Friday, March 26, 2010

But I don't want your help!

For lunch today I decided to pick up Chinese food from a very highly regarded restaurant in my area. As I approached the entrance, I noticed a group of people protesting outside. They held signs and chanted about how the restaurant employs sweatshop labor in sweatshop conditions. Though the restaurant happens to be a very nice one and therefore made it hard for me to believe it could qualify as a sweatshop environment, I mentally yielded the protesters the benefit of the doubt since I had not actually ever entered the kitchen. But by the time I walked into the restaurant, I had already thought of some serious problems with the protest.

The first problem was the irony inherent in the fact that it was protesters protesting and not the employees of the restaurant. Why is this ironic? If the employees found the conditions in the restaurant to be so horrific... they wouldn't work there! Don't walk an old lady across the street if she doesn't want to cross the street! Notice, this is not my attempt to make a statement about how the working conditions must be pleasant at the restaurant, it is to make a statement that employment at this restaurant must be the employees' next best option above all else, otherwise they would be working elsewhere. By protesting at the restaurant, the protesters are potentially risking the employment of the individuals they are supposedly trying to help.

The second problem is even more ironic than the first. Even if we grant that the working conditions are that of sweatshop labor, and that the employees are somehow miserable but choose to stay even if alternative options are better, what are the consequences of this protest? The protesters are trying to raise recognition of the conditions at the restaurant. By pointing this out, they hope that the restaurant will either improve conditions, or have customers choose to stop frequenting the restaurant in disgust to teach the restaurant a lesson. If the restaurant improves conditions, this might very well cost an amount of money that forces the restaurant to fire some of the employees. Are the fired employees now better off? If, on the other hand, customers stop eating at this restaurant, that means less of the good produced by this restaurant (food) is desired, and less labor input is necessary to produce it. Once again, some of the employees could get fired.

This analysis holds true for all protests that take place outside businesses. The well-being of the people the protests are supposedly trying to help is directly endangered by the protests themselves. In fact, the most beneficial act that an individual could do on behalf of an unhappy employee at a business, is to encourage more people to buy what the business produces. Only when demand for the business' product goes up is there a chance that the working conditions will get improved (or the employees will get paid more, or more employees will get hired, etc.).

Tuesday, March 23, 2010

Restricting Choice

We often appreciate having many options in the things that we do. There are different colors in clothes, different sizes in shoes, different lengths of time for massages, etc. Chances are, if anyone proposed limiting our decision-making in any of the just-listed goods/services, we would be very resentful. What if I don't want to choose between a red sweater or blue sweater, but instead want a black sweater? What if my feet don't fit into a size 5 or 15, but rather a size 10? Or what if I neither like to wear sweaters nor like to wear shoes? Instead, I prefer light jackets and sandals. But no matter how simple and logical all of this is, support for the recent health care reform bill seems to emanate from an alternate realm in which restricted options are actually the preference.

I can only think of one criticism of the above that could be offered as a reason for desiring fewer choices: what if not everyone can make a desirable choice and by limiting others' choices we could give everyone at least something? This is not a novel argument, in general. It has been used to justify various collectivist ventures throughout history, whether that be for a country as a whole or for a particular program within a country. The most important question to ask of such a proposal is how does the non-restrictive status quo in certain industries fare when it comes to concern for those who can't make a desirable choice?

We might as well use some of the examples listed above. With clothing, we don't just choose among colors, we also choose among different types. What do we know about the different types of clothing? For one, there are tons! There is clothing catering to the extremely wealthy (that often looks so fashionable the average person often hopes only a small segment of the population will even wear it), and there is clothing catering to those less well off. With shoes we see the same thing. And that goes for massages too, with both high-end spas in existence and cheaper spa-like operations offering their services too. Nobody's options are restricted in these goods/services, yet we see an abundant variety that could cater to just about everyone. We also have non-monetary transactions that take place like clothing donation and friendly massages, for those who either can't or don't want to pay.

