A Birthday Observation

Today is the anniversary of the birth of Thorstein Veblen. He is not well-known now, and he wasn't particularly well-known when he was alive.  Nevertheless, his idea of "conspicuous consumption" is something that many of us understand.  Think of it as "signalling". 

You and I often buy products to send information to others about our status, our class, our likes and dislikes. We do this because it adds value (or at least we think it does).  And it's a concept your students understand.  When they make purchases because something is in, hip, cool or whatever the current term is...conspicuous consumption.

Conditional Cash Transfers

The new edition of The Economist contains a pair of articles that are worth your time. (You can find them here and here.) They're short and they address issues of incentives, income distribution, productive resources and economic development.

The focus of the articles is a relatively new idea in economic development programs, conditional cash transfers (or CCTs). The idea is that the poor are paid for certain activities: getting their children vaccinated or making sure their children are in school. It appears to be successful in many areas, although it is more successful in rural areas than in urban areas.

While I'm not sure to what extent you address economic development (that's an "end-of-the-course" topic that too frequently gets left out, either for lack of time, lack of interest, or lack of understanding); I do suspect you discuss incentives, and possibly income distribution or productive resources. I would be interested in your assessment of these articles.

Americans Cut Back ... The Power of Price

Today's edition of The Wall Street Journal has an article (free content at this writing) that deserves your attention. Amid all of the discussion about health care, one aspect seems to be lost. What incentives are put in place for the consumer (patient) when a third-party payment system (whether private or public) stands between the consumer and the provider? To the extent that the "cost" of service is disguised, either by elimination or drastic reduction, what is the effect on the demand for service? If a more "realistic" price is available, do consumers change their demand for the service? If so, how? If not, why not?

It is possible that the recession is providing some answers. According to the article, Americans have begun cutting back on spending for healthcare. As a greater share of the cost is being transferred to consumers in a way that is immediately apparent, the demand curve may be shifting.

I would suggest you take a look at the article and see if there's anything you can use in your classes. I would be surprised if there isn't.

Comparative Advantage and Tradeoffs

When discussing comparative advantage, students will often ask if it's possible for a nation to gain a comparative advantage where there originally is none. The answer of course lurks in that basic concept opportunity cost. Don Boudreaux at Cafe Hayek gives a good explanation while discussing the idea of energy independence.

I would suggest you could even use a production function to help with the explanation. What do you think?

“New” Podcast Source

For those of you looking for podcast sources, I just ran across InfectousTalk on the Kauffman Foundation site. It is only a couple of months old and it focuses on entrepreneurship.

It looks like it will be the site for some quality discussions.

Wealth Transfer and Credit Cards

National Public Radio's Planet Money program had this story on credit card reward programs, yesterday. It's about who uses credit cards, who pays for the benefits, and who receives them. The piece is based largely on this paper from the Federal Reserve Bank of Boston.

My question is "Is this news?" We learn in Economics 101, "There's no such thing as a free lunch." The fact that using credit cards has a cost is something that should be understood by all students, whether in an economics or personal finance course.  Many people don't understand just how significant the revenues from these fees are to card-issuing banks.

This is why some stores will try to charge different prices for cash and for credit from time to time. Those stores are trying to properly allocate the cost. (A quick search indicated a cluster of stories on this back in 2008 when gas prices spiked.)  And it's why retailers have tried repeatedly to get legislation to limit the fees.

As always, I welcome your comments.

Not Really Much More to Say

July 26 Birthdays

There are two birthdays to recognize today.

First, we extend birthday wishes to Jagdish Bhagwati. Professor Bhagwati is at Columbia University and is one of the leading international economists today. His work is very accessible, one of my favorites being In Defense of Globalization. For a sample of his work, look here.

The second birthday we recognize is that of Alfred Marshall. If you aren't sure why we should recognize Marshall, look at the supply and demand graph you most recently drew. It was Marshall who emphasized that price was the result of BOTH. He was also the thinker behind price elasticity and consumer surplus. For a more complete bio, check here.

