Eikonoklastes by Michael Hartl: Category Economics

Please gouge me

Michael Hartl — Sat, 01 Sep 2007 12:54:00 -0700

I recently moved into a new apartment in Los Angeles, and like many apartments in the area it doesn’t have air conditioning. Because it’s nicely shaded, I was hopeful that I might be able to get by without A/C, and indeed the apartment is habitable well into the 80s. Unfortunately, the current heat wave (the daytime high today is 95°) has burst my bubble of optimism, and I’m now in the market for a portable air-conditioning unit. Today I went looking for one, and, predictably, all the area stores are sold out. The reason is that they refuse to engage in price gouging, and that really sucks.

The vilification of price gouging comes from a more general misunderstanding of price. People seem to think that either buyers or sellers set prices, though which one depends on the circumstances and their political leanings. Evil corporations such as Wal-Mart lose either way, since in the popular imagination they set both the price of the labor they buy and the price of the merchandise they sell. Of course, what they really set is either the bid price (the price they’re willing to pay) or the offer price (the price they’re willing to be paid); whether the transaction goes through depends entirely on whether there is a seller or buyer willing to meet the price.

Ultimately, price is set not by buyers or sellers acting in isolation, but rather by the interactions between buyers and sellers. This mechanism operates at a higher level of abstraction than individual agents, which evidently makes it much more difficult to understand, and makes the consequences more difficult to accept. Consider: Wal-Mart doesn’t set the price of labor, and hence can’t be blamed for the low wages of its employees. (Chew on that one, and try not to choke.)

In the case of price gouging, people’s intuition tells him that there is such a thing as a “fair” price, and anything greatly in excess of that price constitutes gouging. But price is a real thing, and you can’t hide from it. Charge more than the real price and you’ll end up with a surplus; charge less, and you’ll end up with a shortage. Evidently, the local stores are charging too little, because they’ve run out of air conditioners. The reason this sucks for me is because I am willing to pay more than most other people. In other words, I want to be gouged.

Setting the wrong price also leads to a misallocation of resources. This sort of misallocation is particularly severe in exactly the situations most likely to spawn accusations of price gouging, namely, emergencies. People may decry high water prices in the aftermath of a hurricane, but such prices create a critical financial incentive to use potable water only for drinking, rather than for less important uses such as cooking, cleaning, or bathing. (Of course, high prices also give an incentive to get more water there, and fast.) In my case, I want a cool room so that I can better get work done, but I’m sure some people who did manage to acquire air conditioners just want to sit around and watch TV, which seems to me a less important use—and I’m willing to put my money where my mouth is.

There remains an interesting question: why don’t Costco, Home Depot, and the other stores I visited engage in price gouging? I’m not sure what the answer is. Perhaps it’s just too much trouble to change prices dynamically based on demand, but it’s more likely that they fear alienating their customers, who might be offended by price gouging, or maybe they fear government regulation, since politicians are elected by voters who might be offended by price gouging. In either case, it looks as if I may be the victim of economic ignorance. Please, somebody gouge me!

Damn, it’s hot in here.

Speculators and peak oil

Michael Hartl — Mon, 10 Jul 2006 10:30:00 -0700

In my previous post on oil depletion, I claimed that markets are well-equipped to deal with the problem of peak oil. A common objection to this—typically made by those who favor a government solution to the problem—is that markets are not good at long-range thinking. Indeed, this is a common objection to markets in general. The argument with respect to oil goes like this: oil prices might rise as oil becomes scarce, but what if it doesn’t rise fast enough to cause solutions to be invented in time? Since we can see right now that it’s going to be a problem, we can use the government to institute a “Manhattan project” to come up with an appropriate alternative energy source. The central claim, in other words, is that government has better foresight than markets. The secondary claim is that government is better-equipped than markets to discover the solution. Let us examine these claims in turn.

