Tuesday, December 31, 2013

Sectors Combine in Non-Linear Manner.

This is a work in progress:

Sectors are considered to add value to each other.  However, sectors combine in nonlinear manner.  That is they do not just add value between each other, they also multiply between each other, and with themselves.   

Consider transportation.   Transporting an object across country does not add value to that object.  It multiplies that object’s value, say by a factor of, for example, 1.3.  This would ‘add’ 30% to the value of the object, but the real process is not addition. If the process were addition, then driving an empty truck across country would add value to nothing. (Unless the truck were more valuable on one side of the country than the other.  Then the truck’s value would be multiplied.)  But this is absurd.  On the other hand, multiplying with nothing still gives you nothing. 

Manufacturing a good is multiplicative. Each step in the manufacturing process multiplies the value of factors, and the value of the final product is the ‘product’ of these steps. 

Profit is multiplicative.  Where nothing is produced, no profit can be made.  A product or service is sold at a multiple of its value:  Greater than one for a profit, less than one for a loss.   

Government, then, which is basically in the business of redistributing, transferring, demand, is multiplicative.  It is in the business of rearranging factors, seeking to maximize the total produced by the economy.  However, it can really only tax agriculture and other extractive sectors, mineral mining and energy extraction. This implies that the product of the tax (a factor less than one), and the subsidy (greater than one), is always less than one, because of the cost.  That is the cost is always greater than the benefit. But where the government transfers demand from non-productive sectors to productive sectors, that is, where the subsidy is fictitious, an economy can experience real benefit.    

There are cross terms  And powers of terms. The church (charity) is another. It transfers demand down the social scale,  thus expanding the base of consumption and giving more members of society a stake in that society.    

Libertarian states minimize the government source of cross terms, and thus cannot compete against larger effective governments which increase cross terms, and thus greatly magnify the economy. 

Wednesday, October 30, 2013

Growth, CEO Compensation, and Savings

We wish to show, that excessive CEO compensation is deleterious to an economy.  We show that excess savings is also deleterious, the so-called "Paradox of Thrift."

Prove in the case of the Universal Corporation: UC produces everything. Therefore, all it buys is labor. Thus, all revenue goes either to labor compensation or to capital. We include capital’s share in CEO compensation.  Thus, UC’s employee compensation, minus the CEO’s compensation share c, in the nth cycle, is Rn(1- c), where Rn is UC’s revenue.  Suppose now everything UC’s employees buy is produced by UC, and UC sells nothing to the CEO. Then UC gets all its revenue by selling to its employees, 
( Rn (1- c) ) plus a portion, Rn e, selling to persons outside the corporation.. Therefore,  
Rn+1 = Rn((1- c) + e);  The growth in revenue, for a given period: DR  =  e – c.  So, where c > e, DR is negative, that is, revenue declines. The CEO of the Universal Corporation, regardless of competence, if paid to much,  is adversely effective. Done.

Now we can include the CEO as an employee, ie someone who buys from UC, if we instead interpret c just as what the CEO does not spend, but saves.  Indeed, this gives us the Paradox of Thrift, when c is interpreted instead as the sum of what all employees, CEO included, save. So, if the portion the employees of UC save is more than the portion sold to people outside of UC, ie if c > e, revenues will decline.

If instead we separate savings into components, labor savings and capital savings, (where investment is a capital expenditure,) sl and sc, then if sl + sc > e, revenues will decline. If sc > e, then sl must be negative, and of magnitude greater than sc  e, in order for the corporation to grow in revenue.  That is, labor must dissave if capital saves at a rate greater than the rate of selling outside of UC, for UC to grow.  (This can of course be forced by paying labor less than subsistence.)   

Note, if e is negative, eg if the employees also buy from outside UC, at a rate greater than persons outside of UC buy from UC, the employees of UC must dissave, (both  c and e are negative),  |c| > |e|, in order for the revenues of UC to increase.  In components:  we must have |sl + sc | > |e|, where if sc is positive, sl must be negative of magnitude greater than  sc + |e| for there to be positive growth of revenue. 

