Worth reading

My latest issue of Forbes has three editorials that I recommend reading:

1. A column that I cannot yet find on Forbes.com entitled, Economic Growth is Easy. Here’s a snippet:

John Stuart Mill long ago observed that we trade “products for products,” so if the desire is for increased consumption, we must stimulate the supply side of the economy. Specifically, we must remove the tax, regulatory, trade and monetary barriers to productivity. For individuals to consume, they must first produce.

Most people don’t understand that, which is one reason we keep electing fools. Consumption does not drive wealth. Investing to take a chance of realizing benefits do.

2. Another from British historian, Paul Johnson, Men Blinded by Their Brains. In it he writes how intellectuals seem to have an affinity for the powerful and evil. In the print version, this appears immediately after the subtitle, Moral Blind Spot:

Of course, intellectuals, whom I define as those who think ideas are more important than people, are notoriously bad at seeing the ordinary world and coming to moral decisions about it.

This article struck me because I’ve known such men. They could reason their way into very bad things and reason their way out of feeling any remorse or accountability for their actions.

3. Steve Forbes’ lead-off editorial, Gold and the Wicked Magicians, is top-notch and important. From his piece:

Linking the value of money to gold removes a huge source of Big Government’s power. No longer can government confiscate wealth by stealth by devaluing your money. Economists hate the gold standard because they think they’re being deprived of one of their magic wands to shape the economy.

Big Government looks after its own interests. Left to its own devices it will relentlessly expand, crushing the private sector. That’s what’s happening in Europe today. Despite all the talk of austerity, the public sector has hardly been touched, while businesses and individuals have been hit with more and more taxes.

Despite thousands of years of experience to the contrary, central bankers and countless policymakers and economists believe that money manipulation can stimulate and wisely guide an economy.

It’s a destructive delusion. The world today would be an immensely richer place were it not for these hubristic notions that a handful of people can keep an economy rolling smoothly with minimal unemployment.

“I’m not your best friend, I’m your only friend”

Mitt Romney should adapt this speech from Larry the Liquidator, from the movie Other Peoples Money, for his campaign.

I especially like Larry’s 10-year analysis. Here’s Larry’s version (to shareholders):

For the last ten years, this company has bled your money. Did this community ever say, ‘we know times are tough, we’ll lower taxes, reduce water & sewer.’ Check it out. You’re paying twice what you did 10 years ago.

And our devoted employees, who have taken no increases for the past 3 years, are still making twice what they made 10 years ago.

And our stock? 1/6th what is was 10 years ago.

Here’s a version for Romney:

For the last 10 years, our government has bled our money. Did they ever come to you and say, ‘we know times are tough, we’ll share your pain, we’ll lower government spending so you can invest more and grow the economy, that way we’ll all do better?”

No. They increased spending in the good times and increased it more in the bad. They don’t care about you. They care about growing their power and telling you its for your own good.

Check it out. They’re spending twice as much as ten years ago.

Our debt? It’s tripled in the last 10 years. It was about $16 thousand for every man, woman and child back then. That was plenty. Did you just have a baby? Congratulations! She was born owing $50 thousand.

Other parts of Larry’s speech that I really liked:

  • It doesn’t pay to grow market share in shrinking market. The last buggy whip maker was probably the best, but you wouldn’t have invested in it.
  • Take the buyout, then go invest your money in growing businesses. You’ll help the economy, you’ll create jobs and “God forbid, you’ll make a couple bucks!”

That last one is another good one for Romney.  “God forbid that I pursued the American dream and SUCCEEDED. You can too!”

Spoiler alert: Other Peoples Money had a happy ending. Larry the Liquidator gained control of the company off the strength of his speech (hint, hint Romney), but discovered that the company could produce something useful.  I believe it was kevlar or gore-tex fabric, or something like that. So everyone got to keep their jobs and the company became a success again, without being liquidated.

Government is overhead

In this post, I quoted from a Reagan radio address where I thought he created a good mental image of how the private sector and government work together.  Here’s the key point from his address:

To sum it up roughly 70 million Americans [working in the private sector] provide a living for themselves and 143.4 [million] additional people.

Those 143.4 million people included the non-working family members of the 70 million Americans and the folks who receive a check from government — be it through a government job or transfer payment.  (Though, come to think of it, I think Reagan neglected the private sector jobs that are paid by taxes, like with government contractors.  But, perhaps he was simplifying.)

Reagan’s analysis came up in a conversation with an old friend when we discussed the political theater that has been going on in Washington DC.  Specifically, how liberals are hostile to the private sector and business, even though the private sector and business pay for government. Or put another way, without the private sector, government wouldn’t exist.  And, therefore growing government faster than the private sector is not sustainable.

It then occurred to me that few people seem to understand the value creation process that goes on in the private sector and how that pays for government.  They don’t recognize that this value creation process is the very source of our standard of living, which provides for government and that government is just the overhead.

As a rough analogy for economy, let’s consider a business that makes burritos.

The burrito business has two types of costs — direct and overhead.

Direct costs pay for the materials to make the burritos like flour, meat, seasonings, tomatoes, labor and the cost of the space to make the burritos (I’m getting hungry).  This might also include the sales force and advertising used to sell the burritos and the cost of the trucks to deliver them.

