From my experience sending out political emails, I understand the value of a catchy subject line, or in this case a catchy post title. I could have used a title like "laissez-faire economics", which is sort of what this post is about, but then you would have ignored it and signed on to facebook, and now here you are!
Everyone's heard of Adam Smith's famous 'invisible hand', a metaphor for the theory that society's best allocation of resources will be achieved by everyone pursuing their own individual self-interest in a marketplace. Why then, are firms necessary? If individuals can go to the market to get everything they need, why do they become involved with firms? If you think about it, firms are organized in the exact way--centralized, planned, authoritarian--that is rejected by the invisible hand. It's a question that The Economist takes on. The answer, they argue, is due to the high transaction costs associated with going to market, as well as the collective expertise that can be achieved by a company of people.
It's the same reason you join any group--to be more successful than you could be on your own. If you are a great baker but aren't good at accounting, you might want to become part of a bakery so that you can focus on baking and they can keep track of how many people buy your snickerdoodles. If you are a commercial airline pilot, you need to become part of a firm so they can buy the plane you fly, attract the customers that need you to fly them somewhere, and negotiate with the government to make sure you don't fly in restricted airspace.
I'm reminded of a scene in The Beautiful Mind, the movie about the Nobel-Prize winning economist John Nash. In the movie, Nash comes to his breakthrough idea when a group of young women walk into the bar, with one of the women being the most attractive:
For the purposes of our little discussion here, let's call this super-hot woman "Hillary Clinton". The invisible hand would predict that all the guys would hit on Hillary. But Nash reasons that if everyone tries to impress Hillary, only 1 guy could potentially attract her, leaving the loser guys with no girlfriend. And the loser guys would not be able to hit on Hillary's friends, because Hillary's friends are offended that they weren't the original target of the guys' affection. So in Adam Smith's scenario one guy wins and the others lose. Nash reasons that the best outcome is for all the guys to go after Hillary's friends--and not Hillary at all! At least then, all the guys would have a girlfriend, even know nobody would be dating a supermodel. "Adam Smith was wrong", the Nash character announces to his confused friends as he passes by all the Hillarys in the bar to go back and develop his theory.
In both the example of the firm and the 'non-cooperative games' to which Nash's theory is referred, Adam Smith's theory shows some weakness. As an undergraduate economics student, I was forced to tattoo Adam Smith's name on my left bicep as a show of appreciation for the so-called father of economics. "How could he be wrong?", I wondered, a foray into philosophy that was surely a result of a hangover and daydreaming during a class I really didn't care about. I asked this guy, who was my faculty mentor, and remains the smartest person I think I've ever met. The brilliant power of Adam Smith, he advised, was that despite a couple scratches on the fender, the Smith-mobile is still driving in the fast lane. (We're using a car metaphor now--try and keep up!). Despite the odd theory or exception now and then, it still remains mostly true that the best outcome is achieved by everybody doing what's best for them in a market free of coercion.
Taking the position that we are free-market experts, economists from the Chicago School argue that humans are 'economic robots'--that every decision they make is the result of the analysis of all available data related to the transaction. This of course is not possible--most people can't know if a cotton shirt at Target is cheaper than one at Walmart--but you will try! Maybe you ask your friends that shop at both places; maybe you know that milk is cheaper at one place than the other and you assume that all prices at that place are cheaper; maybe you're rich and you hire a private shopper to investigate and get you the best price. In any case, the Chicago school model still might be the best model to use because it just might be the best predictor of what you're going to do.
Free-Market advocates don't have to worry--there is still room on your right bicep for Hillary's initials tattooed inside a heart.
Showing posts with label economics. Show all posts
Showing posts with label economics. Show all posts
Thursday, December 23, 2010
Wednesday, November 10, 2010
Lower Corporate Taxes Mean More Jobs, Which Means More Tax Revenue
Let's get something out of the way first. I love corporations. I think they're great. The public tends to support the abstract of small businesses over that of big businesses, even though every big business was at one time a small business. Moreover, I don't hate on corporations for making big profits, even obscene profits. If a company does such an expert job at whatever they do to earn a profit of a billion dollars in a quarter, more power to them. As long as the market is free of coercion, profits represent mutually agreed upon transactions that make both the buyer and the seller better off than they were before. If a company makes $1 billion, it means that people like me and you are $1 billion better off than we were before. Do you and I want to figure out how to build our own cars?...to mine the aluminum, shape the rubber for the tires? Do you and I want to drill for oil in deep ass water in the middle of hurricanes? No...you and I can't even make it to the bank before it closes. We need corporations so we can pay them to do what they do best, and sell them the things we do better than them.
Partially because people don't like corporations, but mostly because states want more money, there is always talk about closing tax loopholes and collecting more money from corporations. I'm all about abiding by the law, but there's some things to think about.
If taxes are high, businesses will try to avoid them. For our purposes we'll talk about the legal ways. For companies doing business in multiple states, they'll concentrate operations in the states that give them the lowest tax burden. They will hire workers in those states, and those workers will create income, property, and payroll taxes. States with high taxes will chase businesses out and actually lose tax revenue, even though they tried to raise the tax rate, a concept credited to an economist named Arthur Laffer.
Businesses want low taxes, but almost as important is consistency. If a certain tax, fee, permit, or bureaucratic red tape exists, even if it's terrible, businesses can figure out a way to deal with it if they have certainty for the future. Just so you don't think I'm making this crap up, I've found some examples of this whole concept at work for your reading pleasure.
When Daimler merged with Chrysler, they headquartered in Germany to enjoy an effective tax rate 23% lower.
Google, Facebook, and others use legal multi-national businesses to pay a 2% effective tax rate.
Iceland slashes corporate tax rate and enjoys higher tax revenue.
Partially because people don't like corporations, but mostly because states want more money, there is always talk about closing tax loopholes and collecting more money from corporations. I'm all about abiding by the law, but there's some things to think about.
If taxes are high, businesses will try to avoid them. For our purposes we'll talk about the legal ways. For companies doing business in multiple states, they'll concentrate operations in the states that give them the lowest tax burden. They will hire workers in those states, and those workers will create income, property, and payroll taxes. States with high taxes will chase businesses out and actually lose tax revenue, even though they tried to raise the tax rate, a concept credited to an economist named Arthur Laffer.
Businesses want low taxes, but almost as important is consistency. If a certain tax, fee, permit, or bureaucratic red tape exists, even if it's terrible, businesses can figure out a way to deal with it if they have certainty for the future. Just so you don't think I'm making this crap up, I've found some examples of this whole concept at work for your reading pleasure.
When Daimler merged with Chrysler, they headquartered in Germany to enjoy an effective tax rate 23% lower.
Google, Facebook, and others use legal multi-national businesses to pay a 2% effective tax rate.
Iceland slashes corporate tax rate and enjoys higher tax revenue.
Friday, November 5, 2010
Harvard Academics Agree: Budget Balancing Is Best Done By Reducing Government Spending
The reason that many big government types love the economist John Meynard Keynes is that out of all of Keynes' ideas, they are able to single out his recommendation of government spending to stimulate the economy as support for what they want to do politically. The major argument against deficit spending (other than the fact that your kids eventually have to pay for the money you borrow) was that government spending 'crowds out' private investment. When the government prints money to spend on programs, the money supply is increased. When the supply of anything is increased, it's price goes down. So when the supply of money is increased, interest rates go down, and the private sector doesn't invest their money (in business improvements) because the return on investment isn't as good.
With the Federal Reserve announcing QE2, which is exactly what I just talked about in the last paragraph, The Economist picked a good time to talk about the issue. In Britain, they announced some "austerity measures", which is the proper British way to announce that a bunch of government jobs were being cut.
In America, reducing government is of course prohibited by the 88th amendment to the Constitution, so we tried to raise taxes. The money wasn't even used to balance the budget; it was used to pay for new tomfoolery and ballyhoo.
Now, normally this move could be supported by a cadre of Harvard economists. However, in this case, research by professors from Harvard and elsewhere conclude that the 'crowding out' theory holds water:
With the Federal Reserve announcing QE2, which is exactly what I just talked about in the last paragraph, The Economist picked a good time to talk about the issue. In Britain, they announced some "austerity measures", which is the proper British way to announce that a bunch of government jobs were being cut.
In America, reducing government is of course prohibited by the 88th amendment to the Constitution, so we tried to raise taxes. The money wasn't even used to balance the budget; it was used to pay for new tomfoolery and ballyhoo.
Now, normally this move could be supported by a cadre of Harvard economists. However, in this case, research by professors from Harvard and elsewhere conclude that the 'crowding out' theory holds water:
It found that a 1% rise in government consumption as a share of GDP eventually reduced private-sector consumption by 1.9%. Temporary spending to pick up economic slack may be useful but the long-term benefits of austerity seem clear.
Saturday, November 8, 2008
Financial Crisis: The Government Failed In Many Places
I've decided that it doesn't make much sense to attempt an all-encompassing post on the current economic conditions--partly because it would take too much time and effort, and mostly because it would clearly be presumptuous of me to claim to be able to explain it all. But, there are things that people are failing to understand. This is from a Capital (online) letter writer:
The stance of many, notably the Obama campaign, is that the blame for our financial crisis lies mainly in the failure of government regulators. I tend to believe that the regulators knew what was going on, but were powerless to do anything because their interests were in conflict with a more momentous political prerogative. Let's discuss!
Leverage is a great way to make money, and a great way to lose it really quick. It's important to understand that leverage is tied to the assets being leveraged (borrowed against). In this case, artificially easy credit and artificially high demand for homes eventually dried up, rendering the writer's leverage complaint valid.