If we include a third component, call it government, and call UC a nation’s economy, then for positive growth we must have:  sg + sl + sc  > e, or  sg > e – ( sl + sc  ).  If we separate e, net exports, into its components x exports and m imports, we require for growth of revenue
sg   <  x -- m – ( sl + sc ). Clearly, where imports are greater than exports, the problem is exacerbated, and there must be extensive dissavings by government if there is savings by labor and capital. 

We observe, for a system with no net trade, ( x = m ),  sg  < – (sl + sc ).  That is, for an economy with no net trade to grow, (net closed,) government expenditures must be greater than private sector savings.  In general, that is, the economy as a whole must dissave.  That is:   0 > sl + ­ sc + sg .This may be made explicit:  The share of growth of revenue,
DR =  – (sl + ­ sc + sg ).

What do we mean by dissave? Savings, of course, may mean putting money into mattresses.  Dissaving implies there must be an input of money, such that more money is spent, by the components of an economy, than is earned. This may be money taken out of mattresses.  This may be money lent by an entity outside of the economy. It may be money added to the supply, as with inflation. Where it is lent by an entity inside the economy, (finance, say, thus sf) we have the same problem:  We have a change in the relative revenue collected by the components, but the revenue for the whole economy necessarily declines.

With monetary input I, as with inflation, say, we have: I > sl + ­ sc + sg + sf  as the condition for growth of revenue in a net closed economy.  And in general, allowing for imports and exports: 
I + x – m > sl + ­ sc + sg + sf  Explicitly, the share of growth of revenue is:  
 DR = – ( sl + ­ sc + sg + sf ) + I +  x –  m.

This is rather tautological.  With a fixed money supply,  total revenue cannot increase, and any quantity of money taken out of the system leads to a decrease in revenue.  Since nominal profit requires an increase in revenue, a fixed money supply will, in the best of circumstances, result in an average nominal corporate profit of zero, unless there is dissavings. Some might argue that the policy of the wealthy for the past 35 years has been a forcing of dissavings on labor, (and government,) from which they have taken their profit. This is manifest by the fact that the share of wealth of the 1% has increased from around 20% of the total economy to around 40%. The share of wealth of the rest of society has correspondingly decreased from around 80% to less than 60%, and all but 10% is concentrated in ownership by the next 19%.  80% of the population of the United States combine to own only 10% of its assets.

PS:  The diagram is actually kind of a joke.  It's really a copy of the backward bending labor supply curve for an individual worker, a janitor say, who, when 'paid to excess,' is expected to produce less, in particular, work fewer hours. (This effect somehow is not thought to apply to CEO's.) While true for the CEO of  the Universal Corporation, in an economy it is only true for the sum of all CEO's.  Any individual corporate CEO, of course, gets nowhere near the compensation necessary to have a deleterious effect on the economy, (though he still might be expected to produce less if overcompensated.)   But that the sum of all CEO compensation, the sum of all compensation to the wealthy, may be harmful lies the problem, which we discuss in my next post.

Monday, September 30, 2013

The Lone Star Strategy for National Impoverishment

Angry Bear:

and Senator Bernie Sanders of Vermont

itemize some of the features of the Texas Republican Party platform 2012:

“1. An orderly transition to individual private retirement accounts and the elimination of Social Security.

2. Privatization of Veterans health care.

3. Abolish all federal agencies who’s activities are not enumerated in the constitution including the department of education and the department of energy.

4. Oppose mandatory kindergarten

5. Abolish the EPA

6. Abolish the 16th amendment and thus get rid of the IRS to be replaced with a national, state collected
sales tax.

7. Abolish the capital gains tax and estate tax.

8. Repeal the minimum wage.”

Each of these points will transfer wealth and income upward, even the elimination of mandatory kindergarten.  Indeed, what will remain after the implementation of these policies is a rump federal government, incapable of securing even the meanest rights for its poorer citizens. And this will be most of its citizens.  Each agency is an empowerment of the people, a securing of rights they would not otherwise have. The federal government will not be capable of securing the interests of its citizens even within the borders of the country, much less beyond them.

The EPA was established by necessity, unregulated industry having made such a mess of things that rivers burned, and people died from breathing the polluted air.

Privatizing Social Security and Veterans health care is sure to make a few rich, at the expense of many.

