Wednesday, July 30, 2008

Globalization Progress: "Pot Meet Kettle" and the Power of Institutions

Well, the Doha Round of trade negotiations has collapsed amid a flurry of finger pointing, according to this story from The Wall Street Journal. I go back to the old saw, "When something goes wrong, point your finger - and remember three more point back at you." It seems that this holds true this round. The rising economies basically expected to be able to insist on the same exceptions as the Western economies have put in place for decades - at least when it came to agricultural protection. Can you believe it? They wanted to be treated equally when it came to negotiating an equal playing field?

However, this does not necessarily mean globalization is grinding to a halt. There is a great deal that can be done institutionally within individual countries (including ours). Read the case in this opinion piece, also from WSJ.

If you run across more pieces on the collapse of the Doha round during the next few days, please share them if you think they are clear and well-written. And include some ideas for using them in a classroom environment.

Rational Economics: Depends on Your Definition of Rational

There's an interesting piece in The Economist. It seems a financial advice firm was looking for proof that people need their services. The firm placed a man in a sandwich board outside a store. The sign said something to effect "Free five pound notes - just ask." Very few people asked.

The firm says this proves people are not rational decision-makers. I tend to agree with the conclusion of the article; the firm doesn't understand everyone's rationale. I'm not sure I could state unequivocally that I'd walk up to a stranger professing to give away money. How does the character look? (We spend a lot of time teaching our children not to accept gifts from strangers. And if an offer is "too good to be true, it probably is". There's even that old economics joke about the two economists walking down the street, who see a $100 bill in the gutter. One tells the other it isn't real - because if it was it would have been picked up already.) How much of a hurry am I in (time value/time utility)? Do I think I'm going to get hooked into a lecture? Experiments like this are valuable because they give us insights into the decision-making process. I maintain the decisions of every person were rational, whether they asked or not. It was their choice to make and they weighed what they thought might be the costs and benefits. What do you think?

Tuesday, July 29, 2008

Price Affects Behavior

A couple of articles in today's issue of The Wall Street Journal could be easily used to help students understand how price affects behavior. Both of them are worth looking at if you're looking for current issues to illustrate your discussion.

The first article is about the decision facing the town of Plymouth, Mass. As a method of dealing with increasingly high volumes of trash, Plymouth has decided to follow the lead of other cities and adopted a "pay as you throw" (PAYT) system. In it, residents pay a basic monthly fee (lower than it was in the past). Items that can be recycled are placed in separate containers and picked up "free" - we know there's no such thing as a free lunch...or free trash. All other items must be placed in special plastic bags that cost $1.25 each. The concept is economically sound. Those who generate the greatest volume of trash (non-recyclable) will pay the most.

Many residents have embraced the idea. Many are against it. And your students may be able to predict how behavior changes. According to the article, 20% of the communities that have adopted PAYT have experienced illegal dumping. Likewise people, acting rationally, try to cram more trash into each bag. And while the article doesn't mention it, I suspect there's an increase in the amount of non-recyclable material in the recycling bins.

The reaction, while predictable is interesting. In most communities, citizens pay for trash removal, just not directly. The costs of the service are "hidden." And in many cases, the cost may not bear a relationship to the volume of trash generate. For many people, trash removal is a public service. But can it also be seen as an externality - a benefit or cost shared by people outside of a transaction? Here's what I'm suggesting. In systems where there is little or no direct relationship between volume and price, those who generate large volumes may be paying less than their share, thus receiving a benefit they don't pay for - a positive externality. Those who generate less may end up paying more than their rightful share - paying for a benefit they don't receive - a negative externality. Does adopting PAYT minimize exteranalities and allow for costs more accurately assessed? Who knows, a positive consequence out of this may be an increased outcry about packaging.

Now, let's take a look at the second story. This one concerns power blackouts in Indonesia, a nation that is a major coal producer and that generates much of its electricity using coal. This may seem odd, but the story gets more interesting. Indonesia's coal producers, like many coal producers elsewhere, can sell their coal domestically or to the foreign market. Now, your students may wonder "Who cares? What difference does it make?" Enter the price mechanism. In Indonesia, coal sold to the domestic state-owned power company is sold at a controlled price. This is done to control the price of electricity for consumers, either businesses or homes. However, with the worldwide energy situation, the price of coal for foreign consumption has risen. This means more profit for the producers, giving them the ability and incentive to find and produce more coal.

Again, because of an existing price structure, people are not bearing the full cost of their use. Government is subsidizing the use, while at the same time asking people to reduce consumption - something they have no real incentive to do, given the price. This is an artificial price constraint. And the artificially low price encourages consumption. If the domestic price controls are extended to exports, through a tax of some kind, for example, they may actually discourage production. The incentive of an artificially low price is to reduce production and encourage consumption, which leads to shortages.

If the Indonesian government were to move to a domestic energy price that more closely reflected actual costs, there would undoubtedly be political unrest. But I hardly think repeated blackouts such as they are currently experiencing will be a viable alternative.

