The Canadian Giant

When Americans think of Canada, a handful of quaint images usually run through our heads. Lumberjacks. Mounties. Maple syrup. It might seem backwards, rugged, or even primitive. But Canada is America's largest trading partner, greater than even China or India. There are virtually no tariffs put on items exchanged between the two countries--about as close as I've ever seen of actual free trade. It's a wonder Lou Dobbs doesn't focus his wrath on America's northern neighbor.

On the most recent Southpark episode, Canada becomes so angered by their lack of respect worldwide that they strike. After an unknown course of time (several die during the strike due to hunger and fatigue), it's revealed that Canada lost $10.4 million in lost production as a result of the strike.

I suppose the writers felt this was a high sum or knew it wasn't and used to to poke fun at Canada. But in all honesty, for a country of 33 million people, that adds up to less than fifty cents a person. The Canadian economy is actually quite robust (no doubt in part due to trade with the US and other countries), with a GDP per capita on par with the United States ($38,200 versus America's $43,594).

To capture how small the number is, understand that we can use it to estimate the length of the strike. Canada's GDP is $1.274 trillion. That means the strike lasted for 0.00000816 years, or, ignoring weekends and assuming an eight hour work day, 1.02 minutes. (I use USD here; note that if you switch to Canadian dollars it changes nothing since you'd be multiplying the numerator and the denominator by the same constant.)

The world economy is huge. Mind blowingly, fantastically huge. It is so large, Americans scarcely notice a nearby one trillion dollar economy and the toil and effort of a population the size of California. How great we have become, and how small each of us are.

The Paradox of Control

Eliezer Yudkowsky at Overcoming Bias explained scarcity as psychologists think of it: as something becomes less attainable, you value it more. It's not clear how widely this applies but I can see it function in many areas such as dating, fads, and fashion. While Yudkowsky explains the phenomenon with evolutionary psychology (our ancestors had to grab what was scarce or they'd die out) we can also see it as signaling. If you have something that's hard to get, it suggests you're important, hip, or otherwise exceptional in some way.

Contrast this with Robin Hanson's theory of regulation. If a regulator can require something of a person but doesn't, the person will likely conclude doing what the regulator wants isn't all the important. If you can ban something but don't, then it's not all that dangerous. If you can require something but don't, then it's not all that helpful. A lack of regulation is a signal that tells people that if they made a bad decision, they'd still be alright.

Again, it's not clear how widely this framework applies but we can imagine quite a bit of overlap. Drugs come to mind first. If you ban drugs, people will want to do them more to either suggest they're hip or to get them while they can. If you don't ban drugs, people (possibly the same group, possibly different) will then conclude they're aren't a big deal and use them. In other words, if you don't want anyone in a society to use drugs, there's nothing you can do about it.

What About the Rest of Us?

There's a Breast Cancer Protection Act currently circulating in Congress to require health insurance companies to cover a minimum 48-hour hospital stay for mastectomy patients. Makes sense that women wouldn't want to be forced out of bed right after surgery, but what's that going to do to the rest of our premiums?

Is Wal-Mart A Collective Action Problem?

Wal-Mart gets a lot of criticism from a long list of groups from environmental to protectionist to labor union. People complain it destroys jobs and runs local stores out of business. None of these arguments hold water (environmentalism is about private property, free trade emboldens economies, Wal-Mart only works because people choose to go there, etc) and I have yet to hear the rara avis: an anti-Wal-Mart argument that makes economic sense. On a theoretical level, I think I have one.

Consider a small town. Each of these people value two things: their downtown mom-and-pop stores (that small town feel) and low prices (everyone likes a bargain). Let us also suppose that each person values the small town atmosphere over the prices--in other words they are willing to pay a premium to keep the charm of the hamlet.

Now suppose a Wal-Mart comes to town. Each resident has a choice between shopping downtown (and thus supporting it) or shopping at Wal-Mart (and thus get the lower prices). Since the downtown won't go away if one person "defects" to Wal-Mart, that defector can enjoy low prices and still have that small town feel they love so much. It's strictly better. (Note enjoying that small town feel does not require actually trading with them--they simply walk along Main Street and breathe in the atmosphere.)

Naturally everyone has an incentive to do this, thus everyone goes to Wal-Mart (or a lot do) and the downtown disappears. (Set aside any arguments of downtown revival because people can now afford more stuff.) As an individual, you can choose to end your defection and go downtown, but you, lone patron, will not save the stores. It will only work if everyone (or a lot) of people will work with you. But their personal incentives doesn't lend them to that so no one does. It's a collective action problem.

