Did you get that hot Christmas toy?

Last night I heard this sound bite from President Obama:

If you [colleges] can’t stop tuition going up, your funding from taxpayers will go down.

I wonder if he has considered that the funding from taxpayers is the very cause of rising tuition?

Have you noticed that the areas of the economy where costs tend to rise faster than inflation — education (K-12 & college) and health care for example — receive the most taxpayer dollars?

The areas of the economy that have little or no taxpayer funding tend to produce exponentially better and cheaper products.

It’s not just coincidence.  It’s basic economics.  Supply and demand.  We all know what happens to the price of that hot Christmas toy every parent wants to buy their kids — it goes up from the strong demand.

Now, imagine that government comes along and says that no child should be without that hot Christmas toy.   In fact, government is going to give a $50 voucher –provided by taxpayers, of course — to ensure that every family gets one.

What do you think would happen to the price of that hot Christmas toy?  Yes.  It will go up further because of even higher demand.  So, that $50 voucher just gets built into the price.

In the same way, the taxpayer dollars that flow into education and health care just gets built into the price.  Education and health care are our hot Christmas toys.

Enlightening Aggregation

I typically think that looking at things like the economy in terms of aggregates is not helpful.  GDP, for example, is an economic aggregate, or a sum of several different categories of spending that is used as a gauge on the health of the economy.

GDP can be useful for visualization, comparison and analysis.  For example, it’s fair to use GDP per capita to compare the relative living conditions of the U.S. and Zimbabwe, or folks living today and folks living in the U.S. fifty years ago.

The danger comes when those in power believe it is something they need to micro manage.

The following passage provides an example of an author who used aggregation to create an effective visual.  I read it years ago, and every now and then it bubbles back to the surface.  I think it may be especially timely now with the debt limit debate in DC (emphasis added).

Wm. Rickenbacker editor of the Rickenbacker report and author of a recently published “Savings & Investment Guide” has pointed out that 28.6 mil.  Americans depend on gov’t retirement and disability programs.  Then you add in recipients of survivor programs — almost 9 mil, unemp. benefits to 6 mil., Military 3-1/2 mil., civilian emps. & dependents and you come up with a total of 81.3 mil. people dependent on tax dollars for their year round living.

All of those tax dollars must come from 70.2 million Americans working & earning in the private sector.  Ah! but you say govt. workers pay taxes too. And so they do. But all their inc. & therefore the portion they pay in taxes comes originally from tax dollars so they are just returning to gov’t. tax money already pd. by the worker in the pvt. sector.

The 70.2 mil. private sector workers have 62.1 mil. personal dependents, so we’re talking about a private sector of 132.3 mil. sharing their income with an additional 81.3 mil.

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

Now, don’t take this as meaning there should be no recipients of tax dollars or that all who work in gov’t are parasites.  Obviously, we want to provide for the needy & disabled.   Just as obviously we must have & are happy to have in the military those who provide for our security.  This goes also for policemen and firemen & all those who provide services we want & need.

The point I’m making is that somewhere there must be a figure beyond which we can’t go in the growth of gov’t without wimping out those in the private sector who pick up the tab.

The plain truth is every effort to slow gov’t growth or reduce gov’t costs has failed.  In the last 20 yrs. corp. profits have risen 105%–wages have gone up 213%–govt. costs have risen 340%.  There is one sensible, long overdue answer; fix in the constitution a limit on the share of earnings govt. can take without becoming a drag on the economy.

These words are from the book Reagan: In His Own Hand.   They were written as a manuscript for a Paul Harvey-esque radio spot that Reagan gave in those days.  This one aired on radio on November 16, 1976.

I thought this was an interesting way of looking at the economy.  Wealth must first be created in the private sector before it can be used by government.  Government doesn’t divine wealth out of thin air.  It lives off the wealth created in the private sector.  And the ratio of folks living of that wealth is high.  Someday I might try to update these numbers to see if the ratio has changed.

The reason we transitioned from hunter-gatherers — folks who spent most of their time providing the essentials — to where we are now is through private sector trading that allowed us to free up time amongst ourselves and others.  That freeing up of time allows us to use some of our produce to fund things like government.  It allows some people to not produce much at all and do things like occupy government positions.

While people have many different ideas about what wealth is, wealth derives from this savings of time.  How much time does it take to feed ourselves compared to our hunter-gatherer ancestors?  Much less.  If it didn’t, we couldn’t afford government.

I think it’s good to keep that in mind as some of those in government seem awfully preoccupied with biting the very hand that feeds them.

I was the 301st person to watch this on Youtube

Here’s the second round of the Keynes vs. Hayek.  Enjoy.  I donated $50 to this project.

And here’s Round 1 in case you missed it.

Thanks to Russ Roberts and John Papola for their excellent efforts, great lyrics and high production value!  There’s a lot of depth to both videos in the lyrics, in the folks who are mentioned and the folks who pop up in the video.  These are excellent learning tools.

