December 27, 2012

Production as Privilege: Circular Flow

This post is the second in a series attempting to breathe some new life into the connection between production and distribution. Each post presents a different tool for understanding the link; the hope is to arrive at some new insights.

Conceptual Tool #4: The Circular Flow Model

One goal of this series of posts is to understand distribution as not simply a matter of income or wealth (accumulated income), but by examining distribution across the system as a whole: how different parts of the economy fit together and how resources, goods and money move through it. The closest serious academic papers get to this type of holistic analysis is to use "general equilibrium"-type models, which just means that they attempt to model a labor market and a product market at the same time and see how they interact. I want to rewind a bit, back to macroeconomics 101, and take a somewhat a different route into the analysis of distribution.

Your average Introduction to Macroeconomics textbook is likely to feature the circular flow model of the macroeconomy. Sometimes it may feature more complicated flows (scroll down to the 2nd chart) as well. Circular flow models barely qualify as "models" in the standard economic sense, but I have written several pages about them here because they provide a valuable perspective.

Circular flow-style models are helpful because they provide us with a simple foundation for our understanding of the whole system of the economy, which serves as the groundwork for future intuition.

Also, the bird's-eye view they provide reminds us that the economy is a system with individual parts that play specific roles. By extension we can see that the way these parts could, in theory, be rearranged. For example, if production was done entirely by robots and then distributed to people according to something unrelated to the consumer's productive power, we could have an economy where producers and consumers were entirely distinct.

Circular flow models also help us conceptualize the two-way nature of economic transactions, where money flows in one direction and goods, services, or "utility" flows in the other.

Likewise, circular flow models do a good job of capturing the dual nature of workers/consumers: any flow from a consumer has to come from a paycheck, a fact which is both obvious and confusing, and has important ramifications that may be missed by standard models.

Finally, the looping nature of the circular flow model helps remind us that money (as well as everything going in the other direction) is flow that has to keep moving and does not stay put--we can see that if people or businesses or governments stop spending, even in one link of the chain, the flow dries up.

Unfortunately, circular flow models have several important weaknesses--primarily because the economy is difficult to capture in its entirety. Determining causality in the model--always a difficult task--is complicated both by the two-way nature of the flows, and by the circular nature of the model. Essentially, you end up with not only a chicken-egg problem because of the circular flow, but also a chicken-grain problem because of the two-sided markets: you cannot tell whether the chicken wanted to eat the grain or the grain wanted to be consumed by the chicken.

Moreover, trying to incorporate more complex connections between markets, for example including governments and financial institutions, presents too many unknowns to put meaningfully into equations (equations being a prerequisite for any pretensions toward "science"). The advantage of circular flow models, being able to see some of the economy's true complexity, makes them difficult to use for analysis quantitative analysis.

But circular flow models are also far from being complex enough. By assuming a single, "representative" household and business (and government), circular flow models ignore distribution within households or businesses. They also gloss over the different methods of transfers, e.g. wages versus capital gains versus debt interest. Finally, they present money and goods flows as steady and given, ignoring the fact they are caused by supply and demand incentives. (this is the causality problem again)


Despite these flaws, I still find myself attempting to conceive of a circular flow model useful for analysis, i.e. one that we could plug numbers into in a meaningful fashion, get some kind of predictive power from, or at least use to view the economy in a new light. Large think tanks, government agencies, and financial companies have attempted to create comprehensive models of the economy, probably these are useful for spitting out numbers, but they have not to my knowledge led to any obvious revelations in our understanding of economics.

What could a more useful version of the circular flow model look like? I will throw out some ideas.
  • Maybe you have seen the animated visualization of wind developed by some clever researchers. What if we could do this with flows of money? If not using granular location data, then between states or internationally. Or, instead of using spatial locations, animate a traditional circular flow diagram in a similar fashion, showing flow strength between different sectors of the economy. Representative boxes (consumer, producers) could also change over time to depict things such as savings, indebtedness, inequality, or relative size in the economy.
  • The author/entrepreneur Martin Ford tries to develop a visual metaphor for distribution in his book The Lights in the Tunnel, which examines the impact of technology on distribution (free e-book at the link). Ford describes a visual metaphor for individual incomes, a tunnel made of millions of lights, and describes how most get dimmer over time while a few get brighter. Basically he is describing a possible visualization of the gini coefficient (the most common measure of income inequality), but his emphasis on the change over time and the process through which those changes occur makes the metaphor interesting. If a more structural view of the economy, including product markets and other actors, were somehow incorporated into this metaphor it could get interesting.
  • There are plenty of existing economic models featuring winners and losers from technology or trade. These models may explain changes in income between high- and low-skill workers, or between workers and capital owners. Unfortunately, lumping everyone into two groups is not always particularly revealing. Also, the models do a poor job of explaining anything more than a simple before-after scenario for an economic shock: they do not show stocks and flows of money and they can comprehend only rudimentary structural changes. They furthermore exclude entire parts of the economy like government and savings, and typically make strong, unrealistic assumptions such as full employment. These models are good at explaining individual phenomena, but have a difficult time providing a realistic, systemic understanding of an economy.
  • There are certainly some interesting bubble charts to be made (and they many exist already) of sectoral distribution in our economy over time, or transfers to and from different between businesses, government, and different income groups. Two axes are limiting, however, even with the added 
  • It would also be fascinating to be able to visualize where and how economic rents accrue in an economy--at what stages, in what individual industries, and to what type of individuals and businesses.

Let's take a step back and recall what we are fussing about. We are looking for better ways of understanding the connection between production and distribution, and thinking about what we can learn from one type of basic representation an economy: the circular flow diagram. The circular flow diagram teaches us that money is a flow, it flows in the opposite direction of good and services, and it connects markets and so markets influence each other (e.g. we cannot have strong demand without decent wages).

What would some ideal model look like? It would show money and goods flows, not just direction but also the amount over time, and would be easy to disaggregate between not only the consumer and producer "sides" of the economy but also between industries, occupations, and different income groups. It would capture a range of "leakages and injections", as they are called, including international trade and financial flows, savings, inflation, and interest payments. It would also show stocks of wealth at various points.

One possible way to organize such a model would be with the life cycle of money, following it from its creation (loans in banks) through its use and final destruction (loan payments to banks). The difficulty with this method would be that money is fungible and there is no sensible way to determine money's "age" or where it came from or went to. A similar organizing possibility would be the life cycle of goods, but this gets difficult with things such as intellectual property, services, and more abstract types of value that do not have a clear product cycle.

I do not have such a model here to present to you. Merely the idea that with some hard work, lots of data, and some nifty graphics there is a lot of potential for representing our economy in revealing ways. It is important, I think, to keep as holistic a view of the economy as possible. The circular flow model is a nice format for presentation, but the complexity of flow in an economy, from money spent to money earned, is difficult to capture.

December 18, 2012

Production as Privilege: Introduction

Anyone can produce. What is harder is to get anything in return.

The difficulty we have getting anything in return for our production--getting paid for our handmade tea-cozy on Etsy, for our labor stocking the small appliance section at Walmart, or working the trading desk at an investment bank--is what I want to focus on for this series of posts. If it is all work, then why are some types of production better compensated than others?

The common story in economics, and our broader capitalist society, is that we are paid for our work exactly as much as the rest of the economy values that work. The infamous "invisible hand" idea argues that if we are paid for what society values, we will decide to produce what is valuable to society. This rationale serves to justify the system: it provides people with good incentives.

This marginalist/invisible hand story is certainly true, but it is perhaps not the whole story. The relationship between production and distribution (or rather, who gets the fruits of production) is complex and not something economics has done a particularly good job of explaining. In this series of posts I am hoping to lay out some conceptual tools and frameworks that may be of use to construct a better understanding. Or they may not--some will doubtlessly appear divergent or tangential. Please bear with me (and help me along the way) as I hurl mud at a wall, hoping to end up with a discernable shape. And maybe a better idea of what I am even trying to figure out.

I will do this as a series of posts since I have already worked on it for a while and am nowhere near done, and because serialization is the lifeblood of the web. For the first post, I am going to go over standard explanations (within economics) for economic profit as well as the concept of profit itself. Keep in mind that while I am writing about profit for firms, I am ultimately interested in the allocation of profit to individuals, whether as laborers or owners of firms. Distribution within firms is another step of the process that will be addressed later.

