Tuesday, March 26, 2013

Faith in the Free Market? Part 1

Should we have faith in the free market to deliver our common good?

This is perhaps the greatest economic debate of the past few centuries, and one of the more interesting things to talk about as an economist with non-economists, usually because they aren’t that interested in the nitty-gritty of economic discourse and instead prefer to dialogue about politics.

It is also interesting to me because there are Catholics on both sides of the fence: those who vehemently support the free market and those who vehemently attack it. I’ve already noted how CST approaches the battle between liberalism or capitalism and socialism or collectivism in this multipart series. The case they present both against and for the free market is compelling and good, but there are other ways to prove or disprove its effectiveness in achieving the good for society. This is my purpose for this multi-part series. I wish to explore the arguments used to justify or rebuke the free market and point then toward the conclusions I take from this exploration of which we can engage in a friendly debate.

Two great mistakes in this debate must be noted at the outset. The first is that many treat this as a black and white problem. Those who advocate for the free market tend to argue that any measure against it puts us on the road to serfdom, or on the road to soviet communism which clearly had disastrous consequences for humanity. Those who attack the free market are usually less black and white, but are also guilty of putting the blame on the free market as a whole. There is no gray area, there is no middle option, there are no alternatives to communism or capitalism. Pope Pius XI called these the twin rocks of shipwreck—extreme individualism and extreme collectivism. The great mistake here is failing to see alternatives to these twin wreckers of ships. Rejection of “the free market” does not necessarily mean support for total communism and vice versa. We must be able to envision degrees of free market-ness or collectivism and we must direct them always to our common good.

The other great mistake is (logically) prior to the first mistake. It is failing to recognize that there is no such thing as a truly free market. That is, no market system is completely free from government intervention. Free markets fundamentally require private property and enforceable contracts, which require an enforcer. Absent of government, ‘free’ markets are closer to black markets where the market actors provide their own governance, which is why, for example, illegal drug markets are particularly violent. Absent of government protection of property and contracts, they must enforce it themselves with power, weapons, and violence. So a truly free market system is closer to anarchy, and most free market proponents are well aware of this (some seem to forget it though). However, since the government is involved in protecting property and enforcing contracts they are necessarily involved with defining property and legality of contracts and so their ‘intervention’ into markets is more of a degree than of a kind. They DO intervene, the question is, how much? This lends itself well to the lesson learned from the first mistake—free market-ness is a degree, not a black and white situation.

The danger or trap that is so easy to fall into, is putting your faith in the free market, this institution that is supposed to bring about our overall good out of the self-interested actions of individuals. We put our faith and our trust in a direction-less institution that does not see persons and does not consider their good. If we are to rely on a higher degree of free market-ness to provide the common good, then we should do so with good reasoning, but we should not expect our selfish actions to result collectively in the common good. To me, nothing could be more anti-Christian. Christ’s teaching is all about the two commandments upon which all the rest sit: Love your God, who is love itself, and love your neighbor as you love yourself. Love is an authentic gift of self, not a devotion entirely to one’s self-interests.

(There are those who argue self-interest does not necessarily equal selfishness. This of itself requires a long response, but quickly, my reply is: why risk confusing the two? Those who do not properly understand the distinction will think it’s valid to act selfishly when you argue for self-interested action. And why put the emphasis on negative freedom? Authentic freedom does involve freedom from coercion, but must always be directed toward the good which might mean a restriction of complete negative freedom, or complete self-interested action. Christian defense of the free market should make no reference to self-interested action, but rather to Christian self-giving actions. In this case, it is quite reasonable for a Christian to argue that greater free market-ness will allow self-giving actions to collectively bring about the common good).

So the task set to us then, is to decide the appropriate degree of free market-ness for a good society, or from the Catholic Social Teaching perspective, for the common good, which necessarily includes justice, truth, and charity.

How much should the government intervene? In which situations should the government intervene more rather than less and less rather than more?

Economists of all persuasions have researched the impacts of policy on the economy and economic relationships and worked to develop models to support their case on these very questions. Some have started with the data to support their conclusions. Some have started with their conclusions and worked to find data to support them. Others have largely ignored data and have instead constructed great mathematical models based on certain assumptions about human behavior to support certain conclusions.

