Tracing consequences both seen and unseen.
Lee SharpeKrugman Gets The Broken Window Wrong
Posted at 12:03 am on September 12, 2012, by Lee Sharpe

Recently, Krugman wrote that if you think the iPhone 5 will boost the econonmy, then you believe in the Broken Window theory. The Broken Window Theory, more accurately described as the Broken Window Fallacy, is the belief that destruction can boost the economy, as people, companies, and governments spend to replace them. Krugman is a big proponent of this plan, even going as far to argue that spending to prepare against a space alien threat would be good for the econonmy, even if it turned out to be false.

But I’ll focus here on Krugman’s iPhone argument. He writes:

The key point is that the optimism about the iPhone’s effects has nothing (or at any rate not much) to do with the presumed quality of the phone, and the ways in which it might make us happier or more productive. Instead, the immediate gains would come from the way the new phone would get people to junk their old phones and replace them.

In other words, if you believe that the iPhone really might give the economy a big boost, you have — whether you realize it or not — bought into a version of the “broken windows” theory, in which destroying some capital can actually be a good thing under depression conditions.

If the iPhone 5 boosts the economy, and I believe it probably will, it’s because consumers feel it will create more value for them than the other uses they may have for their money. The “destruction” Krugman refers to people’s previous phones. But their other phones are not destroyed!

They could sell their old phone, give it to a family or friend, donate it to charity, or any number of other options. But they find purchasing a new phone to be worth it. If their previous phone was so truly bad that it doesn’t have other uses anymore and the best thing to do is throw it away, then by definition nothing of value has been lost, so even in this case there is no real destruction as meant by the Broken Window Fallacy, where the owner of property suffers an involuntarily loss.

But suppose there was an involuntary loss. Let’s say their old phone broke down and was out of warranty. In this case there certainly was destruction, and the person is buying the new phone to replace their old one. Maybe this is the case that Krugman means, although I would argue this is small minority of the iPhone 5 purchasers. But if these people wouldn’t have bought an iPhone 5 if their broken phone still worked, is that really a boost to the economy in the aggregate? Only if you look at what is seen (buying the iPhone 5 and creating employment in that industry). But we also need to look at what is unseen: Not buying the iPhone 5 would mean spending that money on something else, which creates employment in whatever industry the money would be spent on otherwise. So really when the person’s old phone breaks, the economy is down one phone, which makes it worse off, not better.

Krugman attacks the Broken Window fallacy, as he doesn’t believe it’s a fallacy at all. But the truth is that economic growth created by the iPhone 5 will be because it creates more value for consumers than it costs them to buy it, not because of any destruction that is happening. For a more thorough explanation of why the Broken Window Fallacy is a fallacy, I highly suggest watching this video:

Filed under: Economic Theory
Comments: 3 Comments

Lee SharpeThe Case Against Net Neutrality
Posted at 10:06 am on August 11, 2010, by Lee Sharpe

What is “net neutrality”? Net neutrality is government regulation which prohibits internet service providers from diffrentiating internet traffic based upon its content and/or the service being used. Advocates are concerned about internet service providers charging different amounts for different types of traffic or manipulating how internet traffic is processed so, for example, to increase the priority of a certain website’s traffic or decrease the priority of a certain website’s traffic.

Generally, regulation advocates point to something happening, identify it as a problem that government needs to solve, and propose regulation they feel will accomplish that goal. This is not the case with net neutrality because right now internet service providers are voluntarily complying with the standards net neutrality advocates seek to codify. This is even after a federal appeals court ruled in Comcast v. FCC that the FCC (at least currently) lacks the authority to prevent companies from engaging in this behavior. Given all of this, one must wonder why is regulation needed to address this in the first place.

Like many other newspapers, the New York Times runs advertisements. The newspaper and advertiser agree on the ad, where it will appear, how much it will cost, and on which printing(s) it will appear. All well and good. And, of course, the New York Times can reject any ad which it does not wish to run. The reason could be because the content is inappropriate for the paper’s readership. It could be because it advertises a competing newspaper. It could be because the editor has a random grudge against a local business and won’t support its ads. Whatever the reason, the New York Times has the freedom to not run certain advertisements. The freedom to refuse to facilitate speech one doesn’t like is part of one’s First Amendment freedom of speech rights. There is no reason this right should not carry over to internet providers as well, just like any other entity.

Many airlines offer passengers who pay for a “first class” ticket improved service for extra money. This extra service is for those willing to pay more. In addition to covering the costs of providing the extra service, this revenue helps the airlines lower fares for the other passengers, so its existence helps them as well. Similarly, television providers (both cable and satellite) offer various premium channel packages for extra fees. Nothing is wrong with these business models. Of course, nothing is wrong with a business model that handles all traffic equally either. Supply and demand will determine which business models are best just fine, just as described above in the airline and television industries. Congress and the FCC do not need to enforce a particular business model on internet service providers, as it might end up that way in the future. It’s entirely possible that at some point poorer consumers will be served by options of cheaper, more limited internet. Under net neutrality, however, internet service providers would be prohibited from pursuing such plans.

