Lessons of Joseph Schumpeter

Schumpeter has been the subject of a number of posts on this blog. I find his career and his ideas compelling. Some of you who have heard me speak have heard me call him the second greatest economist of the first half of the 20th century. (I think he would have been number one, but the Great Depression took place and everyone suddenly started reading John Maynard Keynes.)

I find two of his ideas stand out. The first is his idea of "creative destruction." Schumpeter said that a growing economy was an economy of constant change. And that change resulted new firms and products being created, and old products and firms being destroyed - creative destruction.

The second idea of interest to me was his view of the role of the entrepreneur in the economy. He identified five elements of entrepreneurship:

1) Introducing a new good or service,
2) Adoption of new inputs to produce a new or previously produced good or service,
3) Introduction of new technology,
4) Opening a new market,
5) Creating a new economic organization by combining and/or spinning off parts of existing firms.

Last week there was an intriguing series on National Public Radio (NPR) that examined the current economic situation in my home state, Michigan. It is an excellent piece, well-done in ways that regular NPR listeners are familiar with. (I must admit, I did not hear it in the original - I've been listening to other podcasts on my commute. So I thank Don Boudreaux at Cafe Hayek for the link that took me to one of the stories.)

I think if you go to the NPR series site, you will find a number of short pieces to share with your classes that will illustrate either the entrepreneurial opportunity that lies hidden in the current crisis, or the underlying change that is the result of the same event. Either way, you and your students will walk away with a sense of optimism that has been too often lacking in reporting from the Great Lake State.

I look forward to your comments.

This post relates to the following Keystone Economic Principles:
2. There ain’t no such thing as a free lunch.
5. Incentives produce “predictable” responses.
6. Do what you do best; trade for the rest.
7. Economic thinking is marginal thinking.
and
8. Quantity and quality of available resources impact living standards.

Recession, the One-Armed Economist, and the European Outlook

President Harry Truman is supposed to have asked for a one-armed economist after hearing a report. He said he was tired of hearing "on the one hand..., and on the other..."

But if we go with that line of thinking, we may not see that economic downturns can destroy wealth and cost jobs; but they also provide opportunities for others to buy low and sell high - whether it's distressed real estate or depressed stocks. Opportunities for those who can take advantage are often the foundation of better futures.

This post by a couple of Harvard professors is on Voxeu.org and talks about how recent events may cause us to forget that and move toward a more "European" system of income distribution. While the authors don't see the U.S. moving totally toward a European system, they do see a possibility of more government intervention in the economy and towards more redistribution.

Now, while it has nothing to do with the dual nature of economic events, I found the Voxeu article to be an interesting juxtaposition to this piece from today's issue of The Wall Street Journal (subscription content, but I found what appears to be a free version of the full article on this site. It may not be there long.)

Europe's economic outlook seems to be darker than the situation in the U.S., and may slow global recovery. My take on that article was that Europe's problems are complicated by the fact that European bank losses are projected to surpass U.S. bank losses, and much of that is due to lending (both commercial and residential) in Europe. Europe's banks have been more restrictive in their lending since the crisis hit. This is perhaps due to less aggressive recovery policies by government? Or it might be because banking regulations are more complex due to national sovereignty? Or exposure to losses in East Europe may be contributing? They are all part of the puzzle.

It is interesting that Europe, with a more egalitarian approach to social policy is having a rougher time than the U.S. It is also interesting that monetary and fiscal policy responses to the crisis are lagging in Europe. I wonder to what extent European budgets are constrained by existing safety nets. While I’m sure that the complex puzzle of European politics complicates things. It is possible that policy-makers felt their existing safety nets were sufficient, especially if the problem was largely the fault of the U.S. financial system, as many thought. But the global economy may be more global than they thought.

Both of these articles are worth your attention. I welcome your thoughts and comments.

This post relates to the following Keystone Economic Principles:
1. We all make choices.
2. There ain’t no such thing as a free lunch.
3. All choices have consequences.
and
4. Economic systems influence choices.

