Category: Economics

Tami and I were talking about various things Yemen, and we drifted onto the topic of economics. I, of course, had several opinions to offer on the subject:-) I mentioned my two fantasies about this place, that someone would admit that even if the state of Israel had never been formed, this place would still be a mess, and the related point that it is the Yemenis that have screwed this place up and that they are the ones that will have to fix it. I doubt I’ll hear those things…

We continued talking and I brought up the example of Estonia and how well they are doing. It’s one of my favorite stories. After they were separated from the Soviet Union, they were a mess and dirt poor. The leader (whose name escapes me at the time) knew he had to do something, so he started reading. Fortuitously, he read Milton Freidman’s “Capitalism and Freedom,” thought that it made a lot of sense, and started to implement the polices that Milton outlined. His advisors told him that no one does these things, certainly not unilaterally, but the leader was too politically naive to understand why some people (and interest groups) would be against these policies. The end result has been a dramatic improvement in Estonia’s economic status. It is now called the Baltic tiger…

Tami recoiled a bit at the mention of Milton, and I asked her why. “I dunno, it just sounds like anarchy to me…” That seems to be a pretty common perception of him and I’m not too sure where it comes from. Early on in his career, when asked what was needed for strong growth in a country he responded, “Free trade, sound monetary policy, and freedom.” Late in his life, when asked the same question he replied, “Rule of law, rule of law, rule of law.” Milton was a strong proponent of a functioning government. It was needed to secure the rights of the citizens. This is a basic libertarian principle, but many people seem to ignore or forget it. There is a big difference between libertarians and anarchists.

If nothing else, we should all give thanks to Milton Freidman for setting down what sound monetary policy is. His analysis of the great depression showed how critical the Federal Reserve is in avoiding, or at least minimizing, depressions and fighting inflation. Thanks to his economic insights, we have not had another massive depression. Odds are that we will never have another as long as his monetary policies are followed. Regardless of your political leanings, you have to like that…

The latest issue of the Yemen Observer has an article that amounts to little more than the paper mocking the government. The headline reads, “Crisis? What crisis? Government still thinks gas situation stable.” The article describes how prices of propane gas tanks, which are used all over the country for cooking among other things, have risen dramatically over the last 5 or 6 months. Prices are hitting 1000 riyals (as opposed to the 500-600 from 6 months ago) and people are waiting in long lines to get the tanks. The vendors blame the government (which provides the gas) and the government is blaming the distributers. The paper seems to be happy assuming that either the incompetent government or greedy distributers are to blame, but doesn’t bother to look into the matter at all.

The article is rather maddening because important details are missing. Are people standing in lines for tanks at 1000 riyals? Or are people avoiding the lines by paying 1000 riyals? The government claims that its price to the vendors has not changed, it is still 400 riyals. So this leads to some interesting conclusions. If people are waiting in line, that means that the gas in under-priced. Surely the combination of prices that are “too high” and waiting in line do not seem to jibe. Queuing is a classic example of underpricing, see the cap on gas prices in the US during the 1970’s as an example. If you want to get rid of the lines, you need to raise the price of the gas. How much do you need to raise it? Just enough so that people do not think that it is worth standing in line for. The only reason to stand in line is if you think that it’s a great deal or you (along with several thousand of your friends) want to consume a lot of it due to the low price. If it is no longer a bargain, or if it is high enough that you cut back on your use, *POOF* no more lines. I have a feeling that the going rate is well below 1000 riyals but that some people are willing to pay that price in order to avoid standing in line. The upside to all of this is that I haven’t heard the annoying CLANG CLANG CLANG of the gas sellers walking through the streets. They bang the tanks with a wrench to announce their presence. I guess that people are now willing to go to them instead of them delivering at a higher price.