Item 6 is obviously regressive, since poor and middle class consume a larger portion of their income, and thus will end up paying a higher percentage of their income as tax than the wealthy.  

 Item 7 will result in the establishment of a moneyed aristocracy, something which is an anathema to a democracy. 

Repealing the minimum wage will create downward pressure on all wages, making the poor poorer, and impoverishing even those who now get by.  It shows the Texas Republicans to be parochial and shortsighted in their thinking, even with regards to their own fortunes.

They make the fallacy of composition.  They imagine that if they cut the expenses of their businesses, which, in one way or another are compensation to the people, they will make greater profit, and be richer.
But by cutting these expenses, they impoverish the people, and they destroy the market for the production of their own farms and factories, and render idle the foundation of their own fortunes. With the Texas strategy, they seek to impoverish everybody, themselves included. 

Tuesday, August 13, 2013

Regulating the ‘Invisible Hand’

Regulating the "Invisible Hand'

The ‘invisible hand’ has come to imply the idea that the pursuit of narrow self interest by individuals results in the best social outcome.  Adam Smith, who first used the expression, more narrowly applied it to the concept of markets: “specifically that it is competition between buyers and sellers that channels the profit motive of individuals on both sides of the transaction such that improved products are produced and at lower costs.” http://en.wikipedia.org/wiki/Invisible_hand

The generalized idea is not valid.

In general, action by the members of a society must not only be self seeking, it must promote the well being and goals of that society. To put it in economic terms: Society must profit, and the action of individuals must, in that respect at least, be virtuous. Indeed, every prosperous and stable society has elevated the idea of virtue among its citizens, and devised means to encourage it.  Those most esteemed were those who contributed the most to society.  They were those who were held to be the most virtuous, and received the greatest rewards.  Those who were merely self serving were held in contempt, what ever their material income.

While an individual person may or may not be inclined to virtue, a corporation, however, cannot be virtuous, unless forced by law and circumstance of competition.  Only the pressures of competition make a productive corporation stay productive, that and the force of law required to make the corporation internalize its costs. 

For instance, we hear about banks, and other corporations, ‘socializing costs while privatizing profits.When this happens, it is no longer certain that the activities of the corporation are actually of benefit to the economy.   These activities may actually harm society, that is make society poorer, and everyone, on average, worse off.  (Though the owners and some of the employees of the corporation may, of course, be better off.)  Indeed, it is always the case that society is the poorer when the externalized costs are greater than the profits the corporation makes.

For the act of production requires the internalization of cost. The very act of production requires the benefits of production outweigh the costs, and if many of those costs are externalized, their weight is no longer determined by the market.  Thus, while the corporation may reap a profit, the costs to society may outweigh the benefits society receives.

This can be seen from the fact that, when all costs are internalized, the net benefit a company makes to society is equal to that company’s profit. That is, society comes out ahead by the profits of the company. If, when all costs are internalized, the company breaks even, then society breaks even.  But if costs are externalized and the company breaks even, then society pays these costs, and loses.

The profits a company makes are what society is willing to pay the company above the company’s costs.  (Note that in a situation with perfect competition, where there are no profits, there is no growth.)  If society is not willing to pay the company above its costs, its activity is only of use to society to maintain society, and the company itself, in their current state of economic activity. The company makes no profits, and does not grow, and society does not grow. 

If costs are internalized, and the costs are greater than society is willing to pay, then society will cut back on that activity.  That is the company is operating at a loss, and it will contract. 

If there are any externalized costs, and these are less than the total profit, then society will grow at a rate less than the company. 

If externalized costs are greater than the profit, then the company will grow, but society will contract. 

Now  the officers of a corporation can only pursue that corporation’s narrow profit.  In a free but limited market, this may yet be beneficial to society.   However, producing corporations are at a competitive disadvantage to corporations which do not produce, but manipulate the economy to enhance their collection of rents from that economy.  Corporations which do not produce need have no real costs, except those they inflict on society for profit. 

Given the opportunity, then, the officers of a corporation must externalize, or socialize, costs, where it increases profits, no matter the harm inflicted on the larger society.  Thus there is always the pressure on a corporation to change into something which is non-productive, a rent collecting corporation, and a parasite on society.    