These both provide good examples of mind exercises to use with your students. And at the same time, they will provide some discussion about government in the economy. I look forward to your comments.

Friday, July 25, 2008

Economic Hard Times and the Role of Government

You might as well settle back. This could be a long post. But it should offer some tools for those of you who teach American History as well as economics.

The seeds of this post were planted last weekend. As usual, I was the first one up (not counting the cat) and I went to the kitchen to make the coffee and await the arrival of the Saturday morning newspapers. When they arrived, I quickly perused the local paper and then opened The Wall Street Journal. Inside I found this piece by James Grant. Titled "Why No Outrage?", it seeks to answer a question. In a nation with a long history of populist rage against the moneyed interests, why was there not a more vocal grass-roots movement to 'turn the rascals out' - the rascals being the heads of Wall Street firms, mortgage lenders, as well as central bankers, regulators and other denizens of the world of high finance?.

The article was by James Grant, author of a favorite book of mine, Money of the Mind. (It's a history of the democratization of credit from pre-Civil War era to the junk bond days of Michael Milken.)

In the WSJ article, Grant suggests linkages between Wall Street and both ends of Pennsylvania Avenue as a possible reason. But I think the truth in that is related to an earlier portion of the article when suggests that the link between Wall Street and Main Street may be part of the answer.

Grant takes us on a historical examination of the many ways the populist movement changed the nature of the economy as a whole and the financial system within it. (Indeed, in this I think he is drawing a parallel to his work in Money of the Mind.) The periods of economic and financial upheaval the U.S. experienced in the 19th and 20th century, helped shape the rules and agencies that police the financial market - and, if I may point out, that indirectly drive innovation. For as rules are promulgated and agencies incarnated (witness the proposed establishment of a new Federal Housing Finance Agency to oversee Fannie Mae, Freddie Mac, and the Federal Home Loan Banks - all creations of government), the market develops new ideas and products not covered by those rules and agencies. And many of the folks on Main Street take advantage of those new ideas as depositors, investors and borrowers.

Now, let us open today's issue of The Wall Street Journal. On the front page of section one, we see an article on how the "Economy Spurs Government to Grab Bigger Oversight Role". This article, by a number of Journal reporters, also provides historical insights linking the expansion of government to financial upheaval, although not restricted to that industry. (They mention a desire by many in the food industry for increased oversight.) And again, the connection to Main Street is clear. Individuals, citizens, consumers are looking to Washington to solve problems. Those same people are, by their activism, determining the size and scope of the role of government in the economy. And regardless of where you stand on that question, the connection is one that students need to understand.

As members of society, the economy and the policy, our students will make choices. They (and we) can choose to increase the size and scope of government. That will reduce the number of choices (freedoms) they have to make, and will increase the costs of government. They can also choose to decrease the size and scope of government. That will reduce the costs of government, but it means they will increasingly have to bear the risk and direct cost of those choices. After all, as we say here at the Powell Center, "There ain't no such thing as a free lunch." Furthermore, they need to understand that choosing not to choose means they are wiling to accept whatever happens - with size and cost of government and with their personal decisions.

I think the articles can provide a history teacher with additional information and an interesting way to tie the lessons of history to current events in the economy. I think the articles can help the economics teacher who is trying to help students understand the role of government in an economic system, and the ways that rules and agencies (institutions) impact decisions with that system.

I'd be curious to hear your thoughts on this.

Thursday, July 24, 2008

Beatrice's Goat

I'm sure all of you who teach at the elementary level are familiar at some level with the story behind Beatrice's Goat. It's the true story about a young girl in Uganda whose family receives the gift of a goat, and how it changes her life. The goat provides a resource for the family to produce milk for its own consumption and for sale to others. This, in turn, provides capital to improve the family's home.

I'm also sure those of you familiar with the story were aware when Beatrice was able to go to college in 2005, and I hope you saw this story about her graduation. I trust you will share this story with your elementary students.

But I think this also has a lesson for those of you teaching at the high school level. Many of your students were first introduced to Beatrice in their early academic career. But I also suspect many of them lost track of her. You and they would be well served by a reintroduction. There is much to be learned about the value of capital to change one's life; and the importance of reinvesting in one's human capital. I'm sure Beatrice's life was changed by the goat. I suspect she will change the lives of many, many more people.

I look forward to your comments.

Elasticity of Demand and Interdependence

I trust many of you are already aware of this, but Greg Mankiw has an ongoing series on cross price elasticity of demand that is very good. If you're trying to teach your students about this (or just the concept of interdependence - how one part of the economy affects another), you'll find some very good examples on his site.

I look forward to your thoughts and additions to his list (numbering 12 at this writing).

Buy, Rent or Borrow

In a recent piece in The Wall Street Journal, (link no longer available) columnist Neal Templin discussed his aversion to buying books. He's an avid library user, although he admits that he owns books that he reads over and over again - Tolstoy and Willa Cather. He also admits to buying paperbacks and leaving them someplace when he's done so they can be enjoyed by others.