And I don’t want to hear any, “But people HAVE to have it, they are forced to pay the higher price so they can cook!” bullshit. Charcoal is cheap. Yes, it is a bigger pain to use, and that is why people prefer using gas, but it is an option. If you can’t afford 1000 riyals for gas (and many people can’t), 50 riyals for a bag of charcoal sounds pretty good. Grills are pretty low tech to make, I really don’t think that it’s beyond anyone to make one…

So do we blame the government or the distributers? It’s possible that the distributers are deliberately keeping supplies low thus forcing up the price. Unless there are only a few distributers, and it’s a distinct possibility, I doubt that they are doing that. It would just be too difficult to organize all of them and keep the price up. Left to their own devices, someone would start discounting to get more business and others would have to follow suit. If there are only a few distributers, the solution is to open up the market and let competition take over. It wouldn’t surprise me if the government has only “allowed,” ( i.e. given) contracts to some cronies of some important bureaucrat. These licenses to make money are very common in these sorts of governments. In any case, I haven’t heard of a glut of propane that is not being bought by suppliers, so I doubt that this is happening in any case.

The important thing to keep in mind is that even with the higher prices, no one is having trouble selling propane. It sounds like that the distributers are trying to sell gas at the going rate. Perhaps they are feeling the heat of consumers’ ire and that is preventing them from charging the actual market clearing price, hence the lines due to the lower price. That rate is determined by the demand of consumers and the supply. The government claims that the supplies have not changed, so that implies that the demand has. That, combined with the falling value of the dollar/riyal might just be all the explanation that is necessary. To misquote another blogger I read a while back, high gas prices are not a crisis, no gas is. If you try to sell gas at below the going rate, you will face long lines and shortages. it is much better to simply raise the price than it is to try to “force” a market to do your bidding. Let people make up their own minds about what to do with the price and let the producers and distributers try to maximize their profits. Usually, I’d say that the government being the supplier would really mess things up, and it might, but the Yemeni government is pretty good at sniffing out revenue streams. While not as good as a for profit company, they’ll approximate one due to the corruption involved and the dire state of the government’s coffers….

I just listened to the latest podcast from econtalk and it was pretty good. Arnold Kling talks about what is driving the costs in healthcare. By his reckoning, it is primarily due to many more procedures being available these days and because we are very insulated from the actual costs out of pocket, we use too many of them. He talks about various procedures being more cost effective than others and the fact that we have very little incentive to separate the high benefit procedures from the low benefit ones. He, along with many other economists, see the current problem with our health system as being an incentive problem as opposed to a healthcare one. Going to a single payer system would magnify the incentive problem and bureaucrats would make decisions on what procedures to offer in order to keep the costs under control. Kling offers a different alternative, make people bear more of their actual medical bills. In 1960, people paid .50 out of pocket for every dollar they spent on healthcare. Today it is down to about .15 out of every dollar. Doing this would eventually result in lower costs, higher wages, and possibly make more people take care of themselves. Give it a listen, it’s an interesting piece.

The results are coming in and oil companies are posting lower profits this year than last year. Oil is at an all time high, so how can they have lower profits? it’s pretty simple, oil companies are subject to economic forces. It turns out that supply and demand still hold true, who would have thunk it? The conventional wisdom is that people will pay “anything” for gasoline, so any increase in oil prices are passed along to the consumers in full. If it costs an extra 85 cents per gallon to manufacture the gasoline, they’ll just tack it on the price at the pump and people will buy it. The obvious question is if people would have bought the gasoline for an extra 85 cents a gallon, why didn’t those “greedy” oil companies do it before the costs went up?

Here’s the scoop, gasoline, like any other product, is priced at the highest price it can be and still be sold in the quantities that the company needs. What that price is is determined by the combination of consumer demand and how much product the company has to sell. That’s it, the cost of manufacturing is only tangentially related to the quantity that the company has to sell, but the customers really don’t care what it costs to manufacture. The higher oil prices are cutting into the companies profits because they cannot arbitrarily raise the price to cover expenses (or for any other reason). They have to offer the gasoline at the price that consumers are willing to pay if they want to sell it. So the difference is taken out of the profits in order to keep the price where it needs to be.

