Tag Archives: Asymmetric Information

Break the Market, Blame It, Then Break It Some More

28 Sunday Nov 2021

Posted by in Energy, Environmental Fascism, Free markets, Uncategorized

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Much of what is labeled market failure is a consequence of government failure, or rather, failure caused by misguided public intervention, not just in individual markets but in the economy more generally. Misguided efforts to correct perceived excesses in pricing are often the problem, but there are myriad cases of regulatory overreach, ham-handed application of taxes and subsidies for various enterprises, and widespread cronyism. But it is often convenient for politicians to appear as if they are doing something, which makes activism and active blame of private enterprise a tempting path. The Biden Administration’s energy crisis offers a case in point. First, a digression on the efficiency of free markets. Skip the next two sections to get straight to Biden’s mess.

Behold the Bounty

I always spent part of the first class session teaching Principles of Economics on some incredible things that happen each and every day. Most college freshmen seem to take them for granted: the endless variety of goods that arrive on shelves each day; the ongoing flow of services, many appearing like magic at the flick of a switch; the high degree of coincidence between specific wants and all these fresh supplies; the variety and flow of raw materials and skills that are brought to bear; the fantastic array of sophisticated equipment deployed to assist in these efforts; and the massive social coordination necessary to accomplish all this. How does it all happen? Who collects all the information on what is wanted, and by whom? On the feasibility of actually producing and distributing various things? What miracle computer processes the vast set of information guiding these decisions and actions? Does some superior intelligence within an agency plan all this stuff?

The answer is simple. The seemingly infinite set of knowledge is marshaled, and all these tasks are performed, by the greatest institution of social cooperation to ever emerge: decentralized, free markets! Buying decisions are guided by individual needs and wants. Production and selling decisions are guided by resource availability and technology. And all sides react to evolving prices. Preferences, resources, and technology are in a constant state of flux, but prices react, signaling producers and consumers to make individual adjustments that correct larger imbalances. It is tempting to describe the process as the evolving solution to a gigantic set of dynamic equations.

The Impossible Conceit

No human planner or government agency is capable of solving this problem as seamlessly and efficiently as markets, nor can they hope to achieve the surplus welfare that redound to buyers and sellers in markets. Central planners or intervening authorities cannot possess the knowledge and coordinating power of the market mechanism. That doesn’t mean markets are “perfect”, of course. Things like external costs and benefits, dominant sellers, and asymmetric information can cause market outcomes to deviate from the competitive “ideal”. Inequities can arise from some of these imperfections as well.

What can be much worse is the damage to market performance caused by government policy. Usually the intent is to “correct” imperfections, and the rationale might be defensible. The knowledge to do it very well is often lacking, however. Taxes, subsidies, regulations, tariffs, quotas, capital controls, and manipulation of interest rates (and monetary and credit aggregates) are very general categories of distortion caused by the public sector. Then there is competition for resources via government procurement, which is frequently graft-ridden or price-insensitive.

Many public interventions create advantages for large sellers, leading to greater market concentration. This might best serve the private political power of the wealthy or might convey advantages to investments that happen to be in vogue among the political class. These are the true roots of fascism, which leverages coercive state power for the benefit of private interests.

Energy Vampires

Now we have the curious case of the Biden Administration and it’s purposeful disruption of energy markets in an effort to incentivize a hurried transition from fossil fuels to renewable energy. As I described in a recent post on stagflation,

“… Biden took several steps to hamstring the domestic fossil fuel industry at a time when the economy was still recovering from the pandemic. This included revoking permits for the Keystone pipeline, a ban on drilling on federal lands and federally-controlled waters in the Gulf, shutting down production on some private lands on the pretext of enforcing the Endangered Species Act, and capping methane emissions by oil and gas producers. And all that was apparently just a start.

As Mark Theisen notes, when you promise to destroy a particular industry, as Joe Biden has, by taxing and regulating it to death, who wants to invest in or even maintain production facilities? Some leftists with apparent influence on the administration are threatening penalties against the industry up to and including prosecution for ‘crimes against humanity’!”