This got me thinking about the concept of utility or value. Jeremy Bentham wrote about the idea of utility early in the 19th century. And while the subject is rarely discussed at the high school level, I've found it an interesting way to explain the power of price in the market.

My instructors mentioned three types of utility - form utility, place utility and time utility. Form utility meant that the good or service possessed a form that the consumer valued. Place utility meant the good or service was available at a location the consumer valued. And time utility meant the good or service was available when the consumer valued it. These explanations helped students understand that a good or service had different utility to different people at different times. Thus it was possible that something that was worth $5 to a consumer on one day may or may not have the save value the next day. And even if the product was worth the same amount from day to day, it may be for different aspects of utility.

This brings us back to the piece in the WSJ. We may surmise from Templin's piece that he sees little value (utility) in the ownership of most books. Form utility clearly is not a factor because he still is an avid user of books (no mentions of electronic formats were made). One might then think that, with occasional exceptions, Templin places little place or time utility on most books. That is, unless he sees himself going back and rereading a particular book, there is no advantage or value to him in having it at hand all the time, i.e. owning the book.

I admit I am the opposite. I own most of the books I've purchased or inherited over the years, including a few textbooks. For the most part, I see value in having the books at hand to reference whenever I wish. I freely admit I don't refer to them on a daily basis, but I do it. And there is a level of satisfaction (utility) in finding something on the shelf that I had all but forgotten. An example of that is the recent broadcast of the updated movie The Andromeda Strain on A&E. I enjoyed the original version of the film released in the early 1970s. The new version had superior special effects (as one would hope), as well as some unneeded political sub-texts. But I only vaguely remembered reading the book by Michael Crichton. I went back to the bookshelf and found an old paperback copy, which I will now reread with added interest and insight. And I have been encouraging my 18-year old to watch the movies and read the book.

My suggested application of the concept to engage your students in a discussion of what value (if any) they place on ownership an which items have that value for them? I know in the case of my sons, things like music, video-games, and even books have low utility in ownership - with some exceptions. And granted, the internet can make many things available when/where we want - reducing the time/place utility of ownership. But to me, some things still need a certain form - books are among those things.

I look forward to your comments.

Wednesday, July 23, 2008

Thoughts about Credit Cards

I'm not sure how I missed this, but back in June The Wall Street Journal had this great interactive as part of their online site. The feature contains short interviews (less than two minutes in many cases) with people who attended a credit counseling program in the Midwest.

Their stories are informative. And their views about their responsibility, as well as the responsibility of creditors, can be informative and can open a lot of possibilities for your classroom discussion. Playing a couple or all of these and then discussing the information with your class may help them see the danger of improper credit use as well as matching their lifestyle to their resources. I encourage you to take a look and share your thoughts with the rest of us.

Inflation as a Monetary Phenomenon

Economics instructors frequently invoke a phrase made popular by Milton Friedman, "Inflation is always and everywhere a monetary phenomenon." It summarizes some of Friedman's work showing that it matters less what backs money than what the relationship is between the money supply and total output. Whether fiat or specie backed, the relationship between output and total money supply provides more insight to the price level than anything else.

Over on the Financial Times website, I ran across a great interactive that illustrates the relationship between money (and monetary policy) and inflation over time. The graphic shows monetary policy rates for four major central banks (Bank of England, Federal Reserve, European Central Bank, and the Bank of Japan) and how those rates relate to inflation rates in their economies. It also provides some basic information about each of the four banks. It's a useful and interesting tool for introducing the concept to your economics classes.

I look forward to your comments.

Tuesday, July 22, 2008

Teaching Fiscal Policy

Megan McArdle is a regular blogger for The Atlantic magazine. In this post, she explains why using fiscal policy to stimulate the economy may be more limited than in the past. Granted, Congress and the Administration could always issue another stimulus check, but the idea of increased spending on things such as infrastructure, as in the New Deal, may be a bit naive. She points to issues of timing and regulatory barriers as reasons why this aspect of fiscal policy may have more of a lag than monetary policy.

And as to the impact of a stimulus check, check out the last half hour of this interview with Allan Meltzer by Russ Roberts over at EconTalk.

There are some interesting things to work into your classroom presentations, to be sure.

I look forward to your comments.

The Demand Curve Slopes Downward: Who Would've Guessed?

I ran across this article in yesterday's edition of USA Today. And while the implied theme would hardly qualify as news to anyone studying economics, it is still worth drawing attention to the story. The idea that demand for a good or service decreases as the price increases, and vice versa, is fundamental to understanding the price mechanism. One can detour into discussions of elasticity of demand - how much does the quantity demanded change as price changes. But the basic description of demand is not surprising. That is why there's no news in the headline. But the story offers more to consider.

While the author is correct that economic conditions can change behavior, I believe drawing a parallel between now and the behavior change brought about in the 1970s is ambitious. The fundamental long-lasting type of change referred to in the article is a result of long-lasting economic circumstances. The type of behavior change cited in the article was the result of a decade-long period of rising inflation and stubbornly high unemployment. It was that long period that changed behavior.