This last group has been the dominant group in Economics for over a century now and so most of this post addresses their arguments, but I will also present data to support certain conclusions as well. The importance of this is that many politicians and the public in general take the advice of economists on matters of ‘free market-ness’. So if you’re going to listen to us, then you should know exactly what we are saying, the strengths and weaknesses of our arguments and models, and what conclusions we can then draw from them.

Part 2 will take a closer look at the model most often used to defend the free market which also happens to be the model everyone learns in principles of economics courses.

Friday, March 1, 2013

Thank you Pope Benedict XVI

Thank you Pope Benedict XVI for your servant leadership! Here are some of my favorite quotes from your great encyclical Caritas in Veritate.
Charity in truth, to which Jesus Christ bore witness by his earthly life and especially by his death and resurrection, is the principal driving force behind the authentic development of every person and of all humanity.

Charity is at the heart of the Church's social doctrine.

Charity is love received and given.

Charity goes beyond justice, because to love is to give, to offer what is “mine” to the other; but it never lacks justice, which prompts us to give the other what is “his”, what is due to him by reason of his being or his acting. I cannot “give” what is mine to the other, without first giving him what pertains to him in justice. If we love others with charity, then first of all we are just towards them. Not only is justice not extraneous to charity, not only is it not an alternative or parallel path to charity: justice is inseparable from charity, and intrinsic to it.

To desire the common good and strive towards it is a requirement of justice and charity.

It is not a case of two typologies of social doctrine, one pre-conciliar and one post-conciliar, differing from one another: on the contrary, there is a single teaching, consistent and at the same time ever new. It is one thing to draw attention to the particular characteristics of one Encyclical or another, of the teaching of one Pope or another, but quite another to lose sight of the coherence of the overall doctrinal corpus.

The truth of development consists in its completeness: if it does not involve the whole man and every man, it is not true development.

Progress of a merely economic and technological kind is insufficient.

Openness to life is at the center of true development.

Profit is useful if it serves as a means towards an end that provides a sense both of how to produce it and how to make good use of it. Once profit becomes the exclusive goal, if it is produced by improper means and without the common good as its ultimate end, it risks destroying wealth and creating poverty.

In comparison with the casualties of industrial society in the past, unemployment today provokes new forms of economic marginalization, and the current crisis can only make this situation worse. Being out of work or dependent on public or private assistance for a prolonged period undermines the freedom and creativity of the person and his family and social relationships, causing great psychological and spiritual suffering. I would like to remind everyone, especially governments engaged in boosting the world's economic and social assets, that the primary capital to be safeguarded and valued is man, the human person in his or her integrity: “Man is the source, the focus and the aim of all economic and social life.

The dignity of the individual and the demands of justice require, particularly today, that economic choices do not cause disparities in wealth to increase in an excessive and morally unacceptable manner, and that we continue to prioritize the goal of access to steady employment for everyone.

The human being is made for gift, which expresses and makes present his transcendent dimension. Sometimes modern man is wrongly convinced that he is the sole author of himself, his life and society.

In fact, if the market is governed solely by the principle of the equivalence in value of exchanged goods, it cannot produce the social cohesion that it requires in order to function well. Without internal forms of solidarity and mutual trust, the market cannot completely fulfill its proper economic function. And today it is this trust which has ceased to exist, and the loss of trust is a grave loss.

It is nevertheless erroneous to hold that the market economy has an inbuilt need for a quota of poverty and underdevelopment in order to function at its best.

Thus every economic decision has a moral consequence.

An overemphasis on rights leads to a disregard for duties. Duties set a limit on rights because they point to the anthropological and ethical framework of which rights are a part, in this way ensuring that they do not become license. Duties thereby reinforce rights and call for their defense and promotion as a task to be undertaken in the service of the common good. Otherwise, if the only basis of human rights is to be found in the deliberations of an assembly of citizens, those rights can be changed at any time, and so the duty to respect and pursue them fades from the common consciousness.

