Friday, May 1, 2015

Why Companies Are Individuals... and Not

Companies are people. And they aren't.

This concept of legal personhood, or legally responsible entity, is embodied in the United States Code:
1 U.S.C. §1 (United States Code): In determining the meaning of any Act of Congress, unless the context indicates otherwise the words "person" and "whoever" include corporations, companies, associations, firms, partnerships, societies, and joint stock companies, as well as individuals;
The reason for this artificial legal construct is simple, though many progressives, and more than a few conservatives, fail to understand why the construct is necessary. If corporate entities didn't exist as people, they could not conduct business. Consider everything a company does that an individual does:
  1. Buy property.
  2. Pay bills.
  3. Enter into contracts.
  4. Pay individuals (employees and consultants).
  5. Register copyrights and patents.
  6. Pay taxes and fees.
  7. Pay fines… (yes, that matters).
Executives come and go, so suggesting they have the legal obligation for all contracts is absurd. Imagine having to reassign all contracts and property when a CEO, COO, CFO, or other executive left a company. That's not feasible. Likewise, board members and stockholder change. Companies are composed of people, but the composition changes constantly.

When you are hired by a company, no one individual is bound by the agreement: the entire company is. The people hiring you might leave, but you surely wouldn't want the employment contract to be instantly nullified. You need an employer to be bound by basic rules, just as a sole-proprietor would be.

Companies need to own buildings, furniture, technology, equipment, and real estate. Again, those items need to belong to "someone" (the legal entity) who isn't a person… because the people making purchases come and go. A delivery company owns its vans, and is legally responsible for those vehicles. The company has to pay for licenses, insurance, and any operational costs. That's personhood.

Legally, a person has free speech. Legally, a voluntary assembly of people has free speech. After all, that's what a political party is: a group of like-minded people engaged in free speech. So, does a company have free speech? What about a non-profit company? What are the limits and why?

The argument that companies aren't people is also accurate, but it ignores that people are the company.

Companies can't be sent to jail. But of course we should hold the individuals within a company responsible for illegal actions and decisions that harm others.

Trying to detail every case when a company is or is not a "person" would create messy legal disputes. We need to maintain the idea that companies are legal entities, while also holding leaders accountable for what they do as individuals.

Friday, April 24, 2015

The Post-WWII Boom... Not a Norm

I've long argued that it was not unions or government spending that produced the great post-war boom in the United States and much of the Western World. In December 2014, Tim Worstall published a column on The Register ("El Reg") that agrees with my basic theory: we had to rebuild after the war, and the U.S. was fortunate enough to be the one nation not destroyed during the two World Wars.
Bring back big gov, right? If only the economics, STUPID, could tell us more Post-WWII growth rates? Paaah Dec 2014 at 09:00, Tim Worst
You don't have to go all that far leftward these days to find someone brandishing economic growth statistics at you. Proving that growth was higher in the 1945-1973 period than it has been in our own more neoliberal age. Thus, of course, we should bring back the signal economic and political policies of those days so that we can speed up growth again. Big Unions, government controlling the commanding heights of the economy (this is not just Europe, by the way, the US economy was under a great deal of central control at the time as well), detailed planning. Hell, we should bring back the Old Labour wet dream!
Get ready for a lot of these claims during the 2015-16 presidential silly season. The "progressives" will call for a return to the past, arguing that correlation is causation. Obviously, in the progressive worldview, unions and government created the middle class (conveniently forgetting Henry Ford and a handful of other industrialists supported shorter workdays and higher wages for self-serving reasons). 

Unions and minimum wage laws were not created to help everyone, anyway. They were created to help some people — and harm others. 

Anyway, let us return to Worstall:
Which, to bring us back to our current state, means that sure, productivity growth today is slower than it was in the time of Big Unions. But not because of: it's just a coincidence that the unions thrived when we were playing catch up from the 1930s and '40s.
For here we end up with one of the central problems of economics as a field of study (at this point even I'm too embarrassed to try to call it a science). Which is that we've not really got all that information to be working with. We've really only got perhaps a half century of detailed information on perhaps 30 or so economies. What we've got for most places and most times is really pretty ropey stuff.