A Little Bit of Macro for the Classroom

When teaching macroeconomics, we spend time discussing the impact of policy on the economy. There's an interesting essay in the current issue of Monetary Trends, which is published by the Federal Reserve Bank of St. Louis.

In the essay, the author examines the impact of monetary growth on GDP. This is relevant because the Federal Reserve (and other central banks) have been using various tools to stimulate economic growth, not the least of which has been increasing the monetary base - the reserves that impact the amount of lending in the banking system.

The article indicates that there is a positive relationship. However, it also indicates that the relationship is not causal (i.e. money growth is not the cause of GDP growth), and that the lag between increase in the money base and GDP growth appears to be about three years.

I think that has some significant implications not only for policy, but should have some implications on how we teach about policy and the larger economy. (Those of you still involved in the Fed Challenge may find this of interest, as well.)

What are your thoughts?

This post relates to the following Keystone Economic Principles:
2. There ain’t no such thing as a free lunch.
3. All choices have consequences.
4. Economic systems influence choices.
and
7. Economic thinking is marginal thinking.

"Pretty Soon, You're Talkin' Real Money."

One of the problems we face when we discuss macroeconomics is the numbers. Back when I was much younger, a politician was purported to have said "a million here, a million there - pretty soon you're talking real money" when asked about the federal budget. When we begin to discuss issues like GDP, fiscal policy, monetary policy, or even trade flows, the absolute values are so large that they can lose meaning. Numbers of that magnitude are well beyound our ability to visualize them.

Often it helps if we reduce things to percentages and talk about the amount of change, but that may not help. Consequently this aspect of large numbers may prevent us from understanding the whole story. Absolute values are used to convey a sense that something is large. But from a larger perspective, the amount in question may not be as significant.

A case in point is this story from The Washington Post on a forthcoming meeting of President Obama's cabinet.

According to the story, the President will be asking his cabinet for a combined $100 million in budget cuts. As impressive and laudatory as that sounds - (I welcome the announcement) - Greg Mankiw provides this post which puts things into a larger perspective. And he does so in a way that is east to understand.

Share examples you use to clarify the big numbers.

This post refers to the following Powell Keystone Economic Principles:
1. We all make choices.
and
7. Economic thinking is marginal thinking.

Just Remember

If mama's not happy, nobody's happy.

This post relates to the following Keystone Economic Principles:
1. We all make choices.
3. All choices have consequences.
and
7. Economic thinking is marginal thinking.

Japanese Agriculture: A Rich Source of Economic Lessons

Below the fold on the front page of today's issue of The Wall Street Journal was this interesting story. With the current state of the economy, the Japanese government has earmarked funds to retrain unemployed urban workers to become farmers. (There's a parallel story in today's issue of The New York Times.)

It appears that, despite significant subsidies to support and tariffs to protect agriculture, farming is in a bad way in Japan. This report from The Tokyo Foundation indicates that even though the lifestyle is respected and the beneficiary of some economic protection, people don't choose to make it a career. One might guess why after reading descriptions in the WSJ and NYT articles. The current agricultural workforce is aging, and significant portions of Japan's scarce arable land are unused. Japan has long held to the "strategic industry" argument to justify protection, but it appears that, without a shift in labor resources, the idea of food independence, at least in certain categories, may be at risk.

Questions for your students might include the following:
1) Could a reintroduction of "markets" provide different incentives to enter farming as a career?
2) How does the monetary value of Japanese protection compare to the value of Japanese agricultural output? What might this suggest about the efficiency of the current system?
3) How could you make this career and industry more attractive for younger workers? To what extent might access to other resources increase interest?

I would welcome other suggestions for use with students.

This post relates to the following Keystone Economic Principles:
1. We all make choices.
2. There ain’t no such thing as a free lunch.
3. All choices have consequences.
4. Economic systems influence choices.
5. Incentives produce “predictable” responses.
6. Do what you do best; trade for the rest.
7. Economic thinking is marginal thinking.
8. Quantity and quality of available resources impact living standards.
and
9. Prices are determined by the market forces of supply and demand…and are constantly changing.

