A Different Economic Perspective on Traffic

On his New York Times Freakonomics blog, Steve Levitt discusses “profits” and government intervention in the scope of people cutting in line in traffic. If an aggressive driver cuts in line on the road, social welfare is reduced, as people entering the ramp (or wherever) feel unequal costs and subsequently will not allocate themselves efficiently. Levitt concludes that police officers should concentrate their efforts to dissuade such behavior instead of, for instance, speeding, since the latter’s social cost is far less.

Levitt’s argument, technically, is really that line-cutting is rent-seeking and that speeding is profit-seeking. Not to be confused with what you pay for your apartment, “rent” is the term economists use to differentiate unjust gain from profit, which is no more than the financial return one can expect to get given the costs involved. In contrast, rent is the result of government intervention (for example, protectionism), market power, or criminal action. When a pickpocket steals your credit card, her gain is rent. When a firm increases its profits by keeping out foreign competition or receiving subsidies, its gain is rent. Finally, as Levvitt points out, when someone cuts you in line, what he gains is rent.

The most apt metaphor in intuitively understanding the difference between rent-seeking and profit-seeking behavior is to consider all the available goods in the economy as a pie. Profit-seeking behavior desires a larger proportion of the pie, but in doing so, also makes the pie bigger. New technologies and other cost-cutting measures perform such an action. Rent-seeking activities take that larger slice of the pie while making the pie smaller or leaving it the same size. Levitt assumes that the jerks who knowingly disregard those waiting in line do not make the pie bigger. Theirs is a zero-sum action, or that their gain in cutting is canceled out by the loss from everyone else.

Levitt’s other assumption, that speeding is profit-seeking, is enlightening. It calls into question the very structure of the traffic laws of western nations. If it’s five AM and you’re shooting down the interstate at 85 miles per hour, there is very little chance that you’ll hit someone. There is a benefit to driving at a higher speed, and if our assumption is utility maximization, one must balance the loss of life against time savings. Obviously, there is already a certain degree of balancing involved, as otherwise speed limits would be even lower. In any case, speeding in good weather with few others on the road seems intuitively to increase the size of the pie rather than a zero-sum action. Cops should eliminate irrefutable rent-seekers before prosecuting crimes whose true total costs are far more indefinite.

Perhaps, this definition of rent-seeking does not tell the whole story. Instead of assuming a utility-maximizing, pie-”centric” environment, let us take into account property rights and freedom of association. The effects of corporate welfare, crime, and tariffs could all transfer wealth without increasing the size of the pie, but that does not mean that the size of the pie is what matters. Corporate welfare and crime each requisition a portion of a citizen’s income for another’s wellbeing; that is theft, either arguably or literally.  Tariffs financially dissuade citizens from making an informed choice in a transaction; that depresses free association. Considering the factors of why rent-seeking is not beneficial to society, rather than tunnel-visioning the lack of benefit, allows more perspective.

This analysis falls apart when bringing it back into questioning traffic laws. Personally, when I drive, I always leave a car’s length of space between myself and the next bumper, even when traveling 15 miles per hour. I feel justified since, well, the law says I should, but also because I have the right to. However, this isn’t necessarily utility-maximizing, but more importantly, there is no cosmic, underlying “right” I have to that space on the road. Abstractly, you could stretch right to life to fit the notion that I have the “right” not to be very slightly endangered by someone else taking that space, but that doesn’t really mean much in practice. As they say, the right of my fist is up to the skin of your nose. Since I don’t really have the right to the ten feet in front of me (which precludes a line cutter from entering) in any meaningful way, a certain amount of anarchy on the roads is inevitable through this understanding.

Again, let’s rephrase, in the terms of an economic principle I’ve discussed at unconscionable length elsewhere on this blog, externalities. To summarize, externalities are economic transactions where the people making the transactions do not feel the full cost or benefit of what happens. If manufacturing a good causes pollution, it is a negative externality, and the producer sells too many of the goods to be socially optimal since he doesn’t feel the true social cost. If your neighbors’ property values rise because you cut your grass beautifully, it is a positive externality; not enough landowners make their land looks nice. Externalities focus on third parties who are affected but in no way really partake in the transaction.