So then why are there so many problems with health care? Well, the market for health care is not remotely close to as freely operating as the markets I just described. Just think about it. There are various medical associations with exclusive memberships that drive up the cost for everyone if medical providers are required to join. There are pharmaceutical companies whose products are patented, preventing competitors from driving down prices. These are the types of things that indirectly restrict choices (indirectly in the sense that nobody is telling you that you can only shop at this medical provider, but rather someone is telling potential medical providers that they can only be medical providers if they do X and Y). The cure for these ills is not a superficial correction of the undesired outcome ("just give this guy what he can't get"); it is a critical examination of the underlying fundamental characteristics of the problem at hand ("what is it about this situation that is making this guy unable to get what he wants?").

What one should begin to realize is that by requiring everyone to purchase health care, in addition to the already choice-restrictive elements of the health care market, we are moving in the exact opposite direction of that which we would move in if we wanted to emulate the clothing, shoe, or massage markets. There is irony in the fear of what might happen if we do so because we already see the bad outcome of restricting choices. There is a painfully consequential misunderstanding of the status quo. We do not currently have many options when it comes to health-related services. So if right now we recognize many problems with health provisions, and right now we recognize that the provision of health care is not full of options, why would we want to further restrict our choices? I thought the current outcome is the problem! There is indeed a serious issue with health care in this country, but the solution is not even more of the failed same, no matter how much it might be marketed as "change."

Thursday, March 18, 2010

How Big is Too Big?

Senator Chris Dodd has a plan to give the Federal Reserve the power to split large firms into smaller pieces. The rationale here is that during the current financial crisis, we witnessed large firms ready to go belly up and take the economy down too. The assumptions here are that large firms can bring down the economy and by splitting them into parts when they get too big, we can save the economy.

I have a few questions:

1. In the normal course of events in the marketplace, companies are aggregated and companies are broken apart. The metric for these decisions is profit and loss. If there is value to be created by merging companies, they will be merged. If there is value to be unleashed by splitting a company in two, that company will be split in two. There are individuals who put their time and money on the line to make the right decision. In the case of the Federal Reserve, how will it determine when companies are too big and does the Federal Reserve face the same incentives as companies in the marketplace to make the right decision?

2. There are many large companies in the world, not just in the financial industry. The laws of economics are obviously not suspended for this one specific industry. Why do we not concern ourselves when a large non-financial company is about to go under (and being content with the knowledge that its assets will be sold off to others who will use them more productively), but we begin envisioning The End Times when a financial firm is about to go under (as if there is this gigantic piece of wealth, encompassed by the financial firm, that is about to just vanish, taking everything and everyone down with it and leaving nothing in its tracks for the rest of the world to survive on)?

Monday, March 15, 2010

Area's Sole Water Seller Refuses to Pay for Water at Full Price

Before I link to the article that spurred the above title, I thought it would be beneficial to flesh out exactly what the title refers to. Imagine some type of catastrophe happens, like an earthquake for instance, and it turns out that there is essentially only 1 person in the area who also happens to have an abundance of water for sale. It should be self-evident that the water is probably going to cost more than it would under normal circumstances (demand for water is up and the 1 person only has his limited supply, so the price has to go up to bring supply and demand into equilibrium). In addition, it should be self-evident that if someone else in the area were to have water and offered to sell it to our individual, he should probably turn it down seeing as he has plenty of his own. And finally on top of that, it should be self-evident that if our individual were to actually decide to buy water from someone else, it better be at a significant discount, otherwise why would he of all people buy it?

Now that we worked out some basic assumptions in a metaphorical example, let's get to the article that made all of that randomness come to my mind. Bloomberg is reporting that Goldman Sachs is demanding more collateral from counter-parties than it is willing to put up itself. For example, in derivatives contracts with hedge funds, Goldman Sachs is expecting those funds to put up more cash as collateral than Goldman itself would put up if it entered a similar contract in a similar position as the hedge fund. This has allowed Goldman Sachs to benefit significantly from the arrangement. What is not mentioned in the article, however, is how the hedge funds benefit as well since they are voluntarily choosing to enter this agreement even though the terms to outsiders might appear unequal. Nobody is making the hedge funds work with Goldman Sachs, but they are choosing to do so anyway.

The reason for this seemingly sinister situation is summed up by Richard Lindsey, a former director at the SEC. "If you're seen as a major player and you have a product that people can't get elsewhere, you have the negotiating power." Exactly like the water seller. Goldman is benefiting from its clout, and the hedge funds are benefiting from doing business with a reputable business that is offering terms better than could be found elsewhere in the marketplace. It is entirely possible that without Goldman, those hedge funds would experience even worse terms or might be forced to not engage in derivatives transactions at all.