Conceptual Tools #1-3: Standard Explanations for Economic Rents

A foundational concept of modern economics is the "perfectly" competitive market, a market that perfectly matches supply to demand in order to optimally allocates resources. In a perfect market no producer is able to collect economic rents. If you are not familiar with the concept of economic rents, also known as economic profits, the first paragraph of the Wikipedia entry is a fine summary. Basically, making economic rents means getting paid more for something than it costs you to make it.

In the real world, firms are able to collect rents--investors invest and stocks pay dividends. Economics describes a number of reasons this happens, all centering around the idea that supply fails to meet demand, which in turn allows suppliers to charge more for their goods or services than they cost to produce.

1. First Mover Advantage and the Short Run
Supply often fails to meet demand because both demand and supply change frequently, and fast. If demand changes and a business is quicker to catch up than its competitors, this business gains "first mover advantage" and is able to charge more than it costs to make a product. Or if a business creates a new product that is preferable to old products on the market, they are likewise able to charge more. Businesses can also reduce costs in their production process, and if they do so faster than other firms then the market price of a product may remain above their costs.

In all of these scenarios, however, competition will in the long run drive these profits to zero, because new firms will enter new markets. The next two monopoly scenarios describe causes that maintain profit in the long run.

2. State Monopolies
The government often creates barriers that keep firms from entering markets. One of the most well-know and politically acceptible barriers is the patent system, which stops firms from entering markets for new inventions by firms that have patented their processes. The profits that they may realize from their monopoly position in a new, patented market are supposed to give firms an incentive to develop new products, and the public nature of the patent disclosure system is supposed to provide facilitate the eventual elimination of the monopoly.

3. Natural monopolies
Even in the long term, markets may be uncompetitive even without government intervention. Economics 101 courses list different types of markets: perfect competition, monopolistic competition, oligopoly, and monopoly. These types are differentiated by the type of supply they tend towards. The structure of suppliers is determined by technology, regulation, consumer preference, history, and other factors.

Economists typically simplify these factors primarily based on the cost structure of firms. They have a concept of "ideal firm size", which depends on the costs of production and the demand for a good at a variety of prices. Different markets and technologies are conducive to different firm sizes, depending on marginal costs of production and network effects. For a given market size, the "natural number of firms" can be determined by dividing the market size by the ideal firm size. This determines whether firms will be abundant or scarce and, accordingly, how much market power they will have and how much economic rent they will be able to appropriate.


These are some standard explanations for economic rents on a firm level. If we are concerned about distribution to individuals, then we will need to get into the labor market side as well; I will cover that in a future post. I am also going to bring up a range of other "conceptual tools" that will hopefully be of use examining the issue. I am not trying to challenge the standard model of economic rents so much as situate it with a broader conception of production and distribution in today's economy. There is, possibly, a lot more going on.

December 16, 2012

New Era

Rather than actually producing any new content, I have whiled away the past few weeks making purely superficial changes to the site. The name has been changed from "Advanced Common Sense" to the rather blander "Potential Economics", the colors from orangish to bluish. I have procured a domain name ( should already be here) and twitter account (@potentecon).

Now would be an excellent time to update your bookmarks and/or feeds, by the way. Sorry for the inconvenience.

Please let me know if anything is out of whack. Or if you think something/everything is ugly.

November 9, 2012

Panacea Failure

I wanted to share this excellent bit of reporting I came across in the Washington Post a few weeks ago. The original, longer article was done by ProPublica, and I would recommend it if you have time. If not, the shorter Post version should not be missed.

The article is important because it opens up a black box of questions that economists and politicians typically wave away or plaster over with assumptions. Most importantly, many economic models of trade trade and technological change assume "full employment". When economist talk about the "gains from trade", these 'gains' ignore potential losses from unemployment. Or put differently, when someone is laid off because their employer cannot compete with cheaper imports from abroad, these models assume they can instantly find another job. This assumption is valid in some situations, for example when there is high growth in other industries. But in other situations it is absurd on its face. Economists, however, rely on it because modeling the impact of trade on economies without it becomes extremely difficult.

A second, related assumption is that workers are able to move up the "value ladder" to find better-paying jobs than the ones they lost. Or that if this does not happen, then at least the country overall will be richer and the workers benefit via Trade Adjustment Assistance or some similar redistributive program.

A final reason these results are so alarming is that education is a basically the economic policy prescription of last resort. How do we compete with China? More STEM education. How do we get out of the recession? Go back to school to be more competitive. If nothing else is working, policymakers often turn to education and "skills" as the way to appease the market and bring about that illusive world where there are enough jobs and inequality is not spiraling out of control. Education is important, no question, but it should not be the only leg we attempt to stand on.

The Janesville study is an airhorn in the ears of anyone resting peacefully in these assumptions. It is not a perfect study; in fact there plenty of reasons to question the results, many noted by the authors themselves. But its results are so perfectly antithetical to common assumptions about retraining, employment, and competitiveness as to call into question the models that led us to those assumptions. We have to ask: what is the point of economic ideas that give results like these?

November 2, 2012

Who Built That?

Few words have resonated in people's minds this election season, firing up conservatives and giving liberals rashes, quite like the phrase "job creators". The two words loom large in conservative politics and over our national political discourse--a snappy obeisance to the employer class.

Ideas like "job creators" are used because they tell a convincing story about the economy, but the shorthand they provide can be dangerous. While I doubt many readers of this blog are uncritically in love with the phrase, in this post I want to look beyond its easy dismissal ("'job creators' is a sycophantic way to say 'rich people'"; "it's just top-down class warfare") and use the idea as a starting point for a look at what parts of our economy we value and why. In particular, I am interested in the ideas of production and "producerism" and how they relate to a range of economic and political ideologies.

In my last post I wrote about two roles of the economy--production and distribution--and described the critical role labor plays in distribution. This post is ostensibly about the production side, but really it is also about distribution, because the way we understand production impacts the way we understand distribution--and thus it impacts distribution itself. This idea is basically the underlying idea of the post, but I am going to meander a bit and may not mention it for a while, so keep it in mind.

Simplifying Complexity

Economies accomplish amazing things in amazingly complex ways. It is amazing that thousands of people designed and built the intricate mess of hardware and software that constitutes the laptop sitting on my lap. It is amazing that it was assembled thousands of miles away by people in Asia because they will work for less pay than american workers, and then flown--in the sky--back across a vast expanse of ocean. Most of the commercial products we buy boast a similarly byzantine heritage.

But importantly, all byzantine pathways are not the same: we value certain twists and turns in the roots of the production process over others. Differences in valuation are extremely important because they help us decide what to do, how to spend our time and energy. Correspondingly, we value certain types of work and certain types of workers over others. We value doctors over tech support providers. Soldiers over mall security guards. Entrepreneurs over middle managers. Farmers over migrant laborers. And their wages reflect this.

The question, should we bother to ask it, is why? Why do we see certain parts of our economy as more valuable than others?

Certainly some reasons are obvious: things like doctors are valuable because they strongly affect our lives, in good or bad ways. We value that and we pay them for it. But other reasons are a bit less direct, as in Adam Smith's diamonds/water paradox (why are diamonds more expensive when water is so much more useful?). Such "paradoxes" can be explained through concepts like markets, institutions, or human psychology and preferences.

In fact, there are a million different things that affect what is important in the economy. But that does not mean we factor all those things in perfectly when we think about them. Instead, we think in simplified mental models, that may or may not factor in all the relevant details. People think in terms of these modelsm and see those parts emphasized by their models as more important--more critical to the operation of the economy and more valuable.

Productivity Shapes the World

When economists refer to value in an economy, they basically mean "quantifiable economic activity"--typically this includes everything that is paid for, but it may also mean other things like childcare, housework, or barter transactions.

In a way however, typical measures of value like GDP are more about measuring how much is going on than how much is going on that is worthwhile. Past attempts to measure how much is worthwhile, or simply find a more concrete measure of value than the aggregating all economic activity based on what people pay for things, has met with limited success.

