaction costs to make it available. Consider hitchhiking: almost no one in the United States hitchhikes. If you stand on a bridge over an interstate highway, you’ll notice that most cars, and almost all the trucks, have a single passenger. Why aren’t there more people in all those vehicles?
How BlaBlaCar Is Solving the Transaction Costs Problem
The answer is transaction costs. But a company called BlaBlaCar figured out a way to sell reductions in those costs.
Unlike many other software platforms, BlaBlaCar offers pure sharing. The software provides key pieces of information: (1) the passenger’s location, (2) the passenger’s destination, and (3) the time the passenger wants to leave. Someone who has an extra seat in their car or truck and who is traveling that route at about that time is matched with the passenger. The passenger pays part of the cost of the trip that the driver is going to take anyway. The result is a pure efficiency gain with close to zero marginal cost to the system but benefits to both, or all, participants.
The software platform’s name comes from a fourth piece of information: desired “chattiness.” If you prefer a quiet ride (if you are the passenger) or drive (if you are the operator), then you check “bla.” But if you love to talk the whole trip, you can select “bla-bla-bla.” The name of the company is the middle setting, “bla-bla” (“Enjoys a natter,” on the software), as the way to represent the service overall.
As of this writing, BlaBlaCar has well over 25 million “members” in 22 countries. At least 10 million trips are arranged per quarter, and of course each “trip” requires at least two members. In fact, the average car occupancy is 2.8 in a BlaBlaCar ride, compared to 1.6 to 1.8 (depending on the country) for car trips in general. BlaBlaCar estimates a reduction of CO2 emissions on the order of more than 1 million tons per year, but of course that estimate assumes that all riders would have taken their own trips solo, rather than take a train or simply not travel, if the service were not available.
What Sharing Economy Services Really Sell
Notice that Bla-Bla Car does not sell rides, or transportation, or anything remotely like a physical service. What Bla-Bla Car sells is a reduction in transaction costs. And that’s the unifying theme of the new sharing economy: for the first time in human history, entrepreneurs can make money just by selling reductions in transaction costs. We have plenty of stuff; it’s just in the wrong place. The only thing keeping stuff in the wrong place is transaction costs.
Portable platforms (mostly smartphones) using software (often modular, self-contained apps) and connecting over the internet mean that transaction costs are plummeting. Uber doesn’t sell taxi rides; Airbnb doesn’t rent hotel rooms. These companies, and a thousand others, “sell” reductions in transaction costs.
We’ll need a lot less stuff and a lot fewer parking spaces if we can take better advantage of what we already have. And cities will have a lot more space once we aren’t paying the costs of storing cars in parking lots and loads of equipment and clothing in self-storage facilities.
Comments Off on Why I deserve what you created: word count welfare
I am furious. I was scrolling through my Facebook feed this week and learned that my friend Steve Horwitz had written almost 3,000 words in a single day in his new book chapter on inequality. For perspective, that’s about 12 pages, double-spaced.
So of course I’m enraged! My word count for the day was … zero.
In what world is it fair that Steve Horwitz could write 3,000 words in one day while I wrote none? After all, I have a lot of very good reasons for having not gotten anything written that day. I went to the gym, and then after I got to the office I spent the entire morning discussing Virgil’s Eclogues and Georgics at Samford’s faculty Great Ideas Summer Institute. (And besides, my computer is messed up, so I couldn’t write on it!) After that I went to have lunch with my dad, then I caught up on some reading, then I went home to take care of the kids, then I fixed and ate dinner, and then.…
It’s completely unfair.
Completely and totally unfair.
The just and right solution? Redistribution. It’s only fair that some of Steve’s word count be redistributed to me. After all, I work hard, and as you can tell from what I wrote above I had a lot of obstacles that Steve didn’t have to overcome. Why should he get the huge word count while I finish the day with a zero?
