The national debt is expected to grow by approximately $9 trillion over the next ten years according to the Obama Administration's own forecasts. The Concord Coalition recently projected a 10 year debt of closer to $14 trillion. Either way you look at it, these are historically large numbers but numbers that often lack political and historical context when discussed in the media by political operatives.
Many Republicans are quick to criticize the President for these large deficits but always fail to suggest what the deficits might be had they controlled the White House and Congress. Maybe the Republicans believe they could have helped us get out of the longest recession since the Great Depression by spending only $8 trillion, maybe $7 trillion? Pick a number. No doubt Democrats would take the opportunity to criticize Republicans for spending too much.
No matter how you slice it, federal deficits increase during a recession if only because tax revenues are down and automatic stabilizers like unemployment compensation and other income security programs increase. Throw in a large tax cut for households and businesses, and I have no doubt that Republicans would be facing a very similar budget outlook. Recent evidence suggests this might be true.
During the Bush Administration, the national debt increased from $5.67 trillion on 9/30/2000 to $10.02 trillion on 9/30/2008 (http://www.treasurydirect.gov/govt/reports/pd/histdebt/histdebt.htm). During his presidency, Bush's budgets averaged over $350 billion in deficits and added over $2.5 trillion to the national debt (http://www.whitehouse.gov/omb/budget/fy2010/assets/hist01z1.xls). Yet during most of this period, the Bush Administration presided over a growing economy and a soaring stock market until the last year of his term. I also recall Bush Administration spokespeople boasting about the millions of jobs created during his term. So how is it that his presidency left us with a national debt almost twice as large as when he took office? It took 40 years to create the deficit Bush began office with and only 8 years for it to double. Did Republicans forget about that? President Obama hasn't even had a chance to reside over a growing economy yet. I'm not trying to deflect the discussion or defend our current administration, the looming national debt may very well be the catalyst for our next crisis and we need to get real about the idea of raising taxes.
Politicians and political pundits are blessed with amnesia, it's the only logical explanation besides suggesting that they blatantly misrepresent the facts or manipulate the truth.
Wednesday, August 26, 2009
Looking Back on the Economic "Tragedy"
We’ve heard about the potential causes. We’ve cast blame. Now we are trying to sort out the guilty from the innocent. And we all seem to know who to point the finger at, you know “those guys” who caused all the problems. But besides the Madoff’s and Stanford’s, the AIG’s and Fannie Mae’s, who else should we blame? You? Me? Maybe we all should look in the mirror, not because we are negligent, but because we are human.
It’s human nature to want to improve one’s quality of life. For some, a better quality of life might be to live simply and sustainably off the land, for others a better quality of life is a Harvard education, a seven figure salary, and a summer house in the mountains. Economics has nothing to say about whose quality of life is better, nor should a free society. But what economics does say is that everyone has the same underlying objective and that people will, more often than not, make decisions in ways that help them achieve their version of a better life. This is what the study of economics is really about, how do we achieve all of our wants, goals, and desires for our families, our communities, and our planet with the limited resources that we have to work with? It is a difficult and never ending problem, you might even call it a curse, but it’s what defines us as humans.
As we go through life making choices, we evaluate costs and benefits, both present and future. One of the costs that we are always taking into account is the value (price) we place on risks. Hence, it’s logical to expect people to respond predictably to incentives regarding the price of risk. And herein lies the economic tragedy.
Except for a short period defined by the tech bubble recession and September 11th, the nation’s economy was strong for about 18 years. Since the end of 1991 and until recently, unemployment was never higher than 7.5%, the Dow has grown 215%, per capita personal disposable income is up over 45%, prices have risen on average 1.8% per year, and median home values are up 40%. Historically, the last two decades were pretty good and the relative consistency of these numbers over this extended period led many to believe it could be sustained. “Housing prices always go up,” we were told. “The stock market always returns an average of 8% in the long run,” said investors. Couple this notion with subtle deregulatory policy changes and for many decision makers, the cost of taking on more risk went down.
Businesses took on more risk. Banks took on more risk. Homeowners took on more risk and consumers took on more risk. Some took on the risk of growing too fast, borrowing too much, investing too blindly, and insuring too little. Some risks were naively underestimated while others were fraudulently manipulated and too make matters worse, most were unaware of the “tragedy” that was taking place.
