microeconomics

Macroeconomics and Microeconomics

Macroeconomic aggregates (e.g., aggregate demand, aggregate supply) are essentially meaningless because they represent disparate phenomena.

Consider A and B, who discover that, together, they can have more clothing and more food if each specializes: A in the manufacture of clothing, B in the production of food. Through voluntary exchange and bargaining, they find a jointly satisfactory balance of production and consumption. A makes enough clothing to cover himself adequately, to keep some clothing on hand for emergencies, and to trade the balance to B for food. B does likewise with food. Both balance their production and consumption decisions against other considerations (e.g., the desire for leisure).

A and B’s respective decisions and actions are microeconomic; the sum of their decisions, macroeconomic. The microeconomic picture might look like this:

  • A produces 10 units of clothing a week, 5 of which he trades to B for 5 units of food a week, 4 of which he uses each week, and 1 of which he saves for an emergency.
  • B, like A, uses 4 units of clothing each week and saves 1 for an emergency.
  • B produces 10 units of food a week, 5 of which she trades to A for 5 units of clothing a week, 4 of which she consumes each week, and 1 of which she saves for an emergency.
  • A, like B, consumes 4 units of food each week and saves 1 for an emergency.

Given the microeconomic picture, it is trivial to depict the macroeconomic situation:

  • Gross weekly output = 10 units of clothing and 10 units of food
  • Weekly consumption = 8 units of clothing and 8 units of food
  • Weekly saving = 2 units of clothing and 2 units of food

You will note that the macroeconomic metrics add no useful information; they merely summarize the salient facts of A and B’s economic lives — though not the essential facts of their lives, which include (but are far from limited to) the degree of satisfaction that A and B derive from their consumption of food and clothing.

The customary way of getting around the aggregation problem is to sum the dollar values of microeconomic activity. But this simply masks the aggregation problem by assuming that it is possible to add the marginal valuations (i.e., prices) of disparate products and services being bought and sold at disparate moments in time by disparate individuals and firms for disparate purposes. One might as well add two bananas to two apples and call the result four bapples.

The essential problem is that A and B will derive different kinds and amounts of enjoyment from clothing and food, and that those different kinds and amounts of enjoyment cannot be summed in any meaningful way. If meaningful aggregation is impossible for A and B, how can it be possible for an economy that consists of millions of economic actors and an untold variety of goods and services? And how is it possible when technological change yields results such as this?

GDP, in other words, is nothing more than what it seems to be on the surface: an estimate of the dollar value of economic output. It is not a measure of “social welfare” because there is no such thing.

Given that, why do I sometimes use GDP statistics? And, if GDP is really a meaningless aggregate, is there a valid, alternative way of depicting aggregate well-being? To be continued.

Related posts:
Greed, Cosmic Justice, and Social Welfare
Utilitarianism, “Liberalism,” and Omniscience
Utilitarianism vs. Liberty
Accountants of the Soul
Rawls Meets Bentham
Enough of “Social Welfare”
The Case of the Purblind Economist

Monopoly: Private Is Better than Public

In this discursive post, I use the economic concept of perfect competition as a starting point from which to defend monopoly and to expose the folly and futility of governmental intervention in markets.

PERFECT COMPETITION AS A BOGUS STANDARD

I learned, in the standard microeconomics of my college days, that perfect competition is preferred to these three alternatives:

  • imperfect competition, where there is some degree of product differentiation (real or perceived)
  • oligopoly, where a particular product or service is sold by only a few firms (“product or service” is hereafter called “good,” in keeping with economic jargon)
  • monopoly, where there is only one seller of a particular good.

The theoretical superiority of perfect competition rests on the belief that, compared with the alternatives, it yields the greatest output of goods and, therefore, the greatest degree of satisfaction to consumers; that is, perfect competition maximizes “social welfare.”

The standard analysis has many problems, the most fundamental of which is the observation selection effect. The observer, in this case, is the economist who views the world through the lenses of economic efficiency and “social welfare.”