For most people, their homes are their chief investment. Taking that a step further, securities that are tied to mortgages make up a huge pool of investments, and a huge pool of profit for the companies mentioned in the above letter. The government, via Fannie and Freddy, distorted the market for mortgage-backed securities, and essentially forced such risky behavior. Acting on the assumption that every family deserves to own a home--a notion that is much younger than some might think--Fannie and Freddy created demand for sub prime loans by buying them from mortgage lenders. Banks felt the need to participate, lest they lose ground to the competition. Bottom line: the fault does not lie with unregulated capitalism, it lies with the government's forced limitation of free-market principles.
Perhaps more alarming is the preferred method of bailing these companies out. In the late 1990's, a hedge fund named Long Term Capital Management was on the brink of bankruptcy. To put it in perspective, they were leveraged at least 30:1, and probably more--they were very secretive and nobody really knew where their money was or how much was at risk. A failure of LTCM was thought to have far-reaching effects, as many banks had significant stakes. After a bailout offer from Warren Buffet was rejected, the Fed was brought in. BUT, rather than bail the fund out themselves, the Fed merely acted as a mediator--orchestrating a $525 billion bailout from the fund's creditors, and not the taxpayers.
The contemporary method to bail out companies is direct investment or securitization from the government. Unlike the creditors or investors of a company, the government has significantly less expertise in monitoring the company, and significantly less incentive to recover its money (because the government doesn't have its own money, it has our money). And whereas investors only deal with their investments, the government has no clearly defined restraints. First it was only banks that got special protection. Then investment banks. Then an insurance company. Now maybe the auto industry. The list will stop when the government stops sending good money to chase after bad.
Many firms on Wall Street and around the world ran up debt-to-equity ratios
larger than 30 to 1. That means they borrowed $30 for every $1 they actually
had. They didn't get to that point on the strength of mortgages to poor people.
They were playing a leverage casino far beyond the subprime market.
When Lehman Brothers collapsed, its ratio was 45 to 1. That is what is
causing Wall Street to collapse in less than a month, at our great expense. Our
government, including both political parties, have failed us by ignoring the
abuses and failing to exercise proper oversight of the financial industry. Let's
give credit where credit is due.
The stance of many, notably the Obama campaign, is that the blame for our financial crisis lies mainly in the failure of government regulators. I tend to believe that the regulators knew what was going on, but were powerless to do anything because their interests were in conflict with a more momentous political prerogative. Let's discuss!
Leverage is a great way to make money, and a great way to lose it really quick. It's important to understand that leverage is tied to the assets being leveraged (borrowed against). In this case, artificially easy credit and artificially high demand for homes eventually dried up, rendering the writer's leverage complaint valid.
For most people, their homes are their chief investment. Taking that a step further, securities that are tied to mortgages make up a huge pool of investments, and a huge pool of profit for the companies mentioned in the above letter. The government, via Fannie and Freddy, distorted the market for mortgage-backed securities, and essentially forced such risky behavior. Acting on the assumption that every family deserves to own a home--a notion that is much younger than some might think--Fannie and Freddy created demand for sub prime loans by buying them from mortgage lenders. Banks felt the need to participate, lest they lose ground to the competition. Bottom line: the fault does not lie with unregulated capitalism, it lies with the government's forced limitation of free-market principles.
Perhaps more alarming is the preferred method of bailing these companies out. In the late 1990's, a hedge fund named Long Term Capital Management was on the brink of bankruptcy. To put it in perspective, they were leveraged at least 30:1, and probably more--they were very secretive and nobody really knew where their money was or how much was at risk. A failure of LTCM was thought to have far-reaching effects, as many banks had significant stakes. After a bailout offer from Warren Buffet was rejected, the Fed was brought in. BUT, rather than bail the fund out themselves, the Fed merely acted as a mediator--orchestrating a $525 billion bailout from the fund's creditors, and not the taxpayers.
The contemporary method to bail out companies is direct investment or securitization from the government. Unlike the creditors or investors of a company, the government has significantly less expertise in monitoring the company, and significantly less incentive to recover its money (because the government doesn't have its own money, it has our money). And whereas investors only deal with their investments, the government has no clearly defined restraints. First it was only banks that got special protection. Then investment banks. Then an insurance company. Now maybe the auto industry. The list will stop when the government stops sending good money to chase after bad.
Friday, October 10, 2008
Fun With Wine
I am happy to bring you not one, but two wine-related stories as we head into this weekend. The first comes from the notorious 1st Ward, and Alderman Israel, who is proposing to change the permitted operating hours for wine bars in the MX zone, specifically to allow them to stay open until midnight 7 days a week.
The first thing that strikes me is that I only know of 1 wine bar in the MX district: The Purple Tooth. Catchy name, good cheese, old fire station, fine by me. I just don't like the specificity of the bill--instead of writing a bill for one constituent, how about relaxing the Ward 1 Superiority Doctrine and allowing the rest of the city to operate under the same rule. I think it's a bit of a stretch to compare this bill to Alderman Israel's stance on the 2 a.m. issue, but it's interesting to see how Alderman Israel is willing to extend the business hours for 1 wine bar in his district, yet favors reducing the business hours for the regular bars that comprise the majority of hospitality business in his ward.
The second wine story comes from a letter writer to The Capital. For the ever-increasing new readers of this blog, I enjoy having debates with these letter writers for 2 reasons:
1. These letters writers are either more fanatical, or less fanatical, than me.
2. They cannot debate back.
I have not done one of these in a while. A couple of months ago I cancelled my subscription to The Capital, the result of a joint collaboration of this blog's "save-the-blog-publisher-money" and "stick-it-to-the-man" initiatives. However, I have located a gem on the internet version.
The original text of the letter writer appears in bold, with my uncontested commentary in regular font.
Open letter to Gov. Martin O'Malley:
Since you could not be bothered to attend the Maryland State Wine Festival and present "The Governor's Cup" in person for the second year in a row, I can't be bothered to support you on slots, or for any re-election attempt you may make.
Sadly, I have never won the Governor's Cup. However, I have won the Mayor's Cup, a fictional award that my fictional social club has awarded itself for the past 20 years, in recognition of having the best float in the city's 4th of July parade.
By the way, what an insignificant reason to drop your support for someone!
Dear John McCain: In these troubling economic times with major world issues, I cannot support you on anything because when you had hair, you parted your hair to the right and I part mine to the lef. Dear Gov. O'Malley: I cannot support you, for many other reasons.
Wine production in Maryland is a growing and thriving business. As such it brings in an increasing amount of revenue to this state, which you say is much needed to make up for the shortfall that your tax increases did not bring in.
What O'Malley says about the budget shortfall cannot be believed. He spent us into a deficit by withdrawing $1 billion from the rainy day fund and increasing spending, then "solved" that problem with a special session that raised taxes AND ADDED $600 million or so in new spending, but now there is a deficit again, so O'Malley calls for cuts, but also doesn't call for cuts. Got it?
Many liberals do not understand that raising taxes can actually have a negative effect on total taxes collected, a relationship suggested by the Laffer curve. Not always, not immediately, but eventually. Raising taxes depresses total business output, and encourages businesses to move to lesser taxing jurisdictions (think India, offshore bank accounts, etc.), meaning that the government loses income and payroll taxes. The evidence is too vast for me to enumerate here (mainly because I have a doctor's appointment in an hour), but if commenters press me on the issue, I may be forced to comply.
However, I have noticed that you and your band can play every pub and bar in Baltimore.
Do they take requests?
So I can assume that you're not personally opposed to the sale or consumption of alcohol by adults, just opposed to supporting the entire state instead of just one city.
Have you ever considered a career in politics?
RHONDA RYAN
Gambrills
Dear Rhonda,
I live a maverick's life outside of Annapolis, which is near Gambrills. Please send the wine you set aside for Gov. O'Malley to "The Fourth Most Popular Political and Economic Blog In the General Vicinity of The Annapolis Mall, Annapolis, MD, 21401", so I can surprise Mrs. Politics with a fancy dinner.
The first thing that strikes me is that I only know of 1 wine bar in the MX district: The Purple Tooth. Catchy name, good cheese, old fire station, fine by me. I just don't like the specificity of the bill--instead of writing a bill for one constituent, how about relaxing the Ward 1 Superiority Doctrine and allowing the rest of the city to operate under the same rule. I think it's a bit of a stretch to compare this bill to Alderman Israel's stance on the 2 a.m. issue, but it's interesting to see how Alderman Israel is willing to extend the business hours for 1 wine bar in his district, yet favors reducing the business hours for the regular bars that comprise the majority of hospitality business in his ward.
The second wine story comes from a letter writer to The Capital. For the ever-increasing new readers of this blog, I enjoy having debates with these letter writers for 2 reasons:
1. These letters writers are either more fanatical, or less fanatical, than me.
2. They cannot debate back.
I have not done one of these in a while. A couple of months ago I cancelled my subscription to The Capital, the result of a joint collaboration of this blog's "save-the-blog-publisher-money" and "stick-it-to-the-man" initiatives. However, I have located a gem on the internet version.
The original text of the letter writer appears in bold, with my uncontested commentary in regular font.
Open letter to Gov. Martin O'Malley:
Since you could not be bothered to attend the Maryland State Wine Festival and present "The Governor's Cup" in person for the second year in a row, I can't be bothered to support you on slots, or for any re-election attempt you may make.
Sadly, I have never won the Governor's Cup. However, I have won the Mayor's Cup, a fictional award that my fictional social club has awarded itself for the past 20 years, in recognition of having the best float in the city's 4th of July parade.
By the way, what an insignificant reason to drop your support for someone!
Dear John McCain: In these troubling economic times with major world issues, I cannot support you on anything because when you had hair, you parted your hair to the right and I part mine to the lef. Dear Gov. O'Malley: I cannot support you, for many other reasons.