Institutions and Incentives

This article from the summer 2010 issue of City Journal (HT to Cafe Hayek)is a sobering reminder that much of what happens in any economic system can be explained as a logical reaction to incentives. What is particularly arresting is that the incentives were often created by government in an attempt to manage economic growth and decision-making.

If we remember that incentives are the result of institutions, the rules and beliefs that guide our decision-making, it is harder to discount the effect of the institutions that have been put in place over the last quarter to half-century.

That is not to say that the rules were put in place to move the nation toward a financial crisis of the type and at the time of the the one recently incurred. However, one can say that efforts to promote certain activities (whether home-buying or derivative-trading) by distorting or transferring risk, should be seen for what they may result in - the attempted disguising of risk and postponed imposition of market discipline.

I hope you take a few minutes to read the article, think about it and then consider sharing your thoughts.

Origin of Moral Sentiments

A couple of days ago, Don Boudreaux at Cafe Hayek had this very interesting post linking to a recent New York Times op-ed on moral rules.

What was perhaps most interesting to Don (and to me) was that much of the recent research cited in the Times piece comes to the same conclusion Adam Smith arrived at in 1759 in The Theory of Moral Sentiments.

I've said it before on this blog and I'll repeat it, if you're teaching economics and you've only read An Inquiry into the Nature and Causes of the Wealth of Nations, you're only half-way there. If you've not read either, you owe it to yourself and your students to read both. You and your students will gain much from it.

Complementary Goods and Marginal Utility

This recent Dilbert cartoon speaks to a lot of concepts.

But EconGirl at Economists Do It With Models does a much better job of talking about it than I ever could. I recommend you give a it few minutes.

Economists vs. Economics

For me, one of the more interesting aspects of economics is the interest in economic forecasts. People frequently ask me what I think of some recent event. Sometimes I can offer an opinion. Lots of times I can't or won't. In those cases it's usually because there's not enough information to base even an opinion on.

It's more interesting because people will also ask me what I think is going to happen (forecast). While I'm flattered they think I might know, I frequently tell them I don't. It's the truth. I don't have any special power to divine the future. I have a different way of looking at things than many of them. Doesn't mean it's right or wrong, just different. And when people ask, I often tell them about something I remember Louis Rukeyser writing many years ago. He was talking about calling the market, but it applies to the economic forecasting just as well. Rukeyser said something like, "If you're going to tell them a direction, don't tell them when or by how much. If you're going to tell them when, don't tell which direction or by how much. And if you're going to tell them by how much, don't tell them when or which direction."

That came to mind when I ran across this post on EconLog earlier today. Paul Samuelson may be one of the most influential economists of the 20th century, if only because so many people learned economics out of his textbook. (I think I'm one of a few in my generation who didn't.) He made some predictions about the shape of the post World War II economy that I found startling. They were all the more so because the largest ramifications didn't happen.

This was further reinforced when I was speaking about Irving Fisher to a group of students recently. While I think Fisher's crowning achievement is the equation that appears at the top of this blog; some of the students only knew that he had predicted a "permanently high plateau" for the U.S. stock market shortly before the 1929 crash. (As in so much of life, timing is everything.)

So what's the point? This article from The American Spectator (HT to Cafe Hayek) brought everything together. The gist of the article is that while economists may "fail", economics still has value. It tells us much about human behavior, both on a micro and a macro level. It is often more difficult to understand the macro level, but I think it's because we ascribe too much "knowledge" to economists. Economists know much. They understand a lot about human incentives and response. But like anyone else, it's really hard for them to see into the future.

I welcome your thoughts. I also hope you have a nice weekend.

Productivity

This video (HT to Carpe Diem) is about a new, robotic warehousing system. I could see all kinds of lessons arising from this video.