Consumer (and producer for that matter) behavior is fundamentally forward-looking, but it is based on past experience. A decade of difficulty tends to loom larger in the memory than a year of difficulty. And while individuals are changing behavior as a result of current housing and gasoline prices, it is probably too early to call that change a long-run phenomenon. Even if it takes another year for the economy to fully emerge from the present funk, individuals can quickly revert to previous models if the economy picks up steam quickly. The slow recovery from the recession of the early 1990s was all but forgotten (along with many lessons) within five years - remember irrational exuberance?

But this article is worth discussing with your students for a number of reasons. First, have them look for parallels in their behavior and the behavior of the individuals mentioned in the article. Ask them how they and their families have adopted to current prices.

Second, have your students extrapolate from their experiences to the larger national picture. How does what they experience get reflected in the national economic picture (inflation, growth, employment)?

Finally, ask them how long they think it would take them and their families to "return to normal behavior" if the economy started to show improvement in the next couple of months? Would they quickly revert to old patterns of buying? Would yhey reexamine decisions to purchase something major? And if so how?

These types of questions can be useful not only in an economics course, but in personal finance classes as well. We shape our budget, largely on our expectations, but conditions changing for the better do not necessarily imply a pressing need to increase the spending category of the budget.

I look forward to your comments.

Friday, July 18, 2008

Local Produce / Global Trade

An interesting topic to discuss with your students has to do with something they're usually interested in - food.

A trend that has recently gained notice, despite having been around a while, is the move to increase reliance on locally grown food. In the past, the case made for the practice has largely focused on support of local farmers, the sense of knowing more about what you're eating, as well as nutritional value because the local produce is frequently also organically grown.

A more recent argument in favor of the practice relates to the transportation cost for the food we eat. If we buy local, the reasoning goes, it takes less fuel to transport the food from grower to market. This reduces energy costs and carbon footprint.

Now, I've seen other discussions that indicate the cost of transportation per unit of food (per pound, per ton, or whatever) is actually less because of the huge amounts moved and the types of transportation (not every product is transported every mile by truck), but articles have tended to be one side or the other.

This article from The Carnegie Council is one of the better ones I've run across. The article balances local issues against global issues and speaks about the opportunity cost of our choices. In fact, it is the framing of the choices that makes the article so interesting and compelling for me. It frames the choices this way:
1) Think globally, buy locally.
2) Buy local when you can, import when you must
3) Buy local if you can afford to, let others buy imported food
4) Buy what you want
There are, of course, other choices (although #4 includes every option, as far as I can tell). But the choices speak to the idea that each of us needs to be free to pursue our own priorities when making our choices. But as long as we're aware of the impact of our choices, both locally and globally, we can better recognize the opportunity cost. And that makes for more informed decisions.

I think you could engage students down to the upper elementary grades in this discussion, focusing on choices, opportunity cost, and interdependence. If you did this at the middle and high school level, you could focus on interdependence, trade, economic development and world poverty. Regardless, when you put the topics into a food context, you can get attention.

I look forward to your comments.

Thursday, July 17, 2008

Economics in Comics

Thanks to Greg Mankiw for this one.

Free Resources

The .pdf version of the Spring issue of Econ Exchange, the Powell Center's newsletter for teachers is up on the website of the Powell Center for Economic Literacy. The theme is economics and agriculture and the lead article by Jason R. Henderson of the Federal Reserve Bank of Kansas City's Omaha Branch. It also includes outstanding lesson plans for the elementary, middle school by some very talented educators. It also includes a high school web-based activity by yours truly.

This is our first "electronic only" copy. In future, we will not be distributing hard copy. But you are free to duplicate additional copies to share with colleagues or students.

You can contact us with your comments about the issue here.

Schumpeter, Mortgages and GSE's

As I mentioned in yesterday's post, there's a lot in McCraw's biography of Joseph Schumpeter to make you think. As I was working on my personal journal last night, this quote rang a bell.
As he put it in 1921, the essence of the economy lay not in paper securities or even in production equipment "but in the psychological relations between people and in the mental state of the individual." The crucial element was capitalism's orientation toward the future; but when the future looked bleak, people were reluctant to take risks. "The spiritual community is an infinitely complex and sensitive organism," and it is "each individual industrialist or merchant who sets afloat his own little boat."

I was struck by McCraw's appreciation of Schumpeter's orientation toward the future. Schumpeter believed that a real capitalist system can survive only if it is forward-looking. My first reaction was to use the quote as a follow-up to my post of a few days ago on PPP and NNN and how our expectations are important to future economic performance. It does no good to either overplay the negative or underplay the problems. Either keeps the market from assessing reality. Then, upon getting to the office and checking through the morning mix of media, I ran across some other items that, at least in my mind, linked to what Schumpeter was saying.

The first was this short piece from the Federal Reserve Bank of St. Louis Monetary Trends. It provides some interesting insights to the number and type of mortgage originations from 2000 through 2006 and linking those originations to the interest rate on traditional 30-year mortgages. The data, in turn, reminded me of this post on the Creative Capitalism blog by Larry Summers (HT to Econlog). In it, he cautions about what happens when we (read government) try to get "too" creative with capitalism and distort the messages to buyers and sellers that is inherent in price.