Wine production in Maryland is a growing and thriving business. As such it brings in an increasing amount of revenue to this state, which you say is much needed to make up for the shortfall that your tax increases did not bring in.
What O'Malley says about the budget shortfall cannot be believed. He spent us into a deficit by withdrawing $1 billion from the rainy day fund and increasing spending, then "solved" that problem with a special session that raised taxes AND ADDED $600 million or so in new spending, but now there is a deficit again, so O'Malley calls for cuts, but also doesn't call for cuts. Got it?
Many liberals do not understand that raising taxes can actually have a negative effect on total taxes collected, a relationship suggested by the Laffer curve. Not always, not immediately, but eventually. Raising taxes depresses total business output, and encourages businesses to move to lesser taxing jurisdictions (think India, offshore bank accounts, etc.), meaning that the government loses income and payroll taxes. The evidence is too vast for me to enumerate here (mainly because I have a doctor's appointment in an hour), but if commenters press me on the issue, I may be forced to comply.
However, I have noticed that you and your band can play every pub and bar in Baltimore.
Do they take requests?
So I can assume that you're not personally opposed to the sale or consumption of alcohol by adults, just opposed to supporting the entire state instead of just one city.
Have you ever considered a career in politics?
RHONDA RYAN
Gambrills
Dear Rhonda,
I live a maverick's life outside of Annapolis, which is near Gambrills. Please send the wine you set aside for Gov. O'Malley to "The Fourth Most Popular Political and Economic Blog In the General Vicinity of The Annapolis Mall, Annapolis, MD, 21401", so I can surprise Mrs. Politics with a fancy dinner.
Tuesday, September 16, 2008
"Too Important To Fail" Is The New Argument For Socialism
Using strict statistical methods, I have calculated that my productivity has dropped by a record 8% in the last 48 hours while I try and sort through the financial nightmare that is terrorizing some major money moguls as we speak. The latest victim is AIG, which just ceded an 80% stake to The Federal Reserve (yikes) for a barely fathomable $85 billion.
Historically, the government has identified industries that are too big or too important to fail. Amtrak and the airlines both have enjoyed government favoritism to some extent. But the financial industry is in a class by itself. The Federal Reserve came in 1913, and the FDIC came in 1933, creating a foundation for a system that now allows firms to make stupid decisions and people to obtain stupid loans.
In case you didn't realize this by now, with public goods being the notable exception, when the government gets involved in industry it screws everything up, and necessarily produces a result inferior to that of the private market. What incentive do banks have to make responsible loans if the government is going to bail them out?
As an economics student, I learned the virtues of the Fed. After all, countries need central banks. But, the Fed's purposes have evolved. Originally meant to control bank panics, it became a regulatory agency for banks, a monetary policy instrument, and a lender of last resort to banks. There has been some history of the Fed serving as a mediator and broker for emergency rescues of too-big-to-fail financial institutions, with Long Term Capital Management being perhaps the most noteworthy. But in the last 6 months, the Fed has pushed even that boundary and has acted a lender of last resort to investment banks (not regular banks), and now, today, has apparently nationalized the nation's largest insurer! Not only are we taxpayers on the hook for the first $85 billion, but I'm quite sure AIG is about to shell out infinity billion dollars to rebuild Texas from Hurricane Ike--are we going to have to pay for that too?!!!!
If that weren't scary enough, consider this: at some point, the Democrat Congress is going to realize that they now have an 80% stake in an insurance company. Democrats want national health insurance. Get the picture?
I hope to research a mega-post on this, but in case I don't, here's what I'm thinking. Most of this is the fault of Democrats, not of the free market or capitalism. Democrats created Fannie Mae and Freddy Mac, and Democrats ran those agencies into the ground while cooking the books and pocketing tens of millions of dollars. When President Bush tried to reform those agencies in 2003 (I think), Democrats blocked it. Fannie and Freddie gave millions of lobbying dollars to Democrats (Obama, Hillary, and Biden were all in the top 5 I think...McCain was #342)--which essentially means the government was lobbying the Democrat part of itself--and we can now see why.
Even so, I am not happy with the Bush administration. That itwould allow such an overt breach of free-market principles is horrible. If the Fed did this unilaterally using its independence, then we need to find limits to the Fed's powers outside of monetary policy. To borrow terminology from Warren Buffet, we the taxpayers are throwing good money after bad money, and we didn't have an ounce of say about it. Earlier in the post I announced that the latest victim was AIG, but the true victim is us.
Historically, the government has identified industries that are too big or too important to fail. Amtrak and the airlines both have enjoyed government favoritism to some extent. But the financial industry is in a class by itself. The Federal Reserve came in 1913, and the FDIC came in 1933, creating a foundation for a system that now allows firms to make stupid decisions and people to obtain stupid loans.
In case you didn't realize this by now, with public goods being the notable exception, when the government gets involved in industry it screws everything up, and necessarily produces a result inferior to that of the private market. What incentive do banks have to make responsible loans if the government is going to bail them out?
As an economics student, I learned the virtues of the Fed. After all, countries need central banks. But, the Fed's purposes have evolved. Originally meant to control bank panics, it became a regulatory agency for banks, a monetary policy instrument, and a lender of last resort to banks. There has been some history of the Fed serving as a mediator and broker for emergency rescues of too-big-to-fail financial institutions, with Long Term Capital Management being perhaps the most noteworthy. But in the last 6 months, the Fed has pushed even that boundary and has acted a lender of last resort to investment banks (not regular banks), and now, today, has apparently nationalized the nation's largest insurer! Not only are we taxpayers on the hook for the first $85 billion, but I'm quite sure AIG is about to shell out infinity billion dollars to rebuild Texas from Hurricane Ike--are we going to have to pay for that too?!!!!
If that weren't scary enough, consider this: at some point, the Democrat Congress is going to realize that they now have an 80% stake in an insurance company. Democrats want national health insurance. Get the picture?
I hope to research a mega-post on this, but in case I don't, here's what I'm thinking. Most of this is the fault of Democrats, not of the free market or capitalism. Democrats created Fannie Mae and Freddy Mac, and Democrats ran those agencies into the ground while cooking the books and pocketing tens of millions of dollars. When President Bush tried to reform those agencies in 2003 (I think), Democrats blocked it. Fannie and Freddie gave millions of lobbying dollars to Democrats (Obama, Hillary, and Biden were all in the top 5 I think...McCain was #342)--which essentially means the government was lobbying the Democrat part of itself--and we can now see why.
Even so, I am not happy with the Bush administration. That itwould allow such an overt breach of free-market principles is horrible. If the Fed did this unilaterally using its independence, then we need to find limits to the Fed's powers outside of monetary policy. To borrow terminology from Warren Buffet, we the taxpayers are throwing good money after bad money, and we didn't have an ounce of say about it. Earlier in the post I announced that the latest victim was AIG, but the true victim is us.
Friday, July 4, 2008
The Economics of Oil
My normal method of blogging involves typing a secret password into the Republican National Committee Mainframe, and plagiarizing whatever bit of propaganda that has already been developed for my particular issue. For this post, I decided to research facts on my own, which took like 3 weeks of hard work, confirming my worst suspicions. So, I hope you take the time to read this post, because I took the time to write it!
With consumers facing record prices at the pump, there is plenty of anger to be directed and misdirected at various sources. After doing some research, I am now marginally more prepared than I otherwise would have been to present you with the facts about the oil business, and which factors weigh the most on the price of gas and heating oil.
Crude oil is pumped out of the ground, then shipped via tanker or pipeline. The world's largest consumers (North America, Europe, Asia) all import oil, and all other regions export it. The general rule is that it is cheapest to refine oil when it is close to its final source; therefore, oil is almost always shipped in the crudest form possible, and the biggest consumers are also the biggest refiners.
The only US port that can accommodate oil supertankers is in Louisiana, so often the supertankers divide their cargo onto smaller tankers that can go directly into any port, where it then goes to refineries. The Gulf region, specifically Texas and Louisiana, refine more oil than anywhere else in the country. No new refineries have been built since 1976, but refineries have seen significant technological advances. Most demand for refined oil is in the form of light products such as gasoline (think "light sweet crude"). Refineries in the US have focused on something called "downstream processing", which allows refineries to take crude oil and produce up to 60% gasoline, as opposed to the 20% produced by more rudimentary refineries. Many refineries without downstream capabilities were shut down, and the utilization of the remaining refineries remained high.
We use oil for a lot of things: gasoline, propane, food wax, motor oil, asphalt, petrochemicals, and more. Downstream refining allows refineries to quickly adapt to the particular demand profile of final products, and those products are sold to retailers.
The gasoline marketers are a particularly interesting case. Most gas stations that we are familiar with are supermajor brands, whereas a 'supermajor' or 'major' is an oil company that has reserves, refineries, and retail stations. There are 6 supermajors: Exxon, Shell, BP, Chevron, ConocoPhillips, and Total S.A. But all is not as it seems....over 95% of retail stations are independently owned--not owned by the supermajors. The retail stations may or may not be part of a regional distributor, but what they do have is a branding agreement with their respective supermajor to sell only that company's gas.
This brings us to the next item: how gas stations get their gas. When refined gasoline comes to port, it is up for sale. Distributors and branded stations may have some power to set prices--but not much. They have to buy gas from their supermajor's refinery, and cannot shop for the best price. Conversely, the generic gas stations are free to shop the best price, and can typically have some effect on the price they pay, resulting in lower prices at the pump. Consumers decide if they want the lowest price, or the consistency of a proprietary gas blend.
Supply
OPEC countries control about 40% of the world's oil production, with everyone else accounting for the rest. Mining oil supply consists of several steps, including finding the oil, drilling a test well to see if the total find is economically viable, then setting up a pumping operation.