And while the producer, constrained by competition, might be virtuous naturally, the monopolist and the rent seeker will not be.  The monopolist, unconstrained, will provide a service, perhaps essential to that society, at a cost that society may ill afford, a cost possibly greater than the benefit that service provides.  The rent seeking corporation will extract resources from society without net benefit to that society.

Regulation is necessary, and should be designed to force corporations to internalize costs, which would otherwise be externalized, and discourage the collection of rents, or excess profits. (And one might argue that that is all regulation should be designed to do.  One might also argue that the conservation of stocks of resources is a separate reason for regulation, although this might be under the cover of internalizing all costs.)

Where these costs cannot be directly internalized, they should be countered by government activity, supported by corporate tax. 

Since regulated industries are less competitive, they should be protected against unregulated, and subsidized, competition, especially foreign competition, by tariff, if needed. Indeed, failure to do so results in an economic race to the bottom.  Domestic producers are forced to externalize costs onto their society, or go out of business. This process is essentially the taking of resources out of the market, destroying it. It is the exportation of demand.

A nation should in any case be more concerned with securing its domestic market for its own industry than securing foreign markets.  All countries cannot be net exporters, but all countries can balance their trade. 

Virtue is corrupted where virtue has become a measure of success at self-serving.  A society requires its members to include social costs in the calculation of their profit in order to survive, (since society as a whole must also make a profit) and corporate society, a la Milton Friedman, cannot do this. See:  http://anamecon.blogspot.com/2012/06/milton-friedman-social-responsibility.html

The expansion of the idea of markets to other activities of society is destructive to those activities. And those activities are essential to the function, and even the identity, of society.

Indeed, the idea of the self-serving ‘invisible hand’ is inadequate to explain the stability and persistence of societies. Virtuous behavior, in particular on the part of a society’s leaders, is required for that society to maintain itself and prosper.   Since it may be impossible for the law, even where not co-opted, to restrain corporate behavior, in particular the indiscriminate externalization of costs, the corporate state may be unstable, and incapable of sustaining itself in the long, or even the medium run. The structure of corporations, and their place in society, far from encouraging virtue, may even exert a corrupting influence on their officers, who are also many of society’s leaders.  This is especially true as society’s competitive structure is increasingly replaced by oligopolistic and monopolistic structures.  These structures naturally seek rent and externalize costs.

Unlike people, corporate persons, except as they are constrained by law, cannot be good citizens.  Thus, if the law is inadequate to constrain them, 'Corporate Society' may only exist as a transition state to a decapitalized future.

Regulation may be inadequate to secure the future, but it is nonetheless necessary.

Sunday, July 28, 2013

On the USS Gerald R Ford, the Most Expensive Ship Ever

Over at Business Insider:

USS GERALD R. FORD: Check Out The Construction Of The Most Expensive Ship Ever   http://www.businessinsider.com/uss-gerald-r-ford-construction-of-the-most-expensive-ship-ever-2013-7?op=1#ixzz2aJ5YTJHp Nice pictures.

To quote: “The numbers behind the USS Gerald R. Ford are impressive; about $14 billion in total cost, 224 million pounds, about 25 stories high, 1,106 feet long and 250 feet wide. But the sheer enormity of the ship and construction operation is hard to grasp until you're nearly face-to-metal with the massive military beast.”

Whew!  That $14 Billion is up from $4.5 to $6.2 billion for  the Nimitz class aircraft carrier it is replacing.  And a nice write up over at wikipedia: http://en.wikipedia.org/wiki/Gerald_R._Ford_class_aircraft_carrier

Meanwhile,  the planes it flies (from Reuters):
“The new baseline forecasts the average cost of the F-35 fighter, including research and development (R&D) and inflation, at $135 million per plane, plus an additional $26 million for the F135 engine built by Pratt & Whitney, a unit of United Technologies Corp

Again:”The new FORD-class aircraft carrier will be the largest, most lethal ship ever when it joins the US fleet in 2016.”