Three Lessons for Income Inequality
This admittedly absurd example of word-count inequality can teach us at least three important things about income inequality:
- People make different choices. I could have spent the day writing about inequality, like Steve. I chose to do other things. That’s pretty easy. We observe income inequality because some people are willing to give up a lot to earn high incomes while others aren’t.
We professors like to flatter ourselves into thinking we could earn a lot more money doing something else. We forgo that income for flexibility and job satisfaction. It can be pretty misleading to compare money incomes (or word counts) and assert that someone is being wronged. Given the option, I wouldn’t trade places with anyone on the Forbes 400. It’s far from clear that there’s an injustice in the fact that they have more wealth and higher incomes than I do.
- People are in different places in life. Steve has been doing this longer than I have, and he has more experience. His kids are older. Et cetera. The appropriate comparison would be over the life cycle. Just like comparing my word count on any one day to Steve’s is misleading, comparing my yearly income to (for example) my dad’s is misleading. He’s a year away from retirement and finishing his peak earning years. I’m at least 25 years from retirement.
- The hunt for other people’s money or word counts teaches us something useful about the wastefulness of the political process. In the time I spent trying (unsuccessfully) to get some of Steve’s words redistributed to me, I could have been doing anything else — like increasing my own output. The time, effort, and energy I spent trying instead to redistribute Steve’s output is lost forever, just as the time, effort, and energy people spend trying to get their hands on other people’s stuff through the political process or through common burglary will be lost forever.
Obviously, although these three lessons are important, they don’t explore the full range of possible causes and consequences of inequality. If Steve got to his almost 3,000 words by downloading someone else’s paper and replacing the author’s name with “Steve Horwitz,” then that would be a pretty serious problem.
It does show us that it’s not a good idea to covet a colleague’s word count. In doing so, I would make an ass of myself.
- People make different choices. I could have spent the day writing about inequality, like Steve. I chose to do other things. That’s pretty easy. We observe income inequality because some people are willing to give up a lot to earn high incomes while others aren’t.
Comments Off on What Charles Darwin owes Adam Smith
The following is a lightly edited, slightly condensed transcript of the talk “Adam Darwin: Emergent Order in Biology and Economics,” presented by Matt Ridley at the Adam Smith Institute in 2012.
I’ve called my lecture “Adam Darwin” to stress how congruent the philosophies of Adam Smith and Charles Darwin are. The common theme, of course, is emergence — the idea that order and complexity can be bottom-up phenomena; both economies and ecosystems emerge. But my purpose really is to explore not just the history and evolution of this shared idea but its future: to show that in the age of the Internet, Adam-Darwinism is the key to understanding how the world will change.
The Common Ancestry of Evolution and Economics
Darwin’s debt to the political economists is considerable. He spent formative years in Edinburgh among the ghosts of Hume, Hutchinson, Ferguson, and Smith. When he was at Cambridge in 1829, he wrote, “My studies consist in Adam Smith and Locke.” At his grandfather Josiah Wedgwood’s house in Staffordshire, Darwin often met the lawyer and laissez-faire politician Sir James Mackintosh, whose daughter married Charles’s brother-in-law (and had an affair with his brother).
On the Beagle, he read the naturalist Henri Milne-Edwards, who took Adam Smith’s notion of the division of labor and applied it to the organs of the body. After seeing a Brazilian rainforest, Darwin promptly reapplied the same idea to the division of labor among specialized species in an ecosystem: “The advantage of diversification in the inhabitants of the same region is in fact the same as that of the physiological division of labor in the organs of the same individual body — subject so well elucidated by Milne-Edwards.”
Back in England in the 1830s, through his brother Erasmus, Darwin fell in with the radical feminist and novelist Harriet Martineau, who had shot to fame because of her series of short fictional books called Illustrations of Political Economy. These were intended to educate people in the ideas of Adam Smith, “whose excellence,” she once said, “is marvelous.” I believe it was probably at Martineau’s suggestion that, in October 1838, Darwin came to reread Malthus (a person with whom Martineau was on very close terms) and to have his famous insight that death must be a non-random and therefore selective force.