As noted above, most of the world's oil supply is located in the Middle East.
Oil supply has typically fallen victim to a low success rate. Exploration of fields where oil has not already been found historically yields only a 20% chance for finding a supply that is economically viable to pump. Much like in refining, technology improvements have increased this success rate to as high as 50%--still a risky proposition considering the costs involved with finding oil.
The most important feature of the supply for oil is that it is not perfectly competitive. Markets work best when they are perfectly competitive: involving numerous or infinite participants, no restrictions on trade, and no barriers to entry. The supply market for oil has none of those features; rather, it is characterized by high fixed costs and relatively few participants (companies).
Let's consider why. If you want to start a handyman business, all you have to do is buy a hammer and convince your mother that your father hung a painting crooked, and you have your first job. If you want to start a company to pump oil, you need infinity government permits and like a hundred billion dollars.
A market in which suppliers are relatively few, and each relatively large, is called an oligopoly, and the oil market is indeed oligopolistic. And the think about oligopolies is, they usually band together to form a cartel. OPEC is the biggest cartel the world has ever known, and they can basically exert their will over the supply market. In a competitive market, individual suppliers have no control over the price they can charge. If you charge $30 per hour to be a handyman, and there are 10 other guys on your street who do the same job as you for $25 an hour, you will be out of work--you have no choice but to charge the market rate. But for OPEC, they control such a large share of the supply that they can control the price through their decision of how much oil to bring to market. Since there are not enough other suppliers with excess capacity to steal business from OPEC, refiners must buy OPEC oil and bid the price up or down based on scarcity.
It is important to note the price elasticity of oil supply, which means how sensitive oil supply is to price. The more sensitive supply is to price, the more elastic supply is said to be. The more the price of a good goes up, the more of that good suppliers want to produce, as would be expected. If everyone in the country wanted handyman services and the going rate for handymen jumped to $500 an hour, you would cancel your engagements, dump your girlfriend, and try and perform your handyman duties all day long--the supply for handyman services is relatively elastic.
Oil suppliers, on the other hand, cannot respond so quickly. Just because the price of a barrel of crude goes from $100 to $130 overnight doesn't necessarily mean that oil suppliers can capitalize on the higher price by producing more. This is because oil exploration is a lengthy process, and because there are no close substitutes to oil production--oil producers cannot change their oil rigs to produce natural gas if the price of oil drops and gas rises. An elasticity of 0 means total dependence on price, and an elasticity of 1 means total independence of price--oil supply elasticity has been estimated at .1, which is relatively inelastic.
So, how much supply do we still have? Well, nobody really knows because there is still oil that we don't know about plus OPEC countries are shady with their reports of how much they already have. As recently as 2 days ago, The Economist reports that the world has enough oil to accommodate current consumption levels for 42 years. Of note, it also states this is slightly more than last year, implying that we are currently discovering oil slightly faster than we are using it.
The USA has proven reserves to supply ourselves with oil for 3 years given our current usage and without dependence on foreign oil.
Oil supply is a shaky thing. There is always a risk of a supply shock, which refers to an immediate and significant drop in production. I must say that there are reasons to be pessimistic about future supply. First and foremost, oil is not a renewable resource and will eventually run out if we keep using it. Short-term supply is maxed out. Some people think that Saudi Arabia could pump a couple more million barrels a day but that's about it. Long-term supply doesn't look much better. Politicians in the United States are gallivanting around failing to pump or build refineries. Politicians in China need all the oil they make (for the first time), and Russia's oil industry is suffering at a time when demand is peaking.
Demand
First things first: consumption = demand. Now then, industrialized countries consume much more oil than less industrialized companies, and the US and Canada consume the most. Canada and the US consume 3 gallons of oil per person per day, whereas the rest of the developed world averages about 1.4, the undeveloped world .2. The difference is attributed to transportation sectors, where in the US and Canada private vehicles are heavily utilized to travel relatively long distances.
(Column Intermission: If any of you are still reading this, I'm quite sure you are tired of words. I just found a great power point presentation that has a lot of this info in short blurbs, with pretty colors. So look at it if you want!)
The United States is the biggest consumer of oil in the world, using nearly 3 times as much total oil as the next largest user (China). The US consumes between 20 and 21 million barrels per day of oil, which is actually at or below what is has been this decade.
Based on the above graph, the free market price would be 600 and the quantity produced would be 5 (I am just reading the numbers on the axes for simplicity). But in this market, the government has mandated a price of 400! So, the quantity demanded equals 7, but the quantity supplied eqauls 3--creating an oil shortage of 4. Price ceilings create supply shortages. China is the example that we can point to in the oil market.
With consumers facing record prices at the pump, there is plenty of anger to be directed and misdirected at various sources. After doing some research, I am now marginally more prepared than I otherwise would have been to present you with the facts about the oil business, and which factors weigh the most on the price of gas and heating oil.
Ownership Of Oil Reserves
You all know the equation: big oil = Exxon Mobil = Beelzebub. But in the scheme of things, Exxon is small oil. The truly big oil are the nationally owned companies of many oil rich nations. (Note to readers: state ownership = communism). In fact, state-owned oil companies control 90% of the world's oil. Here is the list of the 20 largest oil companies by reserves (not production):
1. Saudi Arabian Oil Company**
2. National Iranian Oil Company**
3. Qatar Petroleum**
4. Abu Dabhi National Oil Company** (United Arab Emirates)
5. Iraq National Oil Company**
6. Gazprom (Russia)
7. Kuwait Petroleum Company**
8. PDVSA** (Venezuela)
9. Nigerian National Petroleum Corporation**
10. National Oil Corporation** (Libya)
11. Sonatrach** (Algeria)
12. Rosneft (Russia)
13. Petronas (Malaysia)
14. Exxon Mobil* (USA)
15. Lukoil* (Russia)
16. Pemex (Mexico)
17. Petrochina* (China)
18. BP* (England)
19. Chevron* (USA)
20. Petrobras (Brazil)
(*Public, ** OPEC)
The Supply ChainCrude oil is pumped out of the ground, then shipped via tanker or pipeline. The world's largest consumers (North America, Europe, Asia) all import oil, and all other regions export it. The general rule is that it is cheapest to refine oil when it is close to its final source; therefore, oil is almost always shipped in the crudest form possible, and the biggest consumers are also the biggest refiners.
The only US port that can accommodate oil supertankers is in Louisiana, so often the supertankers divide their cargo onto smaller tankers that can go directly into any port, where it then goes to refineries. The Gulf region, specifically Texas and Louisiana, refine more oil than anywhere else in the country. No new refineries have been built since 1976, but refineries have seen significant technological advances. Most demand for refined oil is in the form of light products such as gasoline (think "light sweet crude"). Refineries in the US have focused on something called "downstream processing", which allows refineries to take crude oil and produce up to 60% gasoline, as opposed to the 20% produced by more rudimentary refineries. Many refineries without downstream capabilities were shut down, and the utilization of the remaining refineries remained high.
We use oil for a lot of things: gasoline, propane, food wax, motor oil, asphalt, petrochemicals, and more. Downstream refining allows refineries to quickly adapt to the particular demand profile of final products, and those products are sold to retailers.
The gasoline marketers are a particularly interesting case. Most gas stations that we are familiar with are supermajor brands, whereas a 'supermajor' or 'major' is an oil company that has reserves, refineries, and retail stations. There are 6 supermajors: Exxon, Shell, BP, Chevron, ConocoPhillips, and Total S.A. But all is not as it seems....over 95% of retail stations are independently owned--not owned by the supermajors. The retail stations may or may not be part of a regional distributor, but what they do have is a branding agreement with their respective supermajor to sell only that company's gas.
This brings us to the next item: how gas stations get their gas. When refined gasoline comes to port, it is up for sale. Distributors and branded stations may have some power to set prices--but not much. They have to buy gas from their supermajor's refinery, and cannot shop for the best price. Conversely, the generic gas stations are free to shop the best price, and can typically have some effect on the price they pay, resulting in lower prices at the pump. Consumers decide if they want the lowest price, or the consistency of a proprietary gas blend.
Supply
OPEC countries control about 40% of the world's oil production, with everyone else accounting for the rest. Mining oil supply consists of several steps, including finding the oil, drilling a test well to see if the total find is economically viable, then setting up a pumping operation.
As noted above, most of the world's oil supply is located in the Middle East.
Oil supply has typically fallen victim to a low success rate. Exploration of fields where oil has not already been found historically yields only a 20% chance for finding a supply that is economically viable to pump. Much like in refining, technology improvements have increased this success rate to as high as 50%--still a risky proposition considering the costs involved with finding oil.
The most important feature of the supply for oil is that it is not perfectly competitive. Markets work best when they are perfectly competitive: involving numerous or infinite participants, no restrictions on trade, and no barriers to entry. The supply market for oil has none of those features; rather, it is characterized by high fixed costs and relatively few participants (companies).
Let's consider why. If you want to start a handyman business, all you have to do is buy a hammer and convince your mother that your father hung a painting crooked, and you have your first job. If you want to start a company to pump oil, you need infinity government permits and like a hundred billion dollars.
A market in which suppliers are relatively few, and each relatively large, is called an oligopoly, and the oil market is indeed oligopolistic. And the think about oligopolies is, they usually band together to form a cartel. OPEC is the biggest cartel the world has ever known, and they can basically exert their will over the supply market. In a competitive market, individual suppliers have no control over the price they can charge. If you charge $30 per hour to be a handyman, and there are 10 other guys on your street who do the same job as you for $25 an hour, you will be out of work--you have no choice but to charge the market rate. But for OPEC, they control such a large share of the supply that they can control the price through their decision of how much oil to bring to market. Since there are not enough other suppliers with excess capacity to steal business from OPEC, refiners must buy OPEC oil and bid the price up or down based on scarcity.
