Actually, it’s dead easy. No math, no arithmetic. It is in fact the soul of common sense. But you have to understand that comparative advantage is the principle of cooperation, as against competition. The word “advantage” gets us thinking of competition, which is perfectly reasonable in our own individual lives — we do compete with other businesses or other writers or whomever. But the system as a whole, whatever it is, does well of course by cooperating, in business or science or family life. It’s not all we do, admittedly. We also compete. But within a household or a company or a world economy the job is to produce a result in the best way, cooperatively. If you are running a household or a sports team or a world economy, you would want to assign roles to the various contributors to the common purpose sensibly. It turns out to be precisely on grounds of comparative advantage.
Consider Mum and 12-year old Oliver, who are to spend Saturday morning tidying up the garage. Oliver is incompetent in everything compared with Mum. He cannot sweep the floor as quickly as she can, and he is truly hopeless in sorting through the masses of rubbish that garages grow spontaneously. Mum, that is, has an absolute advantage in every sub-task in tidying up the garage. Oliver is like Bangladesh, which is poor because it makes everything — knit goods and medical reactors — with more labor and capital than Britain does. Its output per person is 8.4 percent of what it is in Britain. So too Oliver.
What to do? Let Mum do everything? No, of course not. That would not produce the most tidied garage in a morning’s work. Oliver should obviously be assigned to the broom, in which his disadvantage compared with Mum is comparatively least — hence “comparative advantage.” An omniscient central planner of the garage-tidying would assign Mum and Oliver just that way. So would an omniscient central planner of world production and trade. In the event, there’s no need for an international planner. The market, if Trump does not wreck it, does the correct assignment of tasks worldwide. Bangladesh does not sit down and let Britain make everything merely because Britain is “competitive” absolutely in everything. And in fact Bangladesh’s real income has been rising smartly in recent years precisely because it has specialized in knit goods. It has closed its ears to the siren song of protecting its medical reactor industry. It gets the equipment for cancer treatment from Britain.
Comparative advantage means assigning resources of labor and capital to the right jobs, whatever the absolute productivity of the economy. It applies within a single family, or within a single company, or within Britain, or within the world economy, all of which are made better off by such obvious efficiencies. Following comparative advantage enriches us all, because it gets the job done best. Policies commonly alleged to achieve absolute advantage lead to protection — that is, extortion, crony capitalism, and the rest in aid of “competitiveness.”
Dierdre N. McCloskey, “A Punter’s Guide to a True but Non-Obvious Proposition in Economics”, 2017-10-16.
November 5, 2017
QotD: Explaining comparative advantage
November 4, 2017
Desperate Mayors Compete for Amazon HQ2
ReasonTV
Published on 3 Nov 2017Local politicians clash as they try to lure Amazon’s new headquarters to their towns.
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Cities across the country want Amazon HQ2 and the 50,000 jobs promised to come with it. Some municipalities are offering big incentives. When New Jersey puts $7 billion in tax credits on the table, how can small-town mayors compete? By really screwing taxpayers.Written and performed by Austin Bragg and Andrew Heaton. Produced and edited by Bragg.
November 2, 2017
QotD: Free trade versus modern “Free Trade” agreements
Once upon a time, free-trade agreements were about just that: free trade. You abolish your tariffs and import restrictions, I’ll abolish mine. Trade increases, countries specialize in what they’re best equipped to do, efficiency increases, price levels drop, everybody wins.
Then environmentalists began honking about exporting pollution and demanded what amounted to imposing First World regulation on Third World countries who – in general – wanted the jobs and the economic stimulus from trade more than they wanted to make environmentalists happy. But the priorities of poor brown people didn’t matter to rich white environmentalists who already had theirs, and the environmentalists had political clout in the First World, so they won. Free-trade agreements started to include “environmental safeguards”.
Next, the labor unions, frightened because foreign workers might compete down domestic wages, began honking about abusive Third World labor conditions about which they didn’t really give a damn. They won, and “free trade” agreements began to include yet more impositions of First World pet causes on Third World countries. The precedent firmed up: free trade agreements were no longer to be about “free” trade, but rather about managing trade in the interests of wealthy First Worlders.
Eric S. Raymond, “TPP and the Law of Unintended Consequences”, Armed and Dangerous, 2016-04-12.
October 31, 2017
How Sugar Subsidies Ruin Halloween
ReasonTV
Published on 30 Oct 2017This Halloween while you’re getting pudgy from candy, crony capitalists are getting rich off of sugar subsidies. The system is rigged through price controls, subsidies, and tariffs, all designed to protect the sugar industry from competition – and basic math. In the latest “Mostly Weekly” Andrew Heaton tears into the Willy Wonkas gaming the system, and shows why an open market can more than handle your sugar craving.