Parenthetically, it’s worth recalling the role of anti-slavery in bringing Martineau and Darwin together. Darwin’s grandfather Josiah Wedgwood was one of the leaders and organizers of the anti-slavery movement, a friend of Wilberforce, and the maker of the famous medallion “Am I not a man and a brother?” which was the emblem of the anti-slavery movement. Charles Darwin’s aunt Sara gave more money to the anti-slavery movement than any woman in Britain. Darwin had been horrified by what he called, “The heart-sickening atrocities of slavery in Brazil.” Abolition was almost the family business. Meanwhile, Harriet Martineau had just toured America speaking against slavery and had become so notorious that there were plans to lynch her in South Carolina.
Today, to a bien pensant intellectual, it might seem surprising to find such a left-wing cause alongside such a right-wing enthusiasm for markets, but it should not be. So long is the shadow cast by the top-down determinism of Karl Marx, with his proposal that the state should be the source of reform and welfare, that it’s often forgotten how radical the economic liberalism of the political economists seemed in the 1830s. In those days, to be suspicious of a strong state was to be left-wing (and, if you’ll forgive the pun, quite right, too).
Today, generally, Adam Smith is claimed by the right, Darwin by the left. In the American red states, where Smith’s emergent decentralized philosophy is all the rage, Darwin is often reviled for his contradiction of dirigiste creationism. In the average British university by contrast, you will find fervent believers in the emergent decentralized properties of genomes and ecosystems, who nonetheless demand dirigiste policy to bring order to the economy and society. Yet, if the market needs no central planner, why should life need an intelligent designer, or vice versa?
Ideas evolved by descent and modification just as species do, and the idea of emergence is no exception. Darwin at least partly got the idea from the political economists, who got it from the empirical philosophers. To put it crudely, Locke and Newton begat Hume and Voltaire, who begat Hutchinson and Smith, who begat Malthus and Ricardo, who begat Darwin and Wallace. Darwin’s central proposition was that faithful reproduction, occasional random variation, and selective survival, can be a surprisingly progressive and cumulative force. It can gradually build things of immense complexity. Indeed, it can make something far more complex than a conscious deliberate designer ever could. With apologies to William Paley and Richard Dawkins, it can make a watchmaker.
Each time a baby is conceived, 20,000 genes turn each other on and off, in a symphony of great precision, building a brain of 10 trillion synapses, each refined and remodeled by early and continuing experience. To posit an immense intelligence capable of comprehending such a scheme, rather than a historical emergent process, is merely to exacerbate the problem — who designed the designer?
Likewise, as Leonard Reed pointed out, each time that the pencil is purchased, tens of thousands of different people collaborate to supply the wood, the graphite, the knowledge, and the energy, without any one of them knowing how to make a pencil. Says Smith, if you like, “This came about by bottom-up emergence, not top-down dirigism.” In both cases, nobody’s in charge, and crucially, nobody needs to understand what’s being done.
Why Innovation Happens
So far, I’m treading a well trodden path in the steps of Herbert Spencer, Frederick Hayek, Karl Popper, and many others who’ve explored the parallels between evolutionary and economic theory. But the story has grown a lot more interesting in the last few years, I think, because of developments in field of cultural and technological evolution. Thanks especially to the work of three anthropologists — Rob Boyd, Pete Richardson, and Joe Henrich — we are beginning now to understand the extraordinary close parallels between how our bodies evolved and how our tools and rules evolve. Innovation is an evolutionary process. That’s not just a metaphor, it’s a precise description. I need you to re-examine a lot of your assumptions about how innovation happens to disenthrall yourself of what you already know.
First, innovation happens mainly by trial and error. It’s a tinkering process, and it usually starts with technology, not science, by the way, as Terrence Keeley has shown. The trial and error may happen between firms, between designs, between people, but it happens. If you look at the tail planes of early airplanes, there’s a lot of trial and error, there’s a lot of different designs being tried and eventually one is decided.