The construct of economic efficiency involves gross generalizations about economic reality, which are based on ideal firms in an ideal world, not on the behavior of real firms in the messy world of reality. The construct, in other words, sets up an ideal world of perfect competition, divergences from which are judged less than optimal — as if unavoidable, real-world divergences are less valid than the perfections of an imaginary construct. (This is an instance of a Nirvana fallacy, “the logical error of comparing actual things with unrealistic, idealized alternatives.”)

Then there is “social welfare,” which perfect competition is purported to maximize. “Social welfare” is in fact a fictitious device whereby the person who invokes it assumes (implicitly if not explicitly) that the happiness of individuals can be summed, and that he knows just how to do it. The predictable result of “social arithmetic” is a call for some kind of governmental action that effectively redistributes income; for example:

  • Affirmative action, on balance, redistributes income from shareholders, consumers, and more-qualified workers to less-qualified workers.
  • Progressive taxation redistributes income from persons who earn a lot of money (the job-creators of the economy) to persons who earn less money. It also drives out high earners, to the detriment of the rest of us.
  • Trust-busting (which is of particular interest here) amounts to a redistribution of income from the owners of a oligopolistic or monopolistic firm to consumers.

“Social welfare,” in other words, is a phony excuse for playing God — a variant of the Nirvana fallacy. (For more, see this, this, and this.)

HOW GOVERNMENT INTERVENTION DOES MORE HARM THAN GOOD

Why is it not a good thing for government to act in ways that redistribute income from the owners of firms to consumers? There are several reasons, beginning with the artificiality of perfect competition (or something like it) as a model of how markets ought to be organized.

Then, there is the arrogance of a mindset that judges consumers to be more deserving that the owners of businesses — owners who staked a lot of money (and created jobs) on business ventures that might have gone sour (and often do). Is it possible that trust-busting discourages business (and job) formation? You can bet on it.

Related to that, it is necessary to remember that business owners are humans, too — 160 years of communist-populist-“progressive“-“liberal” rhetoric to the contrary notwithstanding. Business owners’ desire for profit is no less legitimate than consumers’ desire for low prices. Government is in the business of penalizing oligopolistic and monopolistic business owners not only because economists have set up a false standard (perfect competition or something like it), but also because the act of penalizing appeals to the envy of many voters and interest groups toward persons with legitimately high incomes. Trust-busting is neither logically nor morally admirable.

It is true that not all industries lend themselves to perfect competition or something like it, but it is neither necessary nor desirable to regulate firms in industries that are characterized by oligopoly and monopoly. (pace Paul Krugman). Oligopoly and monopoly are not iron-clad. Consumers have alternatives: If the price of X is “too high” they can (and will) buy more of Y and Z; if the price of X rises a lot, relative to the prices of Y and Z, the producer of X is likely to find himself with a direct competitor. In the alternative, more consumers will abandon X in favor of Y and Z.

TWO EMOTION-LADEN CASES

What about situations in which there seem to be no ready substitutes for a particular good? Lurking behind this question are fears of private monopolies controlling the supplis of water and medical goods. The case of medical goods is more straightforward, so I will deal with it before considering the supply of water.

Medicine

The supply of medical goods already is artificially low because of government, not in spite of it. Who licenses doctors and grants the A.M.A. a near-monopoly on the accreditation of medical schools? Who licenses and regulates hospitals? Who approves drugs and licenses pharmacists? The list of questions could go on and on, but the answer is always the same: government.

The average person will react along these lines: “Government has to be involved in the provision of medical goods, otherwise we would be taking our lives in our hands every time we go to a doctor or a hospital, and every time we use a drug.” I respond as follows:

The main effect of government regulation of certain goods (including medical ones) is to raise the cost of those goods by imposing costs on their providers and effectively barring additional providers from setting up shop. This unseen cost means that Americans consumer fewer medical goods than they would if government weren’t imposing costs on providers and barring prospective providers. (There is an argument that Americans, on balance, consume more medical goods than necessary because of Medicare, Medicaid, and tax-exempt, employer-subsidized health insurance. But given those distortions, it is true that regulation raises costs and restricts entry.) Is it possible that the net effect of regulations is to make Americans worse off rather than better off? A good case can be made for that proposition. (See this, this, and this.) The case of medical goods exemplifies Bastiat’s axiom that