That was then reinforced by a couple pieces in The Washington Post. The first is about legislation being shaped to support Fannie and Freddie, even though we've heard repeatedly how both organizations are fine. The second speaks to how some parts of the support package are being modified. It seems that the upper limit on qualifying mortgages is being raised - certainly above what I would consider lower and middle income, but I may be out of touch with the size and price of homes for people in those income brackets.

Now, we come to the final icing on the cake. I opened The Wall Street Journal to find an opinion piece on economic leadership by Karl Rove. Putting aside my sense of irony, I read it anyway. In it, he writes about reform for Fannie and Freddie and points out how Fannie and Freddie secure jumbo loans (see previous paragraph) and how much of the combined GSE's budgets are spent securing political support. This last point is reinforced by an item on the Yahoo Politico site.

Now, to get back to the opening of this blog, economic performance is shaped by expectations. Our expectations are shaped by the past and the present. We can share these news and opinion pieces with our students, or summarize them if necessary. But we also can then ask them how this issue shapes or might shape their expectations about the future economy - the economy they will inherit and live in.

Of course, they may plan on renting. But again, they may not be able to participate in a market shaped by the same rules. And the rules of individual markets are out of their control...aren't they?(HT on both the last links to Carpe Diem.) The rules we put in place, or the rules that we allow our representatives to put into place, shape our economy and ultimately our expectations. And our students need to be able to compare costs to benefits, short-run to long-run.

I look forward to your comments.

Wednesday, July 16, 2008

What I'm Reading

Not too long ago, I finished reading Prophet of Innovation: Joseph Schumpeter and Creative Destruction by Thomas McCraw. I must say it was one of the more interesting books I've read in a long time. And in my view, it had the additional benefit of being written by a eminent historian with a sound understanding of economics.

Biographies of economists tend to go one of two ways. Either they get tied up in the psycho-social aspects of the subject, which may offer insights to the thinker, but does little to explain what she or he thought; or they spend so much time explaining the ideas, that the biography becomes an defense of the economist rather than a journey into what made the economist and what made the work important. McCraw travels both roads and, in doing so, avoids the problems of each.

Joseph Schumpeter is perhaps best known among non-economists by his phrase "creative destruction." In fact, that is all many people know about him. But many who study the history of economic thought would rank Schumpeter among the top two or three economists of the 20th century. So why don't more people know about him? As McCraw makes clear, much is due to Schumpeter's own personality and views about the profession. Schumpeter actively sought the spotlight while being intensely focused on his teaching and research. The latter (along with an unsuccessful stint as Minister of Finance in post World War I Austria) caused him to avoid policy positions in favor of working the fields of academia. He taught and taught with a number of luminaries in the field - von Weiser, Bohm-Bawerk, Fisher, Galbraith, Leontief, Samuelson and Tobin. Additionally, while stressing the need for a more mathematically-based science (he was one of the founders of the journal Econometrica), he felt that economics often ignored the longer, historical view - much to its loss.

He also had the misfortune to advocate a number of ideas which, unpopular at the time, would later prove correct. During the Great Depression, he saw the much of the process of government intervention as more hindrance than help. This, of course, ran counter to the more widely-accepted ideas espoused by John Maynard Keynes.

He also saw the socialism of the Soviet Union as a greater threat than the socialism of fascism - not a popular view given our alliance against Germany. And while many rightly saw the threat that was Germany, just as many chose to ignore the potential threat posed by our ally. This last, combined with his marriage to a brilliant economist known for her research and admiration of the Japanese economy, gained more suspicion than renown during the early 1940s, as one might expect.

But it was Schumpeter's understanding of the history and process of economics that was his greatest achievement. An unrelenting supporter of capitalism, he saw it as a process of ongoing evolution and improvement, rather than a system of institutions and beliefs. And his greatest works Business Cycles and Capitalism, Socialism and Democracy, as well his History of Economic Analysis (finished posthumously by his wife) are testaments to this view.

Anyone who teaches economics would be well served to read this book. While its 700+ page size is imposing, one can gain comfort that almost 200 of those pages are notes in this well-researched work. If you would gain some insights about the true nature of capitalism (as opposed to the popular and/or political version), I would recommend you spend some time with McCraw's book. And if you are just interested in the conflict inherent in the mind and experience of genius and how it is manifested in the works of the genius, you will also find much of interest.

I will actually be blogging from time to time on the many quotes and excerpts I ran across in this work. There was much that can be of use in the classroom.

For an additional review, I direct you to this one by economist Robert Solow.
For an interesting interview with the author, Thomas McCraw, and discussion of Schumpeter and his impact on economics, I direct you to this podcast.

Please feel free to share your thoughts about the book, Joseph Schumpeter, and his ideas.

Monday, July 14, 2008

Election Economics: Economists Platform

Here's an idea for generating discussion in economics and government classes. It addresses the idea that we often have a good idea of what's best for the country, but at election time we vote in our own interest.

