If you want to help the poor, you should read this

I agree with Mark Perry (an economist who has bought me a beer), of Carpe Diem, that the reduction in the world poverty rate is the most remarkable achievement in human history.

The percentage of the world population living on $1 per day or less has dropped since 1970 from around 26% to just over 5%.

It’s hard to argue with those results. They are inflation-adjusted.

I can think of a couple things that might be easier to argue about regarding those results.

1. I can imagine some folks would say that 5% isn’t good enough.

2. I can imagine that some folks would argue about the cause of those results. I agree with Perry’s explanation as provided by Arthur Brooks: “globalization, free trade and international entrepreneurship.”

I can imagine that some folks would say it was the growth in government and aid. But, for them, I’d ask, what if you’re wrong? As Brooks says:

…if you love the poor, if you are a good Samaritan, you must stand for the free enterprise system, and you must defend it, not just for ourselves but for people around the world. It is the best anti-poverty measure ever invented.

I agree. I could be wrong and I think — for the benefit of the poor — I should keep that in mind and stay open to evidence to the contrary, because whether I’m right or wrong doesn’t amount to a hill of beans.

What is important it what really helps them.

I also think us supporters of free markets often forget this. The opposition paints us as the defenders of the rich, the “1%” and king-like CEOs, while we’re really advocating for the benefit of everyone, including the poor. 

Why does socialism fail?

In the same radio discussion that I mentioned in my previous post, I heard the radio talk show host say that socialism — and variants of it — has been responsible for millions of deaths and has proven over and over to be a failure. He encouraged the self-described socialist to read some history.

I hear this point made on occasion. I find it frustrating because rarely is it mentioned why socialism fails.

Why does it?

I believe it’s for a couple main reasons.

There’s the knowledge problem. A free market of prices communicates vastly more and better information to allocate resources better than any small group of people can.

I also believe it stifles risky experimentation, which is the source of most innovations, large and small. Without risky experimentation, society rots. I’m not sure, but I think this may actually be a subset of the knowledge problem.

 

Bottom-up vs. Top-down

Forget comparisons like ‘government vs. free market’ or ‘public vs. private’. We can all pull out examples from each realm that works and doesn’t work.

I think a better distinction of human interaction systems can be drawn between ‘bottom-up vs. top-down’. Bottom-up systems tend to be driven by decisions and interactions very close to the individual. Top-down systems are driven by decisions made by a few individuals at the top of the hierarchy.

I often hear proponents of a central government — a top-down system — cite bottom-up examples to support their view, demonstrating that they don’t understand the top-down/bottom-up distinction.

Fire departments, police departments and roads are prominent examples of this and sound like, “These things are run by government and they work pretty well, let’s expand Federal government.”

Yes. These are usually run by government entities. But local government is not equivalent to Federal government. Local government is more bottom-up than top-down.

I think it’s helpful for discussion and policy-making to be able to recognize the two different systems. Here are a couple of thoughts.

  • To what degree do individuals have the ‘power of voice’?
  • To what degree do individuals have the ‘power of exit’?

Power of voice is an individual’s vote, purchasing decision or the ability to have the decision-makers hear your voice. Votes carry more weight in local elections than national elections. It’s easier to get in touch with city councilmen or the mayor than it is the Congressman or President. A purchase is a vote indicating that the individual values the product at that price.

Power of exit is the individual’s ability to leave or not choose a certain product. If I choose not to buy a product, I’m signaling that it’s not worth it. If I don’t think the city council is steering my city in the right direction, I can move a couple of miles to the next city over. Same if I’m looking for a better a school district.

Power of exit is a function of how many choices are available to me and the dynamics of competition among those choices.

I have lots of choices of products. Competition among those products is generally high. I can incur little cost for choosing one store over another or one product within a store over another.

In my area, I have lots of choices on cities, townships and counties that I can live in. Not as many choices as I have for different types of beer, but still quite a few. Since I do have a fair amount of choice, competition is relatively high and these cities and townships try to do things to voluntarily attract residents — like providing good fire departments, police departments, schools and roads. The cost to move is higher than the cost of choosing one product over another, but still not terribly high if things get really bad (this is why suburbs suck the life out of mismanaged urban areas).