As businesses and consumers evaluated the cost of taking on added risk in their own personal decision making, they underestimated the cost caused by others in the economy doing the same thing. Since so many people were taking on added risk, the real hidden cost of risk to the individual decision maker was much higher. Many were making decisions without taking into account the added cost to everyone in the economic system and the tragedy was inevitable.
Like a wild fire, the economy began to burn out of control. Those who miscalculated or manipulated the cost of risk the most were almost immediately eliminated. Others got caught up in the inferno as it spread. But like the aftermath of a forest fire brings new life to the forest floor, the financial crisis appears to be extinguished and as stated by Bernanke “green shoots” are starting to appear.
What should we take away from our latest economic crisis? Like Hardin argued in 1968, some regulation is necessary to protect the commons. He poignantly referred to it as “mutual coercion, mutually agreed upon” meaning that even free markets need publicly agreed upon rules (coercion) that need to be enforced (agreed upon) even though we may not like it.
It’s human nature to want to improve one’s quality of life. For some, a better quality of life might be to live simply and sustainably off the land, for others a better quality of life is a Harvard education, a seven figure salary, and a summer house in the mountains. Economics has nothing to say about whose quality of life is better, nor should a free society. But what economics does say is that everyone has the same underlying objective and that people will, more often than not, make decisions in ways that help them achieve their version of a better life. This is what the study of economics is really about, how do we achieve all of our wants, goals, and desires for our families, our communities, and our planet with the limited resources that we have to work with? It is a difficult and never ending problem, you might even call it a curse, but it’s what defines us as humans.
As we go through life making choices, we evaluate costs and benefits, both present and future. One of the costs that we are always taking into account is the value (price) we place on risks. Hence, it’s logical to expect people to respond predictably to incentives regarding the price of risk. And herein lies the economic tragedy.
Except for a short period defined by the tech bubble recession and September 11th, the nation’s economy was strong for about 18 years. Since the end of 1991 and until recently, unemployment was never higher than 7.5%, the Dow has grown 215%, per capita personal disposable income is up over 45%, prices have risen on average 1.8% per year, and median home values are up 40%. Historically, the last two decades were pretty good and the relative consistency of these numbers over this extended period led many to believe it could be sustained. “Housing prices always go up,” we were told. “The stock market always returns an average of 8% in the long run,” said investors. Couple this notion with subtle deregulatory policy changes and for many decision makers, the cost of taking on more risk went down.
Businesses took on more risk. Banks took on more risk. Homeowners took on more risk and consumers took on more risk. Some took on the risk of growing too fast, borrowing too much, investing too blindly, and insuring too little. Some risks were naively underestimated while others were fraudulently manipulated and too make matters worse, most were unaware of the “tragedy” that was taking place.
In 1968, Garrett Hardin, a biologist, wrote one of the most cited and read economic articles of all time, The Tragedy of the Commons. In the article, he used simple mathematics and logic to explain how a community with open pasture land (commons) would eventually fall apart because individual farmers were simply making economic decisions to improve their way of life. Each rancher saw that adding one steer to the open pasture yielded benefits greater than costs because the costs were shared by the community. The problem was that individual farmers were not accurately taking into account the hidden costs to the commons. Since all the ranchers were making the same decision, the costs were much higher and eventually there were too many cattle for the pasture to sustain.
As businesses and consumers evaluated the cost of taking on added risk in their own personal decision making, they underestimated the cost caused by others in the economy doing the same thing. Since so many people were taking on added risk, the real hidden cost of risk to the individual decision maker was much higher. Many were making decisions without taking into account the added cost to everyone in the economic system and the tragedy was inevitable.
Like a wild fire, the economy began to burn out of control. Those who miscalculated or manipulated the cost of risk the most were almost immediately eliminated. Others got caught up in the inferno as it spread. But like the aftermath of a forest fire brings new life to the forest floor, the financial crisis appears to be extinguished and as stated by Bernanke “green shoots” are starting to appear.
What should we take away from our latest economic crisis? Like Hardin argued in 1968, some regulation is necessary to protect the commons. He poignantly referred to it as “mutual coercion, mutually agreed upon” meaning that even free markets need publicly agreed upon rules (coercion) that need to be enforced (agreed upon) even though we may not like it.
Thursday, August 20, 2009
How Much Should You Pay for that Chocolate Bar?
Have you heard about this economic news? Can you imagine our beloved, sweet-tooth-curing, sugary snacks becoming more expensive?