In addition to killing Keystone, there remains a strong possibility that Biden will shut down the Line 5 pipeline in Michigan, and there are other pipelines currently under federal review. Biden’s EPA also conducted a purge of science advisors considered “too friendly” to oil and gas industry. This was intertwined with a “review” of new methane rules, which harm smaller, independent oil and gas drillers disproportionately.

Joe Biden’s “Build Back Better” (BBB) legislation, as clumsy in policy as it is in name, introduces a number of “Green New Deal” provisions that would further disadvantage the production and use of fossil fuels. Hart Energy provides descriptions of various tax changes that appeared in the Treasury’s so-called “Greenbook”, a collection of revenue proposals, many of which appear in the BBB legislation that recently passed in the House. These include rollbacks of various deductions for drilling costs, depletion allowances, and recovery rules, as well as hikes in certain excise taxes as well as taxes on foreign oil income. And all this while granting generous subsidies to intermittent and otherwise uneconomic technologies that happen to be in political favor. This is a fine payoff for cronies having invested significantly in these rent seeking opportunities. While the bill still faces an uphill fight in the Senate, apparently Biden has executive orders, held in abeyance, that would inflict more pain on consumers and producers of fossil fuels.

Biden’s energy policies are obviously intended to reduce supplies of oil, gas, and other fossil fuels. Prices have responded, as Green notes:

“Gas is up an average of 57% this year, with corresponding increases of 44% for diesel and a whopping 60% for fuel oil.”

The upward price pressure is not limited to petroleum: electricity rates are jumping as well. Consumers and shippers have noticed. In fact, while Biden crows about wanting “the rich” to pay for BBB, his energy policies are steeply regressive in their impact, as energy absorbs a much larger share of budgets among the poor than the rich. This is politically suicidal, but Biden’s advisors have chosen a most cynical tact as the reality has dawned on them.

Abusive Victim Blaming

Who to blame? After the predictable results of cramping domestic production and attacking fossil fuel producers, the Biden team naturally blames them for rising prices! “Price gouging” is a charge made by political opportunists and those who lack an understanding of how markets allocate scarce resources. More severe scarcity means that prices must rise to ration available quantities and to incentivize those capable of bringing forth additional product under difficult circumstances. That is how a market is supposed to function, and it mitigates scarcity!

But here comes the mendacious and Bumbling Buster Biden. He wants antitrust authorities at the FTC to investigate oil pricing. Again from Stephen Green:

“… the Biden Administration has decided to launch a vindictive legal campaign against oil producers in order to deflect blame for the results of Biden’s policies: Biden’s Solution to Rising Gas Prices Appears to Be Accusing Oil Companies of Price Gouging.”

There’s nothing quite like a threat to market participants to prevent the price mechanism from performing its proper social function. But a failure to price rationally is a prescription for more severe shortages.

Biden has also ordered the Strategic Petroleum Reserve (SPR) to release 50 million barrels of oil, a move that replaces a total of 2.75 days of monthly consumption in the U.S. The SPR is supposed to be drawn upon only in the case of emergencies like natural disasters, so this draw-down is as irresponsible as it is impotent. In fact, OPEC is prepared to offset the SPR release with a production cut. Biden has resorted to begging OPEC to increase production, which is pathetic because the U.S. was a net exporter of oil not long ago … until Biden took charge.

Conclusion

Properly stated, the challenge mounted against markets as an institution is not that they fall short of “perfection”. It is that some other system would lead to superior results in terms of efficiency and/or equity. Central planning, including the kind exercised by the Biden Administration in it’s hurried and foolish effort to tear down and remake the energy economy, is not even a serious candidate on either count.

Granted, there is a long history of subsidies to the oil and gas sector. I cannot defend those, but the development of the technology (even fracking) largely preceded the fruits of the industry’s rent seeking. At this point, green fuels receive far more subsidies (despite some claims to the contrary). Furthermore, the primacy of fossil fuels was not achieved by tearing down competing technologies and infrastructure. In contrast, the current round of central planning requires destruction of entire sectors of the economy that could otherwise produce efficiently for the foreseeable future, if left unmolested.