Congratulations Are in Order...

Friend and fellow-blogger Rob Wedge is the coach of the Fed Challenge team at Collegiate School where the Powell Center is located.

Yesterday, the Collegiate team won the District Fed Challenge competition at the Federal Reserve Bank of Richmond, beating out teams from two other schools in the Fifth District for the right to advance to the national Fed Challenge competition at the Board of Governors in Washington, D.C. in May.

Good job and good luck to all involved.

Protectionism or Slower Economy

This is an interesting development, (HT to Don Boudreaux at Cafe Hayek) although not unexpected. And I think it's one you could easily use with your students to explain the value of trade as well as the concept of comparative advantage.

Considering the logic here, I'm sure that the state of Florida will have no problem with the rest of us spending future spring breaks and vacations in our home states, or visiting local amusement parks instead of one in the Sunshine State, or even buying local fruit instead of something from their state.

We wouldn't want to deprive one of the workers in our states of a job now, would we? The reality is we all benefit when we trade with one another. And while the site in question talks about jobs lost as a result of purchasing from another state, they make no mention of the jobs gained by people in other states purchasing their goods and services.

I look forward to your comments.

This post relates to the following Keystone Economic Principles:
1. We all make choices.
5. Incentives produce “predictable” responses.
6. Do what you do best; trade for the rest.
and
8. Quantity and quality of available resources impact living standards.

Game Theory

I suspect many of you don't teach game theory. But for those who might like to introduce the idea, this is a great video to introduce the "prisoners' dilemma". (HT to Greg Mankiw.)

This post relates to the following Keystone Economic Principles:
1. We all make choices.
3. All choices have consequences.
and
5. Incentives produce “predictable” responses.

Unintended Consequences

First, the Powell Center will be closed for a long weekend. But we will resume operations on Monday. For those of you who are going on spring break, you might want to check back here from time to time if you're going to be away from your school email. Now down to today's posts.

One of the Powell Center's Keystone Economic Principles says that all choices have consequences. When we do teacher training, or when we explain the principle to students, we frequently also discuss the idea of unintended consequences. There are some great examples of unintended consequences in this article from the History News Network website.

The author explains how individual events or choices can have effects that are far removed and are unforeseen. Almost always, these effects are not what were intended

But the real economic lesson lies in the fact that we often don't recognize or fail to consider what the consequences might be beyond the short-term. As individuals and as a society, we focus on the short-term. Too few of us (and I am as guilty as others) consider the incentive structure that a decision creates relative to existing incentives.

The following post, which deals with responding to incentives, has a link that illustrates that. When we seek to intentionally change the institutions that shape how we choose, we change the incentives for all the players. That change in incentives interacts with other incentives in place. And that leads to unintended consequences.

I look forward to your comments.

This post relates to the following Keystone Economic Principles:
1. We all make choices.
3. All choices have consequences.
and
5. Incentives produce “predictable” responses.

People Respond Incentives, Apparently

There are a couple of interesting articles from recent issues of The Wall Street Journal that really make this clear. One speaks to current incentives, and one speaks about possible future incentives.

The current example illustrates how companies (in this case a large shipping firm) respond to the incentives revealed by prices. Everything from falling demand for service, to fuel prices, to canal fees becomes part of the decision matrix. One captain even advances his departure time because it will allow him to cruise at a slower speed, thus saving fuel. It's an interesting story and can be used with students to seek out the examples of cost-cutting, and to extend the ideas to how they are cutting costs at home - responding to the incentives inherent in the price mechanism.

Actually, one of the more interesting parts of the article was the revelation that, in certain circumstances, it was cheaper for the ships to travel to Asia around the tip of southern Africa rather than go through the Suez Canal.

The future example is in an opinion piece. The authors are concerned with a plan to tie Medicare payments to "quality metrics" for medical care. The idea seems logical and one designed to protect the patients, as well guarantee sound use of resources. But the incentive structure that's being proposed could have unintended consequences (see above post).