That's really just not enough information for us to be able to answer most questions definitively and accurately. […]
And, so it is with this discussion of post-World War II growth rates. Other than unions, planning and equaliteee, various thoughts are put forward. For example, that it was really about the rebound from WWII itself, which petered out after a time and we were back to normal.
And that is my argument: the Post-War boom was like a rubber band, pulled back and then bouncing quickly back into place. We had to rush quickly to return to normal, headed right past normal, and then vibrated a bit around the normal state.

War created demand and reduced the workforce. However horrible that is, war created a situation that felt like a huge economic boom. I'd argue that this isn't a great thing, since we have no idea what great minds and opportunities were lost while we built killing machines. Later, we rebuilt destroyed cities, but what if those great cities had not been leveled by carpet bombing? Yes, we had to bounce back, but was that really a "boom" so much as a quick recovery? I'm uncertain and don't want to test the economic benefits of global war any time soon. 

If we look at the global economic costs, the bounce back took until the 1970s for many nations. But, war did benefit the United States. From our perspective, there was a boom because we were not surrounded by the rubble of Europe or Japan. From an American perspective, the Post-War boom looks quite different and leads to assumptions about unions and big government programs. 

This faith in government also requires ignoring some of the problems associated with the New Deal, which likely extended the Great Depression and slowed recovery until World War II.

"What about the Cold War and Space Race?" progressives ask (and several books argue). Spending on technology to "Beat the Reds" led to innovations benefiting companies and society. Big Government spending powered economic growth!

If only the data supported this without any disagreement among economists.  
And – just for kicks – there's another possible explanation of the same facts.
Charles I. Jones, an economist at Stanford University, has "disassembled" American economic growth into component parts, such as increases in capital investment, increases in work hours, increases in research and development, and other factors. Looking at 1950–1993, he found that 80 per cent of the growth from that period came from the application of previously discovered ideas.
This is superficially similar to my own point. But it differs in detail. For people do point to the way that the State funded and directed must research and development post-war. And then tell us that the productivity growth came from that State involvement. But if all the basic research that we were applying to practical matters in that time came from before that time it cannot be the funding method of that time responsible, can it?
What? Research didn't create the economic boom, either? Not federally-funded research, no. 

It's hard to imagine, since we are taught that the Internet, the microchip, the computer, and so many things were dependent on government research. Reality is more complex. Companies wanted computing power, the same as government did. In some instances, the government solution was not the best technological solution, either. Government was one client, one research funding source, but not the only source and not always the best consumer. 

If Worstall and others are correct, we might not experience another boom like the Post-War period. The slower growth of today might be the real "normal" for our economic systems. No massive spending programs (Japan) or stronger unions (Spain, Greece) are going to counter the steady, slow economic normalcy we now inhabit. 

Then again, wars and other disasters do happen… 

Sunday, March 15, 2015

Another Would-Be Critic of Libertarianism Takes on a Straw Man -

The Fountainhead (film)
The Fountainhead (film) (Photo credit: Wikipedia)
When a critique of libertarianism consists primarily of figuratively shouting "Ayn Rand!" and tossing in the Koch brothers, Nietzsche, and Gordon Gecko (a fictional character, nonetheless), you can be assured the author isn't going to address the Nobel economists or noted philosophers associated with libertarianism on the left, right, and center. Instead of discussing the major thinkers of classical liberalism, the author will attack the caricature of "Libertarians" that has little to do with scholarly reflection.
Another Would-Be Critic of Libertarianism Takes on a Straw Man -
How refreshing it would be for someone to set forth the strongest case for libertarianism before attempting to eviscerate it.
Sheldon Richman | March 15, 2015 
We must face the fact that criticism of the libertarian philosophy in the mass media will most likely misrepresent its target, making the commentary essentially worthless. That’s painfully clear from what critics publish almost weekly on self-styled left-wing and progressive websites. How refreshing it would be for someone to set forth the strongest case for libertarianism before attempting to eviscerate it. Is the failure to do so a sign of fear that the philosophy is potentially appealing to a great many people?
I could list a great many economists and philosophers the left (and right) ignore when attacking libertarians and (almost) classical liberals like myself. Instead of engaging Hayek or Mill or Adam Smith, instead of exploring deeply individualistic philosophers on the left and right (not that critics don't rush to call existentialism or utilitarianism childish), the critics attack Ayn Rand… because some mildly educated radio personalities might quote her. Yes, because modern talking heads are the intellectual giants of politics. (Or maybe they are, on all sides. That's a sad thought.)