I have 50 states to choose from, but the costs to move between states is relatively high. I have many countries to choose from, but the costs to change countries is even higher. So, competition goes down as these costs increase and so does my power of exit. I still have it, no doubt, but things have to get really bad before exercising that power.

I think there are a couple other elements of the bottom-up vs. top-down systems that are worth mentioning. I don’t think they are as useful in helping us recognize these systems, but I think they explain why bottom-up system work better than top-down.

1. Lots of independent trials/experiments. It’s hard to tell what will work and what won’t, so it’s best to try a lot of stuff.

2. No single point of failure. Since it’s hard to tell what will work, it’s best not to have a single point of failure, which top-down systems have.

3. How far away are the decision-makers from those effected by the decisions?

I will discuss more about these last three in future posts.

Challenge accepted

I found the following comment from Gunteh on the Idiot’s Collective blog post about Michael Sandel that I linked to here (square brackets are Gunteh’s):

I recently came across a particular individual on Youtube who makes a living by debating libertarians in spontaneous and live radio format.
[He is a self-proclaimed leftist, believes that libertarians are idealistic albeit aloof, and argues on the following argument pattern]:
-There has “never” been historical context for a purely free-market system, both economically/morally.
-There are rules/interventions that are mandatory in order for society to run (laws, subsidies)
-There are always winners and losers, and whether or not government has a responsibility to that, we ourselves pick and “subsidize” businesses/moral opinions relatively. Therefore, there is no reason for government not to do that as well if human beings innately make choices.

I’m not sure who this individual is and I’m not sure I’d be willing to debate him on his home turf. I don’t have much experience with live radio. But, I would be willing to discuss his views on a blog post.

To the specific argument pattern that Gunteh lays out, I would likely respond as follows:

“There has ‘never’ been historical context for a purely free-market system, both economically/morally.”

First, I don’t think there are many libertarians who don’t think there is a role for limited government. Though, there might be some.  But, I think this person paints with too broad of stroke.

Second, and more important, there doesn’t have to be a historical context for a purely free-market system since we have plenty of historical contexts, and current contexts, for “systems” (that is, groups of people) with vibrant free markets and systems without.

Even within these “systems” there are subsystems that we can look at. Within the U.S., for example, there are other organizations of people. Cities, businesses, chess clubs, Home Owners Associations, families, charities, hospitals, states, churches, AA, AAA, crime syndicates, lobbies and so forth.

So, if we are interested, we can look at countries and subgroups and see which ones seem to do better and why. Not doing so, lacks imagination. This has been something that has interested me from an early age. For example, I wondered how two neighboring public school districts could be so different as to prompt my parents to undertake the cost of moving from one district to the other.

In my view, the case is strong that systems that allow people to make the choices that are right for them, within their set of constraints and consequences, produce better results over time.

Granted, it is hard to untangle that and we often confuse cause and effect. Folks often look at the success story of the U.S. and assume that all that government has done has been a cause for the success, rather than a result of the wealth created in the free market.

I think it’s more productive to discuss the features of these groups and subgroups and what makes them different, rather than discuss whether a pure free market system has ever existed or is desirable.

To use an old and tired quip, there was nary a historical context against slavery before that was largely abolished, either, as slavery existed in some shape or form just about every in the world up to that point. That, in itself, did not prove that abolishing slavery wouldn’t be good.

“There are rules/interventions that are mandatory in order for society to run (laws, subsidies)”

The question I would have this radio host to consider is where these rules come from. Did they evolve from emerging practice or were they conjured up by a small group of people?

I’d be looking for more specific examples here, though, before I engage beyond this.

‘There are always winners and losers, and whether or not government has a responsibility to that, we ourselves pick and “subsidize” businesses/moral opinions relatively. Therefore, there is no reason for government not to do that as well if human beings innately make choices.’

I’d argue that government is a poor mechanism for picking winners and losers because its feedback loops are less effective, and sometimes backwards, from market feedback loops.