One thing economists and almost everyone else can agree on, however, is that productivity and production is important. Not the only important thing in life, maybe, but something fundamentral. Because people generally want things, or want to have things done for them. Productivity has always been a crucial aspect of the economy.

It has maybe always been this way, from hunter gatherers surviving on whatever nuts or caribou they could find, to the irigations sytems and metal tools that sustained early civilizations, to the industrial revolutions and the advent of mass production. Economies that are better at making things and doing things for people, or at least make or do more things, are more productive and thus create more value (in the economic sense). The technical details of production, however, are almost banal compared with the influence of production on our culture--our politics, our ethics, and the daily lives we live.

Technology Shapes our View of Productivity

If you are a hunter or a gatherer, production is important in an immediate way: your productivity determines how much you eat for the next few days. If you live in an agricultural society, your production one year may determine how much you will eat until the next harvest. A good harvest could also give you access to other goods, like cookware or building materials, or services, like a doctor.

(Disclaimer: I am not an anthropologist or historian and I realize that I am making incredibly simplistic assumptions about different societies that I know little to nothing about. If what I am saying is ridiculous, please let me know.)

Productivity in pre-capitalist societies was more straightforward, because almost everyone was a producer. With lower levels of technology, people engaged in work with clear inputs and outputs; "hard work" was at least immediately apparent. Those people that did not produce food or goods directly for markets usually engaged in work that was nevertheless understood as important by society: women cooked, cleaned, and raised children, clergy counseled and served as intermediaries with the devine, noblement governed and provided protection.

Two things changed. First, the joint-stock, limited liability corporation was invented (not out of thin air, but I will not get into that here) within the framework of the liberal state. Second, mass production was also invented. These inventions changed productivity forever, because they gave us organizational forms that increased the productivity of any individual exponentially. The more complex organization of production, however, also increasingly obscured the causes of the productivity.

There is a limit to how many fields a man can plow, even with the sturdiest horses. But the potential output of a man with GPS-guided, computer-controlled giant farming machines is almost limitless. Today, the major sources of productivity have almost nothing do with how many hours we spend toiling in the fields--they come instead from our technology. And the process that has produced that technology is managed by enormous, complex corporations.

Technology is best thought of not simply as new machines, but also as new forms of organization and new processes. Organization and processes may be consciously designed, like a legal proceeding or the hierarchy of a business, or they may arise more spontaneously, like a professional network. If we are ok stretching the term "technology" even further we can lump under its banner cultural values and mores, integrated with formal organizations and processes. For example, a fundamentally important aspect of our economy is that it is built to a large degree on trust.

Technology and our complex market economy obscure the source of productivity for a number of reasons. Most obviously, increasing technological complexity (along with increasingly complex societies) means the production process involces more and more people doing more and more things. These different people also become increasingly specialized, often in more and more complex areas--think of biologists that specialize in one small, rare organism or a computer programmer that specializes in programming certain types of software. Furthermore, we can think of such specialization as a kind of technology itself, as a rationalization of prodution processes--think of an assembly line, which is an important invention in its own right. This increasingly productive technology may have a clear source, like Henry Ford's assembly line, or it may be simply a byproduct of the work of many people, like a computer. But these parts of the system that change the system to  increase productivity are also important.

Who do we Value?

All these parts in the system, and designers and remakers of the system, are competing, in a way, for our societal respect. But ideas like "complexity" and "systems" leave us on awfully abstract footing. We have to value something, in the end--like a person or at least an institution. Who should we thank for our productivity and productivity increases?

Well, what are our options? Let's make a list:
  • Workers, because even productive technology needs workers to make it work
  • Inventors, because they make the mechanical technology
  • Businesspeople, because they create new organizations
  • Capital allocators, because they pick good organizations to fund (and allow to exist)
  • Technocrats, because they help the system function well
  • Teachers, because they help train people to be more productive
  • Values, because they keep society working well
  • Market incentives, because they make people want to be productive
  • God, luck, fate, etc...
Each of these different attributions has at least a grain of truth, because they are all parts of our economic system. So how do we differentiate them by importance? We can, for starters, try imagining a world without them: while it may be difficult to construct counterfactuals and hypotheticals about which factors are essential and non-essential in an economy, such ideas do provide important justification for resource direction and control.

But first we should be aware that different political and economic ideologies in the modern age have already built their conceptual models, coherent or not, on different conceptions and attributions of value creation. Marxists celebrate workers, libertarians celebrate market forces and Randian innovators, and the vast middle celebrates a range of investors, teachers, businesspeople, technocrats, family values, and always, again, the market.

Every hero needs an enemy, however. These enemies often define our ideologies more strongly than the ideas themselves. The enemy of the market is the state, the enemy of the worker is the capitalist, the enemy of the technocrat is politics, the enemy of our values are other people's values. These enemies purportedly cripple us, keeping us from our true potential.

Producerism (as an example)

One ideology particularly germaine to this discussion is "producerism". Wikipedia does a good job of presenting many of the facets of producerism, the main idea being that there are productive groups in society and there are unproductive groups in society, and the unproductive leech off the productive.

While few if any people self-identify as "producerist", strains of producerist ideas are visible not just on the conservative side of the political spectrum (liberal elites and lazy underclasses sucking value from the productive middle) but also on the left (powerful ologpolistic corporations and mutant financial sectors diverting resources from productive manufacturing; capitalist owners taking more than their fair share of profit). The different sides vary in terms of where they believe value is created, but their basic argument is that value is being misdirected from its natural, rightful, or most effective course.

The range of producerist concern likely has something to do with the complexity of modern production we wrote about above. It is difficult to know exactly who to thank for your new iphone: Steve Jobs? workers happy to work for meagre wages at Foxconn? some faceless software designer? the bureaucrats who successfully reallocated the electromagnetic spectrum so that you could use 3G internet? investors in Apple? All of these workers and classes of people helped bring that iPhone to your pocket; how do we know they got their fair share of the value?

An interesting thing about producerist critiques is that they inherently utilize a structural model of the economy--and a structural model that is very intuitive. By structural I mean that they take the economy as a whole and examine how parts of it interact. Such models have been out of fashion in mainstream economics for some time, but what has replaced them has been something of a conceptual void in the form of marginalist economic theories of value. Marginalist theories can only describe value as something someone chooses over something else, eschewing normative claims in favor of a set of conceptual tools.

Producerist-type arguments from all sides of the spectrum tend to be directed most vociferously toward those in power, since those in power rarely have trouble demanding their fair share of an economy's value. But it is not just our economy that is complex; our political system is also complex--and we therefore end up with all kinds of ideas about how the system works and who is using it to their benefit. Whether or not these critiques have legitimate grievances, however, they are basically ignored by economists (whose marginalist tools are basically incapable of addressing any political ideologies besides imperfect markets) and rarely make it onto the centrist political radar unless they can raise enough electoral ruckus, a la the tea party.


Where does all this leave us?

We should perhaps return to the link, glossed over earlier in the post by some handwaving about economists, between production and value. As noted, as a society we are basically required to think about value all the time, because it forms a basis for our decisions. And some production is more valuable than others, because it is more useful or scarcer or just because we humans, in our infinite arbitrariness, think it is valuable for other reasons.

Mostly, with all the complexity in the production process, we rely on wages and prices to put a value on work that is done. Wages help incentivize people to become programmers instead of, say, switchboard operators, and these incentives help increase the value in society. The invisible hand is in fact just your very visible paycheck.

But the wage and price system is not perfect. Competitive markets often require tending, new productivity can be nurtured but also stifled, and on top of it all there are people that are affected and allocative possibilities that are simply off the table (such as having government wages, or eliminating welfare entirely). Relying on markets to set the value of everything in society would be a horrible mistake, because markets fail too often in too many ways. Unfortunately we do not have a coherent alternative in our national discourse. Instead we resort to shorthand, simple ideas of what is valuable in our economy. Production is a process often subject to this simplification.