There is nothing inherently wrong with being in a position of power in the marketplace as long as that position of power is not artificially supported by an extra-market institution (like the government, for instance). And while I would be more than willing to entertain the idea that Goldman Sachs is in fact supported artificially by the government, that topic is beyond the scope of this post. The reason for the remark about artificial support is that as long as the position is not being maintained through any forceful means (like using tax money to support a business which might otherwise not be supported at all), the position of power can only be achieved if it is legitimate and warranted (people voluntarily do business with the company because they want to, not because they are being forced to). Without force, companies cannot grow big and powerful unless they offer better products to buyers. The same way that an individual should look favorably upon the water seller for providing a much-needed commodity in the marketplace during a difficult time (even at a higher price, because nobody else is even willing or has the ability to offer it!), the hedge funds should be thanking Goldman Sachs (and Goldman Sachs should be thanking its customers) for providing a good that they need when few other businesses offer it on the same terms.

Friday, March 12, 2010

Characterizing Causation

When a catalyst is thought to bring about something positive, we look favorably on the catalyst. When the catalyst is viewed as having engendered harm, we view it with scorn. A court-ordered report has revealed that JPMorgan and Citigroup helped bring about the collapse of Lehman Brothers. The implication here is obvious: by helping cause the collapse of Lehman Brothers, JPMorgan and Citigroup have done something wrong. In fact, a representative of Citigroup quoted in the article even states that after reviewing the report, the examiner "has not identified any wrongdoing on Citi's part." She made the comment because wrongdoing is the implication.

I found the article's headline to be especially irksome because failure is critical to a healthy marketplace and because I knew the article would reference as bad, actions taken by Citigroup and JPMorgan that put Lehman Brothers over the edge, as if the same actions could have put Lehman Brothers over the edge if it weren't so over-leveraged in the first place thanks to the Federal Reserve's easy money policies (since the central bank puts money in the economy, the problem of too much money is the fault of the central bank). Anton Valukas, the examiner, makes this evident when he says that "the demands for collateral by Lehman's lenders had direct impact on Lehman's liquidity." You don't say! But here is what I say: so what?

The problem with trying to erase Citigroup's guilt and JPMorgan's guilt is twofold: they were unquestionably responsible for Lehman Brothers' collapse, and we should be happy that they were. If you as a consumer stop frequenting your local seafood restaurant because you or someone you know was poisoned by it, outside observers would hardly accuse you of wrongdoing if your actions helped bring down the restaurant. In addition, the sooner you and others stop frequenting a restaurant with poisoned food, the better off everyone is because resources previously used in operating a poisoned-food seafood restaurant can now be used for something potentially better. Another example is that of short sellers who uncover accounting fraud at public firms thereby doing society a service by helping to bring about the end of those companies' fraudulent activities and putting them out of business.

When Citigroup and JPMorgan demanded more collateral from Lehman Brothers, this was an indication that Lehman wasn't doing so well. If you lend someone money with his car as collateral, and he keeps coming back to you for more money, chances are you will demand more collateral from him. Not only are you in your right to do so, but you are also smart to do so because by asking for more money, your borrower is demonstrating to you that his default risk is increasing. What Citigroup and JPMorgan did is no different. If your borrower can't put up more collateral and you cut off his loans forcing him to drastically cut back on his extravagant spending habits, this is better for everyone involved (you are no longer throwing good money after bad, and the borrower is forced to reform his behavior).

This financial crisis has really brought the concept of failure in the marketplace to the forefront. It is vital that we understand the importance failure serves in a properly functioning economy, and cease ostracizing institutions or individuals that cause failure to happen.

Tuesday, March 9, 2010

Is two that much greater than one or zero?

I have been a little behind on my pleasure reading, but this fact wasn't as apparent as it became when I saw an article in New York Magazine about Scott Brown's recent election victory in Massachusetts and if/how Democrats might be able to win his support on some initiatives. That upset victory in Massachusetts now seems like ages ago but here is my post regardless...