a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

Water: The Hardest Case

No Inherent Need for Government Intervention

If the debate about government’s role in medicine evokes much emotion and little reason, any discussion of privatizing the water supply is certain to elicit the rawest of emotions: fear. A typical reaction goes like this: “If government doesn’t provide our water, greedy speculators will corner the market and we’ll all be at their mercy.” It is hard to imagine such a reaction in the 1800s, when a large fraction of the population lived in rural areas, where most water came from privately owned wells or was taken, by private means, from rivers and lakes. Government doesn’t have to provide water, and if it couldn’t stop a you from drilling a well in your backyard (which it can, thanks to its “police power”) many urbanites and suburbanites might be able to supply their own water.

In any event, there is no inherent reason for government to supply water. The simple fact is that “municipal water works” has acquired the totemic status of “public schools.” Both institutions have become so embedded that private alternatives (on a large scale) were unthinkable, until (in the case of public schools) failure became so obvious that it could no longer be ignored. (That the dominant solution to the failure of public schools is to throw more money at them is neither a negation of their failure nor of the widespread perception of failure.)

Scenario 1: “Accidental” Private Monopoly

Given that there is no inherent reason for government to provide water, I begin the analysis of water monopolies with the following hypothetical:

We have with a small, settled community of 25 homes, in which every home has a well (and has had one for generations). It is accepted by all members of the community that each homeowner is the owner of his well; that is, wells are not communal property. Further, every well provides an ample amount of water for such purposes as drinking, bathing, cooking, watering lawns and gardens, washing cars, etc.

Suddenly, because of some unforeseeable geological change, every well but one runs dry. And the owners of the  24 homes without functioning wells (the unlucky 24″) have no immediate or easy recourse to another source of water — a spring, stream, or lake — because there are none within a day’s drive of the community. The only convenient source of water is the 25th  home (“lucky 25″), whose well  seems to provide more than enough water for its owner — enough, in fact, to meet the drinking, bathing, and cooking needs of the “unlucky 24.”

Issues Arising from Scenario 1

How should the “unlucky 24″ cope with the near-term problem of obtaining water for drinking, bathing, and cooking? Suppose that they have two practical options:

  • Appeal to “lucky 25″ by offering him a price for water that would just cover the cost of providing it (electricity, pump repairs/replacements, etc.).
  • Buy water in large quantities from an out-of-area vendor — at a much higher price than they would offer “lucky 25.”

“Lucky 25,” the accidental water monopolist, has the following options:

  • Accept the offer made by the “unlucky 24.”
  • Make a counter-offer by setting a price that is somewhere between the offer made by the “unlucky 24″ and the cost, to them, of buying water from an out-of-area vendor.
  • Refuse to sell water to the “unlucky 24,” for one of the following reasons: (1) It is his right to do so. (2) He doesn’t want to be in the water-selling business, with its attendant distractions. (3) He fears that drawing significantly greater amounts of water from his well will cause it to run dry.

(You should understand that this is a law-abiding community whose residents are respectful of  property rights — unlike the typical government — so that the water monopolist doesn’t have to worry about defending his well and himself against a mob.)

I daresay that the average reader would expect “lucky 25″ to accept the offer made by the “unlucky 24.” But why should the accidental water monopolist accept the offer? He might, out of compassion, help the “unlucky 24″ while they make other arrangements. But his help would be given out of compassion, not obligation.

The Permissibility of “Good Luck”

Yes, the water monopolist may have been “lucky” with respect to water, but perhaps he has been “unlucky” in other respects. Why, if “luck” determines one’s obligations to others, shouldn’t the water monopolist’s neighbors compensate him for his episodes of “bad luck” — the dog that was hit by a car, the underground stream which provides him ample water but threatens to undermine the foundation of his house, an errant wife, incorrigible children, etc.? Must “good luck” be penalized or paid for, as an act of “social justice”?

The answer is “no.” Anthony de Jasay explains, in “Economic Theories of Social Justice: Risk, Value, and Externality“:

Stripped of rhetoric, an act of social justice (a) deliberately increases the relative share … of the worse-off in total income, and (b) in achieving (a) it redresses part or all of an injustice…. This implies that some people being worse off than others is an injustice and that it must be redressed. However, redress can only be effected at the expense of the better-off; but it is not evident that they have committed the injustice in the first place. Consequently, nor is it clear why the better-off should be under an obligation to redress it….