Show the video and ask students to identify which tasks disappear when a system like this is introduced? Using a productivity or growth equation (Y = aF[L,K,N] or some variation), what is happening when a system like this is introduced? What tasks is the system taking over? What skill-level would workers doing that job have to have to do those tasks? How would those jobs be classified (skilled, semi-skilled, unskilled)? How might this system offer an improvement over workers performing those tasks? How would marginal cost/benefit be a part of the decision to introduce such a system?

What would be the implications to a program of unemployment support for displaced workers if systems like this were wide-spread? Would this be an example of cyclical or structural unemployment? How does this relate to Schumpeter's idea of creative destruction?

Education, Skill Sets and Recovery

The Federal Reserve Bank of Cleveland has an interesting article in the recent issue of Economic Trends (see page 14). The author asks whether a mismatch between worker skills and job skills may be a factor in the slow job creation growth.

On the surface, this is a logical question. Recessions are often seen as a time for factors of production to be reallocated. This applies to labor. Certainly, as companies retrench they will look to increase productivity among existing workers before bringing on new ones. Indeed, one lesson we teach is that rising prices increase supply, partially because higher prices allow less productive resources to come into the process. Workers with weaker skill sets may, indeed, face a period where their skills don't match demand.

But I'm not sure I agree with one aspect of the article's conclusion. The author talks about lower productivity and higher unemployment. I would think that the retrenchment would lead to higher productivity. To that point I would point at the long-term trend, as illustrated here by Mark Perry on Carpe Diem. Mark's data is longer-term. And granted, the past does not guarantee the future, but I think it would be logical to expect increased productivity from the existing workforce, at least in the near-term. If there is a skills mismatch, growth will have to come from higher productivity. And that increase in productivity may change the larger economic landscape, establishing a higher premium for certain skills, while those with lesser skills could face an uncertain job market. Recent productivity data would be helpful in this respect.

This brings me to a post by Greg Mankiw. Greg asks whether the current average duration of unemployment may indicate the Non-Accelerating Inflation Rate of Unemployment (referred to as NAIRU or "the natural rate of unemployment" by some) may be increasing. If the economic structure has fundamentally changed, say by requiring more skilled and more productive workers, one could see how this would be possible. However, as has been pointed out here and in other places, the duration of unemployment could be a result, in part, of extended unemployment benefits providing a skewed incentive. I'm not sure I totally buy that explanation, but I do understand it. I think Greg is right in saying we may not have the answer to the question for some time.

To summarize this post, I don't know whether we are undergoing a major structural reorganization of the economy. A skill mismatch would certainly contribute to that, and changing productivity would certainly be expected in such a circumstance. If these issues are tied together, it would indicate a need for a different approach to economic policy than what is being tried. But I find all three links interesting and worth your time. I certainly welcome comments.

Trilemma of International Finance

In a recent post, Greg Mankiw pointed to his piece published in The New York Times this past weekend. In it, he discusses what he refers to as the Trilemma of International Finance. Mankiw notes there are three goals for financial policy-makers. The trilemma arises because you can choose two, but in doing so you forfeit the third. (Doesn’t that present an interesting aspect of opportunity cost?)

Where this article can be of particular value to the classroom is during discussion about open economies, foreign exchange and policy in macroeconomics. Mankiw points out that the U.S. has opted for one combination, China for another and the Eurozone for a third. In doing so, he presents a rubric for analysis to help students understand the trade-offs inherent in policy. If you haven't already seen it, I highly recommend it.

Lizzie Borden's Axe and Unintended Consequences

Today's issue of The Wall Street Journal has an informative article (free content at this writing) on the front page. The subject is the financial reform bill now before Congress and the impact it could have a group many of us don't consider when thinking about derivatives markets - farmers.
It seems that how Congress chooses to deal with derivatives could impact farmers' ability to hedge risk for their operations. Farmers use a type of derivative known as a future to help them control costs.

