Magic of Zero

Part of the source of the magic of zero comes from the odd disparity of society's opinion of borrowers and lenders. Consider someone who has a good steady job with a substantial income and prospects for the future, the bank is willing to lend to him at some interest. This person accumulates debt and then some event causes his income to fall sharply so that he can no longer service the debt. A sensible view would be that both the borrower and the lender took a risk here and both should loose out. In this view zero is far less magical. However, society at large tends to view the borrower as fully responsible and the lender as a sort of victim. This is wrongheaded for two reasons. For one the borrower can pay for his necessary expenses out of the value of his labor, the lender can not. (If he could he would be doing that rather than taking the risks of lending) For another the lender's business model depends upon support from the government. One really has no chance of making a living by lending money at interest unless one has the contract enforcement authority of a government behind him.

Citizens/Heroes

The following Editorial in the NYT by William Deresiewicz is well worth a read, especially the last paragraph. (h/t to Kos).

“America needs heroes,” it is sometimes said, a phrase that’s often uttered in a wistful tone, almost cooingly, as if we were talking about a lonely child. But do we really “need heroes”? We need leaders, who marshal us to the muddle. We need role models, who show us how to deal with it. But what we really need are citizens, who refuse to infantilize themselves with talk of heroes and put their shoulders to the public wheel instead. The political scientist Jonathan Weiler sees the cult of the uniform as a kind of citizenship-by-proxy. Soldiers and cops and firefighters, he argues, embody a notion of public service to which the rest of us are now no more than spectators. What we really need, in other words, is a swift kick in the pants.

This is a sentiment I agree with completely. Our national anthem describes this country as "the land of the free, the home of the brave" and yet for the past ten years certainly we have seen an overwhelming tendency to treat any sort of scary scenario, including purely imaginary scenarios as direct threats that must be eliminated. To no extent are we, or at least a large faction of the population, willing to face the existence of some potential danger while we determine what, if any, danger actually exists. So we invade Iraq to save ourselves from nuclear bombs fired by Saddam's ICBMs, none of which existed. I sometimes disparage this as conservative courage, namely the willingness to be brave once the government first guarantees that there is no chance whatsoever that I might get hurt. The truly sad thing about this attitude is that all experience from history shows that the way to intimidate one's enemies is to treat things that frighten them as if they do not bother you. In short, show courage. A willingness to kill does not intimidate your enemies, showing no fear of death does. To be secure each individual citizen needs to willingly and bravely take on some of the risk, not try and pass off all risk to a small handful.

Another Look at Incorporation

Recent thought I had about the nature of incorporation and the appropriate role of redistributive taxation. This is kind of a new way of looking at things.

I've argued elsewhere that incorporation is a kind of insurance policy for investors (see here and here). Basically, for many types of businesses there exists a very tiny probability of enormously large loss. In short there is a vanishingly small possibility of a loss that would exceed the net worth of all investors. Investors tend to consider feel that vanishingly small is still too large a chance if the loss is all of one's net worth. Hence, those types of activities would never be undertaken under ordinary liability laws. Consider something like a chemical processing plant or a power plant, especially at the time when corporations where coming into existence, that is in the 18th and 19th centuries.

The limited liability corporation then comes into existence as an insurance policy for investors. The investor can put some amount of his total wealth into the business and only that portion of his wealth actually invested is at risk. That amount of wealth is, essentially, his deductible and the rest of his assets are not at risk, no matter how large the loss incurred by the business. Without this insurance, a great many very valuable businesses and industries would never have come into existence.

Note, however, that this insurance is not a private sector policy. The private sector does provide some sorts of insurance against investment loss, but the amount of protection that any private insurance could provide is limited. For this degree of insurance the government has to arrange for the limitation of liability via laws, the courts and law enforcement. In the insurance provided by incorporation, the general populace of the United States takes on some of the risk that private businesses entail. To take an example with relevance to recent news events, the residents of the Gulf coast region take on some of the risk in having BP Oil drill for oil offshore. Those people pay more for insurance to secure the value of their property because they cannot be certain that they will be compensated for all losses that they might incur due to the operation of BP Oil. Other people, in other parts of the country, take on different risks to protect investors in other businesses, but the principle is the same. The investors are protected from risk by some portion of the general population that assumes that risk.