It is important to note the price elasticity of oil supply, which means how sensitive oil supply is to price. The more sensitive supply is to price, the more elastic supply is said to be. The more the price of a good goes up, the more of that good suppliers want to produce, as would be expected. If everyone in the country wanted handyman services and the going rate for handymen jumped to $500 an hour, you would cancel your engagements, dump your girlfriend, and try and perform your handyman duties all day long--the supply for handyman services is relatively elastic.
Oil suppliers, on the other hand, cannot respond so quickly. Just because the price of a barrel of crude goes from $100 to $130 overnight doesn't necessarily mean that oil suppliers can capitalize on the higher price by producing more. This is because oil exploration is a lengthy process, and because there are no close substitutes to oil production--oil producers cannot change their oil rigs to produce natural gas if the price of oil drops and gas rises. An elasticity of 0 means total dependence on price, and an elasticity of 1 means total independence of price--oil supply elasticity has been estimated at .1, which is relatively inelastic.
So, how much supply do we still have? Well, nobody really knows because there is still oil that we don't know about plus OPEC countries are shady with their reports of how much they already have. As recently as 2 days ago, The Economist reports that the world has enough oil to accommodate current consumption levels for 42 years. Of note, it also states this is slightly more than last year, implying that we are currently discovering oil slightly faster than we are using it.
The USA has proven reserves to supply ourselves with oil for 3 years given our current usage and without dependence on foreign oil.
Oil supply is a shaky thing. There is always a risk of a supply shock, which refers to an immediate and significant drop in production. I must say that there are reasons to be pessimistic about future supply. First and foremost, oil is not a renewable resource and will eventually run out if we keep using it. Short-term supply is maxed out. Some people think that Saudi Arabia could pump a couple more million barrels a day but that's about it. Long-term supply doesn't look much better. Politicians in the United States are gallivanting around failing to pump or build refineries. Politicians in China need all the oil they make (for the first time), and Russia's oil industry is suffering at a time when demand is peaking.
Demand
First things first: consumption = demand. Now then, industrialized countries consume much more oil than less industrialized companies, and the US and Canada consume the most. Canada and the US consume 3 gallons of oil per person per day, whereas the rest of the developed world averages about 1.4, the undeveloped world .2. The difference is attributed to transportation sectors, where in the US and Canada private vehicles are heavily utilized to travel relatively long distances.
Gasoline is by far the most important refined oil product, accounting for 45% of total oil consumption. But there are certainly other products, and other uses besides oil for transportation.
The most important demand issue is probably the trends in world demand. The developed countries are feeling the sting of higher prices, and demand for oil in the OECD countries is predicted to decline by 240,000 barrels in 2008. Developing countries, however, are still seeing growth in oil demand. China and its 400 ka-billion people have seen average annual growth in oil demand of 9% since 1990, and predictions are for another 5.5% increase this year! China is consuming about 7.4 million barrels per day of oil.
Now back to Russia...despite the misfortune of its oil producing industries, many of its other industries are starting to hit their stride. Russian oil demand in the 1990's fell off as the economy struggled to reorganize after the fall of communism. As luck would have it, one of the industries to recover in this decade is the auto industry, and as we know, autos need gas. Russian automobile sales have tripled in the past 5 years, and forecasts predict that Russia will account for more auto sales than any other European country by 2010.(Column Intermission: If any of you are still reading this, I'm quite sure you are tired of words. I just found a great power point presentation that has a lot of this info in short blurbs, with pretty colors. So look at it if you want!)
The United States is the biggest consumer of oil in the world, using nearly 3 times as much total oil as the next largest user (China). The US consumes between 20 and 21 million barrels per day of oil, which is actually at or below what is has been this decade.
For economists and other general nerds, the price elasticity of demand is a fascinating study. By how much do gas prices have to increase for people to car pool? By how much do they have to rise before people cancel their vacations? Before they move closer to work? Once the current oil volatility settles, maybe in a couple of years, we will have a fabulously accurate answer to that question. As for now, I found an oil demand elasticity estimate of .1, meaning that gas prices would have to rise by 10% to induce a 1% reduction in usage. Compared to other goods this is particularly extreme; in other words, we are more addicted to oil than most other goods.
How the Market Works
Markets determine how much of a good is sold, and at what price, by the intersection of supply and demand. Supply curves are upward sloping, meaning that as a price of a good rises, producers of the good want to sell more of it. Demand curves are downward sloping, meaning that as the price of a good increases, people want less of it.
The demand side is easy. Individual people have no affect on the price of oil; they simply decide how much oil they want to use given the market price. The supply side is where all the magic happens. Oil companies have to find the oil, which is a pain in the ass. They pump the easiest stuff first, then move on. It is critical to understand this investment decision. If all of the Great Lakes were made of oil instead of water, oil companies would be willing to sell gas really cheap because all they would need is a bucket to scoop it out--their fixed cost would be relatively low.
Sadly, the Great Lakes oil would be quickly used because it would be so cheap. The oil companies would then have to pump oil from deeper into the ground. They would need seismographs to find the oil, drills to access the oil, and numerous environmental permits. Their fixed cost would increase dramatically, and this cost would be incorporated into a gallon of gas. As oil becomes more scarce, it becomes more expensive to pump out of the ground, causing the supply curve to shift upward and raising the general price of oil.
Oil exploration does not continue forever. Oil companies know how much it costs to search for the next oil site, and will not undertake drilling or exploration if the market price of oil will not produce a positive return on investment. That point is is the single most important policy implication of oil economics. If the price of oil is high, more exploration investments will be profitable, leading to increased oil supply, and reduced oil prices. Consider this excerpt from The Economist:
No one in the Saudi oil ministry has forgotten what happened after the oil shock
in the 1970s. The Arab boycott called in 1973 to protest against Western backing
for Israel tripled oil prices. But it also prompted oil exploration in tricky
places such as the North Sea and conservation measures that reduced demand. The
result was a long-term slump in crude prices and a drop in the Saudis' market
share.
Markets work, and this is a beautiful thing. The simple supply and demand interaction outlines by Adam Smith in 1776 can predict almost any outcome--maybe not perfectly, but darn close. Free markets create incentives, and incentives drive behavior. If oil costs too much, oil companies will explore more, and the price will go down. Then, people will demand less of the oil at the new higher price, and the price will go down. So prices go down! Suppliers then cut back while people consume more, and the process reverses itself. The market always gravitates towards its equilibrium.
Market Failure: The Government
The 'how the market works section' above is one of the shortest sections of this post, because markets are pretty simple.....except when the government screws them up. The first government market distortion is environmental permits. For places where drilling is allowed, this is relatively small potatoes--maybe several months of waiting and a couple hundred thousand dollars; I really have no idea, but my guess is that it doesn't distort the investment decision. But consider the extreme, where exploration is prohibited by the government for environmental or other reasons (think ANWAR). In this case, the oil companies cannot move along their natural progression of supply sources, causing a dramatic upward shift in the supply curve and artificially high prices.
Government market distortion #2: TAXES! The tax concept is easy to illustrate using a business decision that most of us have to make at some point: buying a house. A common bit of information listed for potential buyers is the total annual taxes. Let's say a million dollar house in Annapolis incurs a $15,000 per year tax bill. Fine. If a million dollar house in a less desirable area cost only $14,999 in taxes each year, would you buy that house? Of course not. But what if the less desirable house had a tax bill of only $1000 per year? That's a big difference--maybe enough to change your investment decision. As noted above, the oil companies calculate the profit they expect to make from pumping through comparison of the cost of that pumping operation and the market price of refined oil. Taxes simply add to the cost of production. The higher that taxes are, the lower the return on investment, the less oil that is explored, the lower the supply, the higher the price.
Government market distortion #3: price ceilings. Taxes, at least, are a traditional and therefore relatively predictable circumstance. When the government regulates such a specific condition as how much a business can charge for its goods and services, that market will inevitably have a mismatched supply and demand. Supply curves are upward sloping and demand curves are downward sloping; the market price and quantity produced are determined by their intersection: 
Now lets take a look at what happens in the case of price ceilings:
Based on the above graph, the free market price would be 600 and the quantity produced would be 5 (I am just reading the numbers on the axes for simplicity). But in this market, the government has mandated a price of 400! So, the quantity demanded equals 7, but the quantity supplied eqauls 3--creating an oil shortage of 4. Price ceilings create supply shortages. China is the example that we can point to in the oil market.Who Determines Price and The Role of Wall Street Speculators
Supply and demand, even when corrupted by market imperfections, always determine price. If you are ever in a market where the government or some panel of "experts" sets the price, run. Far away. The price of oil is high because world demand is outpacing supply, largely due to political reasons. Demand growth has been unexpected, and there is no excess supply capacity to lower prices in the short run.
Regarding said market (supply) imperfections, we now have to consider them. In a competitive market, producers are numerous and any given producer cannot affect the price of the good being sold. In the oil business, OPEC is a cartel and can control the price of crude by limiting or expanding short-run supply. Note: Exxon, Shell, or any other individual "big oil" company cannot affect the price of oil. They probably couldn't even affect the price if they colluded, and I would hate to see the governmental regulator-types the day after they learned of big-oil collusion. Big oil are price takers, and if you don't believe me you can believe the IMF.
Politics and stupidity also affect the price. Domestically, there has not been a new refinery built in my lifetime, impeding long-term supply growth. OPEC has similarly neglected its infrastructure, causing the same result. We are currently seeing the fruition of this recipe for disaster.