I wrote in 2013:
In the comments to both articles, progressives resort to attacks on Ayn Rand (and Ron Paul, Rand Paul, and few other people). The general claim is that Rand glorified greed. I don't like Rand — she was a lousy human being, but so were many, many other thinkers across the political and philosophical spectrum. But, I at least recognize that Ayn Rand did not glorify greed: she celebrated being true to yourself. The hero of The Fountainhead is not the richest or most powerful character. It is Howard Roark, the architect with a vision, a truly great artist more concerned with the art than money. How can liberals and progressives miss such a clear argument? It isn't about money, it's about the freedom to be true to your desires and talents. Ayn Rand was not a master of subtle plots. 
Rand's villains in The Fountainhead? The rich and powerful. The media. The political elite. The hero? An artist willing to walk away from money and crush rocks rather than surrender his integrity. Seriously? Liberals don't agree with that ideal? And as I wrote above, the classic movie adaptation of The Fountainhead is the only Rand work I can tolerate.

For more on misrepresentations of classical liberalism and the variety of libertarianism:

Friday, March 6, 2015

Society and Success

Success: It's not about money.

One of the critiques of "libertarian" and "classical liberalism" I answer is that these philosophical lines encourage greed, especially in the democratic capitalism of the United States.

Seeking your own success does not have to correspond to the pursuit of wealth as measured by bank statements and material goods. Authentic classical liberalism allows me to pursue whatever fulfillment I seek, without a government bureaucrat deciding we have too many artists, or too many doctors. We pursue our dreams — and the market demand determines if we can earn a "good enough" living.

And yet, there are cultural pressure in our society to count and tally our success in unhealthy ways.

Since childhood I have feared being poor. My family lived in tiny apartments, mobile homes, and small houses. We had "enough" but were always closer to less than more. My wife and I have lost everything. We have been broke. I had no checking or savings. No credit card. Nothing but the generosity of others. And it was horrible. But we survived.

For me, and many other upwardly mobile individuals, that dread of failure, of having nothing, makes us vulnerable to those social pressures of counting things. Oddly enough, you don't stop counting when you move into the top quintile, either.

In 2012, the top quintile started at $104,097. The average household income of families in the top fifth was $181,905 (Brookings Institute, June 2014). The top five percent of households had an average income of $318,052… and that top five percent started at $191,156 — not exactly Carnegie or Rockefeller wealth.

If you read those numbers, as I do, and consider where your household falls, is that a healthy way to look at success? It cannot be, and it should not be how we value ourselves.

My wife and I are successful, now. And I worry about that success vanishing. For the "semi-wealthy" or whatever we might call ourselves, there's a dread that the fall down is a matter of one lost job, one major illness, or the loss of a spouse. For some reason, we cannot relax and feel secure: we've worried our way to the top.

Unfortunately, the middle class tends to compare wealth… constantly. I hear it from my neighbors and coworkers. People earning decent salaries, with homes and cars and nice vacations, worry and compare.

Over the last three years, I have become shallower. I have let myself fall into the money matters nonsense of the competitive middle class, at home and at work. This need to prove to others that we are okay is fed by the poor manners of some people around us. I end up responding to their misguided bragging when I should walk away and remain quiet.

It isn't libertarianism or neo-liberalism or any other -ism that makes people behave this way. I've talked to anthropologists and historians about other cultures (and other times) when comparisons were different, yet still existed. Comparison to others seems to be a natural motivation to do better… but we should also be wise enough to know when comparisons cross a line and become unhealthy.

Looking at data, though, doesn't ease the stress.

I'm a contract university professor. I could have my hours cut to part-time. I could lose my job. Things could happen that would, in a moment, remove us from the top quintile. It shouldn't matter so much, but it does.