Perhaps out of confusion with Wall Street’s reputation for focusing on short-term earnings, many people are unaware of how good markets are at long-range thinking. I’ll use oil as a concrete example, but the general idea should be clear. The mechanism is simple: if oil is running out, then it will be more valuable in the future. This means that if you buy oil now you can make a profit by holding the oil until its price rises. Of course, the future price is not the only relevant variable; it also matters how long until the price is reached, since money has time value. The higher the future price relative to the current price, the farther in advance it makes sense to buy oil and put in storage (or, more plausibly, simply leave it in the ground). Now comes the key: if many people buy oil in anticipation of its higher future price, this will increase its current price by restricting the current supply available. In other words, the current price is a reflection of its future scarcity. It’s through the price system that markets are able to anticipate the state of the world even in the far future. If there is an approaching apocalypse, it is already reflected in current prices.

The price system only functions if those who anticipate future scarcity are allowed to act on their beliefs; such people are called “speculators”. Unfortunately, those who underestimate the ability of the price system to anticipate future events are among the most likely to decry those who would buy oil in hope of future profits, maligning speculators as “hoarders”. Somehow, people’s intuition tells them that buying oil when it’s plentiful and then selling it when it’s scarce is morally suspect; after all, nobody likes a “price gouger”. And yet, as argued above, speculators perform a vital service; if you think about it, what they’re really doing is transporting oil from a place where it’s not needed to a place where it is. That these “places” are actually at different times is irrelevant. That their motive is (at least partially) profit is also irrelevant; as Adam Smith noted more than 200 years ago, as much as the baker might enjoy his work, it is not due to his better nature that we expect him to rise every morning to bake us bread.

Let’s consider now the preferred solution of many peak oil worrywarts: massive government action, sometimes called a “Manhattan project for alternative energy”. The analogy with the Manhattan project is utterly misleading, since not only did the quest for an atomic bomb require the utmost secrecy, but the drive to develop nuclear weapons was not motivated by a market need. For an energy Manhattan project, even the best possible scenario involves government-appointed “experts” allocating huge amounts of resources for alternative energy projects, with no real guide as to which sources of energy are the most promising—or, at least, no real penalty for guessing wrong.

The Manhattan project analogy is also based on the dubious expectation that the “answer” for our energy needs involves a single technology, or at most a few. And even if the experts were spectacularly lucky in identifying the right technology, the government has the wrong incentives for implementing it. With such a huge amount of money sloshing around, we could surely expect there to be massive political influence. It is depressingly likely that the most “promising” sources of energy would happen to involve large projects built in the districts of powerful congressman and in the states of powerful senators.

Markets, on the other hand, are more flexible, able to consider many different possible solutions in a massively parallel fashion. The penalty for guessing wrong is losing your investment or losing your business. If there is a single “solution”, the profits to be had from finding it would be enormous, so there is every reason to expect that the market would find it. If, as is more likely, there are many overlapping answers, involving reduced energy use and a spectrum of new energy sources, the market is well-equipped to find those as well. Indeed, saying “the market is the answer” is really simply an admission of ignorance—an admission that we don’t know the answer, or that there may not even be a single answer.

The solution to peak oil is simple: let the price system—with its heroic if greedy speculators—work its magic.

The WSVP

Michael Hartl — Sun, 18 Jun 2006 22:32:00 -0700

Public education is bad. This problem has been around for years, and people have complained about it for years, but nobody ever seems to do anything about it. (Sounds kind of like the post office, doesn’t it?) I’d like to mention here a proposal which is not original, but bears repeating. Let’s implement the world’s simplest voucher program: calculate the per capita expenditure in each public school, and instead of giving that money to the school, give an educational voucher in exactly the same amount to the parents of the students.

The most common argument against vouchers is that they “drain resources from the public school system”. Obviously, the WSVP is immune to this argument, since any “drain” is a direct result of parents making choices on behalf of their children. If parents are satisfied with the public education system as it currently stands, nothing would change, since they would simply send their children to the school they currently attend. Given the widespread dissatisfaction with public schools, it is more likely that many parents would choose to send their kids to alternative schools—in which case you might as well argue that Toyota drivers drain resources from Ford.

The WSVP is also immune to populist arguments that the public school system is necessary to provide opportunity to poor people through a redistribution of wealth. By construction, the world’s simplest voucher program is exactly as redistributive as the current public school system.