But production is a complex process. And we need to understand this in our political dialogue because the way we think about production influences the way we think about what is a fair, right, natural, or at least acceptible state of affairs. Unfortunately economics provides only the bluntest of tools, rough quantitative analysis, for understanding the relation between production and value, and determining what is important in our economy. Even less helpfully, it has a tendency to peddle the panglossian idea that everything is worth exactly its going rate in the market. In terms of priority-setting and direction, neoclassical economics is is unhelpful in many ways and downright misleading in others.

The void is filled by theories of right and wrong, political narratives of good and evil and efficacy and failure. These stories make sense to us because they offer a coherent story we can believe in and find meaning in. They help us understand what we value and and what we should value, often through their simplified explanations of the production process. Unfortunately they rarely do so except in self-serving ways that offer scant opportunity for real consideration of what we priotize or appreciation of the system's complexity. We should expect more.


Update: I just came across a recent Krugman blog post on basically the same subject, though focusing on the value created by those employed by the government. Krugman compares those people claiming that "government can't create jobs" to the Physiocrats, a sort of economic paleo-ideology. It is easy to see the strains of producerism and claims and confusion about sources of value over the ages.

October 11, 2012

Distribution and Labor

What we refer to abstractly as "the economy" can be understood as (at the very least) two distinct but intimately connected systems: a system of production, and a system of distribution. The system of production includes not only the proverbial "making of things" but the doing of things that makes the making of things easier, and also the doing of things that makes doing things we want to do for their own sake easier. The system of distribution refers to all of the exchanges that do or could take place in an economy and way those exchanges work.

Since at least the advent of industrialization, our economies have had the somewhat counterintuitive problem of functioning better as systems of production that as systems of distribution. This is counterintuitive because if we see scarcity as the fundamental economic problem, distribution would appear to take on a secondary importance. Unfortunately, abundance is irrelevant if it is concentrated in the hands of a few people; good distribution is therefore of paramount importance as well.

However, it is important to understand what we mean when we talk about "good" distribution systems. We can imagine an ideal distribution system that distributes value (resources or money) exactly in proportion to the value provided by a person to society. A different ideal distribution system would distribute production equally among everyone. We can also evaluate distribution systems purely in terms of costs, where a costless distribution system would be the ideal.

Good distribution is important for a number of reasons. There is a substantial, purely moral argument to be made for a degree of distributive equality if we believe it is fair and right. There is also a moral argument to be made for some degree of merit-based distribution. There are political arguments, for example the argument that mass democracies require a sizable middle class. And there are utilitarian arguments from a purely economic standpoint: e.g., that being rewarded for work is an important incentive, or that an economy based on mass production requires a mass base of consumers.

Up to now, when talking about distribution I have been conflating consumption and production, which has made things somewhat awkward to think about. As I explained it in the first paragraph, distribution involves exchange, which means things are going both ways. Generally we do a reasonably good job of distribution in consumption markets--that is, selling products. What is becoming more and more a problem is distribution in production markets--that is, selling labor and capital.

Our economy today has two major means of distribution on the production side: labor and capital. Or at least, this is the common distinction economists use between money that flows to workers and money that flows to capital owners. Historically, the balance between labor income and capital income in the USA and most developed countries has been around 70% for labor and 30% for capital, meaning that 70% of the money going to people in our economy was through wages and 30% was through investment income.

The 70-30 split does not have any special significance. Depending on the amount of workers getting paid and the number of investors making money from investments, you can get significantly different distributional outcomes from a constant labor/capital ratio. The importance of pension funds are an excellent example of this, because they distribute investment income to (former) workers.

Still, the 70-30 split has been a fairly stable historical trend, and as such can tell us interesting things about the economy. Perhaps most importantly, it reminds us that our economy is based on jobs. This fact is not news to anyone, of course, but even amidst weekly unemployment estimates and constant campaign rhetoric we can easily forget the fundamental importance of labor for distributing wealth: labor income is perhaps the most important category of exchanges in our economy.

This assumption is so deeply embedded in our worldview that we take it for granted, even though it is something of a historical anomaly and appears to now be changing dramatically.

The prevalent view among current policymakers is that employment is best created by creating business-friendly conditions and then leaving markets to do their own thing--perhaps with some help for infant industries (e.g. green technology) and a few safeguards to cushion unemployment, if you are a liberal. What does it mean, though, that employers have been paying their employees a significantly smaller portion of income? If we can no longer expect labor income to stay within a certain range, what does that mean for our expectations of full or nearly-full employment? Even if we assume full employment (if workers choose not work, for example), what does it imply for society if only 50% of business income is routed to labor? Only 30%? Clearly we would be looking at a vastly different world. Could we transition to an economy that is not based on labor income? Or should we expect labor income to recover?

Stay tuned.

September 30, 2012

Big Question: Equilibrium and Stability

My senior year of high school I took my first economics course. We did a business proposal for opening a new restaurant franchise, and we learned some theory. The theory seemed fairly inane and innocuous. All we did was draw X's, occasionally with a price floor or a price ceiling. What seemed so straightforward to me at the time is perhaps the major postulate of modern economics: the idea that markets help supply and demand meet in the middle, automatically. In this post I want to look a bit more closely at that idea and when and why it may be true.

One of the big ideas in economics is that in markets, supply and demand tend toward equilibrium. Equilibrium is the happy place where buyers and sellers, in aggregate, agree on a price that allows as many people to buy the goods as can be supplied by the sellers. If the amount people will pay for the good changes, or the amount it costs to produce the good changes, that side changes their offered price and then the quantity adjusts appropriately. If people want lots of tulips and are willing to pay more for them, then more people will grow them. Similarly, if clothes become cheaper to produce, suppliers will sell them more cheaply and more people will buy more clothes. We own a lot more t-shirts these days than they did 200 years ago.

This is all common sense; the interesting stuff begins when equilibrium doesn't happen.

Which we will come to in a second. First, it is worth mentioning that equilibrium can happen too much. That is, sometimes it is possible to have "multiple equilibria"--markets may have two (or more) price/quantity combinations that buyers and sellers could end up agreeing too. This happens when the demand or supply curve gets more complicated than the traditional X (for example). Another famous macroeconomic example of multiple equilibria is the (simplified Keynesian) explanation for the Great Depression, where a collapse in demand dragged supply down supply, and the economy stabilized below its potential. Multiple equilibria can happen in markets for individual products as well: think about an expensive hotel in an exclusive resort destination, and then a few years later when the everyone has heard about it and college kids go there for spring break. The product is the same (minus the exclusivity) but now supply and demand have come to rest at a lower price.

Multiple equilibria are important--as the Keynes example shows, they are a factor in justifying major fiscal or monetary stimulus programs--but they are only one issue with the concept of equilibrium. The very idea that an economic system will gravitate toward any price point because of supply and demand forces is often suspect. Economists get around this by exploring "static" snapshots of reality, but even this is difficult because the only data you have is one point on the graph, and it is difficult to extrapolate the entire X from one point: the lines of the X may have different slopes or not be straight lines at all. Economists end up relying on "shocks" that hopefully affect only one side of the demand/supply equation: if the supply side stays constant, for example, it may be possible to see how the demand side of the curve is formed.

Static pictures, however, may fail to capture important dynamics--how the system may change over time because of the way supply and demand interact. This is what claims of equilibrium mean: that supply and demand, sellers and buyers, eventually agree on a price that supplies as many goods or services as can be supplied at the price people can pay for it. And eventually the amount supplied and demanded goes toward this price.

In many markets equilibrium may be a realistic assumption. But in others it may not be. Let's break it down a bit. Why might equilibrium--any equilibrium at all--not be a realistic state of affairs in a market?

We can think of markets with two other types of equilibria: equilibria that are unreachable or that are unsustainable. Unreachable equilibria are blocked for some reason, such as regulation or monopolization. The classic textbook example of an unreachable equilibria is price controls, where laws keep prices from reaching the point at which demand is met by as much supply as can be sustainably produced. Rent controls are a price ceiling, and may result in too little housing being provided--the shortage of housing prevents an equilibrium from being reached.