The Biden Administration has adopted the radical green agenda. Their playbook calls for a severe tilting of price incentives in favor uneconomic, renewable energy sources, despite the economy’s heretofore sensible reliance on plentiful fossil fuels. It’s no surprise that Biden’s policy is unpopular across the economic spectrum. His natural inclination is to blame a competitive industry victimized by his policy. It’s a futile attempt to avoid accountability, as if he thinks doubling down on the fascism will help convince the electorate that oil and gas producers dreamt up this new, nefarious strategy of overcharging customers. People aren’t that dumb, but it’s typical for the elitist Left presume otherwise.

Inflation: The Leftist “Tax the Poor” Policy

23 Thursday Sep 2021

Posted by in Deficits, Inflation, Redistribution

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Recent years have seen explosive growth in federal deficits along with growth rates in the money supply that would have made John Maynard Keynes blush. It’s no coincidence that a new school of thought has developed among certain “monetary economists”. But as someone trained in monetary economics, I wish I could make those quote marks larger. This new school of thought is known as Modern Monetary Theory (MMT), and it asserts that the money spigot is a perfectly legitimate means of financing government spending and, furthermore, that it is not necessarily inflationary. Here is how Scott Sumner and Patrick Horan describe MMT:

“A central idea of MMT is that a government that issues its own fiat currency can pay its bills in that same currency. These governments need not worry about budget deficits when contemplating additional spending. Thus because the US government has a monopoly on money creation, our federal government does not need to raise all its revenue through tax or bond finance. A government with its own currency cannot go bankrupt because it can always issue more currency to cover any budget deficit. … MMT advocates argue that this why the US government can afford expensive programs such as a jobs guarantee and universal healthcare.”

Spend and Print

Joe Biden’s $3.5 trillion “social infrastructure” package would be just a start, but that’s likely to be more like $5.5T once the budget gimmicks are stripped out. We can be somewhat hopeful, because that initiative looks increasingly likely to fail in Congress, at least this time around. But the tax side of that bill was already $2.6T short of the latter spending figure, and the tax provisions keep shrinking. Now, it’s looking more like a shortfall of $3.5T would require financing. Moderate Democrats may not support this crazy bill in the end, but Dems from deep blue states want to reinstate state and local tax deductibility, which would cut the tax component still more. Well who cares? Print the money, say the brave MMT advocates.

Sumner gets to the heart of the problem in this piece. Progressives, with false assurance from MMT, want loose monetary policy to make their expansive programs “affordable”. As he explains, if this happens while the economy is near its production potential, inflation is a sure thing. These lessons were learned long ago, but have been conveniently forgotten by the political class (or they simply prefer to ignore them), instead jumping onto the MMT bandwagon.

Inflation Is Taxation

No conscientious observer of government finance should ever forget that inflation is a form of taxation. Assets whose values are either fixed or subject to some inertia are devalued by inflation in terms of purchasing power, or in real terms, as economists put it. Strictly speaking, this is true when inflation is unexpected… if it is expected, then lenders and borrowers can negotiate terms that will compensate for these changes in real value. But when inflation is unexpected, the losses to lenders are offset by gains to borrowers. Of course the federal government is a gigantic borrower, so inflation can represent a confiscation of wealth from the public.

It’s not small potatoes. Currently, about $22T of U.S. Treasury debt is held by the public, and its average maturity is more than 5 years. If the Federal Reserve engineers an unexpected 1% jump in the rate of inflation, it shaves over $1T off the real value of that debt before it’s repaid, and it reduces the real interest cost of that debt as well. Of course, the holders of that debt will suffer an immediate loss if they are forced to sell prior to maturity for any reason, since new buyers will be demanding higher yields to compensate for higher inflation if it is expected to persist.

The Poor Losers

Inflation causes redistributions to take place, especially when it is unexpected inflation. We’ve already discussed lenders and borrowers, but similar considerations apply to anyone entering into fixed price contracts for goods or labor. Here’s what Claudio Bario of the Bank of International Settlements (BIS) has to say about these shifts:

“Inflation shifts income and wealth away from those who are least aware of it, or least able to protect against it. These segments of the population often coincide with lower-income groups, which explains why inflation has often been portrayed as a most regressive form of tax. The ‘inflation tax’ takes its toll through the erosion of the value of financial assets and contracts fixed in nominal terms.”