Suppliers as a whole can only move along their supply curve--meaning adjust their level of production based on price--if they have mobility in their production both downwards AND upwards. If total production capacity is at the level of demand, an increase in demand causes a supply shortage and the price starts to move upward. It's been a wee bit since since I stayed current with such things, but I learned the sustainable estimate of industrial capacity to be 82%--meaning that if industrial production is more than 82% of its maximum potential, there tend to be inflationary pressures that push the price of the good upward. Oil production is nearer to 100%, and indeed the price is going up.
There are some who play the blame game with financials, professing the evils to various degrees of either corporate greed and $20 million CEO bonuses, or speculators on Wall Street. The 
Petroleum Marketers Association of America is certainly a loud voice in this room, fulfilling their charge to support gas station owners. The truth is, neither of these 'evils' affects the market fundamentals enough to have even the smallest effect on oil prices. Let's talk speculators first. They deal in future contracts, which essentially means that they bet on the future price of oil deliveries. The first crucial thing to remember is that each future contract has 2 parties: the buyer and the seller. Each party wants to make money, so one side is betting that the price will go up and the other that the price will go down. If they are wrong too often, they will alter the prices they are willing to agree to. The other thing about futures is that they are contracts for actual physical deliveries of oil in the future. But, traders have no interest in receiving the oil, so they sell their futures before they come to maturity. If the supply and demand conditions at that time dictate a different spot price than the price of the future, the trader could make or lose a lot of money--but the price of oil at that time is still dictated by the market fundamentals.
The CEO compensation thing is even more of a joke. Last year, Exxon's CEO got a bounus of $20 million. (Note: Exxon = Exxon Mobil). I am not going to compare that to sales--not even to profit. In the 4th quarter of last year, Exxon spent $6.2 billion on oil exploration. This means that the CEO's bonus was three one-thousandths of 1 percent of the money they spent on oil exploration IN THE FOURTH QUARTER! The scale of Exxon's operations is beyond comprehension, which is why people have trouble accepting the scale of the pay. Let me assure you of 2 things: #1: if their board of directors thought they could hire a CEO that would make them more money for less pay, they would find that person, and #2: giving $20 million to a CEO has absolutely no effect on oil exploration investment decisions, therefore no effect on supply, therefore no effect on the prices you pay at the pump. People got really mad when Exxon gave their old CEO a $400 million retirement package. Consider this: most of that money was in stock, and Exxon's stock valuation is $468 billion. So, in return for making Exxon the largest public company in the world and steering the ship while the stock price went up 500%, the Exxon board gave that guy nine ten-thousandths of 1 percent of outstanding stock. Give me a break. They can do what they want--it's their money and it doesn't affect our money.
Energy Policy and The "Long-Term" Argument
So, what energy policy will lower the price we are paying for gas? This question is undoubetedly why you are still reading this post. Our government cannot control demand to any effecient extent. They cannot control supply that is owned by soverign nations. Individual people can push oil prices down by figuring out ways to consume less, and the government can affect prices by allowing supply capabilities to increase. It's as simple as that.
Imposing a "windfall profits" tax on oil company profits is an example of what the government should NOT do. Whether it's a regular tax, a 'windfall profits' tax, a fee, a cost of getting a license, or any other name for an action when the government takes money from a business--the result is always the same. The supply curve shifts upward because the producer cost structure goes up, and prices are higher for us.
I don't think I will be so presumptuous as to suggest I have a perfect solution. But, I don't think the government does either. In the general sense, I think government should lift restrictions and let the energy companies figure out where drilling, or other energy sources will be viable.The reason why I think this is the proper attitude is that nobody has been able to figure out a good solution yet. Let's talk about the demand side solution. There is little argument, if any, that individuals reducing their own energy consumption cannot be bad. However, any government mandates to control such behavior is an overreach--the benefit does not justify the reduction in liberty.
As for the supply side solution, it's even more confusing. Let's say we mandate battery powered cars--how would we equip the power grid to handle the increase in electricity demand to recharge 100 million batteries every day? Natural gas power plants? Coal? Nuclear? As for ethanol, increased demand has been linked to rising corn prices, and plowing pasture land to plant corn for ethanol releases a negative carbon footprint on the atmosphere!
Some make the argument that energy companies are cannot be trusted to think of long-term solutions because the demands of public stock ownership and of capitalism in general create pressure to make short-term profits. That hazard is certainly possible, but rest assured that businesses would invest in new technologies if they were viable, and the government is not helping that potential return on investment. More importantly, politicians are even less likely to favor long-term solutions because they have to be re-elected every 2, 4, or 6 years!
Petroleoum economics is the same as any other economics--you just have to understand supply and demand. It is fair to say that increasing demand, constrained supply, and fear of supply shock are all pushing up crude prices. Sadly, the oil market is a study in political economy rather than pure economics; 93% of oil reserves are owned by soverign nations. While nations can generally be considered profit maximizers in the oil market, there are politics that undoubtedly determine allocation of the precious resource.
The market will eventually reach the correct prices and resource allocations. If there are high oil profits, companies will undertake more exploration projects, supply will increase, and the oil price will drop. If supply is depleted, companies will work to develop alternatives to meet the energy demand. These companies are expert in such matters, and the government is not. Furthermore, the government cannot do anything to speed a move to market equilibrium: taxes on oil profits discourage exploration, and subsidies for finding more oil delay the development of other technologies. However disappointing or angering some might consider my conclusion, it is the same as it usually is: the government should stay out of the way.
Let me end with the someone else's words, and a rather elegant summation of the future of energy:
The last time such alternatives were widely discussed was during the early
1970s. Then, too, a spike in the price of oil coincided with a fear that natural
limits to supply were close. The newspapers were full of articles on solar
power, fusion and converting the economy to run on fuel cells and hydrogen.Of course, there was no geological shortage of oil, just a politically manipulated one. Nor is there a geological shortage this time round. But that does not matter, for there are two differences between then and now. The first is that this price rise is
driven by demand. More energy is needed all round. That gives alternatives a
real opening.As these alternatives start to roll out in earnest, their rise, optimists hope, will become inexorable. Economies of scale will develop and armies of engineers will tweak them to make them better and cheaper still.
Competition should do the rest—for the fledgling firms of the
alternative-energy industry are in competition with each other as much as they
are with the incumbent fossil-fuel companies. Let a hundred flowers bloom. When
they have, China, too, may find some it likes the look of. Therein lies the best
hope for the energy business, and the planet.
Thursday, November 29, 2007
The Economics Of Bid Pricing
I haven't participated in any mono-logical debates with letter writers recently, nor have I recently talked about economics. In fact, I haven't talked about much of anything recently. Well, of that is about to change.
In case you've forgotten, or are new to this blog, the deal is this:
-Original words appearing in letter to the editor: bold
-My excellent, omni-brilliant commentary: normal font. Because I'm a normal guy.
The "worth Repeating" feature quoted Mayor Ellon O. Moyer as saying that "No crystal ball revealed that our low bid minority contractor (for the expansion of the city police station) would deliver such an inferior product."
What is the deal with the middle initial always included with the mayor's name? We freekin' know who it is....how many Mayor Ellen Moyers are there?
By the way, to know what this person is talking about, click here.
What about "low bid" does the mayor not understand? The architectural firm responsible for the fiasco at the Market House was probably the low bidder also.
Ha! Excellent. Not unlike myself, the letter writer has nothing to lose since his/her writing is not the source of any income nor subject to any professional obligation. Translation: bring on the baseless accusations!
I understand that government wants to get fair value for its money, but invariably the requirement that the low bid be taken means inferior design and workmanship. In many instances the decision-makers look only at the price and do not compare apples with apples, but apples with oranges.
Or coconuts!
Moving on, let's address the claim that taking the low bid invites inferior design and workmanship. The most basic of economic theory is predicated upon 'perfect competition' in the market. A perfectly competitive market is characterized by several things, notably:
-many competing firms
-homogeneous (the same) products/services
-no barriers to entry (meaning any new business can easily start up)
Given a market for contractors with these characteristics, you would always take the low bid. But very few markets are perfectly competitive*. And when you introduce elements of imperfect competition, complications arise and the decision of which bid to take becomes less clear.
(*Agriculture and gas stations are probably as close as you're going to get.)
The most common way that a market becomes imperfectly competitive is differentiated products. For example, you may think that fast food is a perfectly competitive market, but people do choose Wendy's over McDonald's because the spicy chicken sandwich is better. The point is, if you thought this way, you would not buy a chicken sandwich at McDonald's just because it's cheaper, as the only place you can get the product you want is at Wendy's.
Now consider contractors. Not all are the same--some have different expertise in different things. So right off the bat, you should be thinking about soliciting a contractor who can do what you want, not just the lowest price. And once you find the ones that can do what you want, you still have a problem: adverse selection.
Adverse selection roughly means the following problem: the people competing for your business are precisely NOT the people you want to be dealing with. For example: banks want to loan money to people with stable finances. But, people with stable finances don't need loans! So, if someone needs a loan, the bank knows that they are probably not so good at handling money, and will take great precaution to make sure they get paid back.
Again, consider contractors. You want to pay the lowest amount, but the contractors willing to work for the lowest amount are probably the ones with the least skills. After all, the labor market rewards value, and in the absence of a market distortion, a person who does a better job will be rewarded with the ability to command a higher salary.
Ok, enough already. Let's get to the point. Taking a low bid contract is appropriate only if you believe the low price is the result of a comparative advantage in productivity enjoyed by the low-bidding firm. In other words, if a company knows how to do something better, quicker, or using fewer people, they can make the same amount of profit while charging less money. This is when you take the low bid. If not, their bid is 'artificially' low; you are actually buying a differentiated product--and that difference is usually lower quality, or hidden costs elsewhere.
I believe that I was analyzing a letter........
So now, for the police station project, there is the cost of the lawsuit against the insurance firm, the already-lengthy delays in opening the station, and the need for additional remedial work. This could have been avoided.