Gas prices

A common quandary that perplexes many folks is fluctuating gas prices.  Whenever gas prices increase quickly, I typically hear something like the following:

  1. The cost of the current stock of gas in the underground tank at the gas station was bought at a lower price.
  2. Rising gas prices do not change what the gas station paid for that current stock.
  3. The gas station could keep the lower pump price and still have cleared a nice profit on that stock of gas.
  4. Why do they raise the price?  It must be greed.

I have something for folks who have not got past this quandary to think about.

Let’s say you bought a rookie baseball card for pennies.  Years later, that rookie develops into a future hall-of-fame player and is loved by a large fan base.

Ten years from when you bought that rookie card, you discover you have it and look up the market value and find that it is now worth $50.

You tell a friend that you have the card.  He wants it.  What do you consider to be a fair price?

You tell your friend the price is $50 since that’s the market value.  He might argue that it only cost you a few cents and even with inflation, the cost of the card to you in today’s dollars is $1.   He might offer to pay you a storage fee of $0.10 per year, which brings the total offer price to $2. Does he have a fair argument?  Are you motivated by greed for not agreeing to sell it for $2 and wanting $50 instead?

While you are negotiating a price with your friend, the player tragically dies in a car accident and you find out the next day that demand for his memorabilia has increased substantially.  You see his rookie card is now selling for $400 on eBay.

Remember, you only paid a few cents for the card and you have not agreed to a final price yet.  Do you accept your friend’s offer of $2?  Do you stick with your original asking price of $50?  Do you raise the price to $400?

If you choose the second or third option, you are behaving identically to the gas station owner and you are not being motivated by greed, but rather by your opportunity cost.

By selling the card to your friend for $2 you would give up the opportunity to sell it for $400 and you are giving your friend that opportunity. You recognize that what you paid has little bearing on the situation.  You also recognize that you would be giving your friend $398.

Now, let’s revisit the gas station.   The gas station owner fills his underground tank for $10,000 and sets a price that will earn him $11,000 once all that gas is sold – a tidy $1,000 profit.

A fire takes out a major refinery and the price of gas on the commodity market jumps.  The gas that cost the the owner $10,000 last night is now going for $15,000 on the commodity market.

Let’s say there’s a local law that requires the gas station owner to not change his price until he sells out of this batch.  He can sell the gas to his customers and make $11,000 or he can call his supplier and have them come pump the gas out of his tank and sell it back to them for $15,000.  Which would you do?

Macro economics is like magic? Close to it.

F.A. Hayek regarding the ‘Austrian School’ of economics, from The Fatal Conceit (p. 98):

By its stress on what it called the ‘subjective’ nature of economic values it produced a new paradigm for explaining structures arising without design from human interaction.

By “subjective” Hayek means that the value of the things we trade — the morning newspaper, a Coke, a haircut — is determined subjectively by each of us.

By “structure”, I believe Hayek means a system of prices by which a potato’s price becomes relative to how much time it takes you to earn enough to buy it.

All of the prices reflect the subjective values we all place on these items and these prices are discovered through the experience of human interaction and trading these things, not by anyone setting the price.

I’m reminded of an example in Russ Roberts’ The Price of Everything, when the econ professor Ruth asked who set the price of a home she plans to sell.  The seller, answered her students.  Ruth responds, so if I have a house that’s in a neighborhood where like houses normally sell for $800,000, I can set the price for $1.2 million and expect to get that price?  Who really sets the price?  Nobody.

Hayek continues:

Yet, during the last forty years, its [the Austrian school] contributions have been obscured by the rise of ‘macro-economics’, which seeks causal connections between hypothetically measurable entities or statistical aggregates.  These may sometimes, I concede, indicate some vague probabilities, but they certainly do not explain the processes involved in generating them.

Here’s the good part (emphasis added):

But because of the delusion that macro-economics is both viable and useful (a delusion encouraged by its extensive use of mathematics which must always impress politicians lacking any mathematics education, and which is really the nearest thing to the practice of magic that occurs among professional economists) many opinions ruling contemporary government and politics are still based on naive explanations of such economic phenomena as value and prices, explanations that vainly endeavour to account for them as ‘objective’ occurrences independent of human knowledge and aims.  Such explanations cannot interpret the function or appreciate the indispensability of trading and markets for coordinating the productive efforts of large numbers of people.

In other words, macro-economics is really the use of math to relate things that may not really exist.  This is a hard one for people to accept.  After all, GDP is GDP isn’t it?  It’s real?  Those statisticians and economists know what they’re doing, don’t they?

What’s real are the trades between you and others.  What’s real is the thought processes that went your mind that led you to make those trades, as well as the thought processes that went through the minds of your trading partners.

GDP is not real.  The thought processes exist somewhere — in our minds.  GDP is a number printed on a page.  What that number means doesn’t exist anywhere.

Allocation Through Pricing

Several years ago a friend got me hooked on the annual tradition of buying Beaujaolais Nouveau in November.  This red wine is made from the grapes of this year’s harvest and is shipped out across the world on the third Thursday in November.

It was fun.  For a few years we went together to purchase the wine.  It made for a nice story on Thanksgiving.  And, it was cheap.  I think I recall paying around $5 a bottle for the wine.  But, you had to get there within a day or two or supplies would run out.