The idea of unsustainable equilibria is more complicated, because it depends on how supply and demand change and react to each other over time. This process of change and interaction works differently in different markets. One common way that they may fail to interact in a way that creates a sustainable equilibrium is when there is poor information: if price signals function poorly or not at all, suppliers and demanders may not have any way of communicating how much they want. This can happen if buyers do not have a good way of knowing how much a good is worth. Education "markets" are a good example: people buying education know that a good education is valuable but have no realistic way of knowing how valuable it will be, because their future is simply too uncertain.

Another example of unsustainable equilibria is Keynes's well-known idea of "animal spirits". This is slightly different than an information problem because, in markets where animal spirits play a prominent role, supply and demand may be based entirely on irrational emotions and perceptions of economic actors. That is, the problem is not in the imperfect information people have, it is in the imperfect rationality of the people themselves (they may have imperfect information as well, but that is beside the point).

Yet another market attribute that can disrupt the sustainability of an equilibrium is market connectedness: markets rarely exist in isolation, and the supply or demand of one market is often influenced by the supply and demand of other markets. One market may affect another market, and this second market may then affect the first market, either directly or through similar effects in other markets. The use of coal could lead to cheaper power which made the production of coal cheaper, for example.

In some cases linked markets may simply be understood as one market: if the cheaper price of flip-flops drives down the price of shoes, it may make better sense to simply analyze the footwear market overall. But in other cases it makes less intuitive sense to link markets because they do not serve as substitutes or complements to each other--they are only related because there is a finite amount of money in the system and money is fungible. Stuart Ewen, in his excellent critique of the genesis of the modern advertising industry, Captains of Consciousness, gives an example from the early days of industrialization: the demand for consumer products causes people to move to the city and work in factories to produce goods, but some of the goods demanded are demanded because of the move toward urbanization. Ewen writes about the Alpine Sun Lamp, which makes people feel like they are outdoors in the sunshine, which they presumably would have been if they still worked on a farm.

In this case connected markets experienced a kind of feedback loop. However, the connections between markets, or between markets and other social realities (such as politics), may have other impacts that preclude the existence of any meaningful equilibria. One example is the current price of Greek public debt: there is certainly a market "equilibrium" that is reached daily based on daily buying and selling, but this equilibrium is based to such a large degree on political expectations that it has little economic significance. Any equilibrium here only appears to be determined by supply and demand because those are the closest proximate causes. In reality, non-market political occurrences are far more powerful causes of market prices. Another example could be if the prices in a grain market are driven up by speculators searching for safer investments in commodities instead of in volatile currency markets. In such an example equilibrium in a single market may be meaningless, but any attempt to find an equilibrium across multiple markets is simply too complex to make meaningful sense of either (see: how quickly international trade models get hairy).

When thinking about equilibria, we need to make sure we understand that there may be economic forces (that is, incentives for market participants) pushing supply and demand toward an equilibrium, or there may not be. Or those forces could be pushing in several ways depending on other criteria. Or there may be outside forces that completely overpower any intra-market forces. In the words of Polanyi, "in no case can we assume the functioning of market laws unless a self-regulating market is shown to exist."

September 22, 2012

All the King's Theories and All the King's Thoughts

On a fundamental level, a level so fundamental that it describes pretty much everything but is mostly meaningless and uninteresting, our brains are distinguishing machines.  Basically, when we think, we separate things from each other mentally. The easiest metaphor, which is not really a metaphor, is the Hollywood view of someone regaining consciousness. On the screen we see the world through their vision: they open their eyes, their sight gradually sharpens, and they begin to distinguish one thing from another. From the moment we are born--and even before--we are separating things from each other in our mind. You could say we are "de-conflating" things.

But thinking is also about understanding the connections between things--understanding how things are not separate. Just like our hands connect to our shoulders by way of our arms or the light switch connects to the light, things are related by more abstract relationships as well: the ground is connected to the sky by relationships of gravity, distance, and the air in between; people connect to other people by means of family or friendship or professional or other relationships, now connects to later by means of all of the causes and effects that occur in between.

Sorry if this is sounding all mystical and wishy-washy; it is going to get worse before it gets better.

Because I am going to to talk about Yin and Yang for a second. I know next to nothing about non-western philosophy and my understanding of the concept of Yin and Yang does not go far beyond the the first few paragraphs of the wikipedia entry. The article summarizes the concept as describing "how polar opposites or seemingly contrary forces are interconnected and interdependent... and how they give rise to each other in turn in relation to each other." I have heard this described plenty of times and it seemed like an important truth and perspective on things but it never really grabbed me.

But the other day it kind of did, because I started thinking about it more in terms I usually use to think about other things--in this case, the distinction/connection framework above. And I rephrased it for myself in a way that I could understand a bit better.

Economics and politics are enormously complex systems that are full of relationships we can only scratch the surface of understanding. In our scratching, we have an easy enough time distinguishing something--we can measure GDP and payrolls and sales data, or votes, or demographics easily enough. (other things are much harder to measure and therefore distinguish, but that's a topic for another day) But we have a much harder time putting things back together. Economics is about cause and effect, and it has all kinds of snazzy ways to try and pull them apart, but putting them back together meaningfully is an awful lot of work and awfully indeterminate.

And so we arrive at the point I have been dancing around: we separate a lot of things in our minds that cannot truly be separated. Yin-Yang is a specific classic example of this: dark cannot exist without the light, good without evil. But our minds do this in all kinds of less abstract ways as well: supply and demand, employer and employee, policy and politician, winners and losers. We end up with two (or more) parts of something we have separated for convenience or because we did not understand them as one single thing.

And I am arguing that this can be a problem. When we forget that businesses need workers but they also need good leaders. When we forget that every dollar I have is a dollar you do not (or at least it lowers your purchasing power). When we forget that laws need people who understand them and obey them and are incentivized to do so.

Any time we are talking about an economic concept, that concept is embedded within a vast network of other concepts. This conceptual network has in turn been assembled to describe a vastly complex real world. Much of the most dangerous economic ideas--and I don't mean dangerous here in a good way--are those that ignore the vast complexity of reality in favor of their own internal logic. This can happen both through elaborate models based on shaky assumptions, or through a certain ignorance of the status quo and the variety of causes that have brought us to it.

More fundamentally, the idea of economics itself does not stand alone. Politics and economics are two concepts we separate but, when separated, they achieve a certain degree of rarefied meaninglessness. Trade may exist outside of formal authority (two merchant ships swapping rum for ale on the high seas, for example) but is never divorced from relationships of power (the ship with the bigger guns may end up with a better deal). Moreover, actual markets, in the sense of buyers and sellers coming together and creating a price) may indeed require formal authority. Certainly nobody is arguing too loudly that they do not; e.g. libertarians are arguing that markets require a very limited and specific amount of formal authority. Dean Baker describes the connection better than I can.

Our tendency to cut thing up is useful, but it can limit our ability to see the bigger picture. The complexity of political economy makes it difficult to answer many big questions conclusively, but in dividing and conquering we may find our separate territories less firmly in our grasp than we had believed. How do we avoid these pitfalls, particularly when specificity is a prerequisite to truth? When we try to connect the pieces back together, will we have a useful model or a two-dimensional picture of a three-dimensional world? How can we know a complex system in a relevant way?

One way to start is to acknowledge the complexity, particularly where economic ideas intersect with policy and the everyday life of non-economists. The political relevance of economics pushes it toward simplicity--politicians need clear numbers and talking points, not lengthy explanations without conclusions. This is a difficult tendency to counteract, but a possible attempt could be through better economics education. Economics is taught like a hard science, giving new students a toolbox of concepts and uncritical assumptions. These teachings percolate unhelpfully into popular discourse, lacking nuance and serving in the interest of polemics; teaching more of the controversy and the relevance could give students a far better appreciation of the role of economics in our world.

Everyone has, at one point or another, had a feeling of revelation. Some revelations are extremely mundane, others are esoteric--I don't necessarily mean some kind of transcendental religious enlightenment, perhaps just understanding a new mathematical idea or realizing why your friend was acting strangely. Sometimes revelations involve connecting ideas that had existed independently in your mind, sometimes they are new ways of cutting ideas up. But they cause us to think differently about things we already knew, or thought we knew.

