Helping increase demand versus increasing supply

Several years ago during an economic downturn, Range Rover, a British maker of sports-utility vehicles, ran an ad campaign in USA Today.  It announced its formula for ending the recession: "Buy Something."  Range Rover wanted you to buy their vehicle, but in any case, purchase something.  "Buy a microwave, a basset hound, theater tickets, a Tootsie Roll, something."  Anything to get the economy going again.

Range Rover no doubt had simple economics in mind when telling consumers to buy something: Buying increases demand, which will increase supply and therefore create jobs.  With the level of economic understanding that is commonplace among American consumers, buying things = supporting jobs of those that sell and manufacture them.  On the surface, it well appears that way: Candy sales during the recession are surging, creating jobs and making record profits comforting woeful Americans (see NY Times and Las Vegas Review-Journal articles).  Indeed, the NYT article is even titled, 'When Economy Sours, Tootsie Rolls Soothe Souls'.  Clearly, this shows how buying something is good for both you the consumer and for the economy.  But is that really all there is to it?

Lurking beneath the surface, money paid for the immediate comfort also has an opportunity cost.  A dollar spent on candy today could be $1.05 in one month if it had been saved.  That $1 of savings in a banking institution could have helped a new candy maker get a loan to buy manufacturing machinery and create many jobs in your own town.  It could also have helped buy a share of stock in a candy company, that would have used the investment capital to open a new processing plant and made your $1 worth $3 in returns.  Or it could have gone toward a US treasury bond, helping the government raise money for services such as medical care for the uninsured candy-eater that goes into diabetic shock.  It could even have gone toward buying a locally grown organic apple, helping the struggling apple farmers that live next door.

As a general rule, "people are greedy and impatient", as Dr. Bob wrote. (I laughed out loud at that when I first read it.)  To this end, a large part of the consumer base is also uneducated or under-educated in basic economics.  These consumers are the ones especially targeted by marketing for impulse items: they're ready and willing to buy and consume things they don't need or really value.  The immediate comfort and help for the economy that Range Rover suggests has an appeal to that very audience.  Using economic logic that is not wholly untrue, they have influenced the masses to the ready 'solution'- an effective marketing tool indeed.

The greedy impatient masses may be moved to do their part by increasing demand, but for it to work helping the economy, the companies they help must be able to raise capital in order to increase short term and long term supply of their products.  Without that, the demand will go back to equilibrium and the economy will end up no better off.  Those consumers who think purchases through and plan them are unlikely to be moved by "Buy Something" advertising, even though they might have the passing thought that the things they do buy are helping the economy out.  The latter group may well be the savers/investors.  The knowledgeable and prudent consumers are able to step in to provide capital and pave the way for long term exansion of the economy.  They are able to do this in several key ways: Saving in a bank or other financial institution or even in a piggy bank, and buying stocks and bonds.  Money in a savings account is money available to provide loans for capital investment, perhaps for a worker to buy a home in a candy factory town or a small candy business to open a new store.  Perhaps people will eventually take their savings out with interest to spend on a big-ticket high-end item such as a Range Rover or invest in a child's college education that otherwise they could not afford.  Stock and bondholders help the candy company raise capital outright and potentially increase their own wealth in the process as the company expands, thus helping the economy and taking advantage of mass consumerism at the same time. 

CPI and the Rat Race: Reaction to Paul Krugman

Read Paul Krugman's original article at: http://www.slate.com/id/1915/

On the qualitative front, there are a few key differences between 1950 and "today" (1996 in the article) that struck me as key to determining well-being.  Foremost, who was the so-called "average American" this article is really looking at?  I'm sure we all conjure up images of the suburban family with mom in an apron and bottled milk delivery, and indeed this may be what the majority of the experience was.  The average African-American family in 1950 was far far below this comfy ideal that people look at the 1950s as- they had Negro League Baseball and had to give up their bus seats.  Nearly all black people in the South experienced extreme mistreatment, segregation and prejudice, and there was a major uprooting as many migrated to urban areas up North in search of better job opportunities and possilibity of education.  There was little room in America for anyone not Protestant- Irish and Italian Catholics were treated as lesser people.  Lucille Ball was able to have a hit TV show in the 1950s but experienced a lot of public backlash for marrying a Cuban.  In 1950 the rate of marriage was up for both black and white Americans vs today.  But unlike white families, a majority of black children today grow up in families headed by a single mother (sources for much of this: Wikipedia and an in-depth journal article).  Athough there is now Affirmative Action, minorities are still less college educated, more likely to be at or below the poverty level, have higher rates of incarceration, experience racial profiling and other racism, and have lower access to health care.  Like 1950, blacks and other minorities still live overwhelmingly in urban centers, and in neighborhoods that are de facto racially separated. Many of these neighborhoods culturally have more of a community lifestyle.  Perhaps, as Krugman says, this is because they are nearly all at similar income levels.  This implies that quality of life on that measure has not really changed for minorities at all.  It also seems that CPI for the fast-growing, poor minority populations is likely what is driving the poverty levels down today.  Like Mankiw said, there might be 10 white people with all of the wealth and 90 minorities and that gives the same average as an even distribution, even though clearly it is not evenly distributed and the same people are being left out.