Exchange is crucial to innovation, and innovation accelerates in societies that open themselves up to internal and external exchange through trade and communication — Ancient Greece, Song China, Renaissance Italy, 16th century Holland, 19th century Britain — whereas innovation falters in countries that close themselves off from trade — Ming China, Nero’s India, Communist Albania, North Korea.
More ever, every innovation, as Brian Arthur has argued, is a combination of other innovations. As L.T.C. Rolt, the historian of engineering put it, “The motorcar looks as if it was sired by the bicycle out of the horse carriage.” My favorite example of this phenomenon is the pill camera, which takes a picture of your insides on the way through. It came about after a conversation between a gastroenterologist and a guided missile designer.
Adam Smith in other words, has the answer to an evolutionary puzzle: what caused the sudden emergence of behaviorally modern human beings in Africa in the past hundred thousand years or so? In that surprisingly anthropological first chapter of The Wealth of Nations, Smith saw so clearly that what was special about human beings was that they exchanged and specialized.
Neanderthals didn’t do this — they only ever used local materials. In this cave in Georgia, the Neanderthals used local stone for their tools. They never used tools from any distance away, from any Neanderthal sites. But when modern human beings move into this very same area, you find stone from many miles away being used to make the tools, as well as local stone. That means that moderns had access to ideas, as well as materials from far away. Just as sex gives a species access to innovations anywhere in its species, so exchange gives you access to innovation anywhere in your species.
When did it first happen? When was trade invented? At the moment, the oldest evidence is from about a 120,000 years ago. That’s when obsidian axes in Ethiopia and snail-shell beads in Algeria start traveling long distances. These beads are made from marine shells, but they’re found a hundred miles inland. And we know from modern Aborigines in Australia that long-distance movement of man-made objects happens by trade, not migration. So it’s not that people are walking all the way to the Mediterranean and picking up shells and walking all the way back again; they’re getting them hand-to-hand by trade.
Now that’s 120,000 years ago — ten times as old as agriculture — but I suspect it goes back further still. There’s a curious flowering of sophisticated tool kits in Africa around a 160,000 years ago, in a seashore dwelling population, as evidenced by excavations at a place called “Pinnacle Point.” It came and went, but careful modeling by some anthropologists at the University College London suggests that this might be a demographic phenomenon: a rich food supply led to a dense population, which led to a rich toolkit. But that’s only going to be true if there is exchange going on, if the ideas are having sex — dense populations of rabbits don’t get better tools. Once exchange and specialization are happening, cultural evolution accelerates if population density rises, and decelerates if it falls.
We can see this clearly from more recent archeology in a study by Melanie Klien and Rob Boyd. In the Pacific, in pre-Western contact times, the sophistication of fishing tackle depends on the amount of trading contact between islands. Isolated islands, control for island size, will have simpler fishing tackle than well-connected islands. And indeed, if you cut people off from exchange networks, human progress not only stalls, it can go backwards.
The best example of this is Tasmania, which became an island ten thousand years ago when sea levels rose. Not only did the Tasmanians not get innovations that happened after this time, such as the boomerang, they actually dis-invented many of their existing tools. They gave up making bone tools altogether, for example. As Joe Henrich has argued, the reason for this is that their population was too small to sustain the specialization needed to collaborate in the making of some of these tools. Their collective brain was not big enough — nothing to do with their individual brains, it’s the collective intelligence that counts.
As a control for this idea, notice that the same thing did not happen in Tierra Del Fuego. The Fuegan Indians continue to progress technologically. The reason for this is that the Magellan Strait is narrower than the Bass Strait, so trade continued and the Feugan Indians had access to a collective brain the size of South America. Whereas, as the Tasmanians had access to a collective brain only the size of Tasmania.