The downtown atmosphere is what economists call a positive externality--people who aren't paying for it still are able to enjoy it. The town could solve this issue by walling off the downtown and charge a small fee to those who wish to visit it. Taxes to the stores could be reduced by a proportional amount (who could then decrease their prices slightly) and the only difference ends up being that free riders can no longer ride for free. Naturally, the town could also ban Wal-Mart if it turns out internalizing these externalities prove too costly (which it very well might be).

Anti-Wal-Mart groups who wish to use this argument should exercise caution. The assumptions are rather strong (nobody is willing to swap low prices for their downtown) and demonstrating they apply to a given community is difficult. Moreover, the establishment of this argument can quickly be applied to areas the group may not desire. If one can ban Wal-Mart on the grounds that low prices are too expensive, then one can ban Internet access, delivery services, resident mobility, and a host of other options on the grounds that people cannot be tempted by alternatives lest the downtown is abandoned. The line between preventing a collective action problem and outright tyranny is a thin one indeed.

Gaps In the Logic

A lot of dirt is being thrown at financial institutions lately and lot of it's nonsense. Near the top of that nonsense list are the accusations of racism. True, blacks have a harder time getting a loan; no one is denying that. But gaps in outcome does not imply discrimination. As Thomas Sowell points out in his new book,

[In two studies in the early nineties] whites were denied conventional home mortgages loans more often than Asian Americans. The same reasoning that led to the conclusion that blacks were being discriminated against in favor of whites would lead to the very questionable conclusion that whites were being discriminated against in favor of Asian Americans. But however questionable that conclusion, we cannot simply accept empirical evidence when it supports our preconceptions and reject that same evidence when it goes against those preconceptions...A later study showed that Asian Americans took out expensive subprime loans less frequently than whites did--but again the media focus was on black-white differences in the use of costly subprime loans and again the conclusion was that racial discrimination in access to conventional loans explained the difference.

Reality is always a bit more complicated than we'd like it to be or even expect. In the social sciences controlled experiments dwell past the edge of ethics so we have to rely on the observed data with all its chaos and imperfections. With that in mind, we must then look at as much of it as possible so we can parcel out the truth from the nonsense derived from our preconceptions.

Rick and Uncertainty

I hope my money and banking students can answer the following:

T/F and explain.

If a payoff is uncertain (not merely risky), then you cannot calculate its expected value.

Evolutionary Progress

Among the first lesson I teach my money and banking class is Joseph Schumpeter's insight on economic change: creative destruction. It's a strange term but economics is strange itself and sometimes requires language that on the surface doesn't make sense.

Schumpeter understood that economies grow by creating new ideas while simultaneously destroying others. It is not a stationary process but one of constant change. Creating many ideas means society has many options and thus many good innovations. But destruction is equally important. It allows the market process to move resources from bad or obsolete ideas and move them to desirable ones. We not only get the good stuff, we get a lot of it. But that means destroying the bad--or just not as good--options.

People generally recognize the importance of creation. The role of destruction is much harder to grasp. And so it was today when Lou Dobbs once again expressed concern for a loss of manufacturing jobs. He was confused how officials from the U.S. military could defend free trade and building equipment abroad while these jobs are destroyed. But employees are fired, not murdered, and they will go on to do other things. It is from this destruction that breathes new life into the economy and allows the world reinvents itself once more, as it has done before anyone alive today walked the earth.

"No Lye" but a Lot of "Tomfoolery"

I recently picked up a copy of Tulani Kinard's No Lye, a book promoting "natural hair care" for African American women. Surprise, surprise! State regulation was advocated in the same breath as upholding tradition!

Kinard's argument is straightforward: Age-old African hair care methods are safer, healthier, and self-esteem building. In keeping with these traditions, black women today should braid, loc, and twist their hair.

"Now for the clencher": Increased demand for these traditional hairstyles require legal definitions for the techniques and certified professionals to do them.

Gee, these techniques supposedly survive today because of hundreds of years preservation by women who weren't certified. Why change all of the sudden now?

Yea, Governator!