On the other hand, I worry about liking and doing things that are "conspicuous" and coming across as a jerk.

My wife and I are considering a new vehicle. I caught myself thinking about what the neighbors and my coworkers might think of various choices. No, I wasn't thinking about impressing anyone. Instead, I was wondering if we shouldn't get the best rated, second-highest mileage vehicle (by 1 MPG), because it might look like we were trying to show off to someone.

This is the current state of counting and competing: we want just enough to be equal to our neighbors, but we don't want to seem better than anyone else. We want to fit in with our friends, neighbors, and coworkers.

When what we should be wanting is whatever "success" means to us personally.

Friday, January 9, 2015

Rich or Smart... Knowledge, Skills Matter

Being "smart" (or at least hard-working with the opportunity to learn) matters, regardless of the economic class into which you are born. As even the most progressive, class-conscious scholars have found, a college education (in the STEM fields, ideally) at a good school corresponds well to later economic success. 

A year ago, The Atlantic featured this story:
Would You Rather Be Born Smart or Rich? WEISSMANN
DEC 2 2013, 12:17 PM ET
A recent Brookings paper gives reasons for optimism. Over the long term, it finds, smart kids earn more than rich kids. But sadly, there's a big catch.
The Brookings paper looked at the relationship between brains, motivation, and economic mobility among a group of youth the government began tracking in 1979. Here's the executive summary: If they were bright and driven, poor kids stood a decent chance of becoming upper-middle-class, or better. Of low-income teens who scored in the top third of test-takers on the Armed Forces Qualification Test (on the far left in green), more than 40 percent made it to the top two income quintiles by adulthood. Meanwhile, dimwitted children of affluence generally fell down the economic ladder. Among high-income teens who scored in the bottom third of AFQT takers (on the far right in orange), more than half ended up in the bottom two income quintiles. 
Studies using tests similar to the AFQT, such as the SAT or ACT, have found similar trends. Data indicate the rich and powerful are consistently in the top two percent academically. In other words, the "One Percent" (those wealthy people we should envy) consistently come from the "Two Percent" of academic test-takers (the "98th Percentile" in admissions parlance). 

As Jonathan Wai of Duke University wrote in his 2014 paper "Investigating The World's Rich And Powerful: Education, Cognitive Ability, And Sex Differences," the attendees of the Davos forums are well-educated in demanding STEM fields. Wai found: 
Among billionaires and Davos attendees, many majored in business and STEM. In the U.S., top 1% ability individuals were highly overrepresented: 45 times (base rate expectations) among billionaires, 56 times among powerful females, 85 times among powerful males, and 64 times among Davos participants.
As the Brookings Institute researchers found, and Wai confirmed the next year, academic success correlates to financial success and social leadership. Wai carefully recognized that wealth alone might not measure success, so he also included "leaders" of society in his data, though Brookings did limit their study to social mobility and educational potential.

Consider this chart from Brookings:

If you are born into the bottom quintile (the "lowest" class) but score well on academic placement exams, you have a pretty decent chance (clearly not all luck) of moving into the top two quintiles of income. If you are born into a top-income family, but score badly on placement tests, there's a decent likelihood that you will exit that upper-income quintile. 

As The Atlantic's Jordan Weissmann noted, there is a complication — and one I witness at the university at which I teach. 
Now about that catch. The unfortunate truth is that, more often than not, the rich kids are the smart kids. For many years now, the single biggest gap in American education has been between the well-to-do and the poor. Thanks to the resources their families can pour into parenting, wealthy students start out academically ahead the day they walk into kindergarten, and stay ahead through their high school graduation day.
By their late teens, six out of every ten children from the wealthiest slice of families place among the top third of test takers; six in ten children from the poorest slice of families place among the bottom third. They're mirror images of wealth and acumen.  
Now, we have a question that cannot be answered easily. The truth is going to be complicated in ways that please no political ideologues.

The genetic argument leads fallacies along uncomfortable ethnic lines, for example. Are the wealthy genetically predisposed to certain types of skills we now value in this economy? If that's the case, do their genes pass along some portion of the skills for success? 