The Collectivism of Markets
Now for me one of the most fascinating implications of this understanding of the collective brain is just how touchy-feely liberal it is. I’m constantly being told that to believe in markets is to believe in selfishness and greed. Yet I think the very opposite is true. The more people are immersed in markets, the more they collaborate, the more they share, the more they work for each other. In a fascinating series of experiments, Joe Henrich and his colleagues showed that people who play ultimatum games — a game invented by economists to try and bring out selfishness and cooperation — play them more selfishly in more isolated and self-sufficient hunter-gatherer societies, and less so in more market-integrated societies.
History shows that market-oriented, bottom-up societies are kinder, gentler, less likely to go to war, more likely to look after their poor, more likely to patronize the arts, and more likely to look after the environment than societies run by the state. Hong Kong versus Mao’s China, 16th century Holland versus Louis the XIV’s France, 20th century America versus Stalin’s Russia, the ancient Greeks versus the ancient Egyptians, the Italian city-states versus the Italian papal-states, South Korea versus North Korea, even today’s American versus today’s France, and so on.
As Voltaire said, “Go into the London stock exchange and you will see representatives of all nations gathered there for the service of mankind. There the Jew, the Mohammedan, and the Christian deal with each other as if they were of the same religion, and give the name of infidel only to those who go bankrupt.”
As Deirdre McCloskey reminds us, we must not slip into apologizing for markets, for saying they are necessary despite their cruelties. We should embrace them precisely because they make people less selfish, and they make life more collective, less individualistic. The entire drift of human history has been to make us less self-sufficient and more dependent on others to provide what we consume and to consume what we provide. We’ve moved from consuming only as widely as we produce to being much more specialized as producers and much more diversified as consumers.
That’s the very source of prosperity and innovation. It’s time to reclaim the word “collectivism” from the statists on the left. The whole point of the market is that it does indeed “collectivize” society, but from the bottom-up, not the top-down. We surely know by now after endless experiments that a powerful state encourages selfishness.
Let me end with an optimistic note. If I’m right, that exchange is the source of innovation, then I believe that the invention of the Internet, with its capacity to enable ideas to have sex faster and more promiscuously than ever, must be raising the innovation rate. And since innovation creates prosperity by lowering the time it takes to fulfill needs, then the astonishingly rapid lifting of humanity out of poverty that has happened all over the world, particularly in the last 20 years, can surely only accelerate. Indeed, it is accelerating. Much of Africa is now enjoying Asian Tiger-style growth. Child mortality is plummeting at a rate of five percent a year in Africa. In Silicon Valley recently, Vivek Wadhwa showed me a $35 tablet computer that will shortly be selling in India. Think what will be invented when a billion Indians are online.
In terms of human prosperity, therefore, we ain’t seen nothing yet. And because prosperity is an emergent property, an inevitable side effect of human exchange, we could not stop it even if we wanted to. All we could do is divert it elsewhere on the planet (which is what we in Europe seem intent on doing). “Adam Darwin” did not invent emergence: his was an idea that emerged when it was ripe. And like so many good ideas, it was already being applied long before it was even understood. And so I give you Adam-Darwinism as the key to the future.
Comments Off on Reddit AMA with Economist and Iconoclast, Professor Bryan Caplan
Bryan Caplan is a Professor of Economics at George Mason University. He is a prolific blogger and author of three books: The Myth of the Rational Voter: Why Democracies Choose Bad Policies (2007), Selfish Reasons to Have More Kids: Why Being a Great Parent is Less Work and More Fun Than You Think (2011), and the forthcoming The Case Against Education.
Professor Caplan has appeared in the New York Times, Wall Street Journal, and Washington Post, and has appeared on ABC, Fox News, MSNBC, and C-SPAN. He recently appeared on The Rubin Report in association with Learn Liberty, and starred in the Learn Liberty video series: Econ Chronicles.