It was informative for me to learn how, despite Brown's previous characterization as a "right wing nut" (who apparently exemplifies right wing nuttyness by posing nude in Cosmopolitan), he might turn out to be nothing of the sort (I didn't know much about his background). John Heilemann who authored the New York Magazine article, writes "For all the tea-party atmospherics around the Massachusetts race, there are plenty of indications that Brown is hardly a right-wing loony, and even some signs that he might be - wait for it - an honest-to-goodness northeastern moderate right out of the old school." Considering how wide the political spectrum is (taking into account all types of extreme or non-moderate views), the chances that someone actually elected to political office turns out to be moderate... seems to be reasonably high.

After intellectually digesting that, my mind entered a somewhat theoretical realm and considered how if most elected officials are moderate, we could essentially consider them to be identical (to an extent). In which case, what is the point of elections? I then brought my mind back from the theoretical and considered that, practically speaking, each election does involve a contest between two individuals who are at least somewhat different from each other. I am sure I read/heard the soon to be revealed insight somewhere, so apologies to the person that brought it to my attention, but here is the problem: we criticize societies that either have no option to elect someone or only "one option" to elect someone. Do we really live in such an improved society because we get to pick from two (instead of... one or zero!), when each of the two barely differs from the other?

Monday, March 8, 2010

Endangered Shoes

I recently heard the phrase "endangered species," and after thinking about it, realized that those two words always go together, but rarely is the first word following by anything else. Why is it that it seems like species, referring to animals or presumably plants as well, are the only things to be endangered (by endangered I am assuming it is meant there are too few of them)?

The economic word that reflects the observation of there being too few of anything, is scarcity. The way that we typically deal with the quantity of most goods in the marketplace like shoes or services in the marketplace like massages, is to have a market determined price and quantity. If and when shoes were to become scarce, the price would rise significantly and shoe manufacturers would have an added incentive to produce more shoes. We don't need an agency to make this happen. We do however need shoes to be an exchangeable commodity with a price.

Animals and plants that are considered endangered, on the other hand, are not treated like normal goods and services. The purported methodology for dealing with this problem is entirely different. Wikipedia tells us the following:
"Another way to help preserve endangered species is to create a new professional society dedicated to ecological ethics... One final way in which one can conserve endangered species is through federal agency investments and protection enacted by the federal government."
Could you imagine having an ethics course explaining why we need to have a sufficient quantity of shoes in the economy? Or what about having a federal agency invest and protect the quantity of shoes? These ideas are preposterous because we recognize that the best way to have any object remain in society is to make it privately owned, put a price on it, and let it trade in the market. The above-quoted solutions are no more viable for animals than they are for anything else.

Now that we know endangered species should be treated like any other good or service, the next question is how to make it happen. There is something specific to endangered species that requires one more step in the analysis. Where are the endangered species located? Since the endangered species are likely to be located in the wild, that is, land either vaguely owned publicly or specifically owned by the government, it isn't enough to just say "privatize the species" when their area of habitation is entirely unprivatized. In fact, that these species are living on public land and disappearing should be no surprise in the first place; that is what we would expect to happen.

If we value endangered species enough, we should not only encourage them to be traded like any other good or service, but we should also privatize all the land upon which they might currently reside. The best way, after all, to get an individual to maintain and protect an animal so that it (and its progeny) never disappears from the earth, is to have him know that it is his animal, on his land, and worth a lot of money. In contrast, what would you expect to happen if an animal is scarce and located on land that nobody owns?

Saturday, March 6, 2010

Illogical Derivatives

Ever since the financial crisis began in 2007, we have heard just about every component of the economy targeted at least once by someone as the cause of our problems. Most of those targeted components however, hardly ever include the right one, but among them is often found these "very scary" insurance-like contracts known as credit-default swaps. The most recent example of public sentiment towards this specific derivative is found in German Chancellor Angela Merkel, who said, "Credit-default swaps, where you insure your neighbor’s house just to destroy it and make money from it, that’s exactly what we have to curb."

It is probably helpful to continue using Chancellor Merkel's "neighbor's house" metaphor, in order to prove her sentiment is without merit. A credit-default swap is a type of derivative that, as she says, is a form of insurance, just like any other. Where Chancellor Merkel goes astray is in making the statement that first you bought the derivative, and then you burned your neighbor's house down. This is in stark contrast to the more reasonable scenario of first knowing that maybe your neighbors play with fire all day and then thinking it wise to buy insurance on their house. What is the equivalent of Merkel's event causation (first buy insurance, then force disaster) when it comes to Greece? Many institutions did indeed purchase insurance against Greece defaulting on its debt, but how did those same institutions also make Greece potentially default on its debt? Do banks and speculators now determine the level of government spending and tax policy in Greece?