Rent-seeking behavior is similar, but it affects the second party in the transaction, directly or indirectly. A thief’s behavior is rent-seeking in that it directly hurts the person from whom he is stealing (there are externalities within that “transaction”, where the property values of those nearby are hurt, but that is secondary). Likewise, limiting the market through tariffs directly constrains the consumer to the benefit of domestic industry. Far more lucidly, this model of rent-seeking demonstrates how the line-cutter steals from another driver.

But really, steals what? Despite the rules of the road the government provides us, you don’t have a cosmic right now to be queued. The classic example of failed public goods is the Tragedy of the Commons. In the analogy’s dated environment, local farmers brought their herds to the public commons, where anyone was free graze. Since no farmer had any incentive to limit his herd’s consumption, the commons became desolate and everyone gets screwed. Analogously, someone cutting you in line is the equivalent of a rival farmer’s livestock aggressively chomping on every bite of grass right before your cow had a chance to. It’s a jerk move to do, but there isn’t anything cosmically wrong when the good was free to all in the first place. The government legislating against it means nothing… and to say otherwise is begging the question.

The best model for considering jerk drivers is the second model, which I previously rejected. The real problem here is the lack of private property on the roads. If someone breaks a rule on a private road, however arbitrary that rule may be, she is breaking a fundamental, cosmic law of property rights. If the rule is truly arbitrary, then the owner is screwing himself out of profit (assuming that it is a tolled road), and if nothing else, rules for private property can be far more categorically accepted than whatever the local government decided this morning. That is to say, a dissenter can always break a law on public property if he believes that dictated regulation to be unreasonable, but societal concerns are immaterial on private property.

I conjecture a corollary to the Tragedy of the Commons. Since there isn’t ever anything cosmically true about the regulations we choose for public goods, those with differing respect for the law will align themselves differently, thus resulting in a misallocation of those goods. The line-cutters may be right in assuming that the length I put between myself and the car in front of me is not socially optimal and that they might as well jam themselves in there. Most, or any of them, may not think that, but it is a justification. If a private firm (even a monopoly) is in control of the roads, it pays for its mistakes and is subsequently rational. If you cut in line and get banned from the local highway simply because the firm wants to eliminate predatory behavior, guess what jerk? You’ve lost your job since you can’t make it to work on time and you’ll have to move. Such punishments may never pass the legislation, but private owners can do whatever they want.

Until then, we’re getting by with social niceties and fines.

My only investment advice ever

I am a pretend economist who refuses normally to give out investment advice but…

Get the hell out of there.

Don’t think about how we’re at the bottom of the market. You can’t know that. The bailouts Bush is talking about are unheard of. All anyone seems to want is a “solution” when it’s entirely possible that our economy is irrevocably screwed up and needs to be given time to resolve itself. We have no idea what the result such violent intervention may be.

Where is the money going to come from for any proposed bailout? Further public debt. There are no sudden proposed tax increases that will pay for this. After all, we don’t want to actually feel the effect of bailing out a private corporation. Instead, it’s going to be dumped in a seemingly unending pile of private and public debt for which America is liable. A quick and dirty way to estimate how much a private entity is worth is to subtract its liabilities from its assets. By that method, America is coming very close to being worth nothing.

Paul Samuelson famously once said that economists have correctly predicted nine of the five recessions. To be honest, for all of my paranoia, I don’t think it’s more likely than not that the economy will collapse… but that’s not the full story. If there’s a fifty percent chance that, if you make an investment, you’ll increase your assets by 25% and a ten percent chance you’ll lose pretty much everything, would you honestly do that? Anyone who is still in the stock market is taking that chance.

With our impossible debt outstanding, theory is untested conjecture. There are no case studies in what happens to world dominating nations that have nearly bankrupted themselves. Knowing nothing else, what does that tell you about such a nation’s ability to repay its debt (t-bills)? Even apart from the standard issue skepticism everyone should have about the stock market, can we even trust the very fundamental foundation of our economy?