The punchline here is that gasoline is just like any other product, as prices go up, people buy less of it. The oil companies can’t get around this, so when faced with rising costs, their profit goes down. They are not magic money making machines, they have to offer a product at the prices that people want in order to make money. Things have been good for them in the recent past, not so good in the more distant past (1980’s-1990’s) and now things are starting to get back to where gasoline is the lower profit margin item that it was before. I’ve written about the demand side of the equation here, one of these days I will put up a simplified version of the supply side of things…

Tami and I were talking the other night and she happened to mention how she makes sure to go to Citgo gas stations when she’s at home. Citgo gets it’s oil from Venezuela either mostly or totally. I cringed visibly and expressed my hatred for Chavez and his policies. I really do believe that Chavez is going to run that country into the ground and cost millions of people their lives or at least the chance to climb out of poverty. She had a response that was very straightforward, logical, and surprisingly I had never thought of it before. “So it’s better to give money to the Saudis?” Hmmm, now that’s an ugly choice, a Marxist dictator or an autocratic monarchy. Come to think about it, none of the major suppliers of oil are exactly upstanding places. Venezuela, KSA, Iran, Nigeria, Iraq, Russia, etc.

If there were a way to pick where you were going to get your oil from, and there’s only one place, Citgo, that allows you to do that, I’d have to go in the following order. From best to worst I’d say it’s Iraq, Russia, Nigeria/Venezuela, Iran, and then KSA bringing up the rear. I still think that Chavez is awful, and dangerous, but he’s not as evil as some of the other options I suppose. Talk about a complex decision strategy, do you shoot for the middle evil in order to exclude the worst, or do you take your chances of funding the worst in order to have a chance of funding the better options? I think I’d have a tough time choosing a Citgo on purpose, but I wouldn’t feel as bad about it now if I had no choice.

I’m pretty much an optimist when it comes to long term economic outlooks for the US. I assume that we will do what we need to do to be competitive in the world wide market. With any luck that will involve some things like implementing a flat tax, reducing the corporate tax, and going to a private social security plan. Yeah, I know, but I’m thinking really long term:-) Many countries have done these things, or are about to, especially eastern European countries.

In any case, Im pretty confidant that we will do what we need to in order to “Keep up with the Joneses.” I do have some worries though. No, it’s not about income disparity or environmental issues, it’s about monetary policy. There has not been a world wide monetary standard in a long time. All countries used to be on the gold standard, but I don’t think that there are any that do that now. It used to be that every denomination of currency was backed by a certain amount of gold (or silver). This means that the government could only print or circulate as much currency as it had in reserves. Today, we have what is called “Fiat” money, the government could print as much of it as it likes. The value of the currency is determined by simple(!) supply and demand. The more money the Fed puts into the system, the less any particular bill will be worth. The opposite is also true. The nice thing about the gold standard is that it restricted what the government could do with monetary policy. They couldn’t intentionally deflate the currency or even just screw it up. By having the currency backed by something, it limited the government’s impact and allowed the actual economy to do its thing.

Why does this matter? Since the entire world is using fiat money, it isn’t out of the realm of possibility to have a world wide currency crisis. If America’s dollar value really melts down, they are going to take a bunch of other countries with them. Many other countries have either pegged their currency to the dollar (like Yemen) or have just started to use US dollars as the local currency. Additionally, if the US dollar tanks, and I mean really tanks, we would no longer be able to afford the products from China or Europe. So their economies would feel it as well… We gotta hope that the Fed keeps their head and doesn’t allow that to happen…