My post, Profits and Ballot Boxes, summarizes a few key reasons why government feedback loops are bad.

There are more reasons, like the knowledge problem, that Steven Landsburg explains wellAnd, it’s important to understand the only four ways to spend money. The way government spends money (spending other people’s money on other people) ends up being the least careful way to spend it.

It’s also good to remember that government tends to reward failure. Finally, when we discuss private vs. public, it seems we often assume politicians are saints, not subject to the same incentives as other people, which is a rotten assumption.

 

The Hayek and Polyanyi lesson

I learned from this Marginal Revolution post (and its comments) what to call the idea that many successful companies that have emerged in the free market because customers value what they provide would not exist if they had to rely on bureaucrats to approve them.

It’s called the Hayek and Polanyi lesson. Though, this Polanyi is interesting, too.

Interesting Reading Trifecta

Every now and again, I hit upon related topics in more than one reading in one day.

1. kludge…what?  Not sure I like the name, but I like the thought (via Marginal Revolution). Steve Teles writes about a real problem:

The fact that so much of our welfare state is jointly administered — either inter-governmentally or through contracting with private agents — makes it hard for Americans to attribute responsibility when things go wrong, thus leading blame to be spread over government in general, rather than affixed precisely, where such blame could do some good. The consequence of complexity, then, is diffuse cynicism, which is the opposite of the habit needed for good democratic citizenship.

Though, I’d say the government rarely gets the blame. Rather the blame is placed on the free market. When a heavily regulated and government subsidized health care market doesn’t seem optimal, I think there’s a tendency to overlook the government’s cause in the matter and blame the problems on the free market, simply because there exists some for-profit companies in that public-private morass. Same goes for housing and banking.

2. Don Boudreaux of Cafe Hayek quotes from Sandy Ikeda’s The Virtue of Market Inefficiencies:

…government policies that undermine the…reliability of money prices also make the discovery of inefficiencies profoundly problematic.

Using the rules of arithmetic, for example, it’s easy to see that the statement 1 + 2 = 4 is wrong, but what about  _ + _ = _ ?  What’s the solution to this “problem”?  Is there even a problem here?  Money prices fill in the blanks; they “create errors”—i.e., reveal mistakes that no one could see without them—that alert entrepreneurs might then perceive and correct. If mistakes and inefficiencies remain invisible, the search for better ways of doing things could never get off the ground.

3. But somebody had these guys beat by a couple hundred years as I coincidentally discovered on a plane this evening, I happened to start reading Thomas Paine’s Common Sense on my Kindle app and found this passage as he was building his case against the English Constitution:

I draw my idea of the form of government from a principle in nature…that the more simple any thing is, the less liable it is to be disordered, and the easier repaired when disordered.

Absolute governments (tho’ the disgrace of human nature) have this advantage with them, that they are simple; if the people suffer, they know the head from which their suffering springs, know likewise the remedy, and are not bewildered by a variety of causes and cures. But the constitution of England is so exceedingly complex, that the nation may suffer for years together without being able to discover in which part the fault lies, some will say in one and some in another, and every political physician will advise a different medicine.

Holy Schnikes, T. Paine!

I don’t love greed

It’s not often that I disagree with Walter Williams, but I did this week.  Or, at least I disagree with the title of his column,  I Love GreedThough, I will give him some wiggle room.  Column authors don’t always come up with the titles for their pieces.

I think a better title is I Love Capitalism.

In the column, he explains Adam Smith’s observation that capitalism directs greed (or self-interest) to encourage humans to serve their fellow man.  I like his example (emphasis added):

This winter, Texas ranchers may have to fight the cold of night, perhaps blizzards, to run down, feed and care for stray cattle. They make the personal sacrifice of caring for their animals to ensure that New Yorkers can enjoy beef. Last summer, Idaho potato farmers toiled in blazing sun, in dust and dirt, and maybe being bitten by insects to ensure that New Yorkers had potatoes to go with their beef.