Until we start paying down our societal debt, whether privately or publicly, I cannot imagine a scenario where it makes sense to rely on our shaky financial system. Economists and financial advisers scorn at the notion that certain assets are more “real” than others. After all, “real” estate is especially illiquid and capricious. Some assets may still guarantee their value over others in times of extreme financial distress. Yet, what real value is there in corporation that fall to our monetary irresponsibility?

When this government gets off the short-run maximizing train it got on in 2001, business can continue as usual. Those band-aids of short-run maximization, whether they were in the form of “spending ourselves out of a recession”, championing the availability of a home to all Americans, or bailouts, may only be allowing our financial gangrene to fester out of view. Before that point is reached, when we rip off those band-aids, the only investments I could possibly recommend are a broad sample of precious medals, foreign currency, and commodity futures. Losing 5% of your real value to opportunity cost is not a steep price to pay so that you will not end up in the poor house.

In 1987, America’s banks lost more money lost more money than they had gained in profit in the previous century combined. Back then, the FDIC protected us from bank failure.

What happens when the FDIC fails?

Self-Interest

Adam Smith’s Invisible Hand is an effective metaphor in describing how selfish individuals benefit society within the free market. In seeking profit (though not in seeking rent), the entrepreneur pushes costs down for everyone. The selfish entrepreneur gets a bigger piece of economic pie, but in doing so he makes the pie bigger.

This is a cliche, well known by anyone who has spent time studying Classical Economics. The way commentators frequently portray the metaphor, however, causes a great deal of confusion. Smith didn’t want to imply that it is good for entrepreneurs to be selfish. He was saying that, even if you assume the worst in people, profit-seeking behavior is beneficial for everyone. Such selfishness is completely separate from the economic conception of rationality and self-interest.

The difference selfishness and self-interest is very subtle. Selfishness, which is unequivocally not a virtue, provides for one’s own desires alone. In comparison, self-interest provides for one’s values. These values could be feeding the poor, saving the environment, spreading a faith, stopping disease, or any act of concern outside of yourself. They can also be buying a boat. If you do not spend any time or income on anyone but yourself, then yes, such behavior is selfish. Economic theory does not depend on individual actors to be miserly and selfish, but interested in effectively spending their income on the goods, services, and causes they value and in expanding their individual income so that they may continue to do so.

Others have made this delineation elsewhere, but social scientists, moralists, and even some professional economists screw this up. For example, here. Smith, after all, was himself a moralist. A common caricature of a capitalist is an unyielding, power-hungry, cutthroat monster counting his coins for the sake of procuring more coins. Such characterization ignores what many successful entrepreneurs do with their wealth, whose excess allows the possibility of substantial charitable endowments. Of course, there are certain wealthy individuals who do not donate much of anything. Yes, there are selfish rich people out there. That has nothing to do with the morality of self-interest. Whatever our income level, we spend it on what we value most.

The values fueling our individual economic actions, whether that is renting or owning, going to a movie or giving to charity, or visiting family or traveling Europe, are what makes them rational. The choice and the consequences of the choice are born out of the person making the choice. An individual chooses renting an apartment, going to a movie, and visiting family because they are what he values. Hence, they are based on something and thus rational. If another person chooses owning a condo, giving to charity, and traveling Europe, it is equally rational. Questions of whether it is cosmically right to rent, go to a movie, or visit family are completely irrelevant in asking whether they are rational in an economic sense.

Self-interest and rationality are the same concept, viewed from different angles. “Self-interest” defines the heuristic (will this promote what I think is right?) and “rationality” characterizes the decision (was it the same person who made the decision and who lived with the consequences?).  This is what makes a market “rational”. If society allows each individual to decide whether she should buy milk today, the market for milk is rational. Again, it doesn’t matter whether the person had enough milk already, will just let it spoil, or is planning on feeding it to her goldfish. The freedom to pursue her values renders the market rational.