Inflation is a regressive tax! In this respect, economist Noah Smith echos Bario in a recent op-ed in which he discusses “money illusion”, or the confusion of real and nominal income:

“Workers … who are slow to perceive the rise in prices they pay for goods like cars and groceries, won’t realize this, and will be happy with their unusually large raises. But companies, whose accountants and managers certainly know the true inflation rate, will also be happy, because they know they’re not actually paying more for labor.

That information asymmetry between workers and employers may be exactly what keeps wages from rising faster than inflation. If workers take a year to realize how much prices have gone up, they may be satisfied with the raises they got during the time of high inflation — even if that inflation ultimately turns out to be transitory. By then, it might be too late to negotiate for a real, inflation-adjusted raise.”

Inflation taxes and redistributions become more acute at higher rates of inflation, but any unexpected escalation in the rate of inflation will take a toll on the poor. Bario elaborates on the mechanisms by which inflation inflicts budgetary pain on the those at the lower end of the socioeconomic spectrum.

“As regards wealth distribution, the financial assets that are most vulnerable to inflation are cash and bank accounts – the typical savings vehicles held by the poorest segments of the population. This is mostly because the poorest have access only to limited investment options to protect their savings. …

… wages and pensions – the main sources of income for a large majority of households and even more so for the poorest half of the population – are typically fixed in nominal terms and hence vulnerable to inflation. Indexation mechanisms, such as those adopted in many [advanced economies] in the 1970s, are no panacea: they may fail to keep pace as inflation accelerates; …”

In addition to the inflationary gains reaped by government, it’s clear that inflation gives rise to redistributions between private parties: generally from those with lower incomes and wealth to their employers, producers, financial institutions, and pension payers (businesses, state and local governments). An exception is some low income debtors might benefit if they owe long term obligations at fixed interest rates, but low income individuals are often constrained from obtaining this form of credit.

Causing, Then Exploiting, Inequality

Another especially galling aspect of the Left’s focus on money finance is how its consequences fly in the face of their concerns about income and wealth inequality. Inflation is typically manifested in rising equity prices: nominal stock values tend to escalate in an inflationary environment, protecting their owners from losses to the real value of their investments. Stocks are generally a good inflation hedge. Yet we know that stocks are disproportionately owned by those in the highest strata of the income and wealth distributions. Later, of course, the Left will seek to level the burgeoning inequality wrought by their own policies by “taxing the rich”! Apparently, for the Left, consistency is never considered a virtue. This is not unlike another trick, which is to blame “greedy corporations” for the inflation wrought by Leftist policies.

It’s a great irony that the Left, which purports to support the poor and working people, would propose a form of government finance that is so regressive in its effects. To be generous, perhaps it’s just another case of “progressives” unknowingly hurting the ones they love. The expansive programs they advocate will confer government benefits to many individuals in higher income brackets, not just the poor, but those government alms will help to compensate for higher inflation. But this too takes advantage of money illusion, because those benefits might well buy progressives the loyalty of beneficiaries unable to recognize the ongoing erosion in their standard of living, and who are unwilling to come to grips with their increasing dependency.

But Tut, Tut, They Say

Advocates of MMT, in combination with expansive government, also have a tendency to deny that inflation has ever been a consequence of such policies. As Sumner points out, they have forgotten historical episodes that run contrary to the theory, and most “popular” advocates of MMT fail to recognize the important role played by limits on the economy’s production potential. When money growth outruns the economy’s ability to produce real goods and services, the prices of goods will rise.

Statists and Stasis: The Dismal Solutions of Anti-Capitalists

26 Wednesday Aug 2015

Posted by in Capitalism, Markets, Socialism, Tyranny

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Thought Hanging

The anti-capitalist Left is quick to condemn private businesses of unfair practices and even unethical behavior. In their estimation, certain prices are not just and profits are somehow undeserved rewards to private property, risk-taking and entrepreneurial sweat. They somehow imagine that meeting market demands is an easy matter, or worse, that market demands are not “socially useful”. Few have ever attempted to run a business, or if they have, they were unsuccessful and resent it. They also cannot grasp the social function served by private markets, to which we owe our standard of living and much of our culture.

