Tuesday, February 10, 2009

Unintended consequences

My uncle was an engineer maintaining the facilities at Ohio University. He built a little suspension bridge to connect the campus to the golf course. They had no budget, so he scrounged together parts and they built the bridge for about $500 in the 1960s. It was replaced 30+ years later by a bridge that cost about $500,000 -- 1000 times more. Your gov't spenders at work.

But my uncle's bridge was not built far enough over the river. They figured that if the water came up more than four feet, no one was going to go golfing anyway. One winter day, the bridge started catching the ice that was floating down the river, turning it into more of dam than a bridge. It's hard to think of every contingency when designing something. That's true even of something as simple as a 150 foot suspension bridge.

They watched as the water backed up behind the accumulating ice. What to do? One fellow suggested that maybe they could use dynamite to break it up. That seemed a bit dangerous, so they decided to go to breakfast and talk about it.

An hour or so later, they returned to the bridge to find that the water had risen while they were at breakfast and pushed the ice chunks over the bridge and downriver. Problem solved.

Sometimes the best thing to do is nothing at all. Have a nice breakfast.

Thursday, February 05, 2009

The velocity of money

I got a letter from a relative who says that she does not want to buy from companies like Nike because they exploit their workers. There seems to be a bit of a contradiction in what she said, in that she said she doesn't care about these people but she does not want to buy anything made by slaves or children or sweatshop workers (presumably because such work exploits them). Let us leave aside the notion that these people work voluntarily under such conditions in order to avoid worse conditions, that what is seen as a miserable existence to us is a step up for them from an even more miserable existence. I am focusing on this paradox: that she seems to care more about punishing those who make a profit from these people then she does about the people they are supposedly exploiting.

As for jingoism, my father's father ran for Congress in the 1930s and his number one issue was to preserve American jobs by raising tariffs. This was the accepted Republican doctrine of the day, a contrast to today's Republicans who tend to support free trade. Economists agreed then as now that raising tariffs was one of Hoover's big mistakes (another mistake was raising taxes quite a bit in a slow economy, when money was already tight).

But trade barriers, like union labor barriers, look good only when you consider their effect on a subset of people. When you consider the universe of people, they don't look so good. It is true that a union raises the wages of its members, but that also limits the number of people a business can hire at that wage (assuming that the business had already determined what fraction of its budget to devote to labor costs). This means that some people who would be available and willing to work at that company, even at a lower wage, will go unemployed. Is it better for 75 people to get 100 quatloos per month or for 100 people to get 75 quatloos (a quatloo being a Star Trek unit of currency).

The union worker says, "Yeah, it's better to have only 75 workers making a higher wage because I'm amongst the lucky 75 and the other 74 are my brothers and sisters in the union." The poor, unemployed schmucks on the outside have a different opinion. It is obvious they will never agree. But theirs is not the only consideration. Presumably, a group of 100 employees are more productive than a group of 75. All other things being equal, they are 33% more productive and produce 33% higher profit. A company with 33% more profit can afford to either hire more workers (if the market warrants it) or pay higher wages to its workers in order to secure its productive labor force in a competitive market. Or it might not expend the additional profit in labor, but might invest it in equipment. In this case, the benefit spills out of the company and into the coffers of its vendors. Conversely, when that profit is not earned as in our example where the company is restricted to 75 workers, this hurts not only the 25 workers who did not get hired today, but the various vendors who did not sell their wares.

Lowering labor costs is just one of many ways of boosting productivity, but higher productivity is good for society. It is what grows the economy. There was a time when people feared that automation would put people out of work and eventually only the employed elite would be able to survive (the rest, presumably, would have starved). In retrospect, we see that this did not happen. Not only do workers have a higher standard of living than 100 years ago, but we work fewer hours to make that living (and live longer).

As workers, we would prefer that productivity be increased through other means than having our wages cut, but the economic forces have no preference. I am not arguing that unions do not have the right to agitate for higher wages, and I certainly understand the reason for it. It's just that the effect of unions is higher wages and the effect of higher wages is also lower productivity and less than optimal economic growth.

The same principle undergirds trade barriers and union labor barriers: Both restrict the flow of capital. The union constrains capital to be spent on a less productive workforce. Trade barriers constrain capital to be spent on more expensive goods, presumably made by less productive workers. This depresses the economy by keeping money from getting re-spent. If I have to buy more expensive American-made goods, I might run out of budgeted money in the first store, so I never get to the next store to buy something from them. When money is concentrated with one entity, the more likely it is to be saved instead of spent.

Going back to my simplistic union example, the union shop supports 75 spenders and the non-union shop supports 100 spenders. Just as a sieve with 100 holes lose water faster than an equal-sized sieve with 75 holes, a community with 1,000,000 spenders spends money faster than a similar community with 750,000 spenders.

Economists speak of the velocity of money, which measures the rate at which the same dollar gets re-spent. They call this measure the M1 money multiplier. You can see what happened to the velocity of money this fall in this chart. It depicts a historic drop-off in the velocity of money. It would seem to me that the last thing you would want to do at this time is decrease the number of spenders in the global economy by restricting the flow of capital.

This is not just theory, either. America tried protectionism in the 1930s, the very sort of protectionism my grandfather espoused. We see where that got us.