Month: August 2007

That’s the title of the new book by Brian Caplan and it’s making some waves. All of economics is based around the idea that people act rationally, that they act in their own self interest (which often times involves helping other people). Economics shows us what kinds of outcomes you can expect from various policies and it is assumed that people would pick the policy that leads to the best outcomes. The trouble is that the vast majority of people do not choose these policies, they chose the ones that lead to worse outcomes. They expect the politicos they elect to implement the policies they want and so we get a variety of programs that demonstrably hurt people but are very popular. Things like protectionist measures against trade, price controls (anti-gouging laws, minimum wage laws, rent control, etc.), measures to combat automation and outsourcing, and farm subsidies are some of the examples that spring to mind. All of these things hurt the public in general (even if they help certain, small groups) but they enjoy widespread support from the public. Why do people like what can be shown to hurt them?

Caplan postulates 4 biases that people seem to have had for all of history. Some of them may have been beneficial in our ancient past but get in the way today. The 4 biases are:

1) Fear of foreigners
2) Make work
3) Fear of markets
4) Undue pessimism about the economy

The fear of foreigners probably started in our primitive past where new tribes were seen as competitors in the zero sum game of hunting and accumulating women. Back then, it made a lot of sense to be wary of foreigners because the machinery of wealth creation had not come about. Unlike game hunting, wealth creation is not a zero sum game (one person wins only by beating another) so this fear causes us all sorts of problems today. Most of these fears are seen when topics of trade and immigration come up today.

The make work bias shows itself whenever you hear someone judging how the economy is doing by employment figures as opposed to actual production. A common worry today is that America is “losing” because we don’t make as much stuff as before. That’s false of course, America has never been more productive or made more stuff than it does currently. What people really mean is that there are far fewer people employed in the US manufacturing sector. This is a good thing, higher productivity directly relates to wealth creation. Whenever fears of outsourcing or automation come up, it is the make work bias rearing its head. Higher productivity is the source of advancement and continued growth, automation is a great thing.

People in general have an irrational fear of markets. I say irrational because we are surrounded by products and services that are brought to us at varying prices and quality levels by markets, but people refuse to trust them. Farm subsidies are a case in point. They have a fairly widespread base of support not only in rural agricultural areas but in urban ones as well. Most of that is driven by the fear that there wouldn’t be enough food if we left it to the market. There are no shortages of other things that are only market driven, chairs, pencils, computers, concrete, vitamins, etc. As a matter of fact, relatively little food is subsidized and yet we have no shortages of the farm products that are not subsidized (chicken, beef, eggs, fruits and nuts of all kinds, etc.). When economists offer market solutions to things like education, health care, elimination of farm subsidies, etc. they are usually dismissed with the assumption that markets can’t or shouldn’t be involved despite the enormous evidence that they do indeed work. People simply do not believe despite what is in front of them. Part of that is the fallacy that “bad” motives must lead to bad outcomes. Economists make a distinction between self interest and greed, most people do not. Because most people in any given market are driven by a profit motive, the public at large assumes that nothing but bad things can come out of market processes. The facts of the matter are that inevitably, through the magic of competition, the people and firms that succeed are the ones that serve their fellow man the best. Yes, bad things can be done by bad people, but what else is new. Markets, if left to their own devices will provide us with the best services and products at the lowest prices.

There is also an ongoing feeling of pessimism about how the economy is going. This could be understood during times of high inflation and unemployment, but people are pessimistic even now. We have made enormous gains in the last 100 years in every way you can think of. We have better products, longer healthier lives, a cleaner environment, more freedom due to the dramatic drop in the costs of communication and transportation, and even more free time than in 1907. The real kicker is that things are better than they were even 30 years ago, but people don’t acknowledge it despite living with all of the benefits of our ever progressing economy. It goes further than this, whenever something that comes up that could improve our standard of living (outsourcing, freer trade or automation) people point to it as evidence that we are getting worse off! Even if economists didn’t do the research that they do telling us this, it would seem to be obvious that things are indeed (across the country) continually improving. There are some states that are shooting themselves in the foot (Michigan, New York, I’m looking at you) by continuing to use lousy economic policies. If they would simply look at why people are going to other states and start to emulate them, they too could enjoy economic growth and low unemployment…