Denying the right to profess one's religion in public and the right to bring the truths of faith to bear upon public life has negative consequences for true development. The exclusion of religion from the public square — and, at the other extreme, religious fundamentalism — hinders an encounter between persons and their collaboration for the progress of humanity. Public life is sapped of its motivation and politics takes on a domineering and aggressive character. Human rights risk being ignored either because they are robbed of their transcendent foundation or because personal freedom is not acknowledged.

Secularism and fundamentalism exclude the possibility of fruitful dialogue and effective cooperation between reason and religious faith. Reason always stands in need of being purified by faith: this also holds true for political reason, which must not consider itself omnipotent. For its part, religion always needs to be purified by reason in order to show its authentically human face. Any breach in this dialogue comes only at an enormous price to human development.

The principle of subsidiarity must remain closely linked to the principle of solidarity and vice versa, since the former without the latter gives way to social privatism, while the latter without the former gives way to paternalist social assistance that is demeaning to those in need.

Technologically advanced societies must not confuse their own technological development with a presumed cultural superiority, but must rather rediscover within themselves the oft-forgotten virtues which made it possible for them to flourish throughout their history.

I eagerly await the next Pope's social encyclical(s)!

Sunday, February 24, 2013

Step 2: ???

Many years ago, when I was 10 or 11 I had a friend of mine sleepover. My parents had something going on that night, so we had a babysitter for a few hours. She was quite lenient on us, and being young boys, we took advantage of the situation. I'm not sure I've drank more pop over a span of a few hours than I did that night. We also convinced her to let us watch a banned cartoon that night.

I'm not sure why I remember that night so well, but every time I hear a politician or pundit talking about reducing the deficit I can't help but think of the episode I saw that night. You see, the episode I saw was about the "underpants gnomes" who'd go around at night stealing underpants.

They had quite the business model (I'd offer a link here, but I could not find a clip containing no vulgarity, so peruse at your own risk if you like):

Step 1: Collect underpants
Step 2: ???
Step 3: Profit!

For these politicians and pundits, it seems that their modified plan for the economy could be:

Step 1: Reduce deficit by cutting social programs and raising taxes
Step 2: ???
Step 3: Growth!

I have yet to hear a solid explanation of what reducing the deficit would do for the economy to help it grow. The best, or most feasible explanation offered is that businesses would be more confident and would start spending and investing to create jobs. Yet, this magical step two (what Krugman calls the confidence fairy) has some problems with it.

What about reducing the deficit increases business confidence? Reducing the deficit will reduce their sales, because the deficit measures the amount of money leaving and entering the economy over time. A deficit is money entering the economy, a surplus is money leaving. Lower sales do not boost confidence.

What about more stable policies? Sure! Stability in Washington is very important, but you can provide stability without reducing the deficit.

Business investment relies greatly on expectations of future sales. For that, businesses need stability and expected stability. They need to know roughly what wages, resources, healthcare, etc. will cost. They also need to have a rough idea of what they can sell at what prices to make their investment worthwhile. Banks also form their expectations when deciding whether to give out loans or not.

For this, we need Washington to stop kicking the can down the road, to stop passing temporary measures while they continue to disagree over how to reduce the deficit, and they really need to stop threatening to go "over the cliff" or fall into voluntary bankruptcy. This is what makes businesses uncertain, not the deficit. Constant fiddling by Washington must stop if the private sector is going to have any confidence in their bottom line.

The deficit should be reduced, but not directly. It will be reduced with a growing economy. To grow the economy you need to boost spending, which means a higher deficit now. A higher deficit now will equal a lower deficit later with economic growth.

The deficit should be directed toward those who need it most and who will be most likely to spend it. Not big business and not big banks. Not those who own big businesses and big banks. Give it to those who need it and they will spend it. This, in turn, will boost the sales of businesses, small and big alike. They will be more confident of future sales and will invest in more jobs.

Remember that the public sector deficit is the private sector surplus. If we reduce the public deficit, then we reduce the private sector surplus.

There is no magical step 2 to get us growth if step 1 is reducing the deficit.

Friday, January 11, 2013

Should we #MinttheCoin?

The trillion dollar platinum coin idea is making all the headlines these days.

Background on the Coin:
Co-Author of Platinum Coin Law Weighs In
What about money scares everyone so much?