There are a handful of practical issues with going back to the gold standard, not least of which is that the government doesn’t want to give up any control. Milton Freidman had some alternative ideas about stabilizing the currency. He suggested 100% reserve banking and an automatic, rules based mechanism (as opposed to using the discretion of the Federal Reserve) as possible remedies. I’m not really sure how they work, but he was pretty bright when it comes to things like this. In any case, I would eventually like to see some sort of stabilizing mechanism introduced. The recent weakness of the dollar brought this to my mind, I can only hope that our “leaders” get their financial act together before I really have to start worrying about monetary issues…

I just finished listening to the audiobook version of Mark Skousen’s “The Making of Modern Economics.” It was a good overview of the history of economic thought starting just a little before Adam Smith up to the late 90’s. This time period captures all of the really big events, “The Wealth of Nations,” Marxism, the marginal revolution, Keyensism, the Austrian school sorting things out (as usual), and culminating with Milton Freidman’s Moneterist revolution and getting back to Adam Smith’s ideas of freedom being the basis of economic prosperity.

The book has as it’s main theme the idea that Adam Smith got it basically right and throughout the years people have either added more understanding to his basic model (Mises, Hayek) or have taken us down what looked like a promising path but ended in failure (Marx, Keyenes). I think that this is basically right and history certainly seems to back that up. I knew quite a bit about a lot of the bigger names but this book filled in some of my gaps when it came to people like Shumpater, William Bates Clark, and Malthus.

For the non-economic minded among you (what?), I’ll give the you the punch line. If we hadn’t listened to Malthus (there is a limited amount of resources and we’re all doomed), and if the marginal revolution had come about a litte earlier, we could have saved millions of people. Marx had a lot to do with it, but his fatal flaw from a theory point of view was his labor theory of value (I’m ignoring the equally powerful, but much more involved Hayekian critique of central planning). Marx (among others at the time) thought that the value of any given thing could be found based on the cost of the labor that went into it. His whole theory sprang out from that. It wasn’t until the marginal utility theory came around to explain subjective value that economists could point out the problems with socialism in general and marxism in particular. But it was too late, Marxist ideas had taken hold and millions upon millions of people paid for it.

Marx is an obvious wrong turn in history, but Keynes may be more pernicious. Keynes was the economist that popularized the notion of government interference being the only way to get out of depressions. He assumed that capitalism was inherently unstable and used the great depression as evidence. His solutions flew in the face of traditional (classical) Adam Smith inspired economics. Deficit spending, massive government projects, and a hatred of saving were the outcomes of his theories. Keynes’ ideas took hold and basically ruled the roost for the next 40 years.

When you listen to Keynes, you end up with England in the 1970’s. High unemployment, low to no growth, and government debt spiraling out of control. Maggie Thatcher (with some help from Hayek) cleaned that place up… It wasn’t until Milton Freidman’s ideas came into popularity did things start to come around. He proved that the great depression was caused by incompetent monetary policy, not any inherent instability of capitalism, and used that as a springboard to dismantle Keynes’ theories.

Government incompetence and/or ignorance is another theme running through not only this book, but history in general. The great depression is a great example. The crash itself may very well have been a bubble popping, but the blame for the depression that followed can only be laid at the feet of the government. Milton Freidman showed that the Fed shrunk the amount of money in the economy by a third, thus plunging the country into depression. The Smoot-Haley tariffs caused an amazing amount of damage, and FDR’s directionless fiddling prolonged it for another 8 years or so. It wasn’t until the war ended did we pull out of it. If they had left well enough alone and not screwed with the money supply, the depression likely wouldn’t have lasted nearly as long…

With Milton Freidman’s contributions we may have seen the last bit of huge economic principles being introduced. There is still plenty of research into the finer points, but the big picture seems to have been pretty well explained. The hell of it is, Adam Smith pretty much did that way back in the 1700’s, it’s a shame that it took us this long to realize it…