In a recent New York Times piece, Greg Mankiw lists what he would put forth as a platform that would be supported by many economists. My suggestion is to use the piece with your students and then ask them these questions.
"What support or objection would you anticipate for each plank? Why?
Do you think a total platform would like this could be aligned with either party? Why or why not?"

I would think this type of discussion would promote some critical thinking, and lead to some discussion as to the economic understanding of the U.S. electorate.

I look forward to your comments.

P.S. I would make a change to one plank. I think any forms of price controls are uncalled for. On the basis of this story alone, I think the elimination of farm price subsidies should be expanded to get rid of any types of
price controls or subsidies. (HT to Mark Perry.)

Friday, July 11, 2008

PPP vs. NNN: Pervasive Pollyannas of Postivisim vs. Nattering Nabobs of Negativism

I always enjoy it when my reading brings together a number of seemingly unrelated pieces and, serendipitously, everything falls together and starts the mind racing. This has happened over the past couple of weeks and I think offers an opportunity to examine how we measure and address economic progress.

When we talk about economic policy, we often discuss the main objectives of policy: growth, employment, price stability, and exchange. Admittedly, none of these statistics are anything to get excited about. Gross domestic product (GDP), according to the most recent release was up 1% for the first quarter of 2008, and up .6% for the fourth quarter of 2007. It's hardly stellar, but not negative, and certainly not in recession territory if one is to go by the (incorrect) definition of two consecutive quarters of negative GDP.

Unemployment stands at 5.5% according to the most recent release. That is a bit higher than we've been used to for most of the past fifteen years. But it is not outside the bounds of the Non-Accelerating Inflation Rate of Unemployment (NAIRUE) or the natural rate of unemployment which many people believe to range between 5-6%. Furthermore, it is not of a magnitude to compare with the late 1970s and early 1980s, and nothing like the 1930s. First-time jobless claims were at 356,000 this week. This is not a good number. On the one hand, it's over 1/3 of a million people - that's hard to ignore. On the other hand, many expected worse.

Inflation is a concern. We are awaiting next week's release of the June Consumer Price Index (CPI). The May CPI showed year-over-year inflation for all urban consumers was up 4.2%. That translates to a doubling of prices every seventeen years plus a couple months. That's certainly not as good as it was even as recently as a few years ago. But it also does not compare with the inflation rates of the late 70s and early 80s. Back then inflation was near 20% which meant prices stood to double every three-and-a-half years.

Exchange is also a concern. The value of the dollar is very low, compared to most major currencies. As of this writing the dollar trades for about 106 Yen and will only fetch about .6 Euros. And since many major commodities are priced in dollars, the weakness is also contributing to higher commodity prices - especially oil. The flip side is that a weaker dollar is helping our export-oriented industries and narrowing (not eliminating) the trade gap. But it is easy to see how one could slip into the NNN category after looking at these statistics.

But they are not the whole story, just an episode. Just like a single still from a movie can't tell the whole story, the economy needs to consider time for us to get the whole picture. That's where my recent reading comes into play.

The roots of this post started with a recent post on The Big Picture blog by Barry Ritholz. In it, he found fault with an article inThe American magazine by W. Michael Cox and Richard Alm of the Federal Reserve Bank of Dallas. (The American is conservative in its editorial stance.) In the Cox and Alm article, they examine the U.S. standard of living by looking real income - the things we get for our money. I'm familiar with other work by Cox and Alm. And while I'm aware of the problems may have with drawing inferences from an average, the authors manage to tell an important story. And the story is not restricted to a single, still photograph. Their story is based on a movie. It develops over time. And that story is solid. But because it does not offer a moment in time for us to study and dissect, it does give the "now" short shrift. That does not mean the longer story is immaterial. To dismiss the work as belonging to the PPP category because it doesn't solely reflect the current situation is to compare apples to oranges. Cox and Alm are not talking about the same thing Ritholz is - despite what some may think.

Another resource that helped shaped this post was a podcast. It was an interview with Gregg Easterbrook on EconTalk. In it, Easterbrook and host Russ Roberts discussed the U.S. standard of living and how people perceive it. While there were a number of "ah-ha" moments, I found one most revealing and relevant to what Cox and Alm had written. Roberts mentioned that he frequently polls his classes, asking how much the U.S. standard of living has increased over the past 100 years. He said the average (there's that data again) answer was 50% - 50% increase over 100 years. Roberts said he was inclined to believe that a certain level of innumeracy may play into this response. It's possible that those polled believe you can't have an increase of more than 100%. But the interesting thing is that, depending upon the measures you use and how you correct for inflation, the increase is actually between 7 and 30 times! Clearly, we're not the best estimators of our own progress. (I would add that, given economic mobility over the course of a lifetime, it's even harder.)