When the government involves itself in the decision-making process, markets are no longer rational. If a town votes to build a bridge, those who voted against it still must pay. If the town then wants to toll the bridge, how much should it toll? If they price it like a monopoly would (which the bridge presumably is), they would be maximizing the revenue for the town, but not maximizing welfare. If they estimate how much it would cost in a perfectly competitive environment, welfare is maximized, but only helps those who can afford to pay the toll. If the price is set as free or otherwise below the average total cost, too many people will use the bridge. Choosing between these options is not simple. If the bridge was privately owned, the decision would have a clear basis. The person who spent the money on the bridge would weigh pure profit maximization against his civic duty. When a simple majority or politicians take the place of individuals, rationality is lost.

It may be possible for government involvement to be desirable, but it will always remain arbitrary. There is rarely a reason why today one value set may win out over another politically. Some may want a bridge to save time and relieve congestion. Others don’t want it because they won’t use it or because they don’t want more cars on the road. Depending on the circumstances, one side may be right from society’s standpoint as a whole, but which direction voters choose in practice could be anything but that. Still, town selectmen may look at the evidence and are unable to conceive of a situation where building the bridge is not a net positive for the public. They must simply keep the true arbitrariness of the action in the back of their minds before freely going forward with the spending.

We no longer expect atheists to give monetarily to churches. Expecting people who don’t prioritize the environment to pay for cleaning it up is analogous. Claims of science aside, spending income on religion is no less rational than spending it on the environment. Cosmically, such spending is ultimately true or untrue, but self-interest motivates either.

The State and Future of the American Economy

In very broad strokes, the history of the American economy is more or less

• 1797-1861: Capitalism / Mercantilism
• 1861-1933: The American School
• 1933-1981: Keynesian Economics
• 1981-Present: A mix of New Keynesian Economics, Post-Keynesian Economics, and Monetarism

If you walk up to a mainstream, informed citizen and ask her whether it is possible for the government to create jobs, she’ll look at you as if you have two heads. The notion that the level of employment is partially determined by the ability of the government to attract investment and to turn idle wealth into production is taken for granted. Yet, this characteristic is only really possible within some form of Keynesian economics. To other theoretical understandings, outside investment would help our income level, but would only cause an increase in jobs for previously discouraged workers who had not been working on their on accord, which isn’t what most people think of when considering a nation’s employment level. Furthermore, “idle wealth” does not really exist in other forms of economics, as, so long as a banking system functions, this wealth becomes an approved commercial loan somewhere else. Since most people believe that targeted government spending creates jobs, Keynesian Economics still dominate American fiscal policy.

In parallel to our collective belief that the government can create jobs, we have implicitly accepted a series of deregulations over the last two and a half decades. These changes are in utter contradiction to our apparent Keynesian sentiments found elsewhere and require firm belief in the efficiency of the market. The belief that financial institutions will tend towards stability and rational, profit-maximizing behavior, known as efficient-market hypothesis, is tangentially related to Monetarism. In contrast, Keynes himself said,

Playing the stock market is analogous to entering a newspaper beauty-judging contest in which one must select the six prettiest faces out of a hundred photographs, with the prize going to the person whose selections most nearly conform to those of the group as a whole.

While many Americans (anyone who picks stocks, really) do not accept the efficient-market hypothesis, those making policy apparently do.

When the market has blown up, arguably due to deregulation, over the last thirty years, the government has stepped in with bailouts. Leftist economists such as Kindleberger, Shiller, and Minsky have justified the notion of “too big to fall”. At this point, there is no disagreement among economists that an institution (or foreign government) of sufficient size will cause serious damage elsewhere in the economy if it is “allowed” to fall. To avoid a series of bank failures or the destruction of an entire industry, bailing out a single entity, with the government acting as the “lender of last resort” seems like a slam dunk. In this area, mainstream politicians are amicable towards an interventionist policy.

Finally, in the scope of that big important thing -monetary policy as a whole- the strategy has been a non-dogmatic form of monetarism, where the primary goal is to keep inflation between one and two percent. That leaves wiggle room for when the Fed wants to inject some liquidity while avoiding completely the possibility of stagflation. Some have questioned whether the Fed is actually following this in reality, by lying by no longer publishing M3 or by promulgation of geometrically-weighted core inflation. At the very least, however, the ostensible linchpin of contemporary American monetary policy is Monetarism.