October 29, 2017
QotD: Mencken’s revised view of Coolidge
In what manner he would have performed himself if the holy angels had shoved the Depression forward a couple of years — this we can only guess, and one man’s hazard is as good as another’s. My own is that he would have responded to bad times precisely as he responded to good ones — that is, by pulling down the blinds, stretching his legs upon his desk, and snoozing away the lazy afternoons…. He slept more than any other President, whether by day or by night. Nero fiddled, but Coolidge only snored…. Counting out Harding as a cipher only, Dr. Coolidge was preceded by one World Saver and followed by two more. What enlightened American, having to choose between any of them and another Coolidge, would hesitate for an instant? There were no thrills while he reigned, but neither were there any headaches. He had no ideas, and he was not a nuisance.
H.L. Mencken, The American Mercury, 1933-04.
October 23, 2017
QotD: Cargo cult economics
Once upon a time, government officials decided it would help them keep their jobs if they could claim they had expanded the middle class. Unfortunately, none of them really understood economics or even the historical factors that led to the emergence of the middle class in the first place. But they did know two things: middle class people tended to own their own homes, and they sent their kids to college.
So in true cargo cult fashion, they decided to increase the middle class by promoting these markers of being middle class. They threw the Federal government strongly behind promoting home ownership and college education. A large part of this effort entailed offering easy debt financing for housing and education. Because the whole point was to add poorer people to the middle class, there was a strong push to strip away traditional underwriting criteria for these loans (e.g., down payments, credit history, actual income to pay debt, etc.)
We know what happened in the housing market. The government promoted home ownership with easy loans, and made these loans a favorite investment by giving them a preferential treatment in the capital requirements for banks. And then the bubble burst, with the government taking the blame for the bubble. Just kidding, the government blamed private lenders for their lax underwriting standards, conveniently forgetting that every President since Reagan had encouraged such laxity (they called it something else, like “giving access to the poor”, but it means the same thing).
Warren Meyer, “Cargo Cult Social Engineering”, Coyote Blog, 2012-11-28.
October 22, 2017
October 20, 2017
Why the Lights Are Still Off in Puerto Rico
ReasonTV
Published on 19 Oct 2017The government set the stage for a post-hurricane catastrophe.
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Puerto Rico was set up for disaster well before Hurricane Maria hit. Revoked tax breaks, needlessly expensive imports, and crippling debt all led to a shoddy infrastructure that’s still without power on most of the island.On the latest “Mostly Weekly,” Andrew Heaton explores: how did Puerto Rico get screwed over well before the lights went out, and how do we get them back on?
Mostly Weekly is hosted by Andrew Heaton with headwriter Sarah Rose Siskind.
Script by Sarah Rose Siskind with writing assistance from Andrew Heaton, Brian Sack, and Justin Monticello
Edited by Sarah Rose Siskind and Austin Bragg
Produced by Meredith and Austin Bragg.
Theme Song: Frozen by Surfer Blood.
October 19, 2017
Richard Florida oversold his “creative class”
Rick McGinnis reviews the latest book by the much-celebrated Richard Florida … which walks back a lot of what his last book pushed:
With his new book, The New Urban Crisis, Florida concedes that he might – just might – have overstated his case. The gaps between the rich and poor have increased, particularly in the case study cities that Florida described and, later, championed as an advocate of his pet theory. The so-called creative class has transformed cities, mostly by colonizing the most attractive districts, aggregating most of the wealth around them, and increasing house prices exponentially, driving the less fortunate classes – Florida’s “service class” and an equally distinct and diminishing working class – into insalubrious neighbourhoods, often at the city’s fringes.
To be fair, it was a case well sold, and it made Florida a star in his field, ultimately landing him at the head of something called the Martin Prosperity Institute at the Rotman School of Management at the University of Toronto. The idea of some sort of vaguely defined creative class as a benign invasion, reviving run-down areas once home to workers or industry with their peculiar and mysterious social, cultural and economic alchemy, had a lot of appeal to the sorts of people who run cities – politicians, developers and realtors, mostly.
The vagueness of what constituted the “creative class” no doubt helped sell Florida as an urban visionary – it could be stretched to include everyone from gallery owners, photographers, and art directors to claims adjusters, funeral directors, and tax collectors. In Florida’s theory, as one critic noted, “distinctive spatial and political proclivities are bunched together, purely on the basis of educational attainment, and with little demonstrable relationship to creativity.” Much of the good press was probably helped by the fact that journalists had pride of place in the creative class.