Mark your calendar and join us for a rousing conversation at Reddit.com/r/Libertarian this Tuesday, June 20th at 3:00pm ET where you’ll have the chance to chat with Professor Caplan and ask him anything!
Update: The AMA is now live!
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Economies of scale and comparative advantage let us make bigger and better oranges, grapes, and everything else. For more Dan Russell, watch https://www.youtube.com/watch?v=_sLET3sqMgU
Comments Off on Why my students dump their boyfriends (and girlfriends): The 3 most eye-opening ideas in economics
I teach many concepts and principles in my economics classes. But if I only had one brief class session with my students, I would want them to understand three key concepts. Here’s what I’d like them — and you — to know in the hope of viewing different situations and voluntary exchanges in a new and more useful light.
1. Sunk Costs — All the Single Ladies
I tell my students that after my class, their Facebook status will change from “in a relationship” to “single” or at least, “it’s complicated.” This is because they will learn the concept of sunk costs.
A common example to help explain sunk costs is the movie theater experience, where a person buys a ticket and, 20 minutes into the movie, she realizes that it is a horrible movie and it will only get worse. But then the devil on her shoulder says, “You had better stay and get your money’s worth.” The reality is that the money is already gone. What this person needs to understand is that the only costs that should matter in decision-making are future opportunity costs.
What does this lesson have to do with relationship status? Learning about sunk costs opens students’ eyes and leads some of them to tell me at the end of term that they have broken up with their boyfriend or girlfriend.
Many people find themselves in a situation where they have been dating someone for a long time and they think that if they do not continue investing in the relationship or even get married to that person, then their investment of time was a waste. So, they rationalize their decision to stay in the relationship even though their gut tells them something is off. My students unfortunately listen to too much of Beyonce’s “All the Single Ladies.” I tell them, “If you like yourself, then don’t let him put a ring on it” or “Don’t put a ring on it.”
Once they understand that their future is what matters and not their previous investment of time, they realize that it is better to be single and potentially find a new partner than to move forward with the unsatisfactory relationship. Those past years of dating are gone, but that loss doesn’t have to ruin their future too.
If Match.com claims that that no other dating service has resulted in more marriages, I think I can claim that no other professor has broken up more relationships and prevented more marriages. And I’m proud of that!
2. Nothing Is Free — Price vs. Cost
What is the difference between the words price and cost? In everyday speech, people will say, “The movie ticket cost me $15,” or “The cappuccino cost me $4.” The problem is that when people do not pay money for something, they will use the F word — free — or some will say, “ I got it at no cost.” This is wrong! Nothing is free.If someone gets something without having to pay money for it, then they should say they received the item for a zero price. However, there is always a cost — the highest-valued alternative given up. Using the movie ticket example, the correct way to characterize the transaction is that the price of the movie ticket was $15, but the cost was the next best thing that the money (and time) could have been used for.
Why am I so picky about this issue? Because I want my students to understand that even though they may not pay money to get certain items, nothing is free; there is always an opportunity cost involved. Zero price is very different than zero cost.
3. Revealed Preference — Actions Speak Louder Than Words
On the first day of class, I tell my students in a soft voice, as if to make sure nobody outside can hear me, “If you saw my paycheck, you would know that I am being exploited. I am being taken advantage of.”
Many students nod their heads in agreement, as if they are in solidarity with me. They have probably heard from other professors how teachers are underpaid and undervalued. I then ask, “How many of you would do something voluntarily if it was not worth it to you?” No one raises a hand.
In a voluntary exchange, both parties expect to benefit. That is why my institution hired me and has kept me on as faculty, and that is why I choose to go to work each day. Obviously, I would love the number on my paycheck to be much higher, and the institutions would love to pay me nothing; nevertheless, that I choose to go to work each day and that the university continues to give me paychecks proves that both sides of this exchange are winning.