The story describes a bit of a political standoff between some of the major American food manufacturers and the United States government. Companies, such as Hershey and Kraft, want the government to increase sugar import quotas. This would allow more foreign-made sugar to be imported into the United States (it is important to note that the U.S. already imports a hefty amount of sugar from Mexico, but there is no quota, due to NAFTA). The result would be greater competition and lower prices on sugar.
More importantly, this story is a great tie-in to my earlier post, "The Economics of Price Gouging." It also relates directly to Mike's February post called, "Buy American."
In particular, the sugar quota, just like any trade quota or tariff imposed by a government, represents a PRICE FLOOR. In essence, what the government has done is created an artificial, minimum price that is above the equilibrium price of the sugar market. Now, the government didn't set a specific price, but the current quota limits the amount of sugar suppliers available to Hershey, Kraft, and the like, and keeps the price at a level greater than what the food manufacturers and confectioners would normally pay in a free market. the domestic sugar price has no chance of coming down because government has restricted competition.
Now, the argument used by food manufacturers and confectioners, is that there is a shortage of sugar, due to the quota system. This is faulty economic thinking. Sugar manufacturers were quick to point out that there is plenty of American sugar to buy. OF COURSE THERE IS! Government has created a market where prices are artificially high. The suppliers who CAN benefit from those high prices are quick to supply more sugar.
The problem is NOT a SHORTAGE of sugar. The problem IS that GOVERNMENT is keeping prices at a level that Hershey and Kraft don't want to pay.
The story describes a bit of a political standoff between some of the major American food manufacturers and the United States government. Companies, such as Hershey and Kraft, want the government to increase sugar import quotas. This would allow more foreign-made sugar to be imported into the United States (it is important to note that the U.S. already imports a hefty amount of sugar from Mexico, but there is no quota, due to NAFTA). The result would be greater competition and lower prices on sugar.
More importantly, this story is a great tie-in to my earlier post, "The Economics of Price Gouging." It also relates directly to Mike's February post called, "Buy American."
In particular, the sugar quota, just like any trade quota or tariff imposed by a government, represents a PRICE FLOOR. In essence, what the government has done is created an artificial, minimum price that is above the equilibrium price of the sugar market. Now, the government didn't set a specific price, but the current quota limits the amount of sugar suppliers available to Hershey, Kraft, and the like, and keeps the price at a level greater than what the food manufacturers and confectioners would normally pay in a free market. the domestic sugar price has no chance of coming down because government has restricted competition.
Now, the argument used by food manufacturers and confectioners, is that there is a shortage of sugar, due to the quota system. This is faulty economic thinking. Sugar manufacturers were quick to point out that there is plenty of American sugar to buy. OF COURSE THERE IS! Government has created a market where prices are artificially high. The suppliers who CAN benefit from those high prices are quick to supply more sugar.
The problem is NOT a SHORTAGE of sugar. The problem IS that GOVERNMENT is keeping prices at a level that Hershey and Kraft don't want to pay.
- For what reason? To protect American sugar producers.
- Who pays the price? We do, with higher prices at the grocery store cash register.
The Price of Everything
I just finished reading a great book for anyone wanting an easy read about basic economic logic. The book is not a text but a fictional narrative about a college student who stands up to a big box retailer who appears to be price gouging following an earthquake. The student is befriended by the provost of the university who is an economist and they have conversations as the student nears graduation and his valedictorian speech to the student body.
The main story in the book goes great with Bill's posted economics lesson on price gouging.
The book contains some great ideas for teaching economics and is a pretty good story that will keep readers interested. I recommend the book for high school economics and college principles courses.
The Price of Everything: A Parable of Possibility and Prosperity
by Russel Roberts
Princeton University Press (July 28, 2008)
Wednesday, August 19, 2009
So what about these “green shoots”? Are they ever going to grow?
Much has been made about Ben Bernanke’s “green shoots” but not much is heard about when they might turn into trees. Are there any signs that the economy is recovering?
The short answer is, thankfully, yes. But like a gardener needs to meticulously tend to green shoots, especially in the early stages of growth, the economy’s “gardeners” need to do the same.
Over the last few months, much of the optimism for the economic recovery has centered on key macroeconomic variables that show they are slowing down in their rate of decline. Normally we wouldn’t be all that happy over continued job loss or negative industrial demand, but right now we need to take baby steps.
In recent surveys of economists and business leaders, most respondents seem to be a little more optimistic about a recovery than just a couple of months ago. Slightly more than half feel that the economy has hit bottom while some still feel that the recession will extend into 2010. Either way, the forecast has improved. I, too, am optimistic that the worst is over and here are a couple of reasons why.