The article reminded me of an article I wrote for the economic education newsletter, ON RESERVE, when I was with the Chicago Fed. It was written in the mid-1990s so it is somewhat dated; but it followed on the heels of a derivative-driven problem in Orange County, CA. I began each article with a relevant quote, and part of the quote I used for that issue on derivatives said "Lizzie Borden's axe was never on trial." The point then, like now, is that the tool doesn't cause the problem. The problem arises from how people choose to use the tool.

Regardless of how Congress acts on the issue of derivatives in the financial reform bill, it needs to consider behavior - not the tool. I welcome your thoughts, as always.

Debt Issues...Micro and Macro

I've been busy with my online courses and I hope to get busier. 

Nevertheless, here is a comic that, in my opinion, offers all kinds of possibilities as a discussion starter.


The first and third panels carry the weight. 

The first panel can be related to expectations, the business cycle, and employment. (For those of you unfamiliar with the strip, Gene is the soon-to-graduate college age son of the couple you see.)

The third panel can be used to illustrate credit, debt & deficits, normative statements, business cycle, animal spirits, expectations, and behavioral economics.  And those just hit me in the first minute.  Do you see other possibilities?  If so, please share.

Keynes vs. Hayek (continued)

Last Sunday (July 4), I posted on a pair of recently discovered newspaper clippings that featured a real time debate between John Maynard Keynes and Friederich Hayek on the nature of the biggest problem of that time - the Great Depression.

Now here's a follow-up. It's an article that appeared in both The Wall Street Journal and on the Cato Institute web site. (HT to Cafe Hayek for the pointer). In the article, by former Dallas Fed vice-president Gerold O'Driscoll, Keynes and Hayek debate the nature of savings, particularly in a downturn. According to the article (and the clippings), Keynes thought a dollar spent was a dollar spent. Therefore, prime the pump and let the spending do the work. Hayek was actually a bit pickier. He believed some dollars - those spent on investment - as more powerful.

There are a couple of other points Hayek and his colleagues made, but these countering views have much to suggest to us about "proper" (whatever that is) fiscal policy in the current environment - at least as Keynes and Hayek might have seen it.

Hypothetically, What Would It Cost?

Visualeconomics has an engaging visual on some of the costs we might associate with celebrating Independence Day in the U.S. Included is information on where various parts of the traditional mid-summer cookout come from. As I looked at the chart, I thought "what would our celebration cost if we imposed trade barriers between the states - depending totally on locally grown or produced items? Alternatively, how would we celebrate differently if it weren't for ideas like comparative advantage, productivity and specialization?"

It's just a thought as we pass the "mid-point" of summer and start thinking ahead (the local stores have their "back-to-school" displays up).

What's Policy Supposed to Do?

When we teach monetary policy, we tell students that counter-cyclical policy would be to expand the money supply as a recession or panic hits, and these off as the economy turns the corner to recovery. And while we haven't heard anything official on the end of the most recent recession, many economists think the economy turned the corner in summer 2009.

Marginal Revolution provides an interesting link to the Shadowstats website. The charts show growth data for the monetary base, M1, M2 and what appears to be a proxy M3 measure (M3 is no longer officially recorded), beginning in 2006. (Please note, the charts in the explanatory links from the Federal Reserve Bank of St. Louis cover a longer period than the charts on Shadowstats.) There is a clear uptick as the financial crisis kicks in 2008. (The Fed clearly learned something from 1929.) And growth, while still accommodative, has fallen from the higher levels of 2009. These could be useful in teaching those chapters on monetary policy, if you want to illustrate what accommodative policy during a financial crisis looks like.

Is It Different?

There is an excellent article in the July 4 issue of The New York Times. It's about Dr. Carmen Reinhart and Dr. Kenneth Rogoff and the work they've done studying financial panics, the lessons learned, and the lessons not learned. Their research culminated in their book This Time Is Different.

Now, before you dismiss it as "just another theory of what caused this recession", you need to read the article (and maybe the book). Although the work is relevant to the current situation, it is more about the way smart people (including economists) continually make mistakes and repeatedly fail to see the next big disaster. It's not as much about poor theory as it is about human nature. We tend to think we're immune to "the same mistakes", to believe "this time is different". But it often isn't really that different.