The podcast would have been the end of it, but it wasn't. After hearing Easterbrook and Roberts discuss how hard it is to measure "happiness," I ran across one more article in The American, "Can Money Buy Happiness?" I also ran across a review of two books in The New Republic. The American article talked about the link (or lack thereof) between income and happiness. The reviews focused on research into how we choose, combining aspects of economics and psychology. Given some of the ideas that arose in reading these, it occurred to me that maybe our economic mood - ranging from NNN to PPP - has something to do with how we view the current state of the economy as well as our economy.

As an illustration, my view is that we are not in a CRISIS. I will admit that the economy is shaky but it is far from the worst economy in U.S. History. It's not even the worst of the past 50 years. Many will disagree with this view, but I would place them in the NNN category. Conversely, these are not good times. There are problems (largely of our own making) that call for solutions (again, we should be looking to ourselves rather than others for the answer). For those of us whose memories were largely forged in the expansion of the 1990s, the current state of things is disappointing, to say the least. People who would have us believe that the present state of things are nothing to be concerned about would fall into the PPP category.

I would label the current environment by borrowing from Charles Dickens, with a slight but significant alteration. It is not "the best of times". But neither is it "the worst of times." I don't agree with either extreme. The "now" is challenging. Can we work through the challenge? More importantly, can we provide to the tools to our students to work through the challenge? That's the
key question for this post. I think those of us who teach economics need to make sure our students can analyze and understand the short-term as well as prepared to solve the short-term problems. But this needs to be tempered with an appreciation of, and ability to see the long-term. If we do the first without the second, we run the risk of misunderstanding and misapplying what John Maynard Keynes meant when he said "In the long-run, we're all dead."

I apologize for this rather long-winded post, and I look forward to your thoughts.

Tuesday, July 8, 2008

Food Policy

Perhaps one of the better economic issues for classroom discussions about markets, price and price distortion is the current food crisis. To that end, I want to point you to a couple of interesting articles, the first three with an admittedly market-oriented view. The first is an article by Adam Lerrick of the American Enterprise Institute from today's Opinion Page of The Wall Street Journal. In it, Lerrick notes that the current crisis is less a result of speculation than bad agricultural policies. These policies are hurting the countries that can least afford rising commodity prices, and were often put in place by countries that needed protection the least. And while Lerrick offers little in the way of data and policy recommendations in this article, it is easy to read.

The second article, also by Lerrick, is published by the American Enterprise Institute (AEI) and is similar to the first. But it offers a bit more in the way of policy recommendations, and data in the form of some graphs on various foodstuffs.

The third resource is the summary of a recent (July 2) AEI conference titled "Was Malthus Right?" Malthus has long been in disrepute, but in my opinion it is largely a result of his bad timing. Specifically, he failed to foresee the full impact of the Industrial Revolution. But, so did his other contemporaries. The value of his teaching is that it shows how, without changes in our productive resources (specifically capital - human or physical), we can run into the occasional productive wall.

The final piece comes in the form of an article that appeared in the British newspaper, The Guardian. Unlike the first three sources, The Guardian is a self-styled liberal news source. The article claims to reference an internal World Bank study which seems to place the blame for the current crisis at the feet of biofuels. It is a different perspective but it ties in with these other articles nicely. Now, I admit I'm always a bit skeptical about "secret reports" as sources regardless of the politics of the writer. But the four articles together provide some nice ideas to kick around the classroom.

I look forward to your comments.

Natural Disasters as Engines for Growth

Yesterday, I ran across this interesting post by Don Boudreaux over at Cafe Hayek. The reporter (preparing this story for The Boston Globe) was asking whether natural disasters like the recent earthquake in China, can actually be helpful by causing a rapid upgrade in technology and infrastructure as the region is rebuilt. Many of Boudreaux's readers rightfully identified the usual economic arguments against such a view.

I thought Boudreaux's main argument, that businesses constantly reinvest in new, more productive capital without the impetus of a disaster was good -- but with one caveat. To accept the argument, there is an assumption of a market economy, where investment is largely driven by the individual owner seeking advantage in the market. I'm not confident that his point would necessarily hold in a system where many decisions are still largely driven by a centralized authority. And while Don is on the mark about the opportunity cost attending the rebuilding (how might the productive resources involved been otherwise used); it is possible that disasters may reprioritize the use of resources in a beneficial way.

Regarding the article, I find the reporter's use of the "creative destruction" analogy totally misplaced. Schumpeter's concept of creative destruction applied the entrepreneurial process of improvement and replacement. It is a natural process, involving constant tinkering and tweaking to apply new ideas and ways of doing things. The entrepreneur is creating new human capital, and it is that creation that destroys the old industry or method. Earthquakes, hurricanes, floods and tornados create little more than the need to replace and repair. Any creation comes as a result of the destruction. Schumpeter's idea reversed the sequence.

I think this discussion provides some possibilities for discussion with your students. Can or does disaster create growth? Does destruction lead to something better in the long run? (Here's an opportunity to test their time horizon by borrowing from Keynes: "In the long run, we're all dead.") If destruction is beneficial to the economy, why are vandalism, arson and willful destruction crimes? Shouldn't they be encouraged?

I look forward to your thoughts and comments.