Background on where the idea came from:
Trillion Dollar Coin Inventor
Origins of the TDPC

The Fiscal Cliff was averted at the last second, as I expected. The deal struck was horrible for pretty much everyone. Bush income tax cuts were kept intact for everyone under $400,000/yr, but the payroll tax cut was allowed to expire. So, in reality, pretty much everyone's taxes went up. Yay, us.

Now the new point of argument is back on the debt ceiling. Congress reached an agreement to avert the point they created to provide motivation to get a budget done (fiscal cliff), but now they have a new point they created to provide motivation to get a budget done (debt ceiling). Economically, the debt ceiling serves no useful purpose. Hitting it would be disastrous, far worse and more unknown than the fiscal cliff.

If we allow ourselves to hit the ceiling, we will in effect declare voluntary default. This is like telling the bank you have the money to pay off your loan, but don't want to pay it off, except that you are a currency user and could actually run out of money to pay your loan and the government as currency issuer can never run out of money.

What are some of the effects of voluntary default?

1) Faith in the dollar would be gone or shaken severely. The safest assets worldwide are U.S. Treasuries. Failing to make good on them would shake confidence in them and the entire dollar system. All of which amounts to Global Financial Crisis, part II which is much, much worse than part I.

2) Spending would drop precipitously. Increased uncertainty and decreased confidence in worldwide financial markets would mean people would hoard money out of fear of losing more. Spending = someone else's income. So when spending decreases, income decreases. This is the good ol' paradox of thrift. We need to increase spending, not decrease it.

3) Unemployment would go back up. Perhaps faster and way worse than in 2008-9.

4) That deficit we're trying to close would get much bigger. So those wanting to close it wouldn't win in this scenario either.

5) Probable deflation, which further hurts household's balance sheet positions.

6) Interest rates would probably go haywire.

7) Stock market collapse, again. Any gains made since '08 would likely be gone again. Retirement savings and pension funds would be hurt badly, if not completely wiped out.

Basically, we can't and won't hit the debt ceiling. So why are politicians threatening to do so?

Economically, the ceiling is useless, which is why we should just get rid of it, but politically it is a tool to try to limit government spending or the size of government. But note that the size of the debt isn't a measure of the size of government. It IS the measure of the savings in US dollars of all those who hold treasury securities, which includes US citizens. So setting a debt ceiling doesn't usefully limit the size of government either.

Hitting the ceiling just isn't an option. We shouldn't even have a ceiling. If we expect our economy to grow, then we should expect the debt to get bigger and bigger forever and ever and this isn't a bad thing and won't cause hyperinflation.

So if the choice is between minting the coin and hitting the ceiling, the choice is easy. Mint the coin.

The Treasury can mint the coin because of a loophole in the law, but that doesn't mean doing so is invalid or not a viable option. It is very valid, real, and viable. It demonstrates very well that the issuer of the currency does not need to issue debt to spend. It issues debt in part to drain reserves from the private sector to avoid inflation and to control interest rates. It also issues debt to provide safe assets to the private sector.

Spending without issuing debt does not automatically mean inflation. To get inflation, we must spend past capacity. We have lots of unused capacity in our economy, we aren't going to cause inflation with the trillion dollar coin.

Minting the coin would only prolong the malaise of our moderate deficit providing low growth overall. It wouldn't fix the economy by itself.

That said, I am not in favor of using the coin. I would much rather our politicians come together and make a budget suitable for good growth and a strong economy with full employment and a robust financial system. They don't seem to want to do that. It is terrible that one party would unilaterally exploit a loophole in the law to support its own ends, but it is also terrible that a party would hold hostage the economy with a needless debt ceiling because they can't find common ground in the budgeting process. To me, it doesn't matter which party is which. If they were reversed, I'd feel the same.

It is all extremely disappointing. It is disappointing that they don't understand their own monetary system and it is even more disappointing they can't work together.

In summary, 3>2>1.

1) Hit debt ceiling. Voluntarily default on promised payments. Economic disaster.

2) Mint the coin. Avoid economic catastrophe, but continue low growth malaise.