Since Nature never stops throwing good luck at some and bad luck at others, no sooner are [social] injustices redressed than some people are again better off than others. An economy of voluntary exchanges is inherently inegalitarian…. Striving for social justice, then, turns out to be a ceaseless combat against luck, a striving for the unattainable, sterilized economy that has built-in mechanisms…for offsetting the misdeeds of Nature.

Scenario 2: Deliberate Water Monopoly

Suppose, now, that our water monopolist came by his monopoly in an entirely different way — a way that (to most of us) seems to draw on entrepreneurship, not “luck.” Suppose that he (and he alone) drilled a well for the purpose of selling water to his neighbors, whom (he knows and they know) cannot (and never could) find water under their properties. What should the water monopolist charge his neighbors for water? Just as much as they are willing to pay, of course. Is there anything immoral in that? If there is, why is it not immoral for an auto dealer to sell you a car for just as much as you are willing to pay, even if you need that car in order to earn a living?

Why should the water monopolist (or car dealer or anyone else) be forced by a legalized mob (i.e., government) to sell his product for a prescribed price, when he is the person who took the financial risk of drilling a well, not knowing for certain that he would strike water, at what rate it would flow, how long it would flow at that rate, and whether another source of water might materialize because of unforeseeable geological or climatological changes?

The answer to the question is found in emotion, not reason. Emotionally, we hold water to be more precious than, say, automobiles. Yet, many persons consume a lot of water for what might be called non-essential reasons (e.g., watering lawns, washing cars, filling swimming pools), and many persons need cars in order to earn a living. Water, stripped of its emotional baggage, isn’t a sacred commodity; it is merely a commodity that has different prices in different places.

Which brings us to the essential question: Who should supply water?

Why a Government Monopoly Is Worse

Perhaps government should be in the business of telling everyone what kind of cars they can have (or not have). (Not far-fetched, admittedly.) Well, then, perhaps government should be in the business of telling us whom to marry, how many children to have, where to live, etc., etc., etc. If that’s an unappealing prospect, why step down the slippery slope toward it by allowing government to dictate the price of water, as it does by controlling most of the nation’s water supply through municipal and regional water authorities?

What can government do that entrepreneurs cannot? The answer is nothing, except to set prices for water that are unlikely to correspond to the prices that would be set by voluntary transactions between private sellers and their customers. Government monopolies prohibit entry where entry would be possible, for example, along large rivers and around large lakes.

Government monopolies cannot respond quickly, if at all, to changes in costs and variations in demand. The prices set by government monopolies must therefore result in the subsidization of some consumers who would be willing to pay more for their water by taxpayers and/or other consumers who are paying more than they would pay if there were private, competing suppliers of water.

What about the poor persons who, without subsidization, could not afford water for drinking, bathing, and cooking, unless they were to forgo other necessities (e.g., medical care)? So, the market for water should be monopolized by government and the price of water should be distorted for the sake of a relatively small fraction of the population? It would be better to rely on (a) private charity and (if you insist) (b) tax-funded vouchers for the purchase of water.

Scenario 3: Government vs. Private Pricing

Which leads to the next objection to the privatization of the water supply (which was mostly private for a long time in the United States). It goes like this: “Water monopolists would bleed their customers dry; they would conspire to control the supply of water and charge whatever the market will bear.”

To test those assertions, let us consider the extreme case in which the residents of a mountainous area have only one potential source of water (other than rain), which is a river that flows through the area. Suppose “greedy speculator” buys the land surround the river’s source and dams the river, at a place on his land. (I am  ignoring, for purposes of this post, the state of the law regarding such a practice.) “Greedy speculator” then pays for the installation of water pipes to various of his customers, meters their use of water, and charges them (perhaps at different rates) in such a way as to maximize his profit.

If you have been following along, you will have realized that there’ is no difference between “greedy speculator” and government, where it declares a local monopoly on the supply of water. There is, of course, a degree of (misplaced) trust in government, that is, trust that will “do the right thing,” which means robbing Peter to pay Paul. That trust amounts to nothing more than wishful thinking about government and misconceptions about the benefits of private action, spurred by the prospects of profit.