Why has no school district implemented the WSVP? I think it is a combination of an almost religious devotion to public education combined with incredibly effective teachers unions.

First, for some reason to be counted as a “supporter of public education” is an unmitigated virtue in America—but this conflates education with public education. It’s as if the government ran the grocery stores, and anyone opposed to public grocery stores were branded as being against food.

Second, the teachers unions exert enormous control over the political process, especially through their influence on the Democratic Party. The world’s simplest voucher program would expose teachers to competition from which they have been insulated for decades. The best teachers have nothing to fear, of course, but most teachers are not particularly good. And so they have consistently and successfully blocked any serious attempt to break their monopoly on education.

The time for the WSVP has come. Won’t you join me in supporting it?

How much worse it can get

Michael Hartl — Fri, 02 Jun 2006 13:42:00 -0700

There are many things that frustrate and disappoint me about the United States (and Western society in general), but every once in a while something comes along that reminds me to be grateful for everything that is right. The article below appears only in the subscriber’s area of The Economist, but I think it’s too important not to post. It’s a blatant copyright violation; so sue me.

Inside the mad despot’s realm

May 25th 2006 | ASHGABAT AND MARY
From The Economist print edition

A rare visit to one of the world’s most secretive and repressive countries

THERE is not much to laugh about on state television in Turkmenistan. But viewers may be forgiven for feeling a little quiet satisfaction at the spectacle, late last month, of Gurbanbibi Atajanova, the former chief state prosecutor otherwise known as the iron lady, tearfully begging not to be sent to prison after being accused of possessing 25 houses, 36 cars and 2,000 head of cattle. Ms Atajanova led the purges that, in recent years, systematically removed anyone who tried to challenge, or simply to rein in, President Saparmurat Niyazov, the self-styled Turkmenbashi, or “father of Turkmen”.

Not, of course, mentioned by state television was the fact that, on the very same day, Mr Niyazov was himself under attack. A London-based human-rights organisation, Global Witness, was accusing him of siphoning off most of the country’s estimated $2 billion a year in gas revenues and concealing them in offshore accounts. One of these contains $4 billion, alleges one well-informed insider.

Such topics cannot be discussed in Turkmenistan. Any criticism or dissent is defined as treason and is punishable by long prison terms, confinement to psychiatric hospital or internal banishment, mostly to arid salt flats by the Caspian Sea. Private conversations everywhere are monitored by eavesdropping informers, as well as bugs and phone-taps. E-mails are monitored (there is only one service-provider) and internet access rare: a trawl of the capital reveals not one functioning public outlet. Surveillance, already tight, has been ratcheted up after a failed coup attempt in 2002.

Yet there is much that needs to be discussed. Ashgabat, the capital, is a surreal showpiece of grandiose, neo-Stalinist buildings of gleaming white marble, with giant portraits and gold statues of the Turkmenbashi everywhere—including one, arms aloft, that constantly revolves through 360 degrees, so that it always faces the sun. Behind the glitz lies a grim reality; rutted tracks leading from four-lane highways to windowless, one-room homes, including converted railway containers, surrounded by debris and animals. Some of these are inhabited by those whose homes—and entire neighbourhoods—were razed to make way for “renovation” and offered no compensation. In one, a middle-aged woman struggles to bring up her nephew (her sister, a heroin addict like many in Turkmenistan, is too ill). But Olga has lost her job under new laws because she is of Armenian and Ukrainian descent.

Such are the priorities of a regime that squanders money on prestige projects of dubious benefit, including an ice-rink, a huge half-finished artificial lake, vast mosques, gold-domed palaces and soon a new zoo, complete with penguins, in a country where the summer temperature tops 50°C. At the same time, public health and education—the only worthwhile legacies of the Soviet Union, from which Turkmenistan became independent in 1991—have been all but dismantled.