Well, counting its planes.  It will also be the largest, most delectable target, ever, when it joins the US fleet.  Carrying say 90 F35s, costing $160 Million apiece, it will be an investment costing over $28 Billion.  Say $30 Billion.  That’s about 300,000 man-years, or 7000 man-lives, of production.  That is a sunk cost, which is paid whether or not the ship itself actually sinks.  Never mind the annual expense of operating the thing.  If comparable to the Nimitz class, we can expect annual costs of upwards  $350 Million, counting the midlife overhaul, averaged over the years.  Say $1 Million per day.

Anyway, the life’s labor of 7000 men.  Gone.

What else is gone? After all, cost is lost opportunity, what wasn’t built, or was left undone; what those 7000 men maybe should have been doing with their lives.  Well, 1500 high schools, at $20 Million apiece to build. (One F35 figures in at 8 high schools.)  Or 300,000 houses at $100,000 apiece, although some might argue we don’t need any more of those.  

Or power plants enough to provide 6 to 10 thousand megawatts of electricity, enough to supply 3 to 5 million homes with power.

And Mayor Bloomberg’s plan to save (most of) New York City from rising sea levels (for a while) was only $20 Billion, but hey, isn’t global warming some sort of delusion?

Thursday, July 11, 2013

Free Trade and Salaries in Academia

Somewhere, perhaps not in this blog, we pointed out that the equalization of factor prices was eventually going to affect the salaries paid to economists in academia.  In labor terms, equalization of factor prices means the wages of workers in different countries with free trade between them are driven to the same level. (Wages are a factor of production, as are the other inputs of production, such as materials and capital.) So when a country with high wages trades with a country with low wages, its wages are driven down. (While in the low wage country, wages are driven up.  However, with the high wage country running a massive trade deficit, it seems that wages in that country are driven down more than the wages in the low wage country are pushed up.)

Now you might think that industries insulated from free trade, such as home-building and medicine and- economics, would not be affected, but this is not the case, although the insulation does delay the effects. However, no part of an economy is truly isolated from any other, and  depression of wages in one sector will eventually affect wages in all sectors.  

This delay has been part of the cause for the relative increase in educational costs and tuition, as in the rest of the country income has stagnated and more recently even declined. In particular, the taxes paid to the states have remained stagnant, and more recently declined, with median income.  The fact that this is also affecting the quality of education, and universities in general, rather than just depressing salaries, is also interesting.  It hasn't affected private universities as much yet, since they are further insulated from the effects of trade, not being as dependent on income from taxation, but it is just a matter of time before they too suffer from degradation.   

This would seem to be part of a general degradation of capital inputs. This may also be because of the chronic trade deficit, rather than merely the effect of the equalization of factor prices.  Net imports of Goods and Services was $560 Billion for 2012. (BEA Table 1.1.5)  That is a trade deficit of 3.5% GDP, which, since it has been persistent for the past 12 years or so, adds up.  See: 
The nation’s management at all levels seems to be adversely impacted, as we should expect.  One observation is that, with the Sequester, for example, the Federal Government is going after the wrong deficit.

Sunday, June 30, 2013

Labor's Declining Share

By way of:

This is from the Bureau of Labor Statistics, released June 5.  It shows real wages, real hourly compensation, for Nonfarm Business declined by 5.2% in the first quarter of 2013.  The decline real hourly compensation in manufacturing  was 8.3%.   This wipes out most of the gain in wages for the past year.  Average real wages for Nonfarm Business increased by 0.3% for the past year.

                      First Quarter 2013, Revised 

Table A. Revised first-quarter 2013 measures: percent change from previous quarter at annual rate 
         (Q to Q) and from same quarter a year ago (Y to Y)
Sector          Nonfarm                           Durable    Nondurable
                Business  Business    Manufactu   Manufactu  Manufactu
              QtoQ  YtoY  QtoQ YtoY   QtoQ YtoY   QtoQ YtoY  QtoQ YtoY
Productivity    0.5  0.9   2.0  1.2    3.5  1.6    3.5  2.7   3.9  0.5
Output          2.1  2.4   3.1  2.4    5.3  2.5    6.4  3.8   4.2  1.2
Hours           1.6  1.5   1.1  1.2    1.8  0.9    2.8  1.0   0.2  0.7
 compensation  -3.8  2.0  -3.1  2.3   -6.9  4.5   -8.1  5.4  -4.9  2.7
Real hourly 
 compensation  -5.2  0.3  -4.6  0.6   -8.3  2.8   -9.4  3.6  -6.4  1.0
Unit labor 
 costs         -4.3  1.1  -5.0  1.1  -10.0  2.8  -11.2  2.6  -8.5  2.3

Not going to have a recovery until you get money into the hands of labor, which most businesses seem to be trying to prevent.  Note the increase in productivity, year over year three times the Y over Y increase in labor costs.  Good news for the wealthy:  More stuff, but not so much more competition for buying it.