Now, it is true that the general population derives some benefit from incorporation. The goods and services generated by the incorporated businesses, plus the value of employment in businesses that would otherwise not exist is significant. It is not purely a transfer of wealth from the general population to the investors. However, the value of benefit to the two parties is not always comparable. It is frequently, and increasingly, the case that the value to the investors vastly exceeds the benefit to the general population. This is where the role of government and redistributive taxation comes in, but in my opinion, it is better seen as simply the market at work.

The existence of a limited liability corporation is a creation of government. No system for protecting the assets of one part of society against loss in anything resembling a corporation exists in the absence of a government to specifically create it. The government, in our system, acts then as a broker between the investors and the general population. The government guarantees to the investor that others will take up the risk that the investors are unwilling to. The government will use its power of law enforcement and the operation of its courts to see that the investor will not be required to pay more than his investment as compensation for any losses that the investments create. The government provides the guarantee to the investor and arranges that people will take up the risk as is needed.

The role of taxation in this view then is just the operation of the market. The government charges the investors a premium for this insurance, charging them the market value of having the risk assumed by others. The investors are, of course, still free to assume the risk themselves (or to take on some other enterprise), but if they wish to have the insurance of incorporation, the government will charge them the premium. The redistribution of this taxation is then just paying the people who will take on the risk for doing so. Services are provided and payments are made, with the government acting, as I said, as a broker.

The progressive/liberal arguments on this subject often portray the redistributive taxation as coming from a special insight as to what is fair and just and thus subject to the argument that liberals are claiming to know better how to handle your affairs than you do. What I'm suggesting here is that the basis of redistributive taxation and spending is not a matter of liberals knowing better what is fair and just, rather it is a simple matter of requiring compensation from people when you provide them a service and providing compensation to people who provide you one. In other words, paying your way.

Another side note on the progressive view on these matters. It seems to me that much of the conservative policy comes down to conservatives trying to save money by not paying for things such as the value provided by incorporation. The liberal position is that the overwhelming evidence of history (and the overwhelming support of theology and ethics, although I would argue that liberals would do well to make this a secondary argument not a primary one.) is that the cheapest way to acquire the things we need is to simply negotiate a trade. Any other system for acquiring goods and services will be more expensive, all things considered. So if we want the less affluent of Americans to take on the risk of other businesses via incorporation then the least expensive option is to charge the corporations money for it and to provide those Americans something in return. This is especially true given the things they want in return. What they want are things like education, health care and transportation, things which for all of the past five thousand years of human history have increased the value of labor and capital, and thus have increased general prosperity. This in turn will tend to increase the prosperity of the rest of us, included those who ultimately are "paying" for these services to the less affluent.

Progressive Message

I think there are a bunch of problems with the progressive message and how it is delivered. Progressive policies are fine (no doubt could be better, but as they are they're quite good), but the message is poor. When questioned in private people will support the policies indicated above, but are less willing to defend these choices when arguing in public. The reason for this, is in part, because good arguments have not been spread around.

For example on taxing the rich. Large majorities favor it in the polls, but when confronted with opposition in a public debate the charge is made that raising taxes on the rich is no more than theft. The counter argument, I believe, is that this is nonsense. The rich benefit mightily from several government programs such as incorporation and copyright. The income of most of these wealthy folks' labor is inflated hugely by the government via these institutions. Raising taxes on these people is merely raising our prices, prices that are far too low already.

Much has been made by progressive of the absurdity of the conservative talking point that the government needs to reign in spending like any household or small business. The progressive arguments that I've seen is to claim that the government is not like a household and then get into very wonky discussions about how the government is different. But one of the big differences is that no household would be so foolish as a federal government run by conservatives to spend the past ten years trying to operate on the principal that it must not charge its customers money for the services the business provides. And if one were so foolish, the first thing to do when financial trouble came would be to raise the prices.