[…]
There’s a sleight of hand at work with Florida’s theory, as the middle class that he bemoans as disappearing has actually been largely absorbed by him into the very elastic borders of the creative class, where vast armies of white collar workers find their home alongside tiny numbers of arts bureaucrats and musicians. His fetish for IT workers in particular seems curious, since many of the jobs being done in vast, architecturally praised tech campuses are, in basic function indistinguishable from the sort of grinding desk labour done on vast office floors in skyscrapers by men in gray flannel suits, 60 years ago.
October 18, 2017
Cognitive bias – it can be a problem for the “nudgers”, too
Ilya Somin says that replacing private decisions with “rational” government nudges does not guarantee that there are no cognitive biases still being expressed:
Economist Richard Thaler recently won the 2017 Nobel Prize in economics for his important work documenting widespread cognitive errors in human decision-making. All too often, people fail to act as rationally as conventional economic models assume, and at least some of those errors are systematic in nature. Such errors can lead to mistakes that greatly diminish our health, happiness, and welfare.
Thaler and many other behavioral economics scholars argue that government should intervene to protect people against their cognitive biases, by various forms of paternalistic policies. In the best-case scenario, government regulators can “nudge” us into correcting our cognitive errors, thereby enhancing our welfare without significantly curtailing freedom.
Irrational Nudgers
But can we trust government to be less prone to cognitive error than the private-sector consumers whose mistakes we want to correct? If not, paternalistic policies might just replace one form of cognitive bias with another, perhaps even worse one. Unfortunately, a recent study suggests that politicians are prone to severe cognitive biases too – especially when they consider ideologically charged issues. Danish scholars Caspar Dahlmann and Niels Bjorn Petersen summarize their findings from a study of Danish politicians:
We conducted a survey of 954 Danish local politicians. In Denmark, local politicians make decisions over crucial services such as schools, day care, elder care and various social and health services. Depending on their ideological beliefs, some politicians think that public provision of these services is better than private provision. Others think just the opposite. We wanted to see how these beliefs affected the ways in which politicians interpreted evidence….
In our first test, we asked the politicians to evaluate parents’ satisfaction ratings for a public and a private school. We had deliberately set up the comparison so one school performed better than the other. We then divided the politicians into two groups. One group got the data — but without any information as to whether the school was public or private. The schools were just labeled “School A” and “School B.” The other group got the exact same data, but instead of “School A” and “School B,” the schools’ titles were “Public School” and “Private School.”
If politicians are influenced by their ideologies, we would expect that they would be able to interpret the information about “School B” and “School A” correctly. However, the other group would be influenced by their ideological beliefs about private versus public provision of welfare services in ways that might lead them to make mistakes….
This is exactly what we found. Most politicians interpreting data from “School A” and “School B” were perfectly capable of interpreting the information correctly. However, when they were asked to interpret data about a “Public School” and a “Private School” they often misinterpreted it, to make the evidence fit their desired conclusion.
Even when presented additional evidence to help them correct their mistakes, Dahlmann and Petersen found that the politicians tended to double down on their errors rather than admit they might have been wrong. And it’s worth noting that Denmark is often held up as a model of good government that other countries should imitate. If Danish politicians are prone to severe ideological bias in their interpretation of evidence, the same – or worse – is likely to be true of their counterparts in the United States and elsewhere.
QotD: The course of economic progress in a nutshell
It is customary in these days of “slow food” to sneer at these devices, to aver that a real cook doesn’t need more than a cast-iron dutch oven, a good chef’s knife and a sense of adventure. As someone who took herself off to Chicago for three months with pretty much exactly this set of equipment (okay, also an electric pressure cooker), I can testify that this is true — sort of. You can get by with a very minimal set of equipment if you know how to cook. But as someone who has done so, I have to ask: Why would you?
I mean, yes, I know how to chop onions just fine. But doing so makes me cry like the dickens, unless I wear goggles. I know how to make great lemon curd, béchamel, hollandaise, caramelized onions. But my Thermomix makes them just as well, and I can read a novel instead of standing at the stove, stirring. I can whisk up an angel food cake in a copper bowl … or I could let the stand mixer do that, and my arms won’t hurt.
For that matter, I could also go out and grow my own wheat, mill it myself, and then mine some salt and cultivate some wild yeast to bake bread. But I don’t do these things, because subsistence farming is actually pretty arduous and unrewarding, which is why few of us have chosen to live off the grid. I see no reason to romanticize the grunt labor of the kitchen. If a machine does it as well as I do, and fits in my paycheck, I’ll happily outsource to the machine, and save my labor for the stuff the machine can’t do. This being basically the entire history of human economic progress to date.
Megan McArdle, “Give Thanks for Williams-Sonoma and the Garlic Press”, Bloomberg View, 2015-12-07.