Logically, companies in any industry don’t want to be regulated. So it should cause one to pause when companies in an industry come out in favor of them being regulated. Google and Verizon Wireless did just that in a recent joint proposal to the FCC as a suggestion for how to implement Net Neutrality. In the first four of their seven points, Google and Verizon start off sounding like they support their own regulation. (“This means that for the first time, wireline broadband providers would not be able to discriminate against or prioritize lawful internet content, applications or services in a way that causes harm to users or competition.”) However, the fifth and sixth create a couple exceptions to their Net Neutrality propsals for “additional services” (it’s unclear how this is defined) and internet service provided wirelessly.

Now that we’ve examined their proposal, we should ask why would they propose it in the first place? The answer is to gain an advantage over its competitors, an example of behavior known as rent seeking. Businesses can and will use not just market advantages to seek profit, but legislative advantages if it can create them. Verizon is already a leader in wireless internet service, and with its FIOS technology and Google’s constant innovations, it seems like these rules are being constructed to create an advantage over more traditional internet service providers which use DSL or cable lines and would thus be subject to the net neutrality provisions while Google and Verizon are comparitively less regulated.

The common response to this by net neutrality advocates is to reject the Google and Verizon plan and adopt a stronger one instead. Indeed, this is already happening by some advocates. History shows, however, that industry is heavily involved in the regulatory process and puts heavy pressure to implement them in its favor. This is common with regulation, since the benefits to a single given consumer from net neutrality are relatively minor, while the costs are borne by the companies. Since these internet service providers don’t really care about much except internet aceess, they have lot of reason to lobby and shape the regulation to their advantage, and bigger providers have more resources to do this. Consumers care, but it is a small fraction of things they must worry about in their lives, and give the legislation little attention. This results in regulation that hurts consumers by distorting the industry away from customers’ true preferences. For example, exempting wireless from net neutrality may mean that cheap wireless limited internet plans exist, while even cheaper cable ones legally can’t, which hurts consumers seeking this type of plan. The net result of all of this is the FCC implementing policies that actually have significant support from within the industry. However, if the regulation was actually achieving its goals, this regulation should actually be opposed by the industry.

If the government regulates net neutrality, policies for internet access are set by one entity: the FCC. However, if the government stays out, each company will set its own policies. If you don’t like the FCC’s policies, you are stuck with them unless you leave the United States. If you don’t like your internet service provider’s policies, you can simply switch to another one. So which model sounds better to you?

Update: The Electonic Frontier Foundation is also worried about the phenomenon I descibed above (Hat Tip to @wilw):

Efforts to protect net neutrality that involve government regulation have always faced one fundamental obstacle: the substantial danger that the regulators will cause more harm than good for the Internet. The worst case scenario would be that, in allowing the FCC to regulate the Internet, we open the door for big business, Hollywood and the indecency police to exert even more influence on the Net than they do now.

Filed under: Internet, Regulation
Comments: 85 Comments

Lee SharpeFinancial Reform
Posted at 11:19 pm on May 23, 2010, by Lee Sharpe

With the financial reform bill through both houses of Congress, it’s time to look at its contents, which do not look good at all for fans of limited government.

Banks are taxed to pay for bailouts. Since banks will pass these taxes on to consumers, really it means bank customers (almost all Americans) will be paying for more bank bailouts. What those who take this view fail to see is that making banks “too big to fail” means that those banks will engage in as risky behavior as possible. Did their risks pay off? They keep the profits. Did the risks not pay off? That’s not on the banks, because the American public will be covering those losses instead.

Ah, say the the more nuanced supporters of this legislation. That is this bill, to quote CNN:

New oversight power: Creates a new oversight council that would look out for major problems at large financial firms. The Treasury Department gains a key role in enforcing tougher regulations on larger firms and watching for systemic risk. The council also has veto power over new rules proposed by [a] new consumer regulator.

How much risk is too much? I don’t know, neither does the governement, and probably the firms don’t know either. But if firms are all free to be as risky as they like — receiving the profits when they’re correct and being forced to endure the losses when they don’t (even at the risk of going bankrupt) — then the market will learn which risky behavior to avoid and which works.

Instead government is guessing how much regulation is appropriate. Since the government (through creating expectations and in some cases guarantees of bailouts) is already encouraging banks to provide risky loans, if regulations don’t mitigate this enough, the banks have to be bailed out at the public’s expense. If the regulations mitigate this too much, reasonable loans that banks and recipients would both agree to the terms to will be banned by the government, slowing economic growth.