The pure wealth argument (money buys opportunity) leads to ignoring genetics, culture, and other variables. Fallacies arise as simple correlations are used to "prove" the unfairness of tests, school, and the economy. The problem with this is that Wai studied data globally, not merely United States citizens. Success globally correlated to elite university educations. We also know that wealthy parents still can and do raise children who eventually fall out of the top income quintiles. 

The children of the wealthy fall from the top to the next-highest quintile. They do have a safety net, as data reflect. But, as adults those former children of the wealthy, newly part of the upper-middle classes, have children with even greater mobility — up and down the income ladder. Within generations, a family can rise or fall. In two generations, smart children and grandchildren of poor parents can reach the top two quintiles. 

In the United States, this intergenerational mobility isn't as quick as in some nations, but our income brackets expressed as class quintiles cover much wider income distributions. In other words, it is a much, much greater distance from the top to the bottom in the United States than in developed European nations. 

The true nature of social mobility eludes us. We know education is the key to success, including success not defined by money alone. But, how do we ensure access to education? And why do some people with access still fall from the top income quintiles? What variables determine how well someone uses the opportunity to obtain an education? 

Being test-smart and college-educated (at a top-tier school) matters a great deal in our technology-driven global economy. 

Friday, January 2, 2015

Washington Post... The Middle Class

Middle-class families have found themselves stagnating for the last two decades (at least). The Washington Post has published an outstanding series on the issues affecting the middle-class. The stories are long and well researched.

ABOUT THIS SERIES: The American middle class is floundering, and it has been for decades. The Post examines the mystery of what's gone wrong and shows what the country must focus on to get the economy working for everyone again.

My personal favorite part of this series has been Chapter 4, which describes how the appeal of the financial industry has drawn our best and brightest minds from other pursuits.

Friday, December 26, 2014

A black hole for our best and brightest | The Washington Post

Teaching within a top-ranked business school associated with nine Nobel laureates in economics, I am honored to meet some of the brightest young minds in the world. These students excel at math, as one might expect, and many also pursue second degrees or minors in additional STEM (science, technology, engineering, and math) fields. At our institution, economics is paired with statistics by default, as we emphasize quantitative economics over the philosophical approaches to the field.

Although I admire these students, I'm also saddened that so many chase financial industry careers over working in other STEM fields or in the public sector. These great minds set forth to turn money into more money, when they might use their skills to apply the lessons of economics and statistics to greater social good.

As Washington Post reporter Jim Tankersley writes, it isn't that finance is a "good" or "bad" pursuit for an individual — but in the last two decades finance has become a magnet, drawing away great minds from other potential fields of study and work. Worse, the financial industry is now a net drain on economic growth. I believe this explains the explosion of complex financial instruments, leading to yet more specialization and yet more demand for gifted graduates. You need to be a mathematician just to comprehend some of the financial instruments institutions use to generate money out of empty activity.
A black hole for our best and brightest
Wall Street is expanding, and the economy is worse off for it. by Jim Tankersley

In 2012, economists at the International Monetary Fund analyzed data across years and countries and concluded that in some countries, including America, the financial sector had grown so large that it was slowing economic growth. Using a different methodology, the most prominent researcher on the size and economic value of Wall Street, a New York University economist named Thomas Philippon, estimates that the United States is sinking nearly $300 billion too much annually into finance.

In perhaps the starkest illustration, economists from Harvard University and the University of Chicago wrote in a recent paper that every dollar a worker earns in a research field spills over to make the economy $5 better off. Every dollar a similar worker earns in finance comes with a drain, making the economy 60 cents worse off.

It's not that finance is inherently bad — on the contrary, a well-functioning financial system is critical to a market economy. The problem is, America's financial system has grown much larger than it should have, based on how well the industry performs.
Research in the above passages means STEM discovery and deployment, not financial research into the latest credit default swaps or options-based covering. Meaningful, productive research that creates things other than paper wealth is what historically drives an economy forward. We're stuck in neutral, as an overall economy, while wealth creates wealth. If you are fortunate enough to have some wealth, you'll end up with more wealth in the current economy. But, are you creating things that help society more broadly?