Broken Windows

Yesterday, Matt Yglesias posted this about the broken window fallacy. Now the broken window fallacy is based upon the following parable attributed to by by Frédéric Bastiat:

Have you ever witnessed the anger of the good shopkeeper, James Goodfellow, when his careless son happened to break a pane of glass? If you have been present at such a scene, you will most assuredly bear witness to the fact that every one of the spectators, were there even thirty of them, by common consent apparently, offered the unfortunate owner this invariable consolation—"It is an ill wind that blows nobody good. Everybody must live, and what would become of the glaziers if panes of glass were never broken?"

Now, this form of condolence contains an entire theory, which it will be well to show up in this simple case, seeing that it is precisely the same as that which, unhappily, regulates the greater part of our economical institutions.

Suppose it cost six francs to repair the damage, and you say that the accident brings six francs to the glazier's trade—that it encourages that trade to the amount of six francs—I grant it; I have not a word to say against it; you reason justly. The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen.

But if, on the other hand, you come to the conclusion, as is too often the case, that it is a good thing to break windows, that it causes money to circulate, and that the encouragement of industry in general will be the result of it, you will oblige me to call out, "Stop there! Your theory is confined to that which is seen; it takes no account of that which is not seen."

It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way, which this accident has prevented.

The conclusion that the money spent on repairing the window would otherwise have gone to some other purpose is often given as an argument again Keynsian economics. Now, Matt gives a fine reply in terms of modern views on money and so forth, go read him, but it strikes me that the parable itself is a fallacy.

The claim that the money spent on repairing the window must come as a deduction from money spent elsewhere is certainly not, in general true. Unless everyone in the town is providing absolutely the maximum amount of labor that he can, that no time is spent on leisure activities beyond what is absolutely necessary to maintain optimal productivity, then people have the option of increasing their income by increasing the amount of labor they do. Let us assume that the baker can give up some of his ordinary leisure time today (no wonder he is cross with the child) and produce some extra confectioneries that he knows he can sell to the shoemaker. He uses this money to pay the glazier, who repairs the window to its original state, and then, as it happens, go to the shoemaker and uses the income from repairing the window to purchase a new pair of shoes he would otherwise have done without.

Now where do we stand. Well that still depends upon a number of factors, but let us assume that each of these purchases, the confections, the window and the shoes each cost one franc. In terms of cash money then a single franc was passed from the shoemaker to the baker to the glazier and then back to the shoemaker, leaving the status of cash money unchanged. Now it is true that each merchant is out the cost of the materials used to produce his product. But if each merchant is operating at a profit than the cost of the materials must be less than the one franc price at which the items were sold. It is certainly possible that, depending upon the profit margin for these three, that the total cost of the materials is less than the one franc price of replacing the window and that the net loss is less than that one franc cost and that all three now have more money to spend than would be the case had the window not been broken. The extra value comes from the extra labor done, which would otherwise not have been done.

It should also be considered that most likely the glazier values the shoes more than he does the pane of glass (his loss of materials) and the shoemaker values the confections more than he does the leather (his loss). The baker presumably is just out the value of his flour and eggs, but then his child broke the window. (Of course in that case he might get a bit better labor from the child, who most likely helps out in the shop, with less effort on the baker's part, at least for a few days, due to guilt). Also the pattern of people doing a bit more labor to make up for additional costs could be extended further, thus reducing the overall loss from this event. Perhaps the baker does a bit of further extra work for the supplier to the shoemaker in order to earn money to replace his (the baker's) store of flour and eggs. And then perhaps the shoemaker does the same with the supplier to the glazier to replace his store of leather and the glazier does the same to replace his store of glass. Now the loss is only to the materials used by the suppliers, and that again, if people operate at a profit will reduce the overall loss. Furthermore this braid could be extended still further to reduce the loss to whatever small value we like.