Banks profiting from their investments is good for everyone. Home buyers and small business owners often need loans to succeed. Banks make more money in the long run, which they can use to make even more loans to others. Without the government’s help, this has been occuring to the mutual benefit of investors and loan recipiants. These home purchases and small businesses create direct and indirect employment. Having bankers and investors make their own choices and receive both the positive and negative consequences of their lending decisions is a much more effective way of doing that. It also doesn’t cost the public a thing.

Filed under: Finance, Regulation
Comments: Comments Off on Financial Reform

Lee SharpeEmployee Benefit Mandates Are Lose/Lose
Posted at 9:39 pm on April 9, 2010, by Lee Sharpe

If you were an employer, would you rather have (at the same hourly wage) a full time worker working 40 hours/week, or two part time workers working 20 hours/week each?  Most employers would answer with the former.  A worker who has a full time job is (or will be in time) more experienced than a part time worker, because of the larger number of hours worked.  Further, a full time job obviously provides a better source of income to a worker than a part time job does, so a full time worker is less likely to look for more work elsewhere, which once it occurs deprives the employer of the experience that worker already had.

So why are so many employers forcing employees to work part time hours or as temporary employees rather than provide them with a full time job?  Because health care is expensive, and many governments mandate that employers provide health benefits to full time workers.  This incentivizes employers to keep the full time employment payroll to a minimum, which as described above is often worse for both employer and worker.  Many workers now forced to work 20 or 30 hours/week would be happy to work 40 hours/week in order to bring home more money, even without health insurance.  And wanting more experienced workers on the job, employers in many cases would be happy to provide it.  But instead well-meaning politicians are making the lives of these poor workers worse, and the customers of their employer have to deal with a less experienced workforce.

Such policies are worse for employers, worse for workers, and worse for consumers.

Filed under: Regulation
Comments: 1 Comment

Lee SharpeCurrency Devaluation
Posted at 3:34 pm on March 25, 2010, by Lee Sharpe

A recent NPR podcast discussed how Paul Krugman and other economists are criticizing the Chinese bank for increasing the supply of its own currency, thereby deflating it relative to the dollar and other currencies.

As the podcast correctly evaluates, the result of this is that Chinese exports are cheaper to consumers in other countries, and goods China imports are more expensive for consumers there. Chinese exporters understand this phenomenon all too well, and realize they are going to increase their market share and profit if the currency is devalued, and probably lobbied the Chinese government to make it happen in the first place.  Chinese politicians and the general Chinese public can feel great about this wonderful plan to increase Chinese industry and provide jobs!

Naturally, some in the United States are upset because American producers of the same goods are now at a competitive disadvantage with Chinese producers, costing the American producers money and costing them jobs. Sounds like the United States government needs to do something about this, right?  You’d certainly get that impression from listening to the NPR podcast.

Alas, this evaluation is exactly what Henry Hazlitt warns about in the lesson from which this blog derives its name.  It ignores the other results of China’s actions. Chinese currency devaluation means that Chinese goods are cheaper in the United States.  This is wonderful news for American consumers!  (And, for that matter, everyone else in the world except China, but I’ll focus on the United States.)  Meanwhile, Chinese consumers are forced to deal with more expensive imported goods into China.  American consumers are now helping the U.S. economy more, since they can buy more goods with the same amount American money, creating employment to meet the new demand.  Conversely, Chinese consumers will be buying fewer goods with the same amount of Chinese money, meaning that domestic industries in China (Chinese producers selling to Chinese consumers) will be hurt, which is worse for both parties. This is because devaluing currency is really inflation, and this is what inflation does: makes goods more expensive than they otherwise would be, slowing economic growth.

Why is the Chinese government devaluing its currency, then, if this is so bad for them?  Because those to whom the currency devaluation benefits (Chinese exporters) favor it because they stand to profit substantially from it.  Therefore, if they believe the government will go along with them, they have every incentive to lobby the government to help them.  The politicians, meanwhile, even if they understand the economic realities of the situation (which is unlikely), have on the one hand a small number of lobbying exporters who are helped a great deal, and many consumers who in the aggregate are hurt a great deal but individually are hurt comparatively little, and therefore have no real incentive to counter-lobby.  This means that the politicians have the incentive to not anger the only group with substantial individual stakes, while taking the economically correct action likely won’t anger anyone.

The United States taking a “retaliatory” measure (by deflating the dollar) to balance out the Chinese action is a road to disaster for the exact same reason that it’s a bad idea for China to do it for itself. If China wants to devalue its currency, the United States should be happy it has access to cheaper goods allowing it to more easily grow its economy, and not damage its own economy by doing the same.

Filed under: Economic Theory
Comments: 6 Comments

Henry Hazlitt"[T]he whole of economics can be reduced to a single lesson, and that lesson can be reduced to a single sentence. The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."
Henry Hazlitt, Economics in One Lesson






Recent Entries