Understand, I appreciate that capital investments lead to innovation in a normal economic model. Still, that's not what our markets seem to be doing right now. Banks are not lending to start-ups at the same rate as in the past. If anything, large stale companies are expanding their valuations through stock buy-backs, low-interest bonds, increased dividends, real estate investment trust (REIT) lease-back schemes, and other gimmicks. Our brilliant math students enter a business world in which their role is to maximize stock value and trading fees, which is not the same as creating things and services with inherent value.

I'm not anti-Wall Street. I'm anti-stagnation, which is where the developed economies seem to be headed. Instead of improving retail experiences, stores spin-off real estate into holding companies and lease back the property. Instead of innovating, tech companies buy back shares in hopes of increasing earnings-per-share (EPS) or price:earnings (PE) data. Companies merge and invert their legal entity locations, resulting in reduced taxes or other benefits. It's all financial engineering, not real innovation.

Why are the people plotting these complex maneuvers not discovering new medicines? Why are they not working on alternative energy projects? Why are they not exploring distant galaxies? Because finance pays. What would lead bright young graduates into finance? Wealth, of course. It's all about the money — the money people earn in the financial industry.
Philippon is a French economist at NYU's Stern School of Business. He and a co-author, Ariell Reshef of the University of Virginia, have shown that from the end of World War II until the early 1980s, finance was just like any other desk job: The average Wall Street worker was paid about as much as the average worker in the private sector and was only slightly more educated.

But starting at about the time that Jackson joined Goldman, when Congress began tweaking investment-tax rates, Wall Street started drawing more educated workers. This made the average finance salary go up — from less than $50,000 a year in 1981 (which is about $100,000 in today's dollars) to more than $350,000 a year in 2012.

Salaries rose even faster in the mid-1990s. The average finance worker began to earn more than a similar non-finance worker who had the same amount of schooling. Wall Street executives began to command salaries several times the rate that non-finance executives could.

In sheer dollar terms, it became irrational for almost any qualified American graduate to pass on a Wall Street job. By the mid-2000s, finance workers earned about 50 percent more than they would have in a similar job anywhere else in the economy. There are almost twice as many financial professionals in the top 1 percent of American income earners today as there were in 1979, according to researchers from Williams College, Indiana University and the Treasury Department. Almost 1 in 5 members of the top 0.1 percent work in finance.
You could argue, "Four in five members of the top 0.1 do not work in finance!" Yes, and many of those others do have STEM degrees and work in STEM fields. Still, the number of gifted students entering finance continues to outpace what the economy needs. There is a bubble in finance, and it will burst.

Though I wish my words alone would encourage students to pursue more "altruistic" paths — or at least more productive paths, as I define productive — it isn't going to happen. Money is a powerful motivator when graduates of our best universities can't wait to be debt-free and racing for the penthouse suites.

Friday, November 7, 2014

Ideology and Investment -

For once, a post that agrees with Paul Krugman. He makes an argument I have advanced on this blog and I agree with his general premise that now is the ideal time for some infrastructure spending.

See: Ideology and Investment -
There’s an obvious policy response to this situation: public investment. We have huge infrastructure needs, especially in water and transportation, and the federal government can borrow incredibly cheaply — in fact, interest rates on inflation-protected bonds have been negative much of the time (they’re currently just 0.4 percent). So borrowing to build roads, repair sewers and more seems like a no-brainer. .
I've posted an identical call for (sane and limited) infrastructure spending. We have billions of dollars in deferred maintenance that must be done. Now is the ideal time, with low bond rates and an anemic economy.

I'm not calling for or supporting reckless spendthrift approaches to investment. I don't like waste (high speed rail in California) and I hate the poor spending record of government. But, if there is oversight and we address those project in need, we could help repair a crumbling infrastructure.

If I can agree with Krugman on this, and many of our past leaders from both major parties used low-interest bonds to build American infrastructure, what is the problem with Congress?