October 15, 2017
David Suzuki’s (incomplete) economic understanding
Several years ago in the Literary Review of Canada, Joseph Heath explained how he tried “being green” and in the process discovered that Canada’s secular environmental saint David Suzuki literally didn’t have a clue about economics:
David Suzuki’s most recent, The Legacy: An Elder’s Vision for Our Sustainable Future, is billed as an attempt by “one of the planet’s preeminent elders” to “sum up in one last lecture all that he has learned over his lifetime.” Suzuki is, of course, one of the most influential public intellectuals in this country. Like most Canadians of my generation, I grew up watching The Nature of Things, and so tend to think of Suzuki as a constant in the universe.
Suzuki was also an environmentalist long before it was cool to be an environmentalist. Perhaps because of this passionate commitment to the cause, it is startling to discover that Suzuki is oblivious to the logic of collective action. What’s worse, he does not even know what an externality is, and seems unwilling to learn. In The Legacy, he repeats the same incorrect definition that he has been using for years (he equates externalities with anything that is not part of, and hence external to, an economic model, and then claims, on that basis, that economists ignore them). Elsewhere, he even provides a detailed account of where the misunderstanding arose. It was apparently based upon something that the instructor said to him, on the first day of an economics class, which he evidently misinterpreted and never bothered to double check.
It is worth pausing for a moment to reflect upon this. It means that Suzuki does not know the first thing about environmental economics. It means that in 38 years as a university professor, public intellectual and environmental activist, he did not once take the time to find out what social scientists have to say about the problem of global warming. It means that he has never even glanced at the Wikipedia page on environmental economics.
Because of this, Suzuki winds up committing the core fallacy of environmental activism. He thinks that if people only understood the consequences that their actions were having on the environment, they would each be motivated to change their behaviour. And so, to the extent that we are not changing our behaviour, it must be because we do not understand, or that we have not been telling ourselves the right “story.” Yet this is manifestly not the case. My wife understands the science of global warming perfectly well. But she also does not like dandelions growing by the side of the road. And when push comes to shove, the desire to kill dandelions wins over environmental peccadilloes. It is not particularly mysterious. It is called free riding; people do it all the time.
Thus when Suzuki writes “we say we are intelligent, but what intelligent creature, knowing that water is a sacred, life-giving element, would use water as a toxic dump?” he seems genuinely not to know. The answer is easy: we are intelligent creatures who care just slightly more about ourselves than we do about other people. For example, like most residents of Toronto I do not use the water on my land as a toxic dump; I use Lake Ontario for that purpose. Saying that “we are water, and whatever we do to water, we do to ourselves” sounds very nice, but all the “we” talk actually encourages a very serious confusion. What I do to water, I primarily do to other people, not to myself, which is why I care about it just ever-so-slightly less.
In the end, and somewhat contrary to all expectations, Suzuki winds up coming off as a science chauvinist. There are basically two bodies of knowledge that he respects. There is physical science — genetics, biology, the stuff that he studies — and there is what he calls “traditional knowledge” — by which he means the wisdom of aboriginal and indigenous peoples. Conspicuously absent is any interest in what social scientists might have to say about how human beings work, about the political process, about the economy and about how societies mobilize to address collective action problems. As a result, he knows a lot more about the nature of things than he does about the nature of people.
H/T to Andrew Potter, via Stephen Gordon for the link.
October 11, 2017
The Great Recession
Marginal Revolution University
Published on 9 Aug 2016There’s already been much discussion over what fueled the Great Recession of 2008. In this video, Tyler Cowen focuses on a central theme of the crisis: the failure of financial intermediaries.
By 2008, the economy was in a very fragile state, with both homeowners and banks taking on greater leverage, many ending up “underwater.” Why did managers at financial institutions take on greater and greater risk? We’ll discuss a couple of key reasons, including the role of excess confidence and incentives.
In addition to homeowners’ leverage and bank leverage, a third factor played a major role in tipping the scale toward crisis: securitization. Mortgage securities during this time were very hard to value, riskier than advertised, and filled to the brim with high risk loans. Cowen discusses several reasons this happened, including downright fraud, failure of credit rating agencies, and overconfidence in the American housing market.
Finally, a fourth factor joins homeowners’ leverage, bank leverage, and securitization to inch the economy closer to the edge: the shadow banking system. On the whole, the shadow banking system is made up of investment banks and various other complex financial intermediaries, highly dependent on short term loans.
When housing prices started to fall in 2007, it was the final nudge that pushed the economy over the cliff. There was a run on the shadow banking system. Financial intermediaries came crashing down. We faced a credit crunch, and many businesses stopped growing. Layoffs ensued, increasing unemployment.
What could have been done to prevent all of this? You’ll have to watch the video to find out.