The National Memo does a nice discussion of increasing inequality over the past few years, and fires a few deserved shots at the Main Stream Media for ignoring this item.

Here's the long term story, in a couple of graphs: An index of the long term labor share of national income:

 And a graph of the ratio of the real compensation per hour to output per hour, for non-farm labor.

This is labor getting less of what it is producing, and it has to go somewhere. Maybe a little old, but still important.

Thursday, May 23, 2013

Broken Labor and Financial Markets: Talk with Dr. Heiner Flassbeck

Another gem, (this one three part, about 30 min total) from Dr. Heiner Flassbeck and The Real News: 

HF:  “That's exactly the attitude, I'm sure, in the financial markets; that's the attitude, après moi le déluge. They think, I don't care if I made money in the next two years or the next year; what do I care about the future? That's exactly the attitude.”

HF:  “Yeah, that's one thing that I acknowledge already. Many of these people do not care about the long run. But this is mainly true for people in the financial markets, because they don't have any fixed assets. You know? They have nothing that can be lost, so to say.”

HF:  “That is the crucial thing, because due to the ideology that prevailed over the last 30 years, some people, even ordinary people on the street, believe that the government does not have the right to tax away huge profits, because that would be against the efficiency of the market and things like that. And this kind of ideology we have to fight.”

Saturday, May 4, 2013

Trade Agreements, Trans-national Corporations and the Sovereignty of Nations

We have shown the problems with unbalanced trade.  Now we deal with the 'investor-state
system,' whereby trans-national corporations- ‘investors,’ are, by international trade agreements such as NAFTA,  given rights which transcend those of the nations in which they operate.

We note a positive reaction to the abuses of the investor state system:
“12 Latin American governments have gathered to create a common response to an increasingly common menace: investor-state suits, in which foreign corporations are dragging sovereign governments to extrajudicial courts to demand taxpayer compensation for health, environmental, and other public interest policies.”   http://citizen.typepad.com/eyesontrade/2013/05/last-week-13-latin-american-governments-gathered-in-guayaquil-ecuador-to-hatch-a-common-response-to-an-increasingly-common-m.html

The fact is, corporations are obligated to drag sovereign governments before these tribunals. 

Indeed,  if allowed, trans-national corporations are obligated to act contrary to the interests of any and every nation, to pollute and trample sovereignty, to exploit workers and violate public well being as long as it increases profits. According to Milton Friedman: “...there is one and only one social responsibility of business–to use it(s) resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” http://anamecon.blogspot.com/2012/06/milton-friedman-social-responsibility.html

Simply, they have no social responsibilities to any society. The caveat, ‘stays within the rules of the game, engages in open and free competition without deception of fraud,’ is nonsense, a fob for fools.  It is cast aside by corporations at the first opportunity to manipulate competition and the system, and deceive.   Corporations must, in fact, do these things,  in order to compete with other corporations, which are intent on doing the same thing.

And it is a duty of government, and the people, to oppose this manipulation, and to regulate, and  to prevent this from happening.

Transnational corporations *cannot* be citizens of any nation.  They cannot be expected to act in good faith, if by acting in bad faith, if by manipulation of law and system, they can secure greater profits.  Corporations are predators, and the citizens and governments of all nations are their prey.  Governments of all nations must beware, if they are to secure be blessings of liberty and prosperity for their citizens.

And when transnational corporations make the ‘rules of the game,’ when their lawyers sit in judgment, all bets are off:  Anything goes. But you may be sure it will cost you. 