I do disagree with Krugman that this is an entirely Republican issue. People have lost faith in government's ability to execute well. The GOP contributed to this lack of faith with their own spending insanity, so I don't trust them to be good stewards of the budget. But, maybe a new national transportation bill would be a good start to demonstrate we can and will repair roads and bridges within sounds budgeting practices. Maybe.

Friday, October 17, 2014

Economics isn't about what is fair...

Yesterday, I reminded my undergraduate economics students that modern economics, with its quantitative bias, is not about what is "fair" in life. While we can use economics to identify what isn't "fair" and how to better allocate resources, at its core economics is the study of efficiently allocating scarce resources. Math is not moral; it is an amoral aspect of economics that should be informed by philosophical inquiries.

For example, quantitative economics can answer when a person is "unproductive" and "inefficient" within the system. But, economics does not answer if it is moral to reallocate resources from the unproductive to either the currently or potentially productive members of a community. Raw numbers tell us the money spent on extending the last year or two of life might be best spent on educating the young. But is that the right way to approach problems?

Economic models do not tell us if stock market gains driven by low interest rates and stock buybacks funded by lower borrowing costs are morally right. What the models do tell us is that those with stocks do benefit from low interest rates more than those without equity holdings. The judgment of "fairness" is beyond the scope of economic models — fairness is philosophical and, inherently, political.

I'd argue that economics often leads us to the "worst" choices when we apply only mathematics and statistics in a manner that seeks to optimize capital and resource efficiencies. Instead, we must ask much larger questions about what we want, what we consider utility for ourselves and others.

With my biases of culture and experience, I'm a believer in markets, with their bubbles and flaws and asymmetrical transfers of knowledge. Central planning is "efficient" in theory… and lousy in practice.

Statistics alone can tell me what I "should" do to maximize whatever it is I want to maximize, but most of us want to make "inefficient" choices that conflict with what we consider our core values from time to time.

Eugene Fama has argued that markets are efficient over time. The trends are what we study, not the day-by-day, minute-by-minute human transactions. Days are unpredictable, but years or decades tend to follow trend lines. That is because all those unreasonable, irrational, emotional choices we make average out over time.

Markets, free and open, let me decide if I want to "waste" money on my pets, my cars, my games, my lawn. Markets let me decide to eat expensive meals I don't "need" and buy clothes (like ties) that serve no logical purpose. I've long theorized an economist could prove that the production and wearing of ties costs the global economy, diverting resources better allocated to other needs. But, I don't want to be told that I can't buy nice silk ties.

The math of behavioral economics studies we have done to predict what we will do. It doesn't tell us what we should do. The math of macro monetary economics doesn't tell us what interest rates should be, only what they will likely be in specific circumstances. Models are information. What we do with that information is much different question.

If you want to allocate a resource "fairly" you have to make a moral choice, a judgment, of what is fair and why. Mathematics cannot do that for you.

Friday, October 10, 2014

Inflation that Isn't... Why?

Where's the inflation? Where's the run-up in bond rates?

Despite high debt, unsustainable long-term social spending, unfunded pension liabilities, and numerous other fiscal challenges, the U.S. bond market is strong and interest rates remain low.

Companies are facing increasing energy costs, unstable global situations, falling unemployment, rising minimum wages in larger cities, and a regulatory landscape that has shifted.

The Tea Party and the Occupy movements aren't exactly in the mood to reform corporate taxes, and the politicians reliant on both extremes aren't going to collaborate to improve the business climate in any meaningful way. (Yes, there are areas of agreement among most economists, across the political and theoretical spectrum, that good policy isn't good politics.)

If business costs and risks are rising, prices should be rising. With all levels of government fiscally unsound (and ungovernable), bond vigilantes should be circling. In theory, inflation should be creeping up with so many unfavorable variables. Yet, inflation is meaningless.

I discussed this situation with an economist from an investment firm, certainly no Keynesian, and I've also explored these questions with academic colleagues.

From my colleagues in business and academia, I've assembled a list of many theories on why there's neither bond inflation nor extreme consumer inflation.