Here’s my question: Do you think that Texas ranchers and Idaho potato farmers make these personal sacrifices because they love or care about the well-being of New Yorkers? The fact is whether they like New Yorkers or not, they make sure that New Yorkers are supplied with beef and potatoes every day of the week. Why? It’s because ranchers and farmers want more for themselves. In a free market system, in order for one to get more for himself, he must serve his fellow man. This is precisely what Adam Smith, the father of economics, meant when he said in his classic “An Inquiry Into the Nature and Causes of the Wealth of Nations” (1776), “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.” By the way, how much beef and potatoes do you think New Yorkers would enjoy if it all depended upon the politically correct notions of human love and kindness?

I like that last question.  Adam Smith wrote it this way:

We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.  Nobody but a beggar chuses to depend chiefly upon the benevolence of his fellow-citizens.

When I read that passage from Adam Smith for the first time, it caused me to see the world differently.

Before that I had not seen as clearly the motivation of all those who supply me with the goods and services that I demand and how well those motivations work.

But, back to the title of Williams’ column.  Later Williams writes:

Free market capitalism is relatively new in human history. Prior to the rise of capitalism, the way people amassed great wealth was by looting, plundering and enslaving their fellow man. Capitalism made it possible to become wealthy by serving one’s fellow man.

That looting, plundering and enslaving was driven by greed also.  What’s there to love about that? Absolutely nothing.  Sorry Walter.

But, there’s a lot to love about a system that directs that greed away from looting, plundering and enslaving and channels it to serving our fellow man.

Greed and self-interest exists.  This is human nature.  I believe coming to grips with this fact moved me along my political path from neo to classical liberal.

Many people are not willing to recognize this fact of human.  They hold romantic hope that human nature can somehow be different because they feel it should be.

And such people often seem oblivious that their very own behavior is guided by self-interest and does not often live up to the romantic hope they hold for everyone else.

Occupy Wall Street

A friend asked what I thought about Occupy Wall Street.  I directed him to John Stossel’s latest column, Wall Street Protesters Half Right, because Stossel does a great job of summing up my views.

I hope that the OWS protesters learn to better distinguish between the free market and the rent-seeking profits that seem to bug them.  Right now, they confuse those concepts.

Here’s another post on this distinction.

The invisible hand is not the free market

Many people say that the housing bubble was caused by a failure of the invisible hand.

When I encounter such folks, I like to make sure they understand what the invisible hand is.  Many believe invisible hand is synonymous with free market.

It’s not.

The invisible hand is how a free market produces socially desirable outcomes.  It is not the free market itself.

So, what is the invisible hand?

It’s the incentives we face when we make the trade-off decisions that we encounter each day and how we respond to those incentives.

Some of the trade-off decisions might be: Do I go to work?  Do I buy a cup of coffee?  Do I refinance my house?  We face many invisible incentives around each of these decisions.  How much work do I have?  How much vacation have I banked?  What am I going to do with my time off?  Is the coffee good? Is it far out of my way?  Will there be a long line? Is the new mortgage rate worth the closing costs?

Others face trade-off decisions too.  Investors hire business managers to generate good returns on their investments.  Business managers, to stay employed, have to decide how to grow sales.  Do we try a new product or open locations in new markets?

The incentives that help guide our decisions is the invisible hand.  It’s invisible because we can’t physically see incentives, but they’re there.

Adam Smith claimed that the incentives in the invisible hand tended to produce socially desirable outcomes in a free market with little government regulation because in a free market we choose when and how to interact with each other.

That choice to interact or not is the key to producing socially desirable outcomes.

Consider the cup of coffee that you bought this morning.  Did you force the coffee shop to sell it to you? No. Did the coffee shop force you to buy it? No.

You and the coffee shop owner both chose to trade because you both felt like you came out ahead by doing so.  You valued the cup of coffee more than the $2 it cost you.  The coffee shop owner valued the $2 more than the cup of coffee he sold you.

That’s called a voluntary, mutually beneficial trade.  Value was created on both sides of the transaction — for you and the coffee shop owner (though most people forget about the value created for the customer, they only see the ‘profit’ for the coffee shop owner).

Smith’s famous quote illustrates the value creation engine of the invisible hand incentives nicely:

It is not from the benevolence of the butcher, the brewer or the baker, that we expect our dinner, but from their regard to their own interest.