Now, the above, in detail, is not a likely series of events. But it clearly demonstrates that there exist options, centered around the provision of additional productive labor, whereby the broken window leads to an increase in the overall wealth of the society. The glazier gets new shoes and the baker still has money for purchasing a book, although perhaps a somewhat cheaper one. The claim that the broken window makes no difference, while it provides some benefit to the glazier, it must be an equal loss to someone else, is simply not the way people actually function.

Consider a more modern example. While traveling on the highway you see a stranded motorist with a flat tire. The person stranded is in no shape to change the tire (for whatever reason) so you change the tire. You have just done productive labor that would otherwise not have been done. You did it only because the tire went flat. Had the tire not gone flat you would not have done that, or any comparable, extra labor. It this example let us also assume that the stranded motorist will not take the aid for free but insists on paying you $20. Ok, now you've done $20 worth of productive labor that happened only because the tire in question went flat. You are ahead by $20, but the motorist is behind by $20, so no change at all, in line with the parable above. But the motorist, who is now out $20 might well decide to also find some additional labor to do, labor worth $20. But this is labor above and beyond which he would have done had the tire not gone flat. Perhaps he takes an extra shift at work, or he tutors on the side of a local school and takes on one extra student. Perhaps he mows an extra lawn, or takes on another babysitting job. I think I've made my point. Are we really to believe that nothing like this ever happens. I doubt it. Furthermore, once the flat tire has induced the motorist to take on additional labor, what is to constrain him from working only enough to replace the $20. If he is going to give up free time to work, he might as well do more than replace his loss and earn $30 or $40 or more.

It seems most likely to me that the broken window fallacy is itself the error.

Pathologies of Conservative Economics

I've been thinking that one of the things that I find most objectionable about the conservative view on economics is that the proposed policies can only produce results that are diametrically opposed to the stated objectives of those policies. They claim to wish to shrink the role of government in the economy, but the policies advocated can only serve to make government more essential at all points in the economy. Now for many on the right this is intended. They have no more interest in shrinking the governments role in the economy than they are interested in shrinking the deficit. They want rich people to not have to pay for any part of government. Others seem to believe that conservative policies are related to shrinking government, so I've identified, I think, two areas where the policies cannot have the intended effect. These are the pathologies I refer to in the title.

1) Low taxes reduce the amount that a business needs to pay for government supplied services such as incorporation, using the radio spectrum, dumping waste in the environment, copyright protection and others. If these services are supplied at rates below what the market would demand for them (that is the price that would be charged by a private company supplying the services if the government did not and a private company could) then businesses using these services are at an advantage in the market. The profit expected from a given amount of effort and a given supply of capital will be larger for businesses that rely on government services compared to those who do not. Business that do not use government services must pay for the full value of all the inputs they need to run the business out of the revenue they can earn. Businesses relying on government services need only pay for those goods and services not supplied by the government and a part of those supplied by the government. The difference between what the government charges in taxes and the market value of what the government supplies adds to the businesses profits. Thus in a low tax regime investment dollars will go toward businesses that rely upon government services, because the profit margin (or at least the apparent profit margin) will be greater. Eventually these businesses will use those investment dollars for ever more marginal uses until the general return on investment in the industry, however much it uses government services, is equal to other industries not dependent upon the government. However, that dollar level of investment in such a business will be much higher than it would be if the government were not supplying inputs at a reduced rate. So we can expect that in a general low tax environment investment dollars, and thus the asset values of industries should be dominated by those that heavily rely upon government services.

What we see in the US today is, I believe, an economy dominated by the financial sector which depends upon the security provided by such elements as the FBI white collar crime unit, the content industries which rely upon copyright protection, various businesses dependent upon dumping waste products into the general environment, businesses that need to be incorporated, and the like. In short we have an economy that is heavily dominated by businesses that rely upon government services precisely because of having adopted conservative policies supposedly intended to stop government expansion in the economy. If we wanted to shrink the government we should make the government expensive, not free.