Actions speak louder than words, and that is what revealed preference is. I might say, “I am being exploited by my employers,” but my action of choosing to work at my institution proves otherwise. Revealed preference sheds light on numerous discussions that arise in my economic class, including the debate on “sweatshops.”The same lesson applies to our purchases. People often say they are “being ripped off” at the movies by the “high” price of the ticket and the “exorbitant” prices of popcorn and soda. Interestingly enough, though, I have never been to a movie theater where I was forced to go inside — I have always chosen to enter the theater and pull out my wallet. Once inside the theater, I have never been tackled and then dragged to the concession stand and had money forcibly taken from my wallet — I have only voluntarily chosen to stop, smell the popcorn, go the cash register, and order the popcorn.
My choice to go to the movie and buy the soda or popcorn proves I do not think the experience is a rip-off. Obviously, I would not do something if I expected the benefit to be lower than the cost — the next-best thing I could have done with my time and money.
To be clear, I am not arguing that there is no such thing as a rip-off. My point is that if the exchange is voluntary and there is no fraud or misrepresentation, then it is a win-win transaction.
There are, of course, more topics and concepts that students learn about in an economics class, but the concepts of price vs. cost, sunk costs, and revealed preference are three foundational points that clearly address many real-life situations students find themselves in, from dating to complaining about getting “ripped off.” These lessons give them the tools to make better decisions and be happier in their personal lives.
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We live in the richest society in history, but most people never ask what “wealth” even means. For more about wealth and why it’s on the rise, click here.
Comments Off on Lawnmowing licenses: Crony capitalism in action
It came across my news feed this morning that teens in Gardendale, AL, cannot mow lawns for a summer job unless they apply for a business license, which costs $110 (plus a day of dealing with city paperwork).
This story is a perfect example of what licensure regulations are really about and why they are completely at odds with basic human rights. Let’s begin by noticing how this came up in the first place.
Young Alainna Paris was mowing her neighbors’ lawns for $20–$40 each. Now, many teens earn extra money mowing lawns, and yet there don’t seem to be a lot of law-enforcement resources dedicated to licensure enforcement.
So how did Alainna’s illegal lawnmowing come to the attention of the authorities? Someone with a lawn company, upset by the prospect of competition, filed a complaint. This isn’t an accident. That’s the point of the licensure regulations — protecting established interests from competition.
In Howie Baetjer’s now-famous article about hair braiding, the reason a 14-year-old was put on the spot was exactly the same: someone else resented the competition, and used the licensure laws as a cudgel. But this isn’t a misuse of those laws — that’s what they’re for.
I mowed the occasional lawn for money when I was Alainna’s age. When you’re 14 or 15, especially in the summer, your opportunity cost is extremely low. But for the grown-ups who own lawns, it’s a chore. Grown-ups have lots of them: lawn care, oil change, shopping, laundry, vacuuming, cooking, driving your kids from here to there, raising crops.
Actually, for most grown-ups today, raising crops isn’t on the chore list at all — we pay other people to raise crops for us. Now consider the other chores on that list; these are all things we could potentially pay someone else to do. Everyone is a little different here — I do my own yard work, but outsource the oil changes. Some people pay others for all of them. I would outsource more of them if they cost less.
Alainna’s potential customers can afford lawnmowing at one price point, but not necessarily at another. So Alainna’s willingness to mow lawns for less than the professional lawn care company means that she gets to earn some extra money over the summer, and various neighbors get relieved of a couple of iterations of an unpleasant chore. That’s all to the good — unless you run the lawn care company. Then you see Alainna as taking money away from you.
Leave aside for a moment that you are not entitled to anyone’s business in the first place. But many of Alainna’s customers are likely to be people who wouldn’t pay for the more expensive lawn care service in the first place. If the choice is “do it myself or pay Alainna 20 bucks,” that’s a different decision than “do it myself or sign up for 800 dollars’ worth of lawn service.”
Alainna may be siphoning off some business, but she is also creating markets where none had existed. The licensure regulations are there to make it harder for her to do that.