The social sciences are endlessly revealing of the world we know or think we know, and the ways they break apart and reassemble the human relationships we thought we understood can be both immensely useful when juxtaposed against our own. But our recreated understanding is not necessarily any more "true" than whatever understanding we had previously, and we stand to lose something in our careful scientific analysis, because the real world is not an equation. Yin and Yang resist being broken apart, the analysis destroys the subject.

Alright--we probably don't need to be so melodramatic about it. But we should at least be wary of the the limits of abstraction.

September 9, 2012

Understanding Opportunity

In a recent post I did some thinking about opportunity and how we tend to confuse opportunity for one person with opportunity for everyone, overlooking the way systemic effects may overpower individual effects. This post looks more into the nature of opportunity itself; it is less about power and systems and games and more about what opportunity means to us and how it functions in our lives and political ideas.

Merriam-Webster defines opportunity as "a good chance for advancement or progress", but this definition does a poor job of capturing the word's political-economic implications. When we talk about opportunity, I would argue instead that we are talking about "the ability to succeed." But beyond this broad definition there is not a lot of agreement between different political persuasions.

There are several questions that can help us figure out what we are talking about when we talk about opportunity and "the ability to succeed." I start off asking, what is success and who do we see as successful people? Then I explore how likely we are to succeed. Finally, I examine what it takes to get there: how is success achieved? And how do we enourage it as a society?

What is success?

Success is a complex concept, but we can think of it terms of a number of handy ethe (I had to look that plural up): I'll call them White Picket Fence, Zuckerberg, Horatio, and Beating the Joneses. These ideas of success are from a purely economic standpoint; there are other, critically important factors that I do not consider here at all.

White Picket Fence is the idea that everyone who works hard is entitled to a decent middle class life. It's a common formulation of The American Dream. Success here is defined as reaching an acceptable median standard of income and achieving an acceptable quality of life. Part of the idea is that it's available to anyone and everyone--it's your door prize for being American, working hard, and playing by the rules.

Zuckerberg is the idea that you can not just succeed but... succeed. That you can blow everything else out of the water, because nothing is holding you back. The key to the Zuckerberg conception of success is that there are no limits, and that individuals are free to compete and to win, in ways that have never been known before, because it's better for society if they do. Not everyone will succeed, but that's ok--either because the winning ends up benefiting others (e.g. through new inventions) or the chance of being astronomically rich provides a crucial incentive for everyone.

Horatio is the idea that succeeding means doing better than your parents or your current situation. It's most closely aligned with the dictionary definition of opportunity--the idea of improvement and advancement. It measures your success relative to your past success--how you have advanced over time. It also has the most to do with the idea of a meritocracy, which will be discussed more below.

Beating the Joneses is the idea success means doing better than other people. It defines success as being above average, it's it's a relative measure it depends more than anything on the success of everyone around you. Of these models of success, it's at once the most social, small-minded, and maybe the most realistic in terms of what really motivates us. It may have implicit meritocratic assumptions ("I drive a bigger car because I'm smarter and do a better job at work.") or it may not ("I drive a bigger car because my parents were rich.").

While these visions of success are limited to economics (meaning they are only concerned with money and "stuff") they are nevertheless revealing. They can get us started thinking about what our goals are for our society. When we argue that having a large middle class is good for a country, we are arguing for the White Picket Fence idea of success. When we argue that tax rates on the rich are too high, we are arguing in favor the Zuckerberg idea. When we support first-generation college student subsidies, we support Horatio.

There are countless policies, laws, and economic forces that help shape what kind of vision of success is ultimately realized, and for whom. On an individual level, we can think of these things as affecting our chances of success.

How likely are we to succeed?

We often think of opportunity, and whether it exists in a society, in a sort of binary mindset: either on or off, nothing in between. Either you can lift yourself up by your bootstraps or you can't. Either you can get rich or you can't. Either a black man can go to Harvard and become President of the United States or he can't. The ability to do something is an important concern. But it can be a gross oversimplification.

Success is much better understood as a probability. It makes a big difference whether your probability of success is 10% or 100%, whether your chance of getting a job is 3% or 30%, or your chance of getting into a top school is 5% or 50%. If it is 50%, you are competing in with one other person; if it's 5% you are competing with 19. Do we want to live in a country where one person gets to be rich, one person gets to be middle class, and the other 8 people are poor?

As I wrote about in my recent post, we cannot ignore the structural aspects of success. School is a good example because there are clearly a limited set of outcomes (admittance) that qualify as a certain level of success (to a top school). It is important that anyone in the USA can go to a top school, but it is probably more important that everyone in the USA cannot go. If you dismiss the aggregate aspect, you miss out on a critical determinant of what success is and what it means for a society. Thinking of success in terms of probability can help us see those systemic effects in individual terms--it helps us see some of the implicit difference between Zuckerberg and White Picket Fence, for example.

Of course, the probability of success is not the same for everyone, and we need to better understand which aspects of success are structural and which are individually based. While there may be a limited number of admittance slots, some students are clearly more likely than others to get into the most prestigious schools. Some people are clearly more qualified for certain jobs. Merit and ability and a million other factors also play a role in success. But how much and in what way?

What does it take to get there?

The idea of success implies an attempt, an achievement arrived at through some means or another. You do not just wake up one morning and find yourself successful--it has identifiable causes.

One of those causes is luck, of course, but other causes of success are more determinate. You might be a brilliant, risk-taking entrepreneur and design something very useful that everyone wants, and in exchange they might give you enough of their money for you to be successful. You might study hard and work hard and provide a good deal of value for your employer. You might have a well-to-do family that made sure you did your homework and had tutors and got into the best college and got you in the door for an interview at a prestigious firm.

Opportunity as conceived of today in America is intimately connected to the idea of merit. The idea of a meritocracy, though originally intended as a distopian satire, has caught on as a sincere ideal precisely because it is a good thing when capable, motivated people can succeed in a society. Otherwise, why would anybody care about being motivated or capable? Although few people would probably turn down a winning lottery ticket, the visions of success listed above turn on deserved reward, not arbitrary benefit. This is a good thing, and I think it is much better than holding comparatively undeserved respect for an aristocracy.

But Young's original critique of the idea of meritocracy (previous link) still stands. Young argued that we could end up with a solidified ruling class built on arbitrary definitions of merit that are hardly fairer than divine right: a new aristocracy based on whose kids went to the best prep schools, or based on whose kids did not grow up raised by absentee fathers and gangs on the street corner.

Young argues (as I understand from his article; I haven't read Rise of the Meritocracy) that we need to have a broad, accessible vision of success. That even if we can conceive of a completely fair selection process for success, it is dangerously possible to have outcomes of such a system that are anything but fair. If we have an economy where everyone takes a test and the top 10% of people get great jobs and the other 90% of people end up working work fast food, fairness does not get us very far. We would have built a system that fails to incentivize the majority of people.

You may counter that fairness be damned, society still needs some kind of selection process. We would not watch much pro basketball if NBA teams were required to give anybody who tried out a spot on their starting lineup. We prefer our leaders to be competent and hardworking and our scientists to have a clue. We can't just give jobs to whoever wants them--many of them require smart, capable people.

Of course we need a selection process. But the current process is problematic it is in many ways not set up to incentivize people for absolute success--and absolute success is what matters more for society. Businesses want people with certain definable skills, not just someone who is better than somebody else. We want leaders with integrity and competence, not simply a leader who is not as bad as some other guy. Relative comparisons do matter, but not nearly as much. Selection can be fair without it doing a good job of incentivizing real achievement, because our chances are based on relative criteria: if I know I have to be the best to succeed, I might be less motivated than if I instead have to have a high level of competence.

Looking at society more broadly, it seems to make sense to structure an economic system so that individual success is achieved by the creation of public value both now and in the future. This is the whole idea behind the invisible hand. However, a given individual's relative success matters little to the society as a whole--the absolute level of success, as measured by education and skill and competence and motivation is far more important. If we want to have an economic system with opportunity, we need individual freedom and meritocratic individual incentives, but we also need a system that rewards people for absolute performance and achievement and not only relative achievement.