I was appalled when I heard about this recent ruling against California's homeschooling families. Considering that many homeschooling parents - like my own - are better educated than our credentialed public school teachers, requiring the former to submit themselves to special training is ridiculous! I'm really happy that the Governor has made a statement against this ruling and the Home School Legal Defense Association (HSLDA) petition has racked up thousands of signers. I'd encourage Californians to contact their state legislators and House representatives about the issue.

First Kentucky and Now Egypt

When I saw this, I nearly fell over laughing. Copyright the pyramids? Ridiculous! The fact that every little kid is amazed by pictures of pyramids in history books is probably the only reason why they later visit Egypt and spend gobs of American money there as tourists. Please tell me that their copyright laws won't hold up here in the US.

Reward Those Who Know

Rep. Patrick McHenry (R-North Carolina) asked CEOs dragged into Congress today of Paulson Credit Opportunities Fund, which made billions betting the housing market would plummet. McHenry spoke in distaste of this success.

The congressman should think before he speaks. If Paulson has a unique insight in the housing market, don't we want his firm to act on it? By rewarding people who act on accurate information, countless others have a reason to search for problems before they become disasters. Offers of $1,000 for every mistake found leads to very accurate textbooks.

Dump The Dumping Laws

Right now, an old friend of mine is awash with paperwork. He works for a company in the Midwest, importing steel from China. Last month his firm received a notice from the Department of Commerce (which insists on call itself "the Department" while abbreviating virtually everything else). They received a petition that my friend's firm (along with several others) are importing at an unfair price. An investigation is now underway.

First the department required that they spend dozens of hours filling out forms that summarize the company's activities with China (which basically means all their business). Then the department used that information and did acomparison study with India to determine their prices were "too low." The report reads why this is a problem:

The Petitioners contend that the industry's injured condition is illustrated by reduced market share, lost sales, reduced production, reduced capacity utilization rate, reduced shipments, underselling and price depressing and suppressing effects, lost revenue, reduced employment, decline in financial performance, and an increase in import penetration.

These are better known as the effects of competition.

The importer must now spend hundreds of man-hours demonstrating they operate in a free market or be hit with massive fines. People often complain that in an unregulated free market, corporations will set prices too high. Strangely, they now
argue that prices are too low because this company isn't in that same uncontrolled environment.

Earn Rewards Everytime You Stay Married

UTango is offering major amounts of money for remaining a loyal married customer. Don't see anyone crying "Discrimination!" yet, but at least one poll suggests that there are some people out there who don't think that it's worth rewarding.

Money for Nothin'?

A few friends of mine works on commission in jewelry store. The other night, one of them apparently had a bad shift, selling below what he normally does. This was no fault of his; few customers came by. What should be done to improve traffic is not clear, but anyone can tell you that paying my friend a higher base salary will change nothing. His payment is the reward for helping the business do well, not the source of it.

Why then does Paul Krugman continue to insist that low consumer spending is the chief problem with our economy? Like commission, consumer spending is a reward for growth, not its source. Like commission, its fall can be a sign of poor growth. And like anything else, you can't treat the problem by treating the symptoms. Any money sent to the American people is money either taken away from them as taxes, taken from investment as debt, or taken from everyone as inflation. To prescribe a stimulus plan is to prescribe magic, gambling our economy on ignoring the all-too-true adage, "There's No Such Thing As A Free Lunch."

Jobs Americans Won't Do: Win Oscars

All acting Oscars went to foreigners this year, and foreigners also won various other awards. I'm waiting for some nonsensical rant from an anti-immigrant zealot to declare the end of the American film industry since non-Americans are doing so well.

Democrats Vow To Block Out Sun

Exit polls from Wisconsin tonight revealed that a 70% of Democrats believe "trade with other countries causes the loss of American jobs." Both candidates argue against outsourcing and support having more jobs kept in America. Competition with cheap foreign labor and goods seems to be a great evil for Democrats.

Perhaps soon we'll see Hillary and Obama blame the sun for its product that floods our nation's borders. A product it sells for free. Free! Think of all those jobs the sun's rays take away: we have fewer electrical engineers, lighting manufacturers, power plant designers, construction workers, steel workers, glass blowers, and so many others. If we are to take their economic argument seriously then we must entertain the value of ending our dependence on foreign light.

Sen. Obama's Two Faces

In the midst of his victory in Wisconsin Obama spoke of respect for the free market and the importance of trade. But a sentence later he declared to give tax breaks to domestic industries to assuage outsourcing.