The cost of the lawsuit is a perfect example of the hidden costs that I was just talking about, albeit an extreme example. The usable life of the work is another--which would you rather do: pay $5 million in 2007 for construction and another $5 million in 2010 when it breaks, or pay $7 million to have it done right the first time, and it lasts until 2020?**
(**Answer: $7 million once.)
I, too, am a minority contractor. My company has never once won a low bid contract. My company prides itself on supplying products and workmanship of the highest quality. This cannot be accomplished when you have to be the lowest bidder. You really do get what you pay for.
U.G. ALLISON, Severna Park
As the writer alludes to, the real question is why the bid is lower. Certainly some companies are smarter and more efficient, and their prices will be better for it. However, many companies try to offer a lower price at the beginning to gain the initial contract, figuring that when things go wrong, the customer will say "Geez, this company is already familiar with the project, let's just give them more money to finish the job."***
(***For more on this phenomenon, do a search on this blog for 'market house air conditioner'.)
Hopefully the new central services director can prevent this in the future.
In case you've forgotten, or are new to this blog, the deal is this:
-Original words appearing in letter to the editor: bold
-My excellent, omni-brilliant commentary: normal font. Because I'm a normal guy.
The "worth Repeating" feature quoted Mayor Ellon O. Moyer as saying that "No crystal ball revealed that our low bid minority contractor (for the expansion of the city police station) would deliver such an inferior product."
What is the deal with the middle initial always included with the mayor's name? We freekin' know who it is....how many Mayor Ellen Moyers are there?
By the way, to know what this person is talking about, click here.
What about "low bid" does the mayor not understand? The architectural firm responsible for the fiasco at the Market House was probably the low bidder also.
Ha! Excellent. Not unlike myself, the letter writer has nothing to lose since his/her writing is not the source of any income nor subject to any professional obligation. Translation: bring on the baseless accusations!
I understand that government wants to get fair value for its money, but invariably the requirement that the low bid be taken means inferior design and workmanship. In many instances the decision-makers look only at the price and do not compare apples with apples, but apples with oranges.
Or coconuts!
Moving on, let's address the claim that taking the low bid invites inferior design and workmanship. The most basic of economic theory is predicated upon 'perfect competition' in the market. A perfectly competitive market is characterized by several things, notably:
-many competing firms
-homogeneous (the same) products/services
-no barriers to entry (meaning any new business can easily start up)
Given a market for contractors with these characteristics, you would always take the low bid. But very few markets are perfectly competitive*. And when you introduce elements of imperfect competition, complications arise and the decision of which bid to take becomes less clear.
(*Agriculture and gas stations are probably as close as you're going to get.)
The most common way that a market becomes imperfectly competitive is differentiated products. For example, you may think that fast food is a perfectly competitive market, but people do choose Wendy's over McDonald's because the spicy chicken sandwich is better. The point is, if you thought this way, you would not buy a chicken sandwich at McDonald's just because it's cheaper, as the only place you can get the product you want is at Wendy's.
Now consider contractors. Not all are the same--some have different expertise in different things. So right off the bat, you should be thinking about soliciting a contractor who can do what you want, not just the lowest price. And once you find the ones that can do what you want, you still have a problem: adverse selection.
Adverse selection roughly means the following problem: the people competing for your business are precisely NOT the people you want to be dealing with. For example: banks want to loan money to people with stable finances. But, people with stable finances don't need loans! So, if someone needs a loan, the bank knows that they are probably not so good at handling money, and will take great precaution to make sure they get paid back.
Again, consider contractors. You want to pay the lowest amount, but the contractors willing to work for the lowest amount are probably the ones with the least skills. After all, the labor market rewards value, and in the absence of a market distortion, a person who does a better job will be rewarded with the ability to command a higher salary.
Ok, enough already. Let's get to the point. Taking a low bid contract is appropriate only if you believe the low price is the result of a comparative advantage in productivity enjoyed by the low-bidding firm. In other words, if a company knows how to do something better, quicker, or using fewer people, they can make the same amount of profit while charging less money. This is when you take the low bid. If not, their bid is 'artificially' low; you are actually buying a differentiated product--and that difference is usually lower quality, or hidden costs elsewhere.
I believe that I was analyzing a letter........
So now, for the police station project, there is the cost of the lawsuit against the insurance firm, the already-lengthy delays in opening the station, and the need for additional remedial work. This could have been avoided.
The cost of the lawsuit is a perfect example of the hidden costs that I was just talking about, albeit an extreme example. The usable life of the work is another--which would you rather do: pay $5 million in 2007 for construction and another $5 million in 2010 when it breaks, or pay $7 million to have it done right the first time, and it lasts until 2020?**
(**Answer: $7 million once.)
I, too, am a minority contractor. My company has never once won a low bid contract. My company prides itself on supplying products and workmanship of the highest quality. This cannot be accomplished when you have to be the lowest bidder. You really do get what you pay for.
U.G. ALLISON, Severna Park
As the writer alludes to, the real question is why the bid is lower. Certainly some companies are smarter and more efficient, and their prices will be better for it. However, many companies try to offer a lower price at the beginning to gain the initial contract, figuring that when things go wrong, the customer will say "Geez, this company is already familiar with the project, let's just give them more money to finish the job."***
(***For more on this phenomenon, do a search on this blog for 'market house air conditioner'.)
Hopefully the new central services director can prevent this in the future.
Tuesday, November 20, 2007
Ray Weaver Update
Public Information Officer Ray Weaver wanted to clarify his statements from last night, and graciously called me rather than post a comment on the site. I don't know how he obtained my top-secret cell phone number, but since he's in the information business, I suppose it speaks to his talent!
Mr. Weaver emphasizes that he was not angry at, nor berating the council in general or the mayor; rather, a specific member. Since I was checking messages on the above mentioned secret cell phone at the start of the event, I have determined that Mr. Weaver's explanation is plausible and will now correct the record. According to Mr. Weaver:
I actually don't think the display was unfortunate. As I said before, I would have reacted the same way, or at least I would have wanted to. I occasionally speak with former city spokespersons, and the stories that I have heard convince me that the job is no joke. I wouldn't want to do it. Mr. Weaver has apologized, and to answer a commenter on this site, I don't suspect that we will hear about his resignation or (quote) resignation (unquote).
On a related note, the primary purpose of this blog is my personal enjoyment. I want that people read this blog and change their party affiliation, register to vote, or change who they vote for; but to be honest, I won't lose sleep if this doesn't happen. In economics terms, I try to make the blog a net benefit to my utility. (Utility= happiness) Since I don't get paid for this, and I'm not running for office (any time soon), the only way that the blog is a net benefit for me is to amuse myself, keep up on issues, and give people some laughs.
How this relates to people reading this blog, is that if you happen to be the subject of something I write about, and you think you are misrepresented, you can just contact me and give your side of the story. Believe me--I have few, if any, journalistic ethic; unless I really REALLY disagree with you, I will update my statement. Making enemies as a result of a silly blog that I don't get paid for is definitely NOT a utility maximizing activity.
Mr. Weaver emphasizes that he was not angry at, nor berating the council in general or the mayor; rather, a specific member. Since I was checking messages on the above mentioned secret cell phone at the start of the event, I have determined that Mr. Weaver's explanation is plausible and will now correct the record. According to Mr. Weaver:
My comments were not directed at the entire council nor the Mayor. I was
angry that it seemed that a damning message about the Mayor and the Council was
being delivered to the media in the hallway, and another was being delivered to
the Mayor and the City Council in chambers. I expressed that specific concern to
that specific Alderman.
It is my job to represent the Mayor and the City, and I stand by my
statement that I felt the, "If you don't vote for this Bill as is, you must hate
the environment" tactic that was used was unfair and unjust. The compromise bill
addresses much more than just one item and is much more broad based than what
was essentially an anti-littering bill.
In any case, it was unprofessional of me to lose my temper and raise my
voice. I have apologized to the Mayor and the Council, and I extend that apology
to any one else that may have witnessed my unfortunate display.
I actually don't think the display was unfortunate. As I said before, I would have reacted the same way, or at least I would have wanted to. I occasionally speak with former city spokespersons, and the stories that I have heard convince me that the job is no joke. I wouldn't want to do it. Mr. Weaver has apologized, and to answer a commenter on this site, I don't suspect that we will hear about his resignation or (quote) resignation (unquote).
On a related note, the primary purpose of this blog is my personal enjoyment. I want that people read this blog and change their party affiliation, register to vote, or change who they vote for; but to be honest, I won't lose sleep if this doesn't happen. In economics terms, I try to make the blog a net benefit to my utility. (Utility= happiness) Since I don't get paid for this, and I'm not running for office (any time soon), the only way that the blog is a net benefit for me is to amuse myself, keep up on issues, and give people some laughs.
How this relates to people reading this blog, is that if you happen to be the subject of something I write about, and you think you are misrepresented, you can just contact me and give your side of the story. Believe me--I have few, if any, journalistic ethic; unless I really REALLY disagree with you, I will update my statement. Making enemies as a result of a silly blog that I don't get paid for is definitely NOT a utility maximizing activity.
Monday, November 5, 2007
Discounting Time
You might be confused about what this post will be about by reading it's title (this post is about saving or spending your money), but since the title of this blog often belies the content, I have determined that you all will just have to get used to it!
Anyway, 'discount' is a term that applies to many things. Certainly the most familiar is a price reduction or rebate, perhaps a 25% discount on a movie ticket if you are a senior citizen. The 'discount rate' usually refers to the interest rate that the Fed(eral Reserve Bank) charges its member banks for loans.