In the case of water, for example, government may not build enough capacity (to the detriment of consumers), it may build too much capacity (at the expense of taxpayers), or it may fail to keep its system in good repair (to the detriment of consumers). Private, unregulated providers, in the more usual instances where some degree of competition is possible, can respond more quickly than government to rises in demand, are less likely than government to overbuild, and are more likely than government to keep their systems in good repair.

But the provision of water a natural monopoly, is it not? That question (with its the implied answer: “yes”) arises from the belief that there is no room in a market for more than one supplier where an extensive infrastructure must be duplicated (as in the case of water plants and supply pipes). There are market solutions to such seemingly insurmountable problems, although — in the cases of electricity, natural gas, and cable TV — their implementation generally has been botched by regulatory incompetence and intent.

How could there be competition in a market for water? Consider the extreme case of “greedy speculator” who buy the land from which a river rises, and dams the river. If he sets the price of water too high, three things could happen:

  • Some residents self-ration, reducing or eliminating the use of water for such things as watering lawns, washing cars, and filling swimming pools. (Remember, my example involves a “speculator” who is interested in making a reasonable return on a large investment, which requires that he set up shop in place that isn’t destitute.)
  • Some residents leave the area for places where their total cost of living, relative to income, is lower than it becomes after “greedy speculator” sets up shop.
  • Competition arrives in the form of a supplier who hauls water in large tank trucks and installs a water storage tank for each of the homes and businesses that subscribe to his service.

Lo and behold, “greedy speculator” forestalls competition, and perhaps some departures from the area, by setting his price “just high enough.” Is that fair?

Still No Role for Government

Well, ask yourself if it’s fair of government to keep a private individual from earning a profit by providing a product of value to consumers, or to restrict that profit in the “public interest.” Ask yourself if it is fair that such practices on the part of government lead to a general reduction in the willingness of entrepreneurs to establish and expand job- and growth-producing businesses of all kinds. (Remember “that which is not seen.”) Ask yourself if it is fair of government to circumvent the private sector and provide taxpayer-subsidized goods and services to the residents of an area, just because it lacks “good” supplies of water or electricity, or just because it is frequently and predictably devastated by fires, floods, hurricanes, or tornadoes. Ask yourself if it is fair of government to provide taxpayer-funded insurance against predictable natural disasters when private insurers won’t do so — with the result that the areas prone to natural disasters remain heavily inhabited, at taxpayers’ expense.

In other words, private action — however competitive or uncompetitive — alleviates a host of problems. Government action tends to exacerbate those problems, and to create unforeseen (and unseen) ones.

CONCLUSION

It is written nowhere (but in the imaginations of statists) that government owes us a green lawn, a residence on a flood plain, or anything else but protection from predators, foreign and domestic. As soon as government strays beyond its proper role, it begins to corrupt civil society and its essential mechanisms, which include free markets.

One of the ways in which government strays is to interfere in markets and to provide services that can be and should be provided through markets. Government — at the behest of politicians, bureaucrats, academicians, and meddlers-at-large — interferes in markets and sometimes becomes a provider on the pretext that certain markets (most of them, it seems) are insufficiently competitive or otherwise have “failed” because they fall short of measures of perfection devised by — you guessed it — politicians, bureaucrats, academicians, and meddlers-at-large.

Government intervention in markets exacts a very high price, in liberty and material goods. It strips us of the ability to do for ourselves what we think needs to be done — as opposed to what some politician, other meddler, or “aggrieved” group believes we ought to do or have done to us. It strips us — even the poorest among us — of the means to do for ourselves that which we need to do. It strips us — even the poorest among us — of the fruits of those labors which are permitted to us.  The degree of theft is so vast as to be unimaginable, but unseen and therefore (mostly) unlamented.

The bottom line: Private monopolies are superior to public ones, and should not be persecuted or prosecuted. Government monopolies are for the benefit of politicians, bureaucrats, academicians, meddlers-at-large, and the the majority of citizens who have been conned into believing that government action is preferable to private action.