September 3, 2012

Labor Day Grab Bag

Well folks, it is Labor Day again here in the USA. One of the most interesting things about Labor Day, in case you were not already aware of it, is that the rest of the world celebrates labor day on May 1st. But they celebrate it then as a memorial to a labor dispute (and subsequent sham trial) that occurred in the United States. President Cleveland chose the September holiday because the government was worried about encouraging links with international communist and anarchist movements.

I did not have the foresight to write up a long thoughtful post for all of you, so I'll try to redirect you to some long thoughtful writings elsewhere. Here are some of the most interesting things I've read lately related to labor.

For starters, I was recently reading an article in which (fairly prominent) labor economist Richard Freeman discusses his recommended reads about the labor movement, and was surprised to find one a pithy and coherent economic defense of unions in the comments section, of all places. I followed the commenter's link to his short-lived blog and found another good free-market defense of unions there. I will definitely be writing more about this in the future.

The next link is an in-depth look at the dynamics of power within the workplace, in the context of refuting libertarian simplifications about power. This is long but highly recommended; it has definitely been influential in my thought process lately (if you can't tell from some of my posts).

If you have been wasting any time online this past few days you have likely seen and already read Matt Taibbi's brutal article about Romney and Bain Capital. Taibbi is really taking issue with much more than Romney, however: he is arguing against a corporate-raider style, short-term profit oriented capitalist system. Because such a system ends up benefiting almost no-one. This is a disputable point, of course. The question is how tenable companies that failed (or shed workers) after a Bain takeover were before the takeover--whether Bain was simply hastening what would have happened anyway. Regardless, it is easy to see how this style of capitalism has impacted worker welfare.

Finally, more in the spirit of May 1 than September 3, here are two articles about the labor movement in China. Our economies are intimately linked and it is not really possible to understand labor issues from a purely domestic standpoint.

August 29, 2012

Everybody Wins

Everyone loves the Olympics. Normal human beings, through their otherworldly persistence and talent and physique, are transformed for a few weeks into a vast pantheon of gods, each lording over his or her small, specific domain. Three medals are awarded, but there is only is only one winner: the best out of billions.

That's what tournaments like the Olympics are designed to do: find the best. They do this through various designs--single elimination brackets, round robin play, point differentials. Each participant works their way towards a single goal, and after every game or match they are sorted according to strict rules for winning or losing. But regardless of the format, one winner remains. That's how tournaments are designed.

Tournaments are built to find a winner, but in terms of numbers they are much better at creating losers. And that is not even counting the "implicit losers" like you and me--and all the people around the world that don't even try to compete. Imagine if we all had to participate in the Olympics: if everyone in the world had to run the marathon, swim the 400 butterfly, and attempt to lift barbells over our head. It would be a mess.

The tournament format of the Olympics works because competing is optional. If that was you in the pool barely making it back to the wall, how excited would you be every four years?


Just like their Michael Phelpses and Dream Teams, Americans are proud of their Horatio Algers and Mark Zuckerbergs. It's great to live in a society where anyone can become rich with a bit of luck and a dabble of hard work. The word "opportunity" fills us with warm fuzzies and epic trumpets at the same time. It's so fair.

But there's a distinction that doesn't get made often enough, between anyone and everyone. Anyone can become rich, but can everyone become rich? What if you get your bit of luck and put in your dabble of hard work... but so does the other guy. What happens then? Does the wealth just split down the middle? Or does the person with the extra smidgen of luck (or the one short a few scruples) end up grabbing it all?

Sure: in a sense everyone, or mostly everyone, has become rich--relative to Americans 100 years ago or a rural farmer in India. These are absolute terms. And the bar is set rather low. In relative terms, measuring the gap between members of society, it's another story. American income is more unequal now than any time since the great depression (see this excel file); wealth is worse. Further, since the 1980s we things have been getting worse for many people even in absolute terms (see this pdf report).


The rules of our economy are far less clear than the 100m dash. We don't have to run the same direction, we are allowed to carry other people or trip them, it takes far, far longer. But the Olympic metaphor is a useful one, because it's useful to think of an economy as a system of rules that produces certain outcomes. We know this intuitively; for example, we care about how much the government levels the playing field or holds us back. Depending on how we believe certain rules work, we have different ideas about which rules should exist.

What we tend to overlook is the fact that we are all playing together, and, like a tournament, the rules of the game often dictate that our individual level of performance is irrelevant. What matters instead is how we perform relative to others. It doesn't matter if you scored 99% if everybody else got it perfect, if you broke last year's world record if everyone else breaks it more.

Sure, for some things individual performance is fine--if you are cooking your dinner for yourself, for example. But if you want to be a chef--if you want to cook for economic gain--your ability to do so is determined not solely by how good your food is but by a host of other factors as well. These factors (the number of restaurants, the number of other people competing to be chefs, the ease of opening a new restaurant) are not something you control, they are not something any other person controls directly, and they may not be something anyone even could control.

My purpose isn't to conduct a detailed analysis of the restaurant industry, however. I am arguing that our economy, like the Olympics, functions according to a set of rules. Those rules may be as immutable as the laws of physics or the amount of gold currently present on earth. They may be clearly defined but socially determined laws, like the amount of taxes you pay or the fact that you generally aren't allowed to steal things.

BUT--and this is my real point--there are also rules that we understand far less well and may not even realize exist. Causes and effects that are only dimly aware of. These rules are often complex: they depend on giant masses of people each acting in their own way. Such things are what economics tries to study--but as any economist will readily tell you, the tools and scope of economics are extremely limited.

To really understand the distinction between "every" and "any", between the Olympics and, say, a yoga retreat, we need to understand how wealth and resources move around an economic system: to "follow the money" in its weblike complexity. Does wealth spread out or concentrate? Does it flow toward or away from power? Can everybody be a winner? Or does one person's loss necessitate another's gain?

Such questions will be the subject of posts to come.

August 25, 2012

Fear of Powerlessness

Fear shapes our decisions, so it also shapes the society we construct out of those decisions. In this follow-up post to What Are We Afraid Of? and Fear of Loss, I want to explore the way fears shape a social institution fundamental to modern society--the government.


Previously, in a large list of fears, I categorized a bunch of fears as "Fear of Powerlessness". They were the following:

-lack of opportunity
-not being able to choose what we want to
-feeling that we failed
-lack of self-determination
-being forced to do things we don't want to
-youth (as weakness/infantility)
-arbitrariness of other people's power

While this list is not exactly the stuff that horror movies are made of, it's certainly embedded into many political ads.

The Daily Show with Jon StewartMon - Thurs 11p / 10c
Indecision 2012 - Endless Suffrage 2012 - Rick Santorum's "Obamaville" Ad

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(Santorum removed the ad from youtube and this is the only version I could find)

The ad is over the top, but it doesn't exaggerate the fear that many people have of government. What's odd is that government was created in order to reduce fear. To oversimplify Hobbes, governments protect us from our brutish, nasty, short, and perhaps most of all fearful life.

But if we are now afraid of government, does that mean it's not doing its job? If we created government to help us get rid of fear, but now we are afraid of it, maybe we should just get rid of government. Or at least pull out its nasty big pointy teeth.


Let's think for a minute about fear. When you're afraid of something, where does that fear come from?

The answer to that question depends on how you are thinking about fear. In an important way, of course, fear is a wholly interal product of our minds. But most fear is also more than that, and it's the "more than that", the external roots of fear that I want to talk about here. We can also think of our fears as being realized by other people: a thief takes your wallet, your boss fires you, a policeman arrests you and takes you to jail. But while the individual view is true in a way, it disregards the fact that power--and thus the conceptual root of our fear of powerlessness, loss, and other social forms as well--comes to a great extent from groups and their power over us.

It is this power that I want to think about here. We are all ultimately only individuals, and groups represent a potential threat because they have the potential to be much more powerful than any single person. But while groups can be threatening, group membership can also act a safeguard by establishing rules and order among members. The inner dynamics of the groups we are submerged in--their hierarchies, rules, and values--create new power dynamics between individuals. This power can be an enormous benefit to inviduals collectively, but we should respect and fear power in all forms.

