Friday, January 30, 2009

Maybe We Don't Need Government to Save the Planet

Ronald Bailey lays out evidence for the environmental benefits of capitalism.

Environmentalism has traditionally been dominated by the left because government intervention was seen as the only way to protect the environment from the predations of heartless capitalists. But concern for the environment doesn't have to be equated with scorn for the free market. Economics is about the allocation of scarce resources, including natural resources. Believers in the superiority of the free market over government intervention* in allocating natural resources are free market environmentalists.

According to Terry Anderson, a charter member of the free market environmentalist movement,
the first premise of FME is that "wealthier is healthier," meaning that markets generate the wealth that gives us the wherewithal to solve environmental problems. Although many people mistakenly think that markets can only generate consumerism and other gunk, in reality it is markets that produce wealth and thus help the environment.

The second major premise of FME is that "incentives matter." Positive incentives can turn the environment from a liability into an asset for a resource owner. If we own the water and land, we have the incentive to manage and conserve them properly.

The key to the first premise is technological development and dissemination. In a market system, obtaining resources comes with an explicit cost born by the firm or consumer obtaining the resources. Technologies which either reduce the amount of a resource required or make it easier to obtain reduce the cost imposed by the use of the resource. While needing less of a resource clearly leads to an environmental benefit, ease of access generally won't at first. But as technology improves, the environmental impact of bringing resources to market declines as producers find more efficient ways to bring resources to market.

Furthermore, new technologies lead to new uses for the environments from which the resources are extracted, and, assuming an operational market and property rights, owners of land have an incentive to conserve it for, say, hunters or hikers. On top of this, property rights give the owner exclusive access to the property he owns, but no other. Thus, he has to figure out how to allocate his resources in such a way that he doesn't run himself into the ground.

Bailey points out what happens when property rights aren't respected:
It is true that rainforests in Indonesia, Brazil, and the Congo are still declining, but that is largely the result of a gigantic institutional failure. Governments do not recognize ownership of the land, so people rush to take what they can before the next guy can get it--the all too familiar process of an open access commons race to the
bottom.
*This is a general rule. Upholding property rights and the sanctity of contract are two examples of government's legitimate role in the economy.

How Not to Fix an Economy

Enough with the spending, already.


Thursday, January 29, 2009

Which Way to Skin a Cat?

Lawrence White, David Rose and Crispin Odey all agree that excessive debt caused the present economic unpleasantness, but they disagree on how to handle the problem because they disagree on why excessive amounts of debt caused the problems they did. White and Rose argue that
excessive money growth drove asset prices up and drove interest rates down, making people feel richer than they really were and lowering the cost of borrowing money to facilitate more spending. Since the level of spending before the period of excessive money growth was just sustainable, the resulting level of consumption and business investment spending was unsustainable. The solution is to allow asset prices to fall to levels that accurately reflect what our economy can produce. This will make it clear to people that they are not as rich as they thought two years ago and thereby return spending to sustainable levels.
From this, they conclude that "You can't solve an excessive spending problem by spending more. We are making the crisis worse."

Odey's view is slightly different:
The problem is not credit, but the paying back of credit. The asking for repayment and the inability to oblige has shattered the confidence of borrowers as well as savers. The twin engines for paying off the debt, rising wages and healthy profits, are stalled. Assets will be worth less than they are today, the financial economy will shrink further, and capacity and inventory will be taken out of the real economy on massive scale.
This leads Odey to a rather remarkable conclusion:

The world’s total outstanding debts have to be reduced. Our populations and companies need the means and the time to pay them off. These means are profits and pay rises. The other thing we need is inflation.

Inflation will allow debt to reduce day by day. Price rises will make companies going concerns, earning their way back to profit. Pay rises will enable households and consumers to pay down what they owe while saving more and spending some. And inflation allows interest rates to rise but still remain negative in real terms. It is
healthier that people receive an annual pay rise than take out an extra annual loan - as they have been doing since 2000. This package will allow markets to breathe again.

Where White and Rose argue that a certain amount of deflation is necessary, Odey sees inflation as an essential element of recovery from the current mess. Odey also mentions increased profits and increased wages as being elements essential to recovery, but something similar is implied in White and Rose's argument as well. As asset prices fall, they become less expensive relative to capital. This lowers the price of investment, driving down the cost of investment. As investment prices fall, investors become more willing to take risks as the cost of failure falls. This will spur new investment, which in turn will spur expansion and an increase in production. Furthermore, as the value of hard assets declines, it becomes less expensive to acquire new assets, lowering the cost of production. With a lower cost of production, firms can sell their goods and services at lower prices and still make a profit. Thus, a consumer can afford to consume more on the same amount of income, driving up his consumption; allowing him to save more, leading to an increase in investment; or allowing the consumer to pay down his debt, reducing the overall level of debt in the economy.* Thus, White and Rose implicitly argue that an increase in profit and real income are essential to economic recovery.

Odey's argument is interesting for being both novel and plausible.* It is obviously true that, holding the costs of production and the level of consumption constant while increasing the price of goods will increase profits. It is also true that this increase in profits will allow the firm to either hire more workers, pay its current workers more, or some combination of both. These workers will then be able to consume more. Inflation will also decrease the value of the dollar, so the real cost of existing debt will decrease. Two questions present themselves, though. Is demand sufficiently inelastic that the increases in prices will not bring about such a significant decrease in demand as to overwhelm the additional per unit profit? Will the increases in worker pay be high enough that the effect of inflation on real income does not overwhelm the rise in pay?

Interestingly, the Fed's monetary policy seems to line up fairly well with Odey's general policy prescription, and it seems to be having positive effects on the economy. Whether this means such a policy could also fuel a recovery, as opposed to simply preventing a collapse remains to be seen. And the supply-side effects of policies advocated by White and Rose can be seen in the effect of declining energy prices buoying consumption and investment. While I prefer the policies advocated by White and Rose, it could be that a combination of both courses of action is the key to a successful recovery.

*The only way to find out if it would work would be to try it and see what happens.

Hat tip: The Corner

Friday, January 23, 2009

Buying Time

While I remain highly skeptical of the efficacy of diplomatic efforts to end Iran's nuclear weapons program, this would indicate there is more time for these efforts to produce this result if it's true.

Friday, January 09, 2009

This Is Not Kosher

But that's okay because I'm not Jewish.  Besides, it looks delicious.

Hat tip:  The Corner