Second, in 1950 most families had only a single wage-earner.  This means that families felt financially secure enough to have Mom stay at home.  The average families in 1996 were headed by two wage-earners, and this would still only put some of those in the 20th percentile.  One could argue that if both parents worked for wages in 1950 the actual GDP, mean income, and the CPI would be much higher.  In the 1940s during WWII-era, many women were working in the US.  So it really was a sign of security and economic prosperity that women left the workforce by 1950. The amount of money spent on household expenses from 1950 to today has also increased at a high rate as well (interesting government census info source here).  So even with inflation not being as high as originally thought, parents today have to work harder in order to meet the basic needs of a family.

Well-being and the Recession

Recession, as defined, is a shrinkage in the GDP lasting 2 or more consecutive quarters.  The usual pattern in the Economy is for economic growth for an extended time (about 57 months) followed by about a 10-month shrinkage, creating a 67 week "business cycle" (see Article Database).  Directly preceeding a recession, current recession included, there is a period of what economist Kimberly Amadeo calls "irrational exuberance" (on her about.com blog).  The irrational exuberance period signifies the point at which the GDP has risen above the point of comprimise, and recession is the only way that it will be able to reach a point of rational growth again.

For example, the mortgage crisis occured when interest rates were too low and credit was being granted by banks too freely.  This caused a huge increase in GDP- as buying houses is an increase in capital investments.  Those involved must have been incredibly thrilled: What city bus driver wouldn't be thrilled to have a $250,000 home with no down-payment and "creative financing"? What financer wouldn't be excited to be handing out morgages and turning around to market securities using creative speculation?  (This was the situation as described by economist and noted author and housing bust expert Thomas Sowell.)  This was the point at which the GDP had risen too high for its own good, and people were getting far too carried away to realize that there was no sound basis for the economic growth.  Think of GDP growth vs irrational exuberance as being happy vs being happy on cocaine: one is an emotion based on reality and experience and may steadily grow through time, while the other is an instant, over-the-top manic happiness that has an artificial basis and is setting you up for a harsh comedown.

One of the principal lessons from this is that the GDP can't tell you whether or not the economy is actually headed in a good direction.  The periods of economic growth or even irrational exuberance show that for the most part people do believe in the economy and do value economic well-being as a meaure of fulfillment.  While volunteering or being a stay-at-home parent is not counted in the GDP, these pursuits are personally gratifying and represent that people are financially secure enough to afford doing those things, and therefore are silently tied to GDP.  However, when the government increased spending to clean up the aftermath of Hurricane Katrina, that increased the GDP but was a national tragedy.  And we are all aware of the pork projects that politicians are so fond of- workers were ready and willing to build the Bridge to Nowehere, but what is it really contributing to well-being?  US weapons dealing (notably Iran/Contra but debateably any and all other exports) is also increasing GDP but not necessarily making a positive contribution to well-being.  Maximizing the GDP, in essence, means that well-being may be high and many types of spending are contributing to GDP at high levels, although there is no indication whether this spending is helping society in the long run or whether it is leading us directly to another intense recession.

Management and the Market: An Overview

In a competitive market, managers are motivated by the ability to keep their own jobs and succeed in them by maximizing profits at market prices.  In essence, this means keeping costs down, and workers and supplies represent a lot of the variable cost in a firm.  When a market shrinks, laying off workers becomes (on paper) an easy way to trim costs, but much of the time this decision seems to be avoided if at all possible.  Practically speaking, this may do more harm than good if workers are trained and skilled in their jobs, though I think no one would disagree with letting workers go that consistently are performing poorly or lack the necessary skill set.  Public opinion of a firm directly influences business however.  Managers in competitive enterprises are therefore kept "honest" I think by the threat of losing shares of the market to companies that seem more fair to their workers.  This type of market seems to value employee satisfaction, and if absolutely necessary, socially responsible ways of cutting worker costs are used, including freezing of new hires, reducing overtime, putting workers on hourly wage and fixed hours, or reducing salaries and demading more hours. Rather than lose qualified workers or have them under-perform, managers now can see the marginal benefit of training seminars, buying birthday cake, recognizing achievements, etc.

For a monopoly, this all breaks down.  We all know about disgruntled Postal Workers and DMV workers, and from the management side, it makes sense: There is no other DMV in town to take their skills to and the jobs/benefits pay well enough that each worker could be replaced.  Furthermore, cutting costs by cutting workers would, at least initially, actually increase business.  For example, if the Celtics decided to lay off all of its ticket booth workers to lower ticket prices, people would probably buy more tickets.  However, there still would be a limit; if they started laying off everyone at the stadium, there would be no concession service and no T-shirts and no half-time entertainment etc and people would go less frequently because the experience wasn't too great.  But the managers in a monopoly basically aren't kept in line by public opinion the same way competitive markets are, and this is part of why people see them so unfavorably.  I think this becomes especially apparent when managers make cuts in the workforce to trim costs but don't take any sort of pay decrease themselves, like the US airlines did recently.  The public is well aware of this and doesn't take kindly to it, but the cheaper seats on flights keep customers buying more anyway.