This is where we are. If we can agree on anything, it is that the current system doesn’t work. I conjecture that the some of the booms and busts of the last 25 years have been the result of the inherent contradictions between our policies rather than the failure of any economic school in particular. Certain economic slowdowns, such as oil shocks (causing downturns in 1973, 1979, 1990, and 2000), are going to be difficult to get around no matter what. Downturns related to speculative bubbles (2000-2001, 2007) have no consensus for a solution, although further study and argument may form one. However, the cause of the collapses of 1987 and 2008 seem far more pointless and contrived.

First, we deregulate business and tell them to do whatever will maximize profits. Then, by bailing out any important company, we eliminate the downside of risky investments. Financial firms (and other “important” ones like the automotive industry and airlines) no longer feel the true, full cost of risky investments. In our contradictory policy that both supposedly trusts the market and rescues it when it screws up, we are giving firms every incentive to blow up. If we had gone with Monetarism or Post-Keynesian economics all the way, 1987 and 2008, and many of the other mini blow-ups in between, wouldn’t have happened. Pandering to both guaranteed failure.

If we had chosen pure Monetarism, which has strong free market ties, any failing firm would be allowed to fail. It may hurt other sound firms when it goes down, but it is important that a private, profit-seeking enterprise that has not been able to remain solvent dies. A properly functioning economy needs to allow for complete failure so the resources tied up in them go somewhere where they are more useful. If other firms allowed themselves to become so reliant on another firm that they go down with it, perhaps they shouldn’t have become so reliant in the first place.

Post-Keynesian policies would have attempted to keep firms from pursuing risky behavior to begin with. Regulations would be put in place that would trade some freedom to experiment for a greater guarantee of business solvency. Where the private sector repeatedly fails regardless of regulation, the industry would be nationalized. The remaining blow ups that occur simply because firms must take some risk would be bailed out. However, there would not be an incentive for subsequent, excessive risk because such behavior is heavily regulated.

Really, beyond that, what have we learned over the last fifty years?

1. The old Keynesian economics of the 1960s and 1970s doesn’t work. If you try to use the government to eliminate unemployment, you’ll only get inflation and more unemployment.
2. Monetary stability does not guarantee economic stability, as Monetarism argues. In the last two decades, inflation has been remarkably low and stable. Yet, we still have not curbed speculative bubbles or other financial blow ups.

A theme I’ve seen in the works of those with worldviews as disparate as Kevin Phillips and Nicholas Nassim Taleb is that the only thing we can be sure of in economics is the mainstream is wrong. History concretely contradicts the fundamental assumptions of monetarism and New Keynesian economics. That leaves only so-called Heterodox economics, which is virtually synonymous with behavioral economics. Phillips and Taleb both explicitly cite the Post-Keynesian school and Austrian school as far more empirically and historically justified than mainstream economics (other Heterodox economics do not make similarly relevant theoretical criticisms).

Americans keep talking change, so those are our two options, and they are as contradictory as we can get. The Austrian School is a radical, nearly anarchist, departure from our current set of circumstances. Unless Ron Paul is a serious candidate for the Presidency and I’ve been missing something, there is little precedent for America to all the sudden follow one of their financial solutions (have the states each run their own banking system, go back on the gold standard, or privatize currency). Rather, there is a tremendous, untapped sentiment among many moderate Americans in favor of Post-Keynesian Economics. As I mentioned initially, this school has already had an effect on our policies. McCain hasn’t really said much about the economy except liking tax cuts or whatever, while Obama has said he wants to go after oil speculators driving up the price. Such legislation is one of the first things a Post-Keynesian economist would favor. If there is a clear consensus for change amongst Americans on any issue, it is the economy, and the economics of Hyman Minsky fit their collective conception as good as any.

For better or worse, the future of the American Economy is Post-Keynesian Economics.