Rick Matoon, one of the economists at the Federal Reserve Bank of Chicago and an old friend, just posted on the Assessing the Midwest Floods of 2008 (and 1993). It provides a good comparison of the two events, and a solid explanation for those who think natural disasters are really engines for growth.

Wednesday, July 2, 2008

Free Resources

I keep forgetting to post these. You need to know about these two resources for economics and personal finance teachers. They're FREE!

The first is a new newsletter produced by the Federal Reserve Bank of Richmond called 5E Educator. You can download it and subscribe electronically here.

The second is a new issue of old newsletter produced by the Federal Reserve Bank of Boston called The Ledger. You can find the complete issue along with select back issues here.

They're both worth a look and the price is right.

Creative Destruction and the Entrepreneur

As you probably know, Bill Gates is no-longer heading up Microsoft. He has retired from the company he helped found and led for over 30 years in order to spend his time overseeing the Bill and Melinda Gates Foundation. This transition from for-profit to not-for-profit executive by one of the 20th-century's most successful entrepreneurs has been grist for the media mill. Some of the better articles (imho) appeared in The Economist.

The first (and shorter) of two articles explores The Meaning of Bill Gates. It clearly portrays him as an innovator and business leader - an entrepreneur. He saw a demand, he had a product and had a vision for it. He pushed new innovation when he could and he pragmatically adopted (some would say co-opted) other ideas when he saw value he could not duplicate, folding them
into his own products. As an example of what a true entrepreneur does and should do, this article provides a short, thorough description using Gates as an abbreviated case-study.

The second article, After Bill, spends more time discussing the impact of his departure on his corporate legacy, Microsoft. It examines the obstacles (self-imposed and competitor-imposed) and opportunities that confront Microsoft at the time of Mr. Gates departure. While reading it, one considers whether the entrepreneurial culture will continue at that firm, allowing it to grow as a result of continuing innovation or to eventually stagnate into a niche player - granted a very large one.

And while these articles are interesting on their own, this post has another objective. There is a new blog that is worth your time to investigate. Creative Capitalism is an on-line conversation among a number of leading economists, business leaders, and other thinkers. The purpose is to produce a book that will be "a collection of essays and commentary on capitalism, philanthropy, and global development." The idea arose as a result of a speech given by Mr. Gates (and reviewed on this blog back in January, 2008) where he used the term "creative capitalism." I, along with others, took Mr. Gates to task because capitalism is, by its very nature, creative. To imply otherwise is to demean the process.

The essays posted so far (the blog's first entry was on June 26, 2008) have been impressive. The discussion is informed and interesting. When reading Gate's speech that introduced the term "creative capitalism", one senses that he wasn't decrying the lack of creativity in capitalism; rather he was calling for the inherent creativity to be unleashed to solve the world's larger problems. He is asking the business community to apply resources and methods which are either lacking or foreign to government, in order to find new ways to serve the underserved of the world.

Mr. Gates seems to applying the idea of creative destruction to the paradigms that have settled in place. He sees a need for business and business leaders to recommit themselves to an understanding, appreciation and adoption of the long-term over the short-term. There needs to be a willingness to look at the variety of problems, to apply resources in an efficient manner, and to bring more of the world into the marketplace where their wants can be fulfilled.

I think you'll find the discussion a valuable source of information and discussion for your classroom. I look forward to your comments.

Tuesday, July 1, 2008

What I'm Reading

I just finished reading Confessions of a Subprime Lender: An Insider's Tale of Greed, Fraud and Ignornace by Richard Bitner. I got interested in the book via this review this review in an issue of The Wall Street Journal last week. I had recently done a presentation for some students that included a discussion of the role of ethics in economics; and I'll be taking part in another presentation for the same group in a week. For the latter, I thought about talking about ethical failures as they relate to the subprime issue and thought the book might provide some insights. It did.

For the first third and the last ten percent, the book did a good job of putting a face on the subprime market. We get introduced to borrowers, brokers, and lenders that the author dealt with, and he does a good job of selecting his anecdotes to make his point. There is a middle portion of the book that, while less captivating in terms of humanizing the story, provides a thorough examination of how various levels of the "food chain" contributed to failure. From borrowers to brokers, through the Fed and rating agencies, Bitner draws a picture combining ethical lapse with intentional fraud, and colored with unintended consequences or willful neglect. The result is the mess we're in. This section also requires a little more concentration as Bitner explains some of the mechanics of the mortgage market. And while that may sound daunting for people without a background in finance, Bitner does a good job of explaining the basics in an easy-to-understand way.

So how might this help you as an economics and/or personal finance teacher? In both areas, the book is a fine example of how the large macro reflects the decisions and choices made at the micro. At the same time, it offers a fine way to discuss the "everybody did it, why shouldn't I" defense that some young people like to toss back as justification for certain behavior. While Bitner makes it clear that not "everybody did it;" it also is clear that had fewer people gone along with the crowd, the picture would be different.

I look forward to your comments.

(You may also want to look at the review and comments at The Big Picture.)