We choose to interact with the butcher for the very reason he chooses to interact with us:  self interest.  We both benefit from the interaction, otherwise we would pass it up.

When things don’t appear to produce a desirable outcome, we are quick to blame the invisible hand.  We say it failed.

But, we shouldn’t rush to judgement.  What really happened is that the incentives changed somehow so some people traded even when they did not benefit from doing so.

We should look to identify where this occurred, because that will tell us what went wrong.

Alan Greenspan, for one, told Congress that he overestimated the self-regulation of the free market.  (That self-regulation being that two parties of a transaction prudently seek to come out ahead.)

He was specifically referring to trades where investors bought mortgage-backed securities from banks.  Investors bought these for what would turn out to be much more than they were truly worth.  In fact, these investors had an insatiable appetite for mortgage-backed securities.  So much so, that banks created as much as possible by lending to just about anyone no matter their credit history and ability to pay.

But, Alan Greenspan was wrong.

He didn’t understand why investors bought this stuff.  He thought they were incorrectly overvaluing mortgage-backed securities based solely on the expected payback.  If that’s all investors were buying, Greenspan would have been right.

I doubt any of these investors would have lent money directly to many of the folks who they lent money to through the mortgage-backed securities.

So why did they did they lend money to them through the mortgage-backed securities?

Because politicians in government changed the incentives by signing up taxpayers as unwilling, and unknowing, co-signers.  The taxpayers are the folks that traded in this house of cards when it did not benefit them from doing so. 

As Russ Roberts points out in his 2010 white paper, Gambling With Other People’s Money, mortgage-backed security investors weren’t only lending to folks unlikely to repay.  They were lending to these folks with U.S. taxpayers as co-signers.

Think of it this way, a friend with a bad credit history asks you for a loan.  The payment your friend would need to repay the loan would be more than half of his income.  Do you lend him the money?

Judging the transaction solely on its merits — that is, your chances of receiving the loan  back — you’re not likely to lend him the money.

But, what if your friend’s rich Uncle Sam co-signs the loan?  If your friend stops paying, Uncle Sam will pay what’s owed.  Will you make this loan now?

More likely.  But now, you’re not judging the loan purely on the merits of your friend.  You are factoring in the value of the co-signer.  Having the co-signer changed the incentives for you.

Russ Roberts makes a good case in his paper that’s exactly what investors in mortgage-backed securities did — and they turned out to be right.  And, this is the piece of the incentive structure of subprime mortgage-backed securities that Alan Greenspan missed.

Critics of this argument say that there was no explicit guarantee from U.S. taxpayers.  Roberts argues that the pattern had been established with previous government bailouts.  And, I’d argue that politicians from both sides of the aisle were in such a fervor to “expand the dream of home ownership” that they had been sending strong signals that they wouldn’t let these investors go under (though I think they hoped it wouldn’t come to this).

So, it wasn’t the invisible hand of the free market that failed.  What caused the failure was the introduction into the incentive structure a forced trade with U.S. taxpayers in co-signing the loans of people who would not have been able to get a loan 20 years ago.

Now, I do think there were other factors that contributed.  There was an overconfidence in the ability of statistical models to somehow group bad credit risks in a way that lowered risk.  There was also the fever of rising housing prices, which caused more people to want to buy homes just to be able to sell them a few months or a year later at a higher price.

But, even these things really had the implicit guarantee of the U.S. taxpayer underlying them.  Without this guarantee, the demand for housing would not have increased as rapidly, driving up prices.  Without this guarantee, we may have been more skeptical of those sophisticated risk models.

As Roberts has stated, “Capitalism is a profit and loss system.  Profit encourages risk-taking and losses encourages prudence.”  Having the U.S. taxpayer as co-signer reduced the chance of loss and reduced prudence in just about every decision in the chain.

“Your Teacher Said What!?” Review

I’ve been looking forward to reading Joe and Blake Kernan’s book, Your Teacher Said What?! Defending Our Kids from the Liberal Assault on Capitalism.