Regardless of which side of the health care debate you come down on, it is important to study the changes in incentives that result. Those changes can have significant positive consequences that are largely intended. (Otherwise, why would you change the policy?) But it can also have significant unintended negative consequences. My feeling is that much of the current health-care situation is due to the unintended consequences of previously developed policies.

The second article can be used with your students to discuss how incentives tied to performance can have negative consequences. (It seems to me that was part of what happened in the financial crisis.)

I look forward to your comments.

***FOLLOW-UP***
A number of blogs have picked up on The Wall Street Journal piece about Maersk shipping and have linked it to a recent act of piracy that affected one of Maersk's ships. One detail that isn't made clear is that the ship in question was NOT travelling from Asia to Europe or vice-versa like the ship mentioned in the earlier piece. This ship, according to reports, was sailing from Oman to deliver relief supplies to Ethiopia and Kenya - which accounts for what it was doing near to Somalia. (Actually all ships travelling through the Suez Canal would pass through Somali waters. Ships going around the Cape of Good Hope and bypassing Africa, could probably avoid Somali waters.

This post relates to the following Keystone Economic Principles:
1. We all make choices.
3. All choices have consequences.
4. Economic systems influence choices.
5. Incentives produce “predictable” responses.
8. Quantity and quality of available resources impact living standards.
and
9. Prices are determined by the market forces of supply and demand…and are constantly changing.

Forecasting and the Recession?

Here's something of interest to those of you involved in something called the Fed Challenge. But it's of equal interest to rest of us, or should be.

The Federal Reserve Bank of New York has published a research article that uses the yield curve as a lead indicator for economic performance (recession length?). According to that article and data released yesterday by the New York Fed, the chance that the economy may have bottomed looks pretty good. I don't pretend to be an expert on the model or the data, but I'm encouraged. It's one more piece in my personal puzzle that is starting to make a clear picture.

Thanks to Mark Perry for the link.

Your Mind and Economic Decision-making

One of the newer areas of research in economics is that of behavioral economics. The area involves blends aspects of neurological research and economics to study how we make choices. And it is fascinating.

If you find the idea interesting, there's a good short article in New Scientist, which is a UK publication (HT to Arts & Letters Daily). Of particular interest were the images at the beginning of the article. (Click where indicated below the first image to see the second.) The second image shows how economic decision-making may relate to other choices we make. There are also links to the abstracts of a number of articles in research journals.

About the same time I saw the New Scientist article, I ran across this story in a recent issue of The Economist. It would seem to provide anecdotal support to some of the research on the brain and decision making. To me, The Economist piece connects brain growth and evolution under stress and links it to the ability to make certain kinds of choices. It would make sense that changes in growth would impact the decision to make the types of choices we make when faced with a wide range of situations, not just monetary decisions.

Let me know what you think.

This post relates to the following Keystone Economic Principles:
1. We all make choices.
3. All choices have consequences.
4. Economic systems influence choices.
5. Incentives produce “predictable” responses.
and
7. Economic thinking is marginal thinking.

The Other Adam Smith

There is an interesting short article in Standpoint magazine (HT to Arts & Letters Daily) that explains why Adam Smith is still relevant, and worthy of our understanding. It does a very good job introducing this complex thinker to an audience that may have limited (or no) knowledge of his ideas beyond his role as "the father of economics." The article is worthwhile for a short introduction.

But for those of you who find yourself wanting more after reading the article, Russ Roberts is launching a book club at EconTalk. If you're not already aware, EconTalk is a site for excellent podcast interviews with noted economists on a wide-range of topics. It's an easy way to keep up on a lot of ideas when you're working in the garden, in the kitchen, or even driving.