Georgia is facing a problem with the current drought. They are running out of water and they don’t seem to be able to come up with a way to fix the problem. This article tells, at length, the problems, the purposed “solutions,” and the various groups involved in the fight. People are blaming the Corp of Engineers, a species of mussels that has some sort of protection, and too much growth in the area. I’ve got a much simpler explanation and a very simple remedy for their problem. Raise the price of water. The reason they are running out of water is that they have not been pricing it properly. There is a finite supply of fresh water, if it is underpriced, people will use too much of it. If you want to limit how much water is being used, if you want people to conserve water, if you want people to fix leaky toilets and water heaters, raise the price. Everyone will pay attention if their water bill doubles or triples, and I guarantee that water use will fall. Pass more “You can only water your lawns twice a week,” laws and I’m sure not much of anything will happen. If the price is allowed to “float,” with the supply of water, you’ll never have to worry about water shortages again.

This is assuming that all people face the same prices. Frequently, businesses like agriculture, gold courses, and others get special (low) prices. Of course they are the largest consumers of water as well… If you are worried about “the poor,” you can figure out a way not to charge them the extra amount. The key is to make sure that the largest percentage of water users feel the price increase. Viola, no more water shortages!

My housemate came back from the internet cafe in a rotten mood. He had been reading the news and it made him really upset. The cost of the wars in Iraq and Afghanistan are swelling to over 2 trillion dollars, and some people estimate that we reached “peak oil” reserves 3 years ago… OK, the wars are a disaster, and I don’t know what else to do but get mad about that, but peak oil? What a crock.

The idea behind peak oil is “OMG, there’s less oil available, we’re screwed!” That’s a summary of the stance, and I think it’s pretty accurate. It’s ridiculous on a couple different levels. We’ll never run out of oil. That’s right we will never run out of oil. There’s a couple of reasons for that. The concept of peak oil was first brought up in the early 1900s. It was observed that there was not enough oil for the then current needs to be met in 10 years time. Well, guess what, more reserves were found. In more recent times, peak oil was again a worry. There wasn’t enough oil to go around in the decades to come! Well then the shale sand up in Canada added another source of oil, and when the price of oil rose above $50 a barrel, Venezuela’s reserves went online. They went from a minor player in the petroleum market to having the largest reserves in the world within the space of 10 years.

So, as prices rise, more and more oil is found. That’s one reason not to worry too much about running out of oil. Another reason is that when “Peak oil” theories are thrown around, they are talking about the “light sweet crude” grade of oil. That is the stuff that has the least amount of junk in it and is the easiest to refine into various useful products. There is an enormous amount of “sour” reserves. That’s oil with more impurities in it. Last I heard, the reserves of these sour grades is almost unimaginable. At some point, it will be economical to use these grades with more refining instead of the light sweet crude.

OK, so reserves keep growing as prices go up. That’ll be fine for the foreseeable future. If additional refining is needed, and nothing interferes, the cost of that refining will be minimized through compitition. There is a finite amount of oil in the ground, and we do use it at a much faster rate than it is created, there’s no getting around that. That part of the peak oil theory is basicly correct, although I think that it’s blown way out of proportion. The part of peak oil that drives me crazy is the tacit belief that we’ll just stand around and watch the oil be used up until it’s all gone. The idea is that we’ll run out of oil and the entire world will grind to a halt. The people that worry about this really don’t understand how markets work. As the price gets higher and higher, new ways will be found to find oil, new ways to conserve oil will be found (thus conserving the existing supply), and substitutes will be found. There are already substitutes available in the form of electricity and alternative fuels. This is why we’ll never run out of oil. At some point it will be so expensive that no one will want to use it. There will be a transition to some other type or types of fuel and oil, like whale oil, will be a historical curiosity.

All of the peak oil gnashing of teeth is really fear of change and a general distrust of people and their ability to adapt and thrive. It’s a really unnecessary and, IMO, obnoxious abject pessimism. Things will change, people will figure out how to use something else. Environmentalists the world over should be cheering the rise in oil prices, it’s the quickest way to have alternative fuels become viable. Where’s Julian Simon when you need him?

tags technorati : economics peak oil julian simon alternative energy