Beyond established groups, there are social practices or beliefs that large numbers of people engage in. These kinds of beliefs or practices can be powerful because, like a group, they can influence the way large numbers of people act (e.g. homophobia can damage lives without there being a cohesive anti-gay group). Unlike a group, however, there are no identifiable structures or even relations amongst group members. Some political theorists use the word "institutions" to talk about about both groups as well as these other social phenomena. These theorists might utter such a sentence as: "Institutional factors like rampant corruption and the power of rural landowners in government are holding back economic growth."

While there are those who speculate about its loss of influence and possible demise, and some that are in fact quite weak, national governments are nevertheless the most powerful groups in the world today. Like other institutions, governments have been created (in part) to reduce fear of powerlessness. Government is involved in safeguarding us from fears in a myriad ways: police prevent us from hurting people; property rights prevent people from taking our things; public schools provide educational opportunity; in countries with state-run healthcare, the government helps minimize your fear of bad health.

However, one of the important things government does, something that gets lost sometimes amidst our concern for individual rights, is set the rules for other groups. Governments ensure that one church congretation can't just go and kill a different congregation they disagree with, that one racial group can't discriminate against another, that corporations can't use their private security forces to disappear you if you come up with a better product. As I began to explain in the recent post about defintions of power, government tries to minimize exploitative exercise of power; given the natural imbalance of power between groups and individuals, and between different types and sizes of groups, this job of government is absolutely critical. Conservatives tend to believe that government does this job best by simply enforcing property rights, providing a justice system, and letting the market solve the rest; liberals believe government must play a more active role mediating between other types of power, both within and outside of the marketplace.

But government--a group that controls the police and military and vast resources--is always also a source of fears, and we have therefore tried to set it up in a way that minimizes those fears. As everyone who went to school in the US knows well, the US government has a system of checks and balances to prevent the state itself from being taken over and used against other people. This is supposed to help keep the state from acting out the fears of powerlessness, loss, or injury. Having written laws and rules and regulations also, in theory, may prevent the use of state power in arbitrary or biased ways.

These safeguards are meant to ensure that government helps eliminate fears without adding new ones, but they are not enough in all cases. There are good arguments against the concentration of state power, and many people in the USA (particularly conservatives) have a healthy fear of the power of the state, the extention of power of the state for its own sake, and the power of the state being used by certain groups against others. There are things that governments have not been good at doing (like efficient allocation of some resources), and there are things that governments have been too good at doing (like putting people in jail or blocking good ideas about how to reform itself). And as the most powerful group, the government's power can be used by other groups (or individuals) to leverage their own, to the detriment of the country.

But we need that power structure. Laws and police and order are immensely useful and a world without them is reasonably terrifying. So where does this leave us?

Politically aware and engaged, confronting and managing our fears. If we let certain fears dominate us as a society we will not only be unable to deal with other fears, we will be unable to deal even reasonably with the fear we have. We need to understand the many ways our fears listed above can be realized, and the complex systems we have put in place to avoid or eliminate them. I certainly think it's possible; but we need to be vigilant about not letting fear crowd out thinking.

I would leave you hear with a quote by FDR, but I don't think I even need to type it out.

August 22, 2012

Vocabulary and Communication

It can be helpful to define new ideas using new vocabulary, newly affixed meanings, or redefinition; in many ways it is essential. But this kind of thinking, while hopefully productive, may have problematic side effects. It may also lead us further down a sort of linguistic rabbit hole, where we appear to be talking nonsense to everyone else. There are some great blogs out there and some great thinkers...who are borderline incomprehensible.

This is something I would like to avoid. It's easy when you are attempting to think for yourself to create magical worlds out of words and concepts that build on each other. On one hand, this may be necessary or at least conducive to new insights. On the other hand, your ideas may end up bearing little relation to anything but themselves, being insulated from the real world solely through incomprehensibility. Such isolation also prevents the cross-pollination or spread of ideas.

To that end, I am trying to use economic jargon as little as possible and define it clearly and succintly if the concept seems necesssary. I want to avoid blank stares, and perhaps more importantly, coming to brilliant conclusions that would seem obvious if spoken in a more common parlance. If this blog ever appears to be defining and using new vocabulary unnecessarily, please complain. Help fight conceptual isolation!

August 15, 2012

Fear of Loss

This is a follow-up to the post What Are We Afraid Of, looking more specifically at how we fear loss and how we have attempted as a society to deal with that fear.


We have more stuff today, more physical things like chairs and cars and plates and shoes and paintings and houseplants and clothes, than any society before us has ever had. Why is that?

Obviously, it's because our technology is far more advanced than it's ever been. But it's also because our society is set up to help us get stuff--and help us keep it. The keeping part is more important than you might think. As much as we like getting things, we like not losing them more. We don't like losing anything.

Loss happens for any number of reasons: whenever we have something and then someone or something takes it from us. Interestingly, the "something" that we lose can be as immaterial as a hope or desire--we feel loss when the possibility of winning the game is taken from us, or when the red wagon in the shop window is sold to someone else.

There are well-established theories that explain why and how our brain resists giving things up. One of these theories is called "loss aversion" by economists, and they have devised some interesting studies to show how much more "psychologically powerful" losses are than gains. In other words, this means that people value things they already have more than things they do not have, even if the thing is exactly the same (like money). Wikipedia explains it fairly well so I won't go into more details here.

Another relevant theory in economics is simply that people value security. Security helps reduce risk of loss, which people fear. Security also changes incentives, though. If you were going to die tomorrow it would completely change what you did today. In the same way, security can change what people do with their time and money longer term: if you know you will make more money for the rest of your life if you go to college ("invest in your human capital"), you might be more likely to do so.

Laws about property rights, backed up by state power, are very helpful for alleviating fears of loss because they provide security and stop people from taking our things. If our neighbor takes our car and will not give it back, we can go to the police and show them the title and get them to arrest our neighbor for grand theft auto. But of course, that's not what happens: what having property rights really means is that our neighbor will not even try to take our car, because he knows what could happen if he did. And that fact may help us decide to buy a car in the first place--if our neighbor can just drive it away, and all we could do was chase after him flailing our arms, why would we save up for a car at all?

Property rights are great at alleviating our fear of loss, because they help align incentives between people for everyone's benefit. If somebody has something shiny that you want, and you know that if you try to take it from him he will get mad and call the police, what can you do? You can offer him something that he wants. With no property rights, the invisible hand can't function, because it's too easy to resort to non-market action (aka stealing or taking without fair compensation). Property rights have helped get us all the stuff we have today, because they help limit our fear of loss, and instead of taking things we have to trade.

So, it's good that we have property rights. In fact, it's such a good idea that we sometimes forget it's an idea at all. We forget that both the legal infrastructure and the idea of ownership itself are social constructs, that they only exist because everyone believes in them and acts as though they exist. And people are barely even fooled--try leaving your bike unlocked in front of your house overnight. No matter how well you label it (THIS IS MINE! NOT YOURS!), it will likely be gone in the morning. In other words, there is no physical law of the universe that makes something yours and something else someone else's: ownership is something granted by the law and the power of the state, which in turn comes from the consent of the people.

Despite their benefits, we can carry the idea of property rights too far. Do you remember when you were a kid and you had a fight with your brother or sister or friend and drew a line on the ground to show whose side of the room was was whose? How about all the times your parents made you share your toys? At the time, as a 4-year-old, property rights might have seemed like a great idea to you. As adults they seem a bit... exaggerated. We can see that there are more important things.

One of those things is fairness. Property rights are often unfair. And as whiney as that sounds, capitalism does create winners and losers--even the most conservative libertarian will readily admit that. We can debate about what is "fair" and what is not. But there is no reason fair has to mean everything: we as a society have chosen to define private property and thus we as a society, even as an adamantly capitalist society, have the ability to put bounds on how much property a single person can have.

Certain bounds may not be pragmatic, obviously. But if we're thinking about the idea of property pragmatically then I have made my point, that the concept of private property is a means, not an end in itself. It can motivate us to be productive and to trade with others, but we should also be careful not to cling to the idea of ownership for its own sake. There are things it doesn't make sense for a person to own, like roads and schools and money that is sitting in a bank doing nothing while people are starving.

Loss is a powerful fear and we have set up a powerful system to deal with it. We should not be ruled by that fear and we should not forget that the system was set up for a purpose.