Friday, April 12, 2013

More on the Negative Effects of a Trade Deficit

A country experiencing a trade deficit can expect a decline in its manufacturing.  The producer’s welfare is less.  See Diag A, and  http://anamecon.blogspot.com/2011/03/free-trade-welfare-and-debt.html, to refresh yourself on trade, welfare, and the diagrams.

We further examine the case of a nation exposed to unrestricted free trade and where it is trading under a deficit. In Diag. A, the world price level Pw is less than the domestic price level PA.  The domestic price PA is established by equilibrium between the domestic demand D and the domestic supply curve S, which occurs at eA. The world supply is (here) essentially infinite, which is why it is horizontal, at price PW.  While some domestic production is at a cost less than Pw, much is at a cost, along the domestic supply curve S, greater than world price, and these producers are driven out of business.  Those producers which remain lose profits PA – Pw.  The net return to the producing sector is reduced from B + C to just B. 

Indeed, from the point of view of manufacturers, the most marginal are those who lose the most from free trade. They are the ones most vulnerable to foreign competition.  We can iterate this, of course:  Once those most marginal are dis-employed, the next most marginal become vulnerable to trade, and so forth.   

For this, the country running a deficit experiences an increase in consumer welfare A, to A + C + D + E,  for a net improvement in welfare represented by the regions D + E.  But this improvement only temporary, and unsustainable. 

The revenue to domestic industry is reduced to Pw x Qe from PA x QA, while the  expenses to consumers, which were originally also PA x QA, change to Pw x Qw, ( This might not be a change, and indeed should be the same as before, since there is no a priori reason for consumers to have available a different quantity of income.  That is PA x QA = Pw x Qw.  The improvement is that consumers get more for their money.)  Now the country runs a trade deficit of  Pw x ( Qw – Qe ).  This deficit is shown by the box outlined in red.  This deficit is not indefinitely sustainable, and must eventually be repudiated, or repaid.  In the case of repudiation and the deficit is also reduced to zero,  Qw collapses to Qe, Once again, the revenue of producers, and the expense of consumers, is equal.  See: Diag B   Note the country is still trading freely, and so still exposed to world price Pw and supply Sw

What this means is that a new equilibrium is established, at ew, the original demand curve D shifting to a line passing through this equilibrium.  This shift is a result of a loss of consumer income, since, for an economy, the income of its consumers equals the revenue of its producers.  The slope of this line need not be the same, as is indicated the diagram.  This conclusion is a result of the following consideration:  Those who are prepared to pay the most, (even if they don’t have to)  generally have the most money.  These are least likely to be harmed by the collapse of the trade deficit to zero, at the new equilibrium, so their consumer surplus will be unreduced. They have first call on production, therefore if fewer goods are produced, they will still get their share. The demand curve will thus tend to pivot, although other considerations enter in.  In any case, the consumer surplus is reduced by A’ + C’. along with the region D + E,   the reason for running the original deficit. (Consumer surplus may also be increased by some region F  in the upper left hand corner, depending on how the ultimate benefits and costs of trade are eventually distributed.)   

The consumer surplus is reduced to A + C + F, which may still be greater than the original A, (with consequent policy consequences.)  The price level is still the world price Pw, and the producing sector is smaller.  But at the new price equilibrium,  revenue of producers once again equals the money expended by consumers, and this can be maintained indefinitely. This is indicated by the box with the green and yellow hatched border, Pw x Qe.  The reduced producer surplus B is the same as when the trade deficit was active.
We note, however, that an increased portion of the economy is now excluded from the consumer surplus.   Where before the opening of trade, the quantity QwQA, was the only portion of goods not available to the domestic economy, now, with the reduced producer sector, goods in the range QA,– Qe are also not available.  Socially, this must be interpreted as the result of a loss of income for the poorer sectors of the economy.  And this still results if the debt is merely repudiated.