Better Balance Sheets: Both households and businesses have been putting a lot of emphasis on improving their balance sheets. Consumer credit outstanding has declined steadily since its high in July 2008. Some of this could be the result of defaults and write-offs and as long as unemployment remains high, continued write-offs are expected. But lower consumer debt is also coupled with a steady increase in savings deposits over the same period. In addition, consumers’ financial obligations ratio, a ratio of household financial obligations as a percentage of disposable income, has also declined to 18.5% and is back to a level not seen since 2004. Given the economic uncertainty, many businesses and consumers have put off major purchases. Like consumers, many businesses have been aggressive at lowering costs to maintain margins. Many firms are holding historically high levels of cash just waiting for opportunities to invest.
An Inevitable Durable Goods Cycle: As consumers feel more at ease with their household finances and as unemployment stabilizes, as many believe it will, consumers will begin to replace durable goods. Businesses will also take the opportunity to use their cash to prepare for the next expansionary cycle by upgrading factories, redesigning stores, and preparing new product displays. These events precede an economic recovery so look for firms to increase spending on infrastructure and marketing.
Cheap Money: The Federal Reserve has continued a policy of maintaining low interest rates and high bank reserves. These policies have already helped the financial sector recover and will be a catalyst for growth once consumer confidence improves.
Low Inflation: Nothing helps a recession end like the recession itself. As consumer and industrial demand declines during a recession, commodity prices, producer prices, and consumer prices fall. This helps firms manage the bottom line and helps them make strategic investments in preparation for the next cycle. Consumers welcome the relief of lower prices as they struggle to manage household finances.
Now, I wouldn’t be an economist worth my weight in salt if I didn’t stop here and say, “but on the other hand” (that’s why Truman asked for only one-armed economists). There is one key variable in this discussion that will make all of this more difficult to achieve in the short term and that’s unemployment. Nothing will improve consumer confidence more than a decline in unemployment. Not only does lower unemployment indicate that we are putting people back to work, it helps those who were afraid of losing their job feel a little more confident about the immediate future. This will have a tremendous effect on the speed of the recovery.
Of course there are many other variables that I haven’t discussed that may play a role in this recovery like the effectiveness of fiscal stimulus, large federal deficits, inappropriate government intervention, and the global economic recovery. But that’s why I love teaching economics, always new things to talk about.
Monday, August 10, 2009
ECONOMICS LESSON: The Economics of Price Gouging
Given the current economic climate in the United States, many citizens are worried about their financial well-being. When citizens are confronted with rising prices on staple products, necessary items, and generally inelastic goods, they turn to the media, government, or anyone who will listen to their complaints. We see reports in the newspaper, or on television, about "price gouging" and unsympathetic businesses hurting middle class America. But is so-called "price gouging" really a bad thing? Or, is government control of prices really doing more harm than good?
This clip by John Stossel of ABC's 20/20 was made in the wake of Hurricane Katrina. But its message and reasoning are founded in Adam Smith's view of a free market economy, and certainly apply to America's current economic situation. It offers a great introduction to the topic of price ceilings and government intervention in the economy.
So, what is a PRICE CEILING?
So, what is a PRICE CEILING?
- A price ceiling is a legal maximum price that can be charged for a good or service.
- When a price ceiling is set below the equilibrium price, it will cause shortages.
- Price ceilings occur when government is dissatisfied with the outcomes of free markets.
When government limits the price of rental units to $400 per month, the suppliers are only willing to provide 3000 units. The market, on the other hand, is demanding 6000 units. As you can see, the Rent Ceiling, represented by the red line, has resulted in 3000-unit shortage. In addition, when 3000 units are available to rent, consumers are willing to pay $625 per month. Since the price established by government is only $400, landlords are experiencing a loss of $225 per month, per unit. That is a $675,000 loss per month by all property owners in this market.
- Some questions to think about...
- What are some additional economic and societal effects of this situation?
- How might third-parties be affected by this?
- Government can also set prices greater than the equilibrium price created naturally by the market. This type of price control is known as a PRICE FLOOR and results in surpluses. Suppliers are willing to supply at the artificially high price, but consumers won't buy.
- Government doesn't have to set a specific price for shortages or surpluses to occur. Interventions such as trade barriers, tariffs, and subsidies can have the same effect.
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