The book for this endeavor is The Theory of Moral Sentiments by Adam Smith. For those of you whose knowledge of Adam Smith is restricted to "something about an invisible hand", or even a broader reading of his other main work, An Inquiry into the Nature and Causes of the Wealth of Nations, this will introduce you to another side of Adam Smith - one that is frequently overlooked by critics of Smith's ideas. The Theory of Moral Sentiments was Smith's first major work, and highlights his role as a philosopher and one of the leaders of the Scottish Enlightenment. In the book, Smith sees us as individuals who are motivated by a search for approval from others, as well as a natural sense of right and wrong. Because of this, one school of thought considered it as "the Adam Smith problem" - contradicting the motivations in The Wealth of Nations. But for those who have read both, it is not a problem. Rather a richer understanding of ourselves. It is not beach reading, but I found it to be fascinating. If you're looking for something to deepen and enrich your understanding of economics, this is a rare opportunity.

The EconTalk site has links to free versions of the work, a partial schedule for the club postings, as well as links to some related information that may be of interest. Even if you don't plan on reading the book, the club promises to provide some insights and information that are sure to be thought-provoking.

I look forward to your thoughts.

This post relates to the following Keystone Economic Principles:
1. We all make choices.
3. All choices have consequences.
and
5. Incentives produce “predictable” responses.

Interesting (and to Some Extent, Fun) Graphics

Here are a number of items to that you can share with your students. The first is quite serious, the rest are less so.

The first is a well-done and sobering graphic that many of you are probably already using. It was from an edition of The New York Times early in March. That means the data is a bit dated, but if anything the situation is probably darker than it was in March. It's an interactive map depicting unemployment rates across the United States on a county by county basis. It can be adjusted to show the rate as of January, 2009 or the one year change in unemployment to that date. It can filter all counties by metropolitan areas, rural areas, manufacturing centers and areas with housing bubbles. You can also zoom in to the state level to more easily find a specific county and surrounding areas.

The second graphic was actually the April Fool's Day contribution from The Economist magazine. The story indicates that the parent company of the magazine is opening an appropriately focused theme park named Econoland. The park has three main areas: Financial Fantasyland, Underwater Adventure Land, and the Magic Jungle of International Politics. My guess is this could offer a great discussion starter when you find yourself with a few extra minutes.

Finally, the comic strip, Frazz, offers an insight into commodity markets that most educators are familiar with.

(Click on the image to see the entire strip.)

Frankly, it's a wonder that derivatives haven't been developed...oh wait, according to this story on National Public Radio, it's been tried.

I look forward to your comments.

This post relates to the following Keystone Economic Principles:
2. There ain’t no such thing as a free lunch.
4. Economic systems influence choices.
5. Incentives produce “predictable” responses.
6. Do what you do best; trade for the rest.
and
8. Quantity and quality of available resources impact living standards.

Economic Concepts in Personal Finance

Occasionally, I still get questions about whether it's more important to teach personal finance or economics. My answer is "You can do both. Either class is enhanced by your ability to connect the theory to the practical."

This can be well illustrated using this post on Marketwatch.com. The post addresses saving when money is tight. Now I believe we should be saving money all the time. But the author frames the issue as one of choices. And economics is about choices.

In fact, all of the five steps listed in the article (prioritize, build an emergency fund, be creative, pay yourself first and walk the talk) are about making choices - voluntary actions that we must choose to undertake. And in each case, the idea is to look at the costs/benefits (marginal thinking), or understand and accept the foregone options (opportunity cost) in pursuit of a larger goal.

I would not hesitate to use this brief piece in a personal finance course as a way to introduce the theories behind budgeting. Likewise, I think this would be a good piece to use in an economics class to illustrate how we use concepts of choice, opportunity cost and marginal thinking on a day-to-day basis. The choices we make determine what resources we have available to meet our goals. Making wise choices can impact our living standards, even in down times.

Please share your thoughts.

This post relates to the following Keystone Economic Principles:
1. We all make choices.
2. There ain’t no such thing as a free lunch.
3. All choices have consequences.
7. Economic thinking is marginal thinking.
and
8. Quantity and quality of available resources impact living standards.