Eco 2013 -- Mankiw # 2-4
Macroeconomics
Thoughts from a coffee container:
Everywhere, unthinking mobs of ‘independent thinkers’ wield tired clichés like cudgels,
pummeling thosewho dare question ‘enlightened’ dogma. If ‘violence never solved any-
thing,’ cops wouldn’t have guns and slaves may never have been freed. If it’s better that
10 guilty men go free to spare one innocent, why not free 100 or 1,000,000? Clichés
begin arguments, they don’t settle them. Jonah Goldberg, editor-at-large, National Review
Online, Starbucks Cup, “The Way I See It # 22”
Once again Thomas Sowell cuts through the conventional wisdom or dogma (fr. Greek, dok: ‘to seem, to think, to seem good) – “Time and Money and Housing,” columnists/thomassowell/ts20050830 and “Time and Money and Housing: Part II,” columnists/thomassowell/ts20050901. His main focus in the articles is on hypocrisy (fr. Greek, hypókrisis; play acting, play a part) of political correctness – how in California Planning Commissions which purport to serve the general common (public) interest (preserve green areas, slow urban sprawl, etc.), but the ‘real’ benefits accrue to a small special interest group and the costs are imposed the majority of citizens. Once again the ideas formulated by Frédéric Bastiat in his pamphlet, “What is Seen and What is not Seen” helps to explain what is happening [also see: Gwartney and Stroup’s Key Element # 10 – “Ignoring Secondary Effects and Long-term Consequences is the Most Common Source of Error in Economics.” Sowell is discussing the lengthy delays in obtaining permits for development projects and the costs that they impose on large segments of society. Commenting on the fact that the San Mateo (California) Planning Commission has debated for five years on alternative uses of a piece of property, he explains:
None of this delay has cost the members of the Planning Commission a dime. This is why
the delay is still continuing. But whatever is finally done with the racetrack site will be
vastly more expensive because five years of delay are not cheap.
There is something called the ‘time value of money’, i.e., money has income earning potential over some period of time, since it may be invested in income earning activities. In any decision-making process involving alternative future outcomes, both time and the prevailing interest rates must be taken into consideration.
Such delays are not uncommon in the more politically correct parts of California.
Permission to build an important complex near San Francisco has taken even longer
[five years]. Whoever ends up living in those apartments will have to pay far higher
rents as a result.
The implications of delays and higher costs, Sowell argues that:
…one-fifth of new home-buyers in California pay at least half of their income for
housing. So do nearly one-fourth of California renters. When it costs half of what
you make just to put a roof over your head, that is a big restriction on what else
you can afford to do.
Here again the ‘Principles’ and/or ‘Key Ideas’ of economics provide the explanations for critical contemporary issues. In this case a scarce resource (income) forces folks to make trade-offs, since ‘there’s no such thing as a free lunch’ and ‘the cost of something is what you give up to get it.’ Sowell asks:
How did this situation come about and why does it continue?
He answers this rhetorical question, simply:
…it is newcomers who have to pay outrageous prices for houses, while it is existing
homeowners who vote for laws and policies that drive up housing costs by obstructing
the building of new homes.
Remember, people act in their own self-interest and that in a free market, Smith’s ‘invisible hand’ will bring personal self-interest and the general welfare into harmony. Sowell continues his analysis:
Those who already own homes are not hurt by soaring housing prices. In fact, they
benefit when the value of their homes becomes several times what they originally paid
for them.
Given this situation and these incentives, it is easy to understand why such things as
planning commissions, ‘open space’ laws and ‘historical preservation’ policies
proliferate. These roadblocks to building are essentially idealistic-sounding ways of
being completely selfish.
Despite much liberal rhetoricabout compassion for the poor, it is precisely in such over-
whelmingly liberal enclaves as those in California where high housing costs resulting
from restrictive laws have imposed the heaviest burden on lower income people.
Nearly half of those California renters who earn $30,000 a year or less pay half or more
of their incomes for rent. Among those in this income bracket who have bought a home
within the past two years, 72 percent are spending at least half of their income on mortgage
payments.
These hypocritical behaviors are characterized in the popular media as NIMBYism or ‘Not In My Back Yard.
All sorts of lofty talk about ‘open space’ or ‘saving the green foothills’ is used to disguise
the plain fact that those who already have theirs want to keep other people out, especially
other people not as upscale as themselves.
One summer, I taught at the University of Montana located in Missoula, a relatively small city (with more bars than any other retail outlets). Nestled in the BitterrootValley, surrounded by the Rocky Mountains, even new resident half jokingly talked about sealing up the passes into Missoula – we’ve found paradise and we want to keep others out!