I highly recommend it. It exceeded my expectations.  I found it well-written, easy-to-read, entertaining, critical, well researched and fair.

In the book, Kernan describes how he handled presenting ideas of about liberty, free markets, business and the government to his daughter.  We can all benefit from it.

For those unfamiliar, Joe Kernan is the morning host of CNBC’s market and business program Squawk Box and an unabashed capitalist.  His daughter is (or was) ten-years-old and attends public schools.

Despite the title, the book doesn’t focus a great deal on what Blake’s teachers say.  Though, in the book he gives credit to her teachers for doing a fine job of teaching everything other than liberty, markets and business (an example of where he is fair).

Here’s another example of his fairness (p. 3).

When Barack Hussein Obama took the oath of office, I admit I understood the proud cheers of the hundreds of thousands of people lining the parade route in Washington that day.  I didn’t vote for the guy, but I’m not a complete dolt, and I could see how his election said something pretty positive about America.

The hangover didn’t take long coming.  My hangover isn’t the result of concerns about the president’s birth certificate. Or worries that he is some kind of Manchurian candidate in the pay of a foreign power.  I don’t think he’s Muslim, or racist, or anticolonialist, or un-American.

No, my problems with the president are on an entirely different plane: I hate what he’s doing to my children’s future, and I don’t have to think that Barack Obama is the devil to know that he has a very different idea than I do about what America should look like when Blake and Scott are adults.

It’s a belief thing.  Penelope (Kernan’s wife) and I believe in free markets–that the best economic decisions are made by the largest number of individuals acting in what they believe to be their own interests.  President Obama and most of his administration believe in an economy that depends on the cleverest people acting in what they believe to be the interests of everyone else.  We believe in voluntary associations.  They prefer compulsory ones, at least when it comes to health insurance or union organizing.

This sets the stage.  Kernan is not out to make unsubstantiated personal attacks.  Rather, he presents why he thinks his beliefs are right.

In one chapter, Kernan dives into anti-business portrayals and caricatured markets in movies like WALL-E and Avatar.   He concludes:

…I still don’t understand the reflexive hostility of the entertainment business to free markets and capitalism.  Maybe the best explanation is that the writers, directors, and actors who produce our filmed entertainment are allowed (maybe even encouraged) to retain a child’s view of the world.  Like ten-year-olds, they retain a belief in obvious heroes and villians, in perfection as a place where things don’t change (especially as the result of human action), and in happy endings.

A little later, Kernan defines Progressivism (p. 127):

The desire to regulate economic life might be the defining characteristic of Pregressive philosophy.  It combines a mistrust of the free market in allocating resources; an appeal to a vague and indefinable virtue (“fairness”); a desire to achieve perfection in economic outcomes; a deference to experts over the judgement of ordinary folks; and, best of all, a chance to tell other people what to do.  Oh, heck, let’s just say it: Regulation is progressivism.

It is also the perfect way to illustrate just how much Progessive thinking depends on treating adults like kids.  Because kids love regulation.

“Blake?”

“Yes, Dad?”

“You know cigarettes are bad for you, right?”

Eyes roll upward.

“And you know that people aren’t allowed to smoke in restaurants or lots of other places, right?”

“They shouldn’t be allowed to smoke anywhere.”

“Why not?”

“Because it’s bad.”

These two previous passages spurred the idea that many people form their sense of how government, business, markets and the economy work when they are about 10-years-old.  And, they don’t reconcile these views with the real world often, even against compelling evidence.

This brings to mind folks I know who haven’t realized that markets have made available, even to folks with modest income, a standard of living unmatched on this planet, ever.

Or folks who haven’t yet realized that all politicians should be considered narcissists only interested in their own political gain.  I admit, this one took me some time.  I spent too many of my younger days defending “my” politicians for their disappointing behavior before I realized that was a waste.  Assuming all politicians are in it for themselves dispels with the vacuous “I really like that guy” vote and helps you focus on whether or not you agree with the politician’s positions.

If it’s true that many folks think of government using their 10-year-old logic, this may make Kernan’s book one of the most important of the year because it provides nice advice on how to deal with this.