3) Repeal the debt ceiling. Cut payroll taxes. Spend more on infrastructure and less on defense and porkbelly spending. Don't worry about the deficit and debt. Focus on unemployment, inflation, GDP, and poverty instead.

Tuesday, December 18, 2012

Fiscal Cliff Notes

Some of my (somewhat well-educated) thoughts on the fiscal cliff:

1) The fiscal cliff is NOT the point at which the government runs out of money. Somehow this has become the widespread notion of what the Fiscal Cliff is, descriptively. Remember, the issuer of a currency cannot run out of that currency. The U.S. government, as issuer of the dollar cannot run out of dollars.

2) The fiscal cliff IS the point at which spending cuts kick in and tax cuts expire so that the deficit closes. That is, (G - T) becomes smaller. Every economist understands that this will hurt the economy because it contracts overall spending in the economy. GDP = C + I + G + (X-M). So if Taxes go up, our spending (Consumption and Investment) will go down and if government spending goes down, overall GDP will drop unless somehow we miraculously become a large net exporting nation.

3) Knowing this, we still think we have to shrink the deficit. I detailed this a couple of weeks ago, so I recommend reading that piece. IF we let the fiscal cliff happen, the economy will shrink quickly. If we reach a deal, the economy will sputter and will likely fall some if not a lot--it depends on the magnitude of the deal.

4) We need a larger deficit! This can be accomplished through spending increases or tax cuts, but the only way to actually shrink the deficit is to increase GDP. The private sector is still deleveraging, the foreign sector--our trading partners--is in poor shape, and so the only institution that can help is the government. Otherwise we're in for a long, slow deleveraging period--see The Great Depression. This is needless because the government has policy tools to prevent it, and it doesn't necessarily have to mean a concentration of government power.

5) What we spend money on matters! Some spending has a higher multiplier effect or employs more workers. Much spending is extremely wasteful and so wouldn't do much to help our society or our economy. All spending will benefit some more than others. Some spending is immoral. We need to make these decisions as a society in the political arena, but note these decisions have economic effects--see my most recent post on this.

6) We have a particular duty to look out for those left behind or trampled on by the system. We can do this personally and through institutions--including Churches, non-profit organizations, local governments, and the federal government. All have advantages and disadvantages, but all are needed according to the principle of subsidiarity, which is not a limiting principle (thinking of it solely as a principle that limits the size of government), but is rather a cooperative principle (thinking of it in terms of all institutions of all sizes working together to accomplish the common good).

Tuesday, December 11, 2012

Demand Signals

Economics, in some sense, is the study of choices. The study of how your choices and my choices affect economic variables and economic outcomes. This is, in part, why economics cannot be completely separated from other social science disciplines concerned with human behavior, such as history, psychology, sociology, political science, and anthropology.

One advantage of capitalist economies over other modes of production is the freedom it gives to its citizens to participate in economic life--to make choices mostly free from constraints. This freedom isn't without necessary prerequisites, qualifications, or undesirable results, however.

Instead of being organized around a central planner, our economy is organized around 'demand signals'. Production decisions aren't made by the state, but by producers usually thought of as capitalists but are really more likely small business owners, CEOs, Boards of governors, etc. They obtain funds, at least initially, from banks through loans or from the public through sales of stock. In order to obtain those funds, they must have some prospects for selling their proposed product. This puts production decisions largely in the hands of bankers, who estimate the expected rate of return on the proposed investment, or stockbrokers who do the same. For the former it means getting the loan paid back, the latter a rise in the share price.

Yet both are looking at expected rate of return, a hard to gauge variable that because it is based on uncertain expectations of the future depends more on current sales or current demand. This is where our choices come in, or our demand signals.

You see, we demand with our money and the purchase of a good or service sends a signal to the producer or to the bankers making lending decisions. That signal is usually to invest more in that product or service--to increase investment, or to raise the price of that good or service to obtain more profits with which they too use to purchase goods and services to send signals to their suppliers. It is this interconnected web of demand signals using paper money (or money from bank accounts) that organizes real output in our economy.

We don't have a central organizer or planner who has to guess how much to produce, or to guess how much we want or need of any one product or service. We send signals through 'the market' and 'it' organizes production along those signals.

There are many implication or conclusions to be drawn from this.