If the debt is not repudiated, but is instead is attempted to be repaid, we have the situation in Diag C:   Here, the producing sector is further reduced, because debt repayment raises the expenses of all producers.  We have pivoted the supply curve at the axis, (it is certainly to the left of the original curve) on the consideration that some of the most efficient producers will have occasioned the least debt.  Debt otherwise will be accrued throughout the supply chain, resulting in higher costs, and thus lower return, which will affect the ability of all but the most efficient firms to compete.  The new equilibrium, instead of being at Qe, is at QD, The loss of producer surplus is the region outlined in blue, B’.  The consumer surplus is also further reduced by A” + C”, (The triangle outlined in orange.)  Allowing for a change in the domestic debt structure, there may be an increase in consumer surplus  F’, in the upper left hand corner.  The idea is that producers are less often creditors, but more often debtors. (This is a consequence of the ‘real economic’ principle: Only producers can repay debts.) That is, debt increases the consumer surplus, at the expense of the producer surplus.   The new equilibrium eD is still at the world price.    

The contrary consideration to the wealthy being largely represented at the left end of the demand curve is that the poor are largely represented at the right end of the demand curve, having last call on quantity produced.  That is, only if the quantity Q at  equilibrium is large, will the poor, those ‘far down the demand curve,’ be able to purchase any. Thus, the less well off, who benefit from the original increase in welfare, since prices are lower for everyone, and thus for them as well, are cut out when the quantity is subsequently reduced to Qe or QD.  We can be somewhat fuzzy about this because we are implicitly dealing with averages.  Yes, strictly speaking, the diagram describes one good in trade between a country and the world.  And in a regular supply and demand diagram, those unwilling, or unable, to pay the equilibrium price are cut off from the supply, and do without.  Here, rather, they, that is all but those who are the most well off, do with less. 

Since, in a market economy, power is proportionate to demand, the consequence of running a deficit is a radical redistribution of power in that economy:  Power is taken from the less well to do, and concentrated at the top.  At the same time, the economy is, as a whole, poorer, and thus, on the world stage, less powerful.  

We see, therefore, that free trade is disadvantageous to a country that runs a deficit.  Unless a country can maintain a surplus, its economy will eventually contract.  This contraction will not be uniform, but will be concentrated at the lower ends of the social scale, resulting in an increase in inequality.  Since all countries cannot run a surplus, the unmitigated benefits of free trade are, at least, questionable.

Tuesday, March 26, 2013

States Cutting Higher Education and the Future

Here is a nice chart showing the one aspect of the decapitalization of the US, and how we are short changing our future.

A case of present wise, future foolish:  Do taxpayers think they are coming out ahead?  Not so:  The people they are depriving of education, first of all, are their own children.  And second of all, their children are the people who will be supporting them in their retirement.

When a person is retired, they live off the labor of the current work force.  They do not somehow save up their labor, and get what they produced all back when they stop working.   The retired are supported by the people who are still working.  It is the labor of the younger generations which supports the elderly.   

Any sensible person would want that workforce to be as prepared and as capable as possible to support them in their retirement. But by reducing, cutting back on their education, the taxpayers are depriving this workforce, on which they will depend, of the resources, the preparation and capabilities, necessary to support them.  They should instead want them to be prepared, to have the capital, the human capital, to produce enough goods and services to support them in a reasonably comfortable retirement. 

And so also that the next generation themselves can be reasonably comfortable, as they work. If they are not reasonably comfortable, they will be resentful, at the least, and may choose to cut their elders off, at the worst, when they come into their power.     

Helping to pay for the higher education of the upcoming generations is one of the most important ways a person saves for their retirement. Seeking instead to secure their labor with debt bondage is counterproductive, since it discourages the investment the young must make in the first place, and also makes them resentful of the imposition of social burdens.   

Money in the bank is useless without a well functioning economy.  And you cannot have a well functioning economy without an educated workforce.

And this is another case of inter-generational warfare, See: http://anamecon.blogspot.com/2012/10/inter-generational-borrowing.html
And it also points up its folly.

There is another interpretation:  Trade. Everything in an economy is connected.  Thus the equalization of factor prices applies to all factors.  Those which are more insulated from the direct effects of trade, such as education, are affected more slowly, but affected still.  The persistent trade deficit will result on downward pressure on all production, on all sectors of the economy, including education and the capitalization of the workforce.   

The increased necessity for the importation of skilled labor, brought about by short-changing domestic investment in higher education, is another aspect, and a case where the feedback is reinforcing and aggravating the trade deficit.