I would also recommend a couple of things to accompany the review. The first is this long interview (over an hour) with Dr. Reinhart by Russ Roberts on EconTalk. The second is this shorter interview with Dr. Rogoff by Kai Ryssdal of Marketplace. And finally, here is a transcript of an appearance by both Dr. Reinhart and Dr. Rogoff at the Carnegie Council.

All in all, this is good material for your Saturday or Sunday morning coffee.

Risk and the Limits of Monetary Policy

Two articles in the newspaper caught my attention this morning. And as they are related, they had more significant impact.

The first was from The Washington Post. Ezra Klein discusses some moves the Fed is said to be contemplating as there are signs the recovery may not be as strong as previously thought. The efforts are largely designed to provide banks with an incentive to lend.


This brings me to the second article, which was in The Wall Street Journal. (Subscriber content at this writing, but put “Risk Aversion Keeps Economy in the Slow Lane” in your browser and you may find a free version. This article talks about risk aversion both by borrowers and lenders. For borrowers, the desire to avoid debt when the future appears shaky is understandable. I suspect you tie in Keynes’ “paradox of thrift” when you discuss this. On the lenders side, it may be more complex. Yes, lenders are reluctant to lend, especially to businesses when the outlook is uncertain. But add the pressure being put on lenders by regulators and the government. The lenders are being chastised (in many cases correctly) for taking on excessive risk. This is being translated by many as “lenders shouldn’t take risk.” Unfortunately, credit involves risk.

We can get into the aspects of maturity risk, liquidity risk, and default risk another time. But when lenders are being chastised for lending, and borrowers are being told that things aren’t as rosy as we would have hoped, the appetite for risk is muted. I look forward to your thoughts.

Adam Smith & the Contemporary World

For those of you who sometimes wonder if there's anything to be learned by studying the works of the great economists, I would direct you to this piece in the Erasmus Journal of Philosophy and Economics. It's by Dr. Amartya Sen, professor of philosophy and economics at Harvard, and winner of the 1998 Nobel Prize.

Dr. Sen raises highlights a number of thought-provoking aspects of Adam Smith's work, and relates to the present day. And before you dismiss this as just another piece on The Wealth of Nations, I will again remind you that Smith also wrote The Theory of Moral Sentiments.

In the article, Dr. Sen discusses not just prudence, a virtue that Smith described as "useful to the individual"; but Smith's discussion of "qualities most useful to others" - qualities like humanity, justice, generosity, and public spirit.

Sen also discusses the ideas that other perspectives provide value by giving us insights into the choices of others without necessarily agreeing with them. "To listen to distant voices, which is part of Adam Smith's exercise of invoking 'the impartial spectator', does not require us to be respectful of every argument that may come from abroad. Willingness to consider an argument proposed elsewhere is very far from a predisposition to accept all such proposals."

I submit, in that respect, Smith may be an early pioneer in the field of institutional economics - seeking to understand what motivates others to choose as they do, whether we approve or disapprove of the choice.

The article is a bit longer than many I recommend here, but I think you will find much of value, if you are at all interested in the link between philosophy and economics, and the link between Smith and the present.

I welcome your thoughts.

Is Growth Good?

Arts & Letters Daily recently linked to a book review that captured my attention. The book, Ferraris for All by Daniel Ben-Ami, (available on July 14) offers a counter to much of the criticism of economic growth that we've heard and read over the past several years, even before the recession hit.

We've heard about many of the concerns: humanitarian, environmental, emotional and psychological. Ben-Ami's take is that all of these are ways of disguising a growth skepticism that might cause us to miss the opportunities to advance through growth.

It looks like it will be an interesting read. I hope to get the chance to read it. If I do, I'll review it and give you a better take on it.