Overhead are the indirect costs like accountants, lawyers, and HR and IT people and the resources these folks use like space and utilities.  These folks aren’t necessarily needed to make the burritos.  Their jobs wouldn’t exist without the value created from the burrito making operation.

Now, overhead does perform some useful functions for the business, just as government performs some useful functions for society.  It’s much better that the business has an accurate accounting of its financials and pays its bills on time.  These sorts of things helps the business remain in good standing with the folks they do business with.

But most people intuitively understand that there’s a limit to the overhead costs the business can support.  It’s not an exact number, but they understand that if a business grows it’s overhead costs faster than profits from making and selling burritos, it would not last long.  And everyone who depends on the business for a living and for good burritos would be in trouble.

They also understand that if the company’s burrito sales declined, the best strategy to fight this probably is not to expand overhead costs.  The best strategy is probably to focus on producing and selling burritos folks will buy.

Yet, when the economy declined, increasing overhead was the idea to save it.  Not surprising that it didn’t work.

This is one reason I dislike the equation for economic output or GDP.  It treats overhead costs, or government spending, as if it were interchangeable with direct costs, like buying more flour to sell more burritos.  And this leads politicians to do crazy things, like increase overhead when what really need to do is make a better burrito.

Why C+I is a better measure for the health of the economy

In this post, I claimed that Gross Productive Domestic Product = Consumer Spending + Investment Spending – 2 times Government Spending, or GPDP = C + I – 2G.

Tyler Cowen explains why during this EconTalk podcast:

Considering our economy right now: about 17% of it is health care; about 6% in terms of GDP is education; and with some overlap, 15-20% is what we call government consumption–government activity, not just transfers. At all levels of government, including state and local. Add those all up, take out the overlap, and it’s a pretty big chunk of the economy, like 20-30%. Those are all sectors where there are massive subsidies, massive distortions of incentives, a lot of bad policy; and it’s hard to measure value.

So, when we talk about biases in measuring output and living standards, the bias I worry about the most is we’re spending a lot of money and simply writing it down as value added when it might not be.

GDP measures how much money was spent in the economy, not how much value is created.

What do you do when you spend money that destroys value?  You try not to do it again.

If you buy something and you don’t think the value you received was worth the price, you stop buying it and you might warn others to save their money or spend it elsewhere.  As I pointed out in the post, What is a job?, when we spend our own money we typically think in terms of cost vs. benefit relative to the cost vs. benefit of alternative choices for the spending.   This is the engine of value creation.

But, what happens when third parties, not just governments, spend money and it destroys value?  Often, money continues to be spent because it is being spent for reasons other than value creation.  Sometimes more is spent to try and fix perceived problems.

Third party spending doesn’t have to hold to the same rules as first party spending.  As I also pointed out in What is a job?, there are many reasons for third parties to spend money that have nothing to do with value creation.  This is the engine of value destruction.

This is why I don’t believe C + I + G is a good representation of value created in the economy.

This is also why we should carefully consider the change in incentives when we make changes that moves payments from first parties to third parties, like in the areas Cowen points out — health and education.

Given the incentives around G, I’d rather keep as much of the economy as possible in C and I transactions and use C + I as the measure of the productive, or value creation, estimate for the economy.

“It isn’t working”

Is the stimulus working?  The Wall Street Journal Editorial Board doesn’t think so.  Read today’s editorial, It isn’t working.  Here are a couple of key paragraphs (emphasis mine):

So far the Obama team has thrown the entire Keyensian playbook at the economy. We have paid people to buy cars, purchase homes, pay off their mortgages, weatherize their homes and put solar paneling on their roofs. And of course there was the original stimulus package of $862 billion, though some of that remains unspent. None of it has put America back to work.

The policy lesson is that you can’t have a jobs recovery without private confidence and investment. The Obama crowd bet that you could force-feed private investment with government spending and politically directed credit, but the result has been to traumatize business instead. Why would a small business owner hire anyone new if he knows that taxes are going up, health-care costs are sure to rise, and the cost of each new employee is uncertain? Nor can you inspire business confidence if you demonize bankers and business.

Take a look at the bold sentence.

Those who believe Keynesian economics (named after economist John Maynard Keynes who thought government could keep the Continue reading

If they can send a man to the moon…

I started the draft for this post before reading Steven Landsburg’s The Big Questions.  Only now, as I get back to completing it do I realize that he provided the perfect words to back up this point, and I’ve already posted those words.

The fact that “we (I certainly didn’t have anything to do with it) sent a man to the moon” has been used in many debates over what the government is capable of achieving.  Maybe you’ve heard it.  It usually goes something like this:

“If we can send a man to the moon, then we can…

…end poverty

…make sure everyone has health care

…ensure everyone has a good standard of living

…give everyone a vacation?” (This one surfaced recently in the UK.  While they didn’t send a man to the moon, this shows where this logic can lead.)

Sending men to the moon was hard, no doubt.

But, the fallacy is generalizing what it takes to send a man to the moon is similar to what it takes to end poverty or give everyone health care.

Continue reading