Another friend asked me if I bought the Beaujaolais this year?  “No.”  “Why not?”

My first answer was, well it has become too mainstream now.  Everybody knows about it.

Then I thought for a second and continued…

“And, they raised the prices.  At $5/bottle, I’d buy 2 or 3 bottles.  Now the prices are around $10 – $14.  I guess it wasn’t worth it to me.  I have other wines I enjoy more for that price.  Also, I notice you don’t have to get there on day one now, supplies last with the higher pricing.”

I thought back to the story of flashlight pricing at Big Box retailer in Russell Roberts’ The Price of Everything.

After an earthquake, Big Box raised prices.  Of course, that made everyone mad, yet Big Box was the only place in town where you could get what you needed (p. 71).

[Ruth – Econ professor]: “On the night of the big earthquake, there aren’t enough flashlights to go around. At the usual, everyday prices, people want to buy more flashlights than there are flashlights on the shelves, agreed?”

[Ramon – outraged consumer]: “Yes.”

“Given that there aren’t enough flashlights to go around, who should get them?”

“That’s easy.  The people who need them the most.  Not the people who already have one.  Not the people who have lots of candles.  Not the people who are going to sleep most of the night anyway.”

The conversation continued.  Ruth asked how you would decide who needed the flashlights the most.  She points out the problem is knowledge.  You could interview people and see who makes the best case, but Ramon is skeptical that people might not tell the truth.  Ruth adds that along with flashlights you would need to make the same decisions for candles, diapers, portable generators and items to numerous to have any hopes of being effective.

[Ruth]: “If you leave prices alone at their regular everyday levels, who gets the flashlights and the milk and the generators?”

[Ramon]: “The people who need them.”

[Ruth]: “I don’t think so.  If you leave prices alone, the people who get the flashlights are the people who get there first.  When you went to Home Depot, the stuff you wanted was already gone.  But at Big Box, anyone who wanted a flashlight could have one.”

[Ramon]: “If they were willing to pay for it.  That made it harder on the poor people…”

[Ruth]: “Agreed. But for thousands of people, there were flashlights waiting for them.  Remember that knowledge we wanted to have? The knowledge about who needed flashlights the most? When Big Box raises the price of flashlights, someone who had candles at home decided to do without the flashlight and left it there for you on the shelf.  No one had to interview either of you. The higher price induced both of you to act as if you had been interviewed.  The person with the candles, by refusing to buy the flashlight at the higher price, was saying, I’ll pass on buying a flashlight. I’ll leave it for someone who needs it more. But no one begged him to do the right thing or passed a law that would have to be enforced or interviewed him to find out who needed it the most.  The higher price made sure you got the flashlight, that seems pretty just to me.”

With the higher price on Beaujaolais, I decided to pass on it and leave the 2 to 3 bottles I would have bought on the shelf for someone else who valued it more.  I would make due with other wines and without the stories of drinking this year’s harvest.

If you’re still curious about poor people not being able to afford flashlights and would like to know more about what Ruth Lieber says, I encourage you to get a hold of Roberts’ book and read it.

As for me, I’m thinking about buying extra flashlights, batteries and a generator while the prices are reasonable.

George Lopez Agrees With Louis CK

I saw George Lopez live last night.  Very entertaining, though he seemed a bit punch drunk and bitter from a divorce.

A common theme in Lopez’s act was how well we live compared to even just a generation ago, which reminds me of the comedian Louis CK’s “Everything’s Amazing and Nobody’s Happy.”

He harped on how good our kids have it and showed that he’s a good economics thinker by asserting that we’re raising our kids as dependent wimps and that probably won’t end well.  We are the broken feedback loop.

One story he used to illustrate the point is how he baby-proof our homes to prevent our young children from getting hurt.  This is me, paraphrasing:

We put rubber on the corners, we plug the outlets.  When I was a kid, if we were walking around with a butter knife, adults encouraged us to stick it in the wall socket.  We’d shoot across the room and as we’re lying on the floor recovering the adult would come over and tell us to use our brains.

Kid walks into the kitchen and asks, “Is that pan hot?”  Adult: “You tell me.”

He talked about how we don’t even think twice about spending $30 here and there to buy our kids stuff now.

Back then $30 was a lot of money.  Heck, today it’s a lot of money.  We give our kids so much.  We didn’t have that back then.   We climbed trees, played marbles and doctor!

One line of Lopez’s reminded me of a Tony Blair, and perhaps Churchill quote: “You can take a true measure of a country by looking at the number of people trying to get in and the number trying to get out.”

Lopez:  “America is a great country.  You can tell because a lot people try to sneak in and not very many want to sneak out.”

And, I agree with Lopez on immigration.

Most immigrants come here to work and earn a better life than they had by doing jobs that Americans don’t really want to do.  Let them.

We all benefit from immigrants and most of us are too dumb to realize it.

I think the the biggest immigration problem we have is that our government places artificial limitations on the number of immigrants to admit and it creates other artificial barriers to them becoming legal, like the minimum wage.