What alternatives do these deep thinkers suggest? A socialist utopia? Jonathan Newman discusses the many practical problems presented by socialism and why it always fails to achieve success comparable to societies that rely on free markets. Newman’s treatment covers the inability of administered pricing to convey accurate information and effective incentives, the waste induced by queuing, neglect of comparative advantage, waste induced by production quotas, retarded innovation and technological development, and a deeply embedded stasis in the face of changing conditions. Little wonder that poverty is a consequence.

Warren Meyer at Coyote Blog has written of the stasis seemingly promoted by the progressives. They are quite protective of the status quo. Ironically, and quite rightly, Meyer calls them “deeply conservative”, too conservative to accept the dynamism of a capitalistic society. From Meyer:

“Progressives want comfort and certainty. They want to lock things down the way they are. They want to know that such and such job will be there tomorrow and next decade, and will always pay at least X amount. Which is why, in the end, progressives are all statists, because only a government with totalitarian powers can bring the order and certainty and control of individual decision-making that they crave..

Progressive elements in this country have always tried to freeze commerce, to lock this country’s economy down in its then-current patterns. Progressives in the late 19th century were terrified the American economy was shifting from agriculture to industry. They wanted to stop this, to cement in place patterns where 80-90% of Americans worked on farms.“

Freezing the diffusion of technology and often the state of technology itself is a consequence of socialist policy. And technology may well be the enemy of the Left in another sense: An interesting twist is provided by Fred Foldvary of the Mercatus Center in “Government Intervention Is Becoming Obsolete“. He writes that technology is undermining all of the usual economic rationales for intervention: asymmetric information, external effects, public goods, and monopoly. The article is brief, but he refers the reader to more extensive treatments.

A good example of socialism’s perverse appeal is the rhetoric of Senator Bernie Sanders, now a candidate for the Democrat Presidential nomination. Sanders has criticized the “the dizzying (and socially useless) number of products in the deodorant category….” At Reason.com, A. Barton Hinkle wondered what Sanders might consider the appropriate number of deodorant choices in our society. Would he wish to dictate a limited number as a matter of policy? And what other “socially useless” choices might he choose to limit in his failure to grasp that these choices reflect the incredible health and vibrancy of a market economy. Here’s Hinkle:

“… central planners think they can allocate economic resources better than the unguided hand of individual free choice. Like any good scientific experiment, this one is easily replicated, and has been time and again. See, for example, Venezuela, which has now run out of toilet paper, tampons, and other basic necessities because some people there think they should make all the choices for other people. And yet for many, the repeated lesson still has not sunk in. In an unintentionally hilarious essay about Cuba not so long ago, one writer noted that “the people are hungry here. There are severe food shortages. I do not understand why a tropical island would lack fruits and vegetables . . . and my only assumption is that maybe they have to export it all.”

Never forget that government can only pursue policy objectives via coercive power. I don’t think socialists have forgotten at all. Without the power to coerce, nothing proposed or done by the state can be accomplished and enforced. This is the course that progressive, anti-capitalists must follow to achieve their collectivist vision. But Chris Edwards reminds us that “Coercion Is Bad Economics” with the following points about government:

  • When it “uses coercion, its actions are based on guesswork.“
  • Its “actions often destroy value because they [arbitrarily] create winners and losers.“
  • Its “activities fail to create value because the funding comes from a compulsory source: taxes.”
  • Its “programs often fail to generate value because the taxes to support them create “deadweight losses” or economic damage.“

By arranging voluntary, mutually beneficial trades, market forces avoid all of these problems. As Robert P Murphy explains in The Freeman, “Capitalists Have a Better Plan“.

The anti-capitalists do not hesitate to saddle private businesses with confiscatory tax and regulatory burdens in the name of their own vision of society. Want to live in a bleak world of decline? Then here’s your prescription, courtesy of the anti-capitalist Left: regulate heavily, monitor transactions, impose wage and price controls, dismantle markets, tax at punitive levels, confiscate property, censor “offensive” speech, extend dependence on the state, absorb private savings and crowd out private investment with government borrowing, and inflate the money stock. Smells like a crappy “utopia”.