Wal-Mart and Small Farmers

As long as I'm referencing NPR, let me talk about another story.  Last week, I put up a post on positive externalities attendant to a new Wal-Mart. Somehow, I missed this story from National Public Radio about Wal-Mart and its effect on local agriculture (HT to Carpe Diem).

My local Wal-Mart has been featuring produce grown in-state recently. And quite frankly, I don't expect it to be able to provide all kinds of local produce all year round - comparative advantage and specialization are operative concepts the last time I checked. But I am happy to see locally grown food at an affordable price in a convenient location.

That's what I call form, place and time utility. And when I can get all three at a good price, I will take advantage of it.

What are your thoughts?

Haiti Update

A few weeks back, I posted on the unintended consequences of foreign aid. Specifically I highlighted a story on National Public Radio about how food aid to people in Haiti who had been impacted by the earthquakes earlier this year was affecting local rice farmers.

NPR did an earlier story (which I did not see or cover) about a Haitian woman who was in danger of losing her small business, which had been devasted by the earthquake, because she did not have the funds to make a loan payment.

But her life has changed. Many NPR listeners sent her money - more than enough to make the payment. She has taken the bulk of the extra funds and reinvested in her business. It's a great story, and speaks to the positive side of aid to developing countries - and especially to the power of small amounts of capital to change a life.

Now in NPR's Friday podcast, there is a follow-up on that story. You can listen beginning at about the 3-minute mark. I see it as an interesting variation of an unfettered market. Funds did not have to go through a government bureaucracy, and they provided a benefit to both parties - the donor and the recipient. The recipient’s business is clearly better off, and the donor "profits" although not in a monetary sense. Rather the donor feels better knowing they have done some good. This is similar to what I try to teach about Adam Smith. It is not just about The Wealth of Nations, but it is also about The Theory of Moral Sentiments. (However, suffice it to say, there is a trade-off to success. But I don’t want to give it away.)

In that same podcast, there is another story about economic success in Haiti, beginning at about the 14:45 mark. In this case, it involves an economic development project to help Haitian mango farmers. The previous attempts by various governmental and non-governmental entities failed. But through the combined efforts of the villagers who benefitted, the work gets done - apparently including digging up and replacing 27 miles of pipe to bring water to a newly-built processing center.

I recommend this. If you can’t sit and listen, download and put it in your personal device and listen while you jog, while you work in the yard, or around the house. It will be time well-spent.

Keynes vs. Hayek

There's been a lot of discussion in economics resurrecting the Keynesian approach vs. Hayekian approach to the downturn.  And I suspect most of you have seen this video.

(If you're having trouble viewing it on the blog, here's a direct link.)

But you may not have much knowledge of the actual debate these two eminent economists carried on in the newspaper. Thanks to Marginal Revolution, we link to an item on the Coordination Problem blog that includes access to a couple newspaper clippings from the 1930s. In it, the Cambridge economists (led by Keynes) are debating economists from the London School of Economics (led by Hayek).  For policy wonks or for people interested in the history of economics, this is good stuff.

Put a Cork (or Plastic Stopper) in It

This article from The Wall Street Journal (still free at this writing) has been in my inbox for a couple months. But it's a good one. It's about how the corks in wine bottles have increasingly been replaced by plastic stoppers. It's a good example of how firms mature and evolve, how substitution drives competition, and potentially about efficiency and creative destruction. It also has an interesting slide show.

Frederic Bastiat and the Simpsons

Yesterday, there were numerous salutes in the blogosphere to the memory of Frederic Bastiat on the anniversary of his birth. Many (like mine) referred to his Petition of the Candlemakers. But EconGirl over at EconomistsDoItWithModels came up with a modern version, courtesy of The Simpsons.

Broken Window Fallacy

Mind you, I've never heard anyone make the argument in the cartoon below. But if you hear it, you can make the counter argument.

By the way, the story that gives name to the broken window fallacy comes to us from Frederic Bastiat (beginning paragraph 1.6).