So why do people cling to these things instead of taking research seriously? A lot of it has to do with clinging to a world view. In just about every other part of life, people either defer to, or at least take seriously the experts in the field. Many, if not most people cling to beliefs that they have no idea if they are true or not. The healthy way of dealing with things you don’t understand is to be agnostic about it, listen to some experts and then do some of your own research. Instead, people tend to blindly believe in awful economic policies. It’s to the point where a person in Mexico may vote against politicians that support freer labor markets, freer trade, and a reduced welfare state and then illegally move to the US to take advantage of the benefits that those things provide. It’s sad to think that most people wouldn’t think twice about that despite the obvious disconnect. Caplan’s book sounds like it does a decent job explaining of why people turn away from things that actually help people and towards the tried and not so true… You can hear (and read) the interview with him here.

Just finished listening to some podcasts from here and I really enjoyed them (as usual). The first one was about outsourcing and trade in general and had some interesting tidbits. One thing I liked was his idea about economies of scale. Instead of talking about the efficiencies of returns to scale due to large purchases of supplies, etc. he posited that the efficiencies come from the continual use of human capital. Economists use the term “human capital” to describe the skills and knowledge that people have and use to produce stuff and services. His idea was that in a production environment capital is used all the time. If I decide to make an amplifier, my human capital involving cameras and Arabic aren’t used. I can only use one skill at a time so anything I decide to make is inherently inefficient. If you get several people (or a lot) together and they specialize, human capital can be used around the clock leading to much greater efficiency. Well, I thought it was interesting…

He also brought up the idea that there are no longer the manufacturing jobs to employ a lot of the immigrants like there used to be. He used the example of the Endicott Johnson shoe factory in Johnson city to discuss his point. I used to wander around the old grounds of the EJ factory in Johnson city a lot back in my college days. Anyway, I don’t think it’s necessarily a problem, but it is interesting to see the difference between today’s immigrants and the ones from years past.

When they started to talk about outsourcing, Russ came up with an interesting way of analyzing things. The usual issue is weather or not the decreased costs are “worth” the loss of jobs stateside. People sometimes have difficulty determining who comes out ahead in these sorts of deals. Imagine some product, like computer software, became totally free. Or imagine that a teleportation device was created. Both of these hypothetical situations would eliminate hundreds of thousands of decent paying jobs. Certainly the people that had those jobs would be worse off, but what about everyone else? It’s pretty clear that everyone in the world would be better off with zero cost software and transportation. The thing that people usually forget is that the money that would no longer be spent on those things would be spent on something else, and that is what drives economic growth long term. The same general idea applies to automation and outsourcing. By making things less expensive (they can never be totally free), the world benefits and money is freed up to be spent on other ideas and services. It’s a great way of putting things into perspective.

On another podcast, they were talking about recycling. It’s interesting to think about the idea between resources and trash. In short, a resource is something that someone will pay you for and trash is something that you have to pay to get rid of. It turns out that aluminum cans are usually a resource and as such are worth recycling, newspaper is a bit of a wash, and glass is a real money loser. What that means is that is actually more expensive (in many cases) to make glass from old bottles than it is to make it from scratch.

Some people might say that it doesn’t matter what it costs, we should reuse and recycle as much as we can, even if it loses money. These people tend to sneer at economists as being short sighted and resource hogs. The shame is that economists are the only ones that take all resources into account, most people that are rabid about recycling think that only the things we get out of the earth are important. Economists take into account time and alternative uses of human capital as resources, things that are frequently ignored by many people. It turns out that if prices are allowed to be set accurately (always easier said than done), it’s easy to find the least resource-intensive product, it is the cheapest one. That’s one more reason to allow prices to rise and fall on their own, it’ll allow us to accurately determine the relative resource use of the products we use.