Quota Question

I hope my international economic policy students can answer the following:

Sketch a standard supply and demand graph, illustrating the market for imported cars from Japan. Suppose the government set a consumption quota on imported cars from Japan well below the equilibrium quantity. Identify the areas of deadweight loss and the price of imported cars from Japan. Also indicate the area of rent and indicate who (as specifically as possible) the rent goes to.

Striving for Specificity

In homework three, I give my students a little history lesson:

According to amendments to the Clean Air Act of 1970, new coal power plants have to install scrubbers to reduce the carbon and ash of their emissions. Environmental groups called this amendment a great victory for clean air. The scrubbers, which are about as large as the power plant itself, consume a great deal of power (10% the plant generates) and are very expensive to operate. There are two basic types of coal in the United States that could be mined for such power plants: “dirty” coal (which has a high carbon and ash content, mined in the east) and “clean” coal (which has a low carbon and ash content, mined in the west). The latter is slightly more expensive, but does not need to be scrubbed (and is in fact cleaner than scrubbed emissions from dirty coal).

The punchline to all of this is that power plants buy dirty coal instead of clean coal since scrubbers have to be installed regardless. In the end, we get dirtier air (scrubbed dirty coal is dirtier than unscrubbed clean coal), the opposite of what the Clean Air Act was suppose to do. In a podcast about this topic, Bruce Yandle notes that environmentalists, scrubber makers, dirty coal miners, and railroad companies (who specialized in that kind of coal transport) celebrated at the regulation. Strange bedfellows, indeed.

A student notes that the rule should be that all power plants purchase clean coal. It's certainly a step in the right direction, but not likely to be a good, lasting solution. Whenever you discover a law encourages people to do X when Y is more efficient, the proper response is not to require people to do Y. Just because it's specific, doesn't mean it's going to be smart. Institutional and technological change might make X better later, or a third option, Z, better than Y. The goal is not to force people down a particular road but to encourage them to the road that's most efficient at any given time. In other words, taxing the emissions (with all that calculation problems that brings along) is a much smarter solution. It not only deters the essence of what we dislike, it encourages new ways to solve the problem. Striving for specificity, no matter how smart it might seem in the short run, is ultimately a recipe for centralization and encourages the delusion that "just the right static requirements" are better than the competing efforts of countless millions.

Hands and Heads

Here's the latest PhD comic, published yesterday:

The author, notably, did not consult an economist on the issue of sustainability, just foresters. And in doing so, we miss half of the evidence of what's going on when it comes to long term economic development. We are told people are just mouths and stomachs: they just consume and more people or development means more consumption. End of story. But people are also hands and heads: we produce and (most critically) we invent.

Which is the bigger factor? The evidence suggests that, certainly, in the short run consumption matters more. More consumption raises the price of goods (meaning they are more scarce). But the long run results (the sustainability concern) favors production. Goods (adjusted for inflation) keep getting cheaper. That short run boast in prices generates the incentive to ration, find substitutes, and ultimately develop new technology. People say it's different now, especially with energy (one of our most fundamental inputs). We've reached some peak that we can never return from. Armageddon is always just around the corner.

Humanity faced an energy shortage since our conception as a species. We sought it in plants, rivers, wind, fire, and a menagerie of animals. We built waterwheels, windmills, stoves, ships, sails, yokes, collars, carts, and harnesses in pursuit of of more efficient sources of energy. We dug mines all over the planet. Wood begot peat begot coal begot oil begot gas begot uranium. Now we seek it from the inner depths of out planet (geothermal) to the distant reaches of space (solar) and one theme permeates this unending quest of one of our most precious of resources: energy is cheaper. What new trend could have possibly emerged that makes them think it's suddenly different now?

Next time, Mr. Cham, I suggest you ask someone versed in both consumption and production. Next time, ask an economist.

Corn Laws and the Ironies of History

In the 1840s, England's Corn Laws (corn being a generic term for wheat, barely, and rye) were under a hot debate. The Laws issued a series of tariffs ensuring bread prices stay two to three times higher than they were 100 years ago. But as the Industrial Revolution pushed forward, mill owners knew cheaper food was crucial to feed their employees. There thus arose a battle between the landed aristocracy, arguing mercantilism and questioning this "new" economy, and manufacturers, citing Adam Smith and the logic of free trade. Thankfully the latter, led by Richard Cobden, won the day.

Manufacturing, once a great advocate of free trade, now in the West is its enemy. And if Lou Dobbs, a vocal opponent of free trade on the grounds that it hurts factories, lived a century and a half ago, he would be raging against the very sector he so persistently defends today.

Fixed Exchange Rates

I hope my 385 students can answer the following:

True or False:
If a currency with a fixed exchange rate is undervalued, its central bank will have to buy the domestic currency to maintain the fixed rate.

What Vegas Can Teach You About the Recession

In last week's EconTalk, economist Allan Meltzer argued one of the main reason for our current financial mess is the Fed's policy of too big to fail. If a large financial institution collapses, it will harm countless other institutions and hamstring the the market as a whole. By preventing disaster and saving these companies, the Fed saves the economy. Knowing that in the worse case scenario someone will help you out, these banks then took riskier chances than they otherwise would. Thus the mess we're in now. In a world of superheroes, there are more extreme athletes.

Some are skeptical of this relationship, made evident by the fact that this is not at the forefront of the popular debate (the much more vague and non-scientific "animal spirits" is). But suppose you went to a conference in Las Vegas and your company agreed to reimburse you for any gambling losses you suffered during the trip. It's obvious that you would gamble more. And you would take bigger risks. Why wouldn't you?

You could point out that the companies are worse off than those that didn't take the housing gamble (such as JP Morgan Chase, Pittsburgh National, Wells Fargo). But they are better off than if the Fed hadn't intervened at all. If the company compensates you only half or a third of what you lost from gambling, you would still gamble more but not as much as full compensation. Regardless, this policy would immediately prove to be a terrible idea. But that's the rule in place at the Fed now.