Mild inflation is considered "good" in many ways by economists. Inflation devalues current debts, for example. This helps people and governments assume debt for socially beneficial investments. Governments selling bonds at a low interest rate to build roads that current receipts might not cover is something economists (generally) agree is sound policy. Inflation devalues the debt, making repayment a lower percentage of tax receipts. But, high inflation and rising bond rates make government invest risky, and debt repayment can ruin a government.

People want their houses, land, bank accounts, and wages to increase in perceived value. We could argue how real such increases are, and over the psychological value of inflation, but economists generally concur that our current global economies, two to four percent inflation is manageable.

And now, the theories on why there's minimal inflation:

1. Slack in the labor market. Yes, unemployment has fallen and 200,000 or so jobs have been created each month for almost two years, but underemployment and workforce participation rates indicate significant slack. Although skilled labor is tight, and wages are rising in places like North Dakota, overall there's little pressure to hire more people and pay higher wages.

2. Automation is working… in place of people. With emerging market factories opting for machines and software over once-cheap employees, the machines are rising. This allows companies to replace people or to avoid hiring new people. Some economists argue that since there are no mass layoffs, automation isn't hurting the economy. This is the same mistake made when considering higher wages: hiring deferred hurts economic growth, but it also reduces inflationary pressure.

Understand that automation and optimization are unavoidable. In nations with aging, shrinking populations, automation might be a great thing — allowing fewer young people to provide for their elders. But, automation that displaces workers or assumes roles of people never hired goes back to item 1.

3. Best of the worst economies. The United States and its various governments are among the best risks for investors. We're a safe haven in a world experiencing turmoil. This keeps U.S. bond rates low. Even a handful of large municipal bankruptcies didn't affect the muni bond market. If you want a safe, tax-free investment, bonds remain okay. Not great, but okay.

4. Generally benignly neglectful government. Our political system is in disarray, with gridlock at all levels. Yes, this creates some uncertainty, but not as much as some claim. As the business economist told me, no government action is at least predictable. Real uncertainty would be if we couldn't predict which party would have clear majorities in the House and Senate. Instead, we know that no majority will control the Senate, Republicans will control the House, and the President Obama has two more year. In other words… nothing significant is changing for at least two years and, barring a major electoral wave in 2016, gridlock is the norm.

Stability means companies have some certainty in the United States. Like being the best of the indebted economies, we're among the best of the worst governments. Not a point of pride, but it helps control inflation and bond vigilantes.

5. Domestic energy production. Energy, especially oil prices, affects inflation across product and service categories. How much domestic energy production, and increased energy efficiency, are counteracting other pressures is unclear, but these are helping control producer prices.

6. Frugal consumers, extravagant consumers. The consumer market is bifurcated, with the low-end consumers struggling. These consumers are keeping cars longer, buying fewer durable goods, and doing their best on flat or even declining salaries. These consumers, however, are masked by the steady consumption of the high-end consumers. Walmart shoppers become Dollar Store shoppers; Kroger gives way to Aldi. People are adjusting to lingering effects of the Great Recession… and that offsets inflationary pressures.

The economy grows, thanks to the high-end consumers. It grows slowly, though.

7. Weak housing market. The single-family, owner-occupied, mid-range housing market is weak. Housing demand being soft reduces inflationary pressures. Studies now show some people migrating from the pricier cities to lower-cost metro areas. House prices are rising, steadily, but demand limps along.

Other Theories

There are lots of theories on what happened and what's happening in the United States economy. Models failed to predict the Great Recession, and models haven't accurately predicted a recovery. Things are a mess, and might be a mess for many years to come.

I've read academic papers and institutional reports suggesting quantitative easing by the Federal Reserve, though potentially increasing inflation by devaluing the dollar, was absorbed by the equities market. The rich got richer, without any corresponding inflation. The access liquidity raised stock prices.

There is a theory that inflation is understated by the Consumer and Producer Price Indices. Prices of volatile food and energy being removed, and purchasing patterns changing among low-end consumers, leads to low official inflation rates, while the inflation in our daily lives is significant.

Whatever is happening, there will be consequences for fiscal mismanagement and political inaction. I doubt there will be hyper or even extreme inflation unless investors find a better place than the United States for their money.

The odds of that are pretty slim. Thankfully.