The logic of the free market does not stop at political borders. Entrepreneurs do not become stupid once they cross over to Mexico or China or Germany. Products made overseas are not inherently undesirable. And ones made within this country are not handed down from God.

Change is the essential element of all free markets and Sen. Obama should know this; he is the candidate for change. So he should celebrate our economy's evolution from manufacturing to service. He should revel in the constant experimentation and that remains so prominent. He praise people who find better ways to make the things we desire, embrace those that invent tomorrow's standards, and inspire more to engage in our oh-so dynamic economy.

Few forces are as potent sources of change--real, positive social change--than that of the free market. But it works best if we leave it unmolested and free to go places some may not want it to. As a self proclaimed free marketer and the candidate of change, Sen. Obama should know this.

The Greater the Risk, the Sadder I Am

Michael Shermer at the LA Times wrote about loss aversion: that people are willing to take a financial hit to avoid any pains of regret. This follows nicely from my money and banking on Monday, when we explored the equity premium puzzle.

Adjusted for inflation, equity (stocks) have a much higher payoff than bonds. Over a period of 20-30 years, the former will return at about 8% a year; the latter just 1%. One of the possible explanations is loss aversion: people don't like to see value decrease so they gravitate towards bonds, which are always increasing. Shermer uses loss aversion to explain why people tend to choose B:

A is waiting in line at a movie theater. When he gets to the ticket window, he is told that as he is the 100,000th customer of the theater, he has just won $100.

B is waiting in line at a different theater. The man in front of him wins $1,000 for being the 1-millionth customer of the theater. Mr. B wins $150.

Amazingly, most people said that they would prefer to be A. In other words, they would rather forgo $50 in order to alleviate the feeling of regret that comes with not winning the thousand bucks. Essentially, they were willing to pay $50 for regret therapy.

Another possible reason is the tendency for people to judge their wealth in relative and not absolute terms. I'd rather be wealthier than the people around me, not even more wealthier if it means others become richer than I. In the land of the blind, the one-eyed man is king. Research suggests a lot of people would rather be king than have depth perception.

The origins of loss aversion and relative wealth probably lie in evolutionary psychology. Economics should be particularly interested in this field; it can explain why people dislike free trade, feel economies are zero-sum, and romanticize the poorer but more familiar past.

HT: Brian Hollar

Political Rules

Paul Krugman calls them "Clinton rules," where everything a candidate says is distorted by the other side into a negative ad. Negative campaigning in general sickens Krugman and warns the DNC "...if history is any guide, if Mr. Obama wins the nomination, he will quickly find himself being subjected to Clinton rules. Democrats always do." (Hate Springs Eternal, February 11, 2008)

It's not clear which party engages in more negative campaigning, but I bet it has a lot more to do with the desperation of the campaign than its party. Despite what the electorate claims, negative campaigning works and is especially tempting in the political sphere where the runner-up is still a failure. There is so much to lose. Recall one of the most famous (and most negative) campaign ads in U.S. history, where Democrat Lyndon Johnson suggested Republican Barry Goldwater would be responsible for a nuclear war if he was elected. Mr. Krugman should read his own titles: hate truly does spring eternal.

Do You Want Morphine With That?

It's quite clear that as manufacturing jobs disappear, they are being replaced with service jobs. Really this is only a half-truth; professional and related occupations are increasing at the same rate as the service sector (17%) and each have about the same number of workers (just shy of five million).

Most people bemoan the growth of services. When they think of "service sector" they think of waiting tables and stocking shelves. And yes, in absolute terms most of the new jobs in the next ten years are likely to be in retail.

But the absolute numbers don't really matter; the growth rates do. Suppose we see 1000 jobs added in a high wage sector and 1000 added in a low wage sector. You might think the two are keeping in perfect step with each other. But suppose the former had 10,000 to begin with and the latter had 100,000. Now it's a 10% increase versus just 1%. Percents are much more useful because they show us the trend of employment. Is America heading to a high-wage service sector or a low-wage service sector. These projected numbers from the BLS (2006-2016) have the answer.

25% Health care and social assistance
23% Professional and business services
14% Financial activities
14% Leisure and hospitality
13% Other services
11% Educational services
10% Construction
9% Transportation and utilities
8% State and local government (except hospitals and education)
7% Information
5% Retail

Just because your most common exposure to the service sector is retail doesn't mean that's what is seeing the most growth. Guess we all won't work for Wal-Mart after all.