This year’s outlook is even grimmer than last’s. In January, 100,000 people had their pensions cancelled, those of another 250,000 were severely cut back, and sickness and maternity benefits were ended. Unusually, the decrees led to protests, including demonstrations in the port town of Turkmenbashi, while a Niyazov statue in the city of Mary (once known as Merv) had its arm sawn off and a bucket of human faeces thrown over it.

Then, in April, Mr Niyazov announced a further “reform” to the already crippled health service, adding new charges that will make its few remaining services yet more inaccessible. Most hospitals outside the capital have closed and the remainder offer only rudimentary care, lacking staff, equipment and medicines, condemning thousands to death from common, treatable illnesses such as tuberculosis.

And education is even worse

Every Monday at 8am, Turkmenistan’s schoolchildren line up to recite the oath of allegiance to the president, part of a youth-indoctrination programme that is progressively replacing the conventional curriculum. Its core is the two-volume Ruhnama, “The Book of the Spirit”, a homespun collection of thoughts on Turkmen history and culture that pupils are required to spend hours studying. Visits to bookstores reveal shelves lined with nothing but the president’s works. Meanwhile, mandatory education has been reduced from ten years to nine and most rural kindergartens have closed, as have all libraries outside the capital. Russian-language teaching has been largely phased out, music and ballet schools closed and almost all teachers of ethnic-minority origins sacked under rigorously enforced “Turkmenisation” policies that demand racial purity, traceable back three generations, for all workers in state institutions, including hospitals.

Higher education is severely run down. The annual intake is now under 3,000, a tenth of the pre-independence figure, courses have been cut to two years and standards are so poor they are unacceptable abroad. Worse, the president has ordered that no foreign degrees will henceforth be recognised. Anyone with a qualification gained abroad is either being sacked or refused a job. One economist says that all but two of her high-school class of 30 have emigrated because they see no future at home. “You have students returning with degrees from the world’s best universities—MBAs from Stanford, for instance—who can’t get jobs,” she says. “We are the last educated generation,” sighs another professor.

In rural areas, the problems are different. Cotton is the main crop, but the past three harvests have been catastrophic because of a requirement to sell at state-set prices so low that farmers are left with annual incomes of around $100. Unemployment is estimated at over 70%, exacerbated by public-sector layoffs, and by laws restricting job-seekers to their home towns. Such is the pressure to obtain work that bribes are standard. Even the scarf-swathed army of women sweeping Ashgabat’s streets with twig brooms have to pay officials, Turkmen say.

Despite widespread unhappiness with the regime, most Turkmen do not see a way out. Rebellion looks impossible, given the level of repression and fear; and state benefits (free gas and electricity and highly subsidised fuel, since plentiful gas and oil are Turkmenistan’s only blessing) take some of the edge off discontent. Besides, people are brainwashed by a relentless propaganda machine orchestrated by four state-television channels, two radio stations and several newspapers propounding the idea of a “golden age”. Exiled opposition groups have little influence, and pressure from the outside, given Turkmenistan’s large mineral reserves, is shamefully muted.

There is, though, much speculation about the 66-year-old Turkmenbashi’s health. He has had heart surgery, and has a team of eight top-notch German doctors constantly on call. This raises other problems, most obviously the lack of a mechanism for an orderly transfer of power, coupled with the lack of any democratic tradition in a conservative, tribal society. Pessimistic Turkmen fear that a lost generation, uneducated beyond the Ruhnama, may fall prey to Islamic radicalism—and create a nasty failed state that could destabilise an already volatile region. A fine mess for a father to leave to his children.

Open borders

Michael Hartl — Wed, 31 May 2006 21:29:00 -0700

My friend Sumit mentioned some problems with open borders unrelated to economic issues. He raises good points; there are significant challenges associated with assimilating immigrants. Will they learn English? Will they overwhelm native culture? Will they believe in the essentials of America’s Constitutional republic?

I suspect that immigrants are still a net win, but I agree with Sumit that 100m new Americans could have negative effects. In any case, the core point of my previous post remains: the pseudo-economic arguments against immigration are bogus. And even if we don’t open the borders, it is clear to me that the US can and should welcome many more immigrants—both skilled and unskilled—to the land of opportunity.