Sowell received an e-mail ‘pointing out’ and ‘correcting’ the errors that Sowell had made in this paper. His response is to be found in the second editorial, “Time and Money and Housing: Part II.”The writer tells Sowell that ‘money isn’t everything.’ Dr. Sowell’s response is:
That is certainly true – and especially when it is someone else’s money.
The e-mailer from Santa Barbara continued:
We have fought very hard to prevent developers from profiting from the beautiful
community we have worked so hard, and for so many generations to create and
preserve….
To which Sowell responded:
In other words, the people who have lived in Santa Barbara a long time, and who
therefore have not had to pay the outrageous housing prices that the home-building
restrictions force newcomers to pay, are on a higher moral plane the ‘developers’ –
practically a cuss word in coastal California.
The fact that developers, like most people, want to earn money is regarded as sinister
by some and the fact that the money is called ‘profit’ makes it different from money
that is called something else. It is amazing how many of those who consider themselves
‘thinking people’ respond automatically to words the way Pavlov’s dog was
conditioned to respond to certain sounds.
What developers want means absolutely nothing economically unless other people
are prepared to pay for what they offer. In other words, developers are just
intermediaries who represent the demand for housing by vastly larger numbers of other
people.
Remember what we’ve learned from Adam Smith, Ludwig von Mises, Frederick Hayek and Murray Rothbard: People earn their living by serving the needs of others.
In the housing market, as in other markets, there are always people who want to use
the same resources for different and conflicting purposes. There is nothing unique in
in the housing market when there are two sets of people wanting the same things and
there is not enough to satisfy both.
The ‘Law of Scarcity’ necessitates the allocation of scarce resources to their highest and best uses (most productive activities). This socially efficient resource allocation may be best accomplished through ‘voluntary’ free market exchanges (the highest bidder gets to use the resource for the purpose they choose). Gwartney and Stroup remind us that such voluntary market exchanges “promote economic progress.”
The proponents of purpose of home-building restrictions, according to the Santa Barbara e-mailer, is
…to try to preserve natural beauty and avoid the congestion and obstructed views
of an urban environment….
To which, Dr. Sowell responds:
Avoiding ‘congestion’ is hypocritical. Since the number of people is the same,
whether or not there are housing restrictions, keeping them out of Santa Barbara
just transfers the ‘congestion’ elsewhere.
Please note that this is, once again, a manifestation of NIMBYism – we don’t want the congestion [a benefit for us – no congestion] in our community, let others live with it [bear the costs]. In the first article, Dr. Sowell had noted that the ‘building restrictions’ bear down hardest on the poorest segments of society. In conclusion, Sowell observes:
Ugly as such selfishness may be, it is no worse than the zealotry of the nature
cultists who join with them to make life miserable for thousands of other people in
order to give themselves a cheap sense of importance that some confuse with
idealism.
Chapter 2 Thinking Like an Economist
Economics and the ‘Scientific (or Inductive) Method’
We’ve all been exposed to what has been called the ‘scientific method’ – an approach to the natural world that begins with careful observation of phenomena. It has been associated with Sir Francis Bacon (and others, such as Galileo) that the Aristotelian method of ‘deductive logic’, which worked well in mathematics, was not easily applied to the natural world, since it required the use of axioms – true statements – from which other statements may be deductively derived. Galileo recognized that it was extremely difficult to prove the truth of the initial statements and that the true statements or not the starting point, but the goal of science. The inductive method has been so fully integrated with science that it is known as the scientific method. The inductive method begins with observation of nature in the hopes of formulating a few true statements about how the natural world works – laws and theories.Mankiw notes that economics employs both ‘theory and observation’, like evolutionary biology and astronomy, it lacks a laboratory making the development of experimental evidence difficult. He states, “Economists, … , usually have to make do with whatever data the world happens to give them.”
Mankiw argues, as a justification that the methodology of economics is analytically ‘scientific,’ by noting that the very:
…essence of science, however, is the scientific method – the dispassionate
development and testing of theories about how the world works. This method of
inquiry is as applicable to studying a nation’s economy as it is to studying the earth’s
gravity or a species evolution. (20)
Sadly, adherence to the scientific method, as outlined by Sir Francis Bacon, has become increasingly less frequent, in both the physical and the social sciences – the claim for human-induced global warming is simply the most recent example. Michael Crichton has commented on this in his latest novel, State of Fear. His comments have been excerpted and appear on his website [ Earlier, in his lecture – “Aliens Cause Global Warming” – at Caltech (Michelin Lecture, January 17, 2003, he had expressed his concerns:
I want to discuss the history of several widely-publicized beliefs and to point to what
I consider an emerging crisis in the whole enterprise of science – namely the increasing
uneasy relationship between hard science and public policy. [Emphasis added]
Julian Simon, in his last book, Hookwinking the Nation, has identified a number of reasons ‘scientists’ abandon the scientific method and pursue the implementation of public policies – money, notoriety, saving the world from disaster.