The bearers of the burden of licensure regulations like this include both young people trying to make some honest money, and also lower-income people who would benefit from a more affordable service.
Who benefits? Larger lawn service companies, and of course the taxman.
This is crony capitalism in microcosm: the established firms lobby for regulations that burden would-be competitors, which protects them from competition, and the municipality or the state is happy to put the regulations in place, which become a revenue source. Alainna’s story puts in clear view how these restrictions on entrepreneurship and competition harm the many to give an unearned benefit to the few.
More philosophically, if you need a license to do something, it means you are required to ask permission — indeed, you have to pay the state to ask permission. This is very different from having a right to do something. I would argue that Alainna has the right to choose to sell her time and sweat to someone who would rather not do yard work. That’s what it means to be a free person.
Comments Off on Flip or Flop? What home flipping shows don’t tell you
Shows like Flip or Flop make it look easy to turn huge profits from renovating a home. But what they don’t tell you might convince you to keep your day job.
Personally, I love watching the home renovation shows on HGTV. From tiny apartments to sprawling estates, all it takes is a minute or two of watching people muse on the potential of a dilapidated structure for me to be hooked. How will they make that fixer-upper look amazing?
Depending on the show, current homeowners may wish to renovate their house, or a “flipper” may buy a vacant property and completely renovate it with the intention of selling it for a profit. In either case, the owners always talk about their estimates of costs and profits before they start work and then update those figures after completing the project.
For instance, a flipper may say, “I can purchase this house for $70,000, and I expect to spend $60,000 on renovations, so I need to be able to sell it for at least $130,000.” They research the local market, and if they think they can sell the house for more than $130,000, they make the purchase and begin the repairs. At the end of the show, they will revisit their estimates. “We bought the house for $70,000; it only costs us $55,000 for the renovations, and now the current market value is $250,000!” If they were fortunate enough to sell their house for the asking price, they go through the numbers again and add, “We made a profit of $125,000!”
Accounting Profits vs. Economic Profits
After watching a run-down, outdated house be transformed into a modern, perfectly staged abode in the span of half an hour, I start to ask myself questions like, “Could I make this much flipping houses? Wouldn’t it be rewarding to turn ugly homes into something worthy of the cover of Sunset magazine?”
But then my economist brain switches on and other questions come to mind. “How many hours did they work on this renovation? What would that break down to in terms of an hourly wage?”
What I’m really doing when I start to ask questions like these is assessing the project’s economic profit. It’s tempting to add up all the explicit costs and benefits, like building materials, permits, and the selling price, to determine profits. That calculation will leave us with what’s called an accounting profit. However, that figure ignores the implicit costs — how the resources employed in the project could have been used elsewhere (aka opportunity cost). These are the additional costs we must consider when determining economic profits.
Labor Costs and Opportunity Costs
One of the most commonly overlooked implicit costs in these types of shows is labor. I have yet to see a single episode where they address the cost of the labor that goes into completing the renovations. Often a couple of “amateurs” are brought on to help complete the renovations under the guidance of the show’s resident expert. Though it seems like they can work miracles in under an hour, the reality is that it takes hundreds of man-hours to complete the extensive projects presented on these shows.
What could these laborers have been doing instead? What would they have been paid to write computer programs, for instance? Taking a realistic hourly wage and multiplying it by the number of hours spent working on the project is one place to start in computing the economic profit. When the opportunity cost of labor is accounted for, the resulting profit will be much lower than the numbers quoted on these shows would lead one to believe. And of course, that’s only one implicit cost. Would it have been more profitable to raze the house completely and build something else?
So the next time you’re watching Flip or Flop and wondering if a career change is in order given the enormous profits to be had, take a more realistic approach and ask yourself how much someone would have to pay you to take on that job. While you’re at it, add in the cost of hiring someone to coach you through the renovation work and someone else to be the creative genius behind it all. That $125,000 profit may quickly disappear!