Taxes should be specific: US-China Trade issues

When you look at what China imports, a lot of the cheap goods they import are actually inferior goods.  And many of those are just that, and in fact some are getting to be too inferior, as seen by the rising levels of product recalls from China.  The point of this is that there is a high but very elastic demand for these goods because of the recession.  As the US economy improves, many will be happy to abandon these goods and that sector of the market will shrink rapidly.  The deadweight loss in this case would be too high to justify anything beyond minimal taxes, and the overall market for Chinese imports will shrink without inferior goods.  Until that time, the goods are being bought and sold through US distributers and this creates US jobs (in retail etc), which are important in the current economy.  Chinese currency manipulation is another component that makes the cheap inferior goods possible.  Floating the currency would at this point very detrimental to the elastic market and have a negative impact.  Therefore regulations should be minimal for the elastic imports market during the recession so that the trade of these items continues to fuel economic growth. (See Pro-currency manipulation arguements in regard to economic growth.)

There is, however, an inelastic market for normal goods made in China.  Indeed, as Sara Bongiorni found out in "A Year Without Made In China", it is nearly impossible to avoid consuming Chinese imports.  For these imports, the deadweight loss will be lower and a higher tax can be implemented without a large impact on the economy.  Regulations and restrictions could help, especially those that aim to level the playing field- China has regulations in place against imports from the US, for example (see Economics Help, and 247WallSt).  The overall goal would be to force the end of currency manipulation over the next few years as the US economy improves and to strengthen the presence of US goods in China.  Floating the currency has the advantage of raising the prosperity of Chinese citizens, which would give them more income with which to purchase US goods.

Are Farm Subsidies Wasteful Spending?: Technology vs Subsidy

I did some research on the subject, and thanks to USAspending.gov and EWG.org, as well as many other websites that want to broadcast government info, found that the US government awarded about $2.5B for agriculture-related research and about $16.4B for farm subsidies including crop insurance in 2009.  The less widely broadcasted info is why this continues, and apparently the whole subject is more twisted than you might expect.  Foremost, institutions at the cutting edge of crop technology- including and especially those that create new GMOs- can then trademark the discovery and turn around and charge farmers a much higher price for their product (see an interesting article about this in usatoday.com and usagovernmentspending.com for more raw data).  Farmers must then be subsidized at higher rates or their insurance subsidy must be raised in order to compensate for the increased value of the crops.  So basically, the government funds research to increase efficiency, helps the discoverers make millions by granting a patent, and then pays the extra cost that has been passed down to the farmers throu the subsidies.  It looks to me like an absolute disaster. 

BUT: Agencies such as WHO and UN come into play on the research side, saying that the food supply will need to increase to meet the demands of a rapidly growing population, as well as to grow crops to survive disasters such as flooding and global warming.  (The disasters ironically would be good for market prices, however).  So for short-term market, I would vote on the side of decreasing research funding immediately and over the long-term decrease subsidies.  The way I see it now, without the constant input of fresh technology, the cost of insurance would eventually decrease and the prices would go up, lowering the need for subsidies.  Plus with prices going up and fewer subsidies paying farms to under-produce, the supply would increase.

After a little background reading about OPEC, I really saw the Big Oil cartels in a new way.  First, it is clear that they are purposefully drilling at below capacity and or selling at so that they can keep a shortage and hike up prices more than the competitive market would allow if there were a higher supply.  (Before this week's lesson, I have to honestly say I did not fully understand why OPEC was doing this.)  Since the market is mostly inelastic in the short-run, the demands remain the same and countries essentially must pay the price to have oil (I see there are other posts about elasticity so I'll leave that alone for this post).  OPEC countries realized the inelasticity of the market after they placed an embargo on the US for the US defense of Israel in a Middle-East conflict.  Realizing the power they had over market prices, those Arab countries formed a cartel in the early 1980s that literally dominated the market, and used shortages to essentially charge whatever price they wanted.  

However, the market since then has become more competitive as more suppliers entered the market, moving the supply curve to the right and thus driving down prices (although supply is still short of demand).  With OPEC in check a little, the market is now more competitive, which is good.  Which is why, on a strictly economic basis, drilling for oil in Alaska would make sense as far as lowering prices for oil.  Even at the current prices which are relatively low, however, world supplies are kept short.  The market proving to be elastic as countries like India continue to develop mean that oil-producing countries must still step up production if they want to keep a share of the market.  OPEC says they're drilling at much higher capacity now than ever before.  Although keeping the supply low would still help prices, they would lose their market share.  More increases in the supply curve are now being balanced by increases in the demand curve, so prices overall are pretty stable and relatively more fair than when OPEC was completely in charge.  However, no oil producer wants to cut themselves out of the profits that can be made through the short supply, so they have to constantly be looking at demand and then falling short of that.

A little story about price gauging I read in Mankiw's textbook Principles of Applied Economics on how price gauging has its benefits got me thinking: Maybe this Big Oil/ OPEC strategy is not actually that bad.  It means that there will be enough oil for those that really need it and keeps demand in check for this valuable non-renewable resource.