2) The operators of a publicly owned company have a fiduciary responsibility to the shareholders to maximize the value of the company. If there is some option available to increase the value of the company to the shareholders and the CEO and other offices fail to take advantage of that opportunity they are failing in their responsibility and acting unethically. So if the government is to provide services at a rate below the market value (by this I mean the amount that would be charged by a private company if the services were provided by such an entity) then the operators are obliged to take advantage of this sub-market price to increase the value of the firm they operate.

To put this in specific terms, consider that there are many projects the firm can undertake that will bring in just a bit more revenue than it would cost to undertake. These the firm are most likely engaging in so as to maximize the firm's income and thus value to shareholders. There are other projects that would bring in less revenue than it would cost to carry out, these the firm does not undertake. But if the government is charging sub-market for some of the inputs the firm needs, that will make otherwise unprofitable projects, profitable, at least as far as the firm's books are concerned. As the price charged by the government falls, then the firm will increase the extent to which it engages in projects which are made profitable only due to the effective subsidy of the government providing services at below market rates. As the prices government charges fall a firm could certainly find itself so heavily invested in projects that depend upon this government subsidy that its overall profitability is dependent upon this government subsidy. I think it likely that, again as a result of conservative policies, a large fraction of American business remain a going concern only as a consequence of this government subsidy via below market pricing.

That is not to say that they could not become truly profitable again, should the government return to a more sensible pricing scheme. But at this point, it is likely that American firms are highly dependent upon the government.

Conservative Economics

The central mystery of conservative economics is that it is based on two fundamental truths

1. Without various services of government such as incorporation, copyright, licensing the radio spectrum and others, American business would not be able to compete and be profitable.
2. Government does nothing of any value for business, it only takes and hinders.

One might think these are contradictory, but this is just the central mystery.

Note: Actually, the above is tongue-in-cheek. A careful examination of conservative economic thinking reveals that they are not contradictory per se. Rather when providing the above services, they are essential. When charging money for them, they were never really needed.

Patent Madness

Matt Yglesias has had a few posts up (most recently here) about technology patents and their role in (both good and bad) in the economy.

So a bunch of patents have recently been sold by one company for a cool $4.5 billion. This is but a small part of the total value of patents. This doesn't even touch on the money put into suits and planning on how to use patents to stifle innovation and competition. The things are valuable.

My snarky observation is that whatever business or organization came up with the idea of patents and was able to enforce them, it should be making a mint off the things and paying a huge dividend to its shareholders. Off course, its the government that has created this valuable instrument and we shareholder are gripped with the bizarre belief that our prosperity is dependent upon giving these things away for free. Sigh.

Content Aggregators

This is an interesting article in the Atlantic from last week about the rise and success of Netflix. Netflix has been an enormously successful business operating on a model of aggregating content (TV shows, movies, stuff like that) and making it available for a fee to folks who want to view it. It turns out they've been a lot more profitable doing that than experts expected, indeed a good bit more successful than the produces of the content. According to the article this comes as a bit of a surprise to experts, expecting instead that the content produces would be mostly making money off of the content they produce.

Now the article points up a number of reasons why this expectation would turn up wrong and describes circumstances in which aggregators can be expected to be very profitable. It seems to me thought that the points I've been raising could play a role as well. Success as an aggregator of content depends upon a number of things, one of which is copyright. To be able to make money off of selling (or renting) content you need to be able to make sure that no one else can sell (or rent) that same content at a lower price. Given that the marginal price for providing content is about zero, the price competition would quickly doom any hope for a large revenue stream.

So this copyright protection service is really important, and copyright is provided only by the government. Given our recent passion for providing these government services for free (or as close to that as we can manage politically), business that rely upon them will be at a competitive advantage. The major inputs for a content aggregator include copyright, so given that it is provided at a rate far below market the aggregator can expect a higher return on investment than a business that must pay market rate for all the inputs to its business. A business like content producers for example.

There really are huge distortions to the economy if we are going to have the government provide these extremely valuable services and not charge money for them.