The missing element here is by what process does Greece's level of indebtedness get determined. As revolutionary as it might sound, the answer is straightforward. It is not an institution like a bank, whose assets might be in Greece and whose concerns therefore might include Greece's level of indebtedness, that determines how indebted Greece is; rather, it is the Greek government, which controls Greek fiscal policy, that controls the level of Greek indebtedness. Rest assured, if Greece's fiscal situation were not as bad as it is, nobody would be interested in buying these derivatives on Greek debt. Similarly, if you live in an area extremely prone to flooding, you are not making yourself more likely to get hit with a flood by buying lots of flood insurance. The level of flooding is determined by something else called the weather. And if a place is not very prone to flooding, rest assured there won't be many people buying flood insurance on their homes.

The Greek government's fiscal irresponsibility is responsible for Greece's debt problem, not the institutions who were concerned about what they saw happening and who were acting accordingly to protect themselves against it.

Wednesday, March 3, 2010

Truth-in-Prosecution Law

I found out today that New York City has something called a "Truth-In-Pricing Law" (scroll to the middle of the page after clicking the link). The law is described as follows:
Truth-In-Pricing Law
Businesses are free to charge what they like, and consumers are free to look elsewhere for a better price. When businesses give false information about an item, consumers get burned. That’s why the truth-in-pricing law requires that price displays provide adequate information to the consumer. Violators will be fined.
Upon reading the first sentence in the explanation, I was delighted to see just how well lawmakers have the potential to understand the workings of the free market. In a free market, all association and transactions are done on a voluntary basis. Someone might be mean, but you don't have to interact with him. Someone might try to rip you off, but you don't have to buy what he is selling. When individuals engage each other on a voluntary basis, everyone is better off because each person is allowed to make decisions he deems best (not necessarily the "right" decision, but the decision made is always the person's best available option determined however he chooses to determine it). When interactions take place under force, someone is always worse off at the expense of someone else (the one who is forced is worse off at the expense of the one doing the forcing).

I then read the second sentence of the law and became puzzled because I thought I understood what the first sentence said (the two sentences contradict each other). Isn't giving false information about an item potentially (but most likely rarely) part of the bargaining process between two individuals, and therefore should be left up to the two individuals to decide? Isn't it true that if a seller engages in giving false information to customers long enough, word will spread about his lies and he will lose business? Doesn't it therefore mean that when businesses give false information about an item, businesses too get burned? Why do we assume that a lawmaker, or the government agency enforcing this law, will be more adept than a customer at determining what is and is not false information? Isn't it at least remotely possible that this law could be used to prosecute more harshly some businesses that are specifically targeted by the enforcement agency, while ignoring other businesses, for any number of reasons (friendships, connections, bribes, etc)? Why is the government agency presumed to act better than the business?

This law is just one of many examples of legislation that is useless at best and dangerously tyrannical at worst. Look at it this way: do you think you should be more concerned about a business lying to you knowing the business would probably like to maintain a good reputation (otherwise it loses customers), or do you think you should be more concerned about individuals at a government agency promising to protect your interactions when those government agents are not necessarily likely to be any different from a lying business-owner but have the force of law behind them unlike the business-owner? Laws passed by the government are not necessarily good just because the government passes them, and individuals who enforce government laws are not necessarily brilliant or selfless just because they work for the government.

Monday, March 1, 2010

Enforcing Contracts Without a Contract

After giving this post the title that I did, I realized it made it seem like the post would be more interesting than it probably is. So if you expected a fancy expose about how the laws of economics could make contract-like outcomes take place without any actual contracts... you won't find it here.

What I actually wanted to post on is the idea that one of the basic purposes of the government through the Constitution is to enforce contracts. The assumption is that without contract enforcement we would not have functioning markets and society would be worse off than with contract enforcement.

So here is my question: for all the talk of contracts being vital and the basis of society's cohesive glue, has anyone alive today signed the contract known as the U.S. Constitution?