In terms of global warming, it must be noted that the world’s temperatures have cooled and warmed at least four times [continental glaciation] during the Quaternary Period (the last million years or so. The Quaternary is subdivided into: (i) the Pleistocene, which lasted for about 990,000 years; and (ii) the peak of the last ice age occurred about 24,000 years ago and warming set in thereafter. The most recent period, the Holocene (encompassing the most recent 12,000 to 15,000 years) has been the era of man. The beginning of the Holocene marked the end of the last glacial epoch. For more precise dating of the end of the Pleistocene and the beginning of the Holocene, see: Hans E. Suess. 1956. “Absolute Chronology of the Last Glaciation,” Science, Vol. 123, No. 3192 (2 March). Note that Suess uses the term: “Last Glaciation”, implying both earlier alternating periods of ‘glaciations’ and warmings.
If one is to believe that human activities have caused the current global warming, the activities our early hunter/gather ancestors (Paleolithic/Mesolithic cultures) must have been responsible for the warming of the Holocene. For this to be true, it would be necessary to ignore the so-called ‘bottle-neck’ in human evolution, when the number of people collapsed and the human race was on the brink of extinction. But this would leave unanswered, the causes of the three previous warming periods (interglacial periods) of the Pleistocene. The most recent phase of human evolution, the Neolithic cultures, have been correlated with both the Holocene AND domestication of plants. The evidence for the thorough domestication of lentils, peas, barley and wheat on the Anatolian Plateau (Turkey) dates from about 8,400 years ago – domestication of plants is one of the characteristics that anthropologists use to define the Neolithic or (New Stone) Age. Domestication of food producing animals occurred more recently, the cow, for example dates from about 7,500 years ago.
Economist as Scientist
Mankiw discusses the “ways in which economists apply the logic of science.” He asserts that an economist:
…might live in a country experiencing rapid increases in prices and be moved by this
observation to develop a theory of inflation. The theory might assert that high inflation
arises when the government prints too much money….To test this theory, the economist
could collect and analyze data on prices and money from many different countries. If
growth in the quantity (21)
In such a manner he maintains that the economists adhere to the scientific method, just as do practitioners of chemistry and physics.
yet unlike them, and more like evolutionary biologists and astronomers, economists lack experimental laboratories.
Both the physical sciences and economics use abstractions from or simplifications of the real world – known as, models – to help explain external realities. The fist model Mankiw formulates is the so called circular flow model or diagram representing the manner by which individual elements in the economy (‘households’ and ‘firms’) interact.[See: Figure 1, Chapter 2, pg. 23] The ‘household’ serves as a source [supplier] of the ‘factors of production’ (land, labor, capital and entrepreneurship) that ‘firms’ require [demand], in order to carry on their productive activities. Simultaneously, the ‘household’ serves as a ‘consumer’ of the products (outputs) that the firms have created. Alternatively, a firm is a provider of goods and services [supplier] that meet the needs and wants of households [demand]. For their use of the factors of production by firms,households are compensated by payments or income (rents, wages/salaries, interest/dividends, and profits) made by the firms. The voluntary exchanges of the factors of production by households for compensations provided by the firms take place in Resource Markets. Households use their incomes to purchase the goods and services produced/provided by firms. These transactions take place in Goods and Services Markets. If we add-up (sum) the value of ALL compensation to ALL households in a nation it is equal to Gross Domestic Product (GDP). If we add-up (sum) the value of the ALL the revenues of ALL firms in a nation it is equal to Gross Domestic Product (GDP). [See: Figure 1, Chapter 10, pg. 205]
Note: both households and firms are pursuing their own self-interest – households may choose to work for one firm, rather than another because it pays a higher wage, provides better benefits or is more convenient; while, firms may choose to produce guns rather than butter or sell in the local, national or in international markets, whichever leads to higher profits. Reflecting Mankiw’s Principle # 1 – “People Face Tradeoffs” – allocate household resources to firm A or to firm B; Principle # 2 – “The Cost of Something is What You Give Up to Get It” – the benefits firm B would have paid the household had the household not allocated its labor to firm A;Principle # 4 – “People Respond to Incentives” – firm A decides to produce a given product because it is able to maximize its profits; Principle # 5 – “Trade (or Exchange) Can Make Everyone Better Off” – voluntary trade or exchange between firms and households make both better off, or the transactions would not take place; Principle # 6 – “Markets are Usually a Good Way to Organize Economic Activity” – prices direct resources to their ‘highest and best (most desired) uses; and Principle # 8 – A Country’s Standard of Living Depends on It’s Ability to Produce Goods and Services”.