We also make discounting decisions when it comes to time, specifically present vs future. We all know that a dollar today is worth more than a dollar in the future (When I was young, a Coke cost a nickel!, etc.), and that combating such inflation requires investing and not keeping your money in the form of cash under a mattress.
There's also this question: if given an equivalent sum of money, when is the best time to spend it? Ric Edelman, a financial advisor whose column is published in The Capital, has this advice:
Mr. Edelman was making the point that you can find the money to contribute to a retirement plan if you want to, but his view rests on the following assumptions, if not more:
1. Money spent in retirement years produces more enjoyment than money spent today.
2. Free time when you are older is more enjoyable than free time today.
3. You will not be able to earn enough money in the future to cover your needs/wants.
In other words, he is telling you to sacrifice yourself in the present for the benefit of yourself in the future. This is a good strategy for some, but not for everyone. The following would be reasonable arguments for not saving money when you are young:
-You are convinced you will die at a young age.
-You think your income will increase significantly in the future and be sustainable.
-You like working and don't want to retire.
-You think that you can have more fun when you are young.
It would be enough for me if the readers of this blog realized that they make financial decisions not only between various goods and services, but between different time periods as well.
Anyway, 'discount' is a term that applies to many things. Certainly the most familiar is a price reduction or rebate, perhaps a 25% discount on a movie ticket if you are a senior citizen. The 'discount rate' usually refers to the interest rate that the Fed(eral Reserve Bank) charges its member banks for loans.
We also make discounting decisions when it comes to time, specifically present vs future. We all know that a dollar today is worth more than a dollar in the future (When I was young, a Coke cost a nickel!, etc.), and that combating such inflation requires investing and not keeping your money in the form of cash under a mattress.
There's also this question: if given an equivalent sum of money, when is the best time to spend it? Ric Edelman, a financial advisor whose column is published in The Capital, has this advice:
I offer a simple game plan: Walk up to your spouse, look him or her in
the eye, and say, "Honey, I'm sorry that we won't be able to retire, but it's more
important that we watch HBO." Then call 911 or a divorce attorney.
Mr. Edelman was making the point that you can find the money to contribute to a retirement plan if you want to, but his view rests on the following assumptions, if not more:
1. Money spent in retirement years produces more enjoyment than money spent today.
2. Free time when you are older is more enjoyable than free time today.
3. You will not be able to earn enough money in the future to cover your needs/wants.
In other words, he is telling you to sacrifice yourself in the present for the benefit of yourself in the future. This is a good strategy for some, but not for everyone. The following would be reasonable arguments for not saving money when you are young:
-You are convinced you will die at a young age.
-You think your income will increase significantly in the future and be sustainable.
-You like working and don't want to retire.
-You think that you can have more fun when you are young.
It would be enough for me if the readers of this blog realized that they make financial decisions not only between various goods and services, but between different time periods as well.
Monday, October 1, 2007
The Economist's Weird Mind
Much like my promise to bring you all the news about signs I could possibly find, if there is a mention of economics anywhere in my sphere of influence, you can bet that it will show up on these glamorous, highly-read pages. In fact, if it weren't for some dumb luck and the catchy ad slogan "Keeping the Hot Girls Happy and the Fat Boys Full", my catering career would not be where it is, and I would spend my Friday nights trying to understand why the dollar has sustained relative undervaluation and why a monopoly's marginal revenue curve is precisely twice the slope of the demand curve.
Scott Adams, the writer of Dilbert, used his blog to make some remarks about this particular discipline:
I studied economics in college.
Me too!
One thing I’ve noticed is that other people who have studied economics tend to think a similar way. Some of the similarity is probably because it takes a certain kind of person to be interested in economics in the first place.
The type of person that it takes to study economics can be politely described as open-minded, but probably more accurately described as emotionless and at least slightly geeky. Economics explains all decisions as functions of incentives. It tries to figure out how many people would change a particular decision they make in response to a certain incentive with which they are faced. The majority of man-kind is bored with such exercises, but economists are different. We (I am including myself) are motivated by an intense desire to understand the way things work, and be able to predict how they will work in the future. In other words, it may seem that people do illogical things, but we try to understand the rationale.
But I’m convinced that the study of economics changes brains in a way I can identify after about five minutes of conversation.
This is true, and I can give you a perfect pop-culture example. In the movie A Beautiful Mind, Russel Crowe is a young John Nash at a bar in Princeton. Several attractive females enter the bar. Rather than getting rowdy, buying drinks, etc., Nash--who propagated one of the most influential economic theories in the last half of last century--calculated that his best chance of courting any girl was to ignore the prettiest girl. He then immediately left all the girls in favor of modeling his findings mathematically.
In particular, I think the study of economics makes you relatively immune to cognitive dissonance.
(I had to look up what Cognitive Dissonance means. Basically its the uneasiness you feel from experiencing two apparently conflicting phenomena, or being dumbfounded that you can't understand data that conflict with each other.)
The primary skill of an economist is identifying all of the explanations for various phenomena. Cognitive dissonance is, at its core, the inability to recognize and accept other explanations. I’m oversimplifying, but you get the point. The more your brain is trained for economics, the less it is susceptible to cognitive dissonance, or so it seems.
He is right. In fact, I would imagine that observing two apparently conflicting facts is a fantastic surprise for research economists. Because it means that there is an explanation of life that they don't know about yet, and they can spend the next year, up to a lifetime, trying to figure it out.
The joke about economists is that they are always using the phrase “On the other hand.”
Believe you/me, this is not the joke about economists. There are many more.
Economists are trained to recognize all sides of an argument. That seems like an easy and obvious skill, but in my experience, the general population lacks that skill. Once people take a side, they interpret any argument on the other side as absurd. In other words, they are relatively susceptible to cognitive dissonance.
Now this is a great point to make, and it's one that AP has made before. People argue based on emotions. They draw a line in the sand, and refuse to accept any other explanation of whatever event people are trying to analyze. I would say that in most cases, the people arguing the most violently have the most common ground in their beliefs.
Taking this point a step further, ideological political arguments are very rare in city politics. I caution you: when observing city politics, do not place too much emphasis on party affiliation. Avoid the temptation to say "he's a democrat and she's a republican, so they won't get along on anything", because the truth is the things that really matter on the local level have little to do with the sweeping philosophies that are supposed to be rivaled in republican and democrat platforms.
So 2 concluding points.
1. If you find yourself speaking with an economist, listen. (For credibility purposes, I will exclude myself from the following claim). They probably know what they are talking about, and they will probably give you the a fairer and less biased explanation of something than you could get anywhere else.
2. Analyze the people, not the party, in city politics.
Scott Adams, the writer of Dilbert, used his blog to make some remarks about this particular discipline:
I studied economics in college.
Me too!
One thing I’ve noticed is that other people who have studied economics tend to think a similar way. Some of the similarity is probably because it takes a certain kind of person to be interested in economics in the first place.
The type of person that it takes to study economics can be politely described as open-minded, but probably more accurately described as emotionless and at least slightly geeky. Economics explains all decisions as functions of incentives. It tries to figure out how many people would change a particular decision they make in response to a certain incentive with which they are faced. The majority of man-kind is bored with such exercises, but economists are different. We (I am including myself) are motivated by an intense desire to understand the way things work, and be able to predict how they will work in the future. In other words, it may seem that people do illogical things, but we try to understand the rationale.
But I’m convinced that the study of economics changes brains in a way I can identify after about five minutes of conversation.
This is true, and I can give you a perfect pop-culture example. In the movie A Beautiful Mind, Russel Crowe is a young John Nash at a bar in Princeton. Several attractive females enter the bar. Rather than getting rowdy, buying drinks, etc., Nash--who propagated one of the most influential economic theories in the last half of last century--calculated that his best chance of courting any girl was to ignore the prettiest girl. He then immediately left all the girls in favor of modeling his findings mathematically.
In particular, I think the study of economics makes you relatively immune to cognitive dissonance.
(I had to look up what Cognitive Dissonance means. Basically its the uneasiness you feel from experiencing two apparently conflicting phenomena, or being dumbfounded that you can't understand data that conflict with each other.)
The primary skill of an economist is identifying all of the explanations for various phenomena. Cognitive dissonance is, at its core, the inability to recognize and accept other explanations. I’m oversimplifying, but you get the point. The more your brain is trained for economics, the less it is susceptible to cognitive dissonance, or so it seems.
He is right. In fact, I would imagine that observing two apparently conflicting facts is a fantastic surprise for research economists. Because it means that there is an explanation of life that they don't know about yet, and they can spend the next year, up to a lifetime, trying to figure it out.
The joke about economists is that they are always using the phrase “On the other hand.”
Believe you/me, this is not the joke about economists. There are many more.
Economists are trained to recognize all sides of an argument. That seems like an easy and obvious skill, but in my experience, the general population lacks that skill. Once people take a side, they interpret any argument on the other side as absurd. In other words, they are relatively susceptible to cognitive dissonance.
Now this is a great point to make, and it's one that AP has made before. People argue based on emotions. They draw a line in the sand, and refuse to accept any other explanation of whatever event people are trying to analyze. I would say that in most cases, the people arguing the most violently have the most common ground in their beliefs.
Taking this point a step further, ideological political arguments are very rare in city politics. I caution you: when observing city politics, do not place too much emphasis on party affiliation. Avoid the temptation to say "he's a democrat and she's a republican, so they won't get along on anything", because the truth is the things that really matter on the local level have little to do with the sweeping philosophies that are supposed to be rivaled in republican and democrat platforms.
So 2 concluding points.
1. If you find yourself speaking with an economist, listen. (For credibility purposes, I will exclude myself from the following claim). They probably know what they are talking about, and they will probably give you the a fairer and less biased explanation of something than you could get anywhere else.
2. Analyze the people, not the party, in city politics.
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