Archives: July, 2011

Basic Economics for Financial Journalists and Other Dummies

While driving home last night, I had the miserable experience of listening to a financial journalist being interviewed about the anemic growth numbers that were just released.

I wasn’t unhappy because the interview was biased to the left. From what I could tell, both the host and the guest were straight shooters. Indeed, they spent some time speculating that the economy’s weak performance was bad news for Obama.

What irked me was the implicit Keynesian thinking in the interview. Both of them kept talking about how the economy would have been weaker in the absence of government spending, and they fretted that “austerity” in Washington could further slow the economy in the future.

This was especially frustrating for me since I’ve spent years trying to get people to understand that money doesn’t disappear if it’s not spent by government. I repeatedly explain that less government means more money left in the private sector, where it is more likely to create jobs and generate wealth.

In recent years, though, I’ve begun to realize that many people are accidentally sympathetic to the Keynesian government-spending-is-stimulus approach. They mistakenly think the theory makes sense because they look at GDP, which measures how national income is spent. They’d be much less prone to shoddy analysis if they instead focused on how national income is earned.

This should be at least somewhat intuitive, because we all understand that economic growth occurs when there is an increase in things that make up national income, such as wages, small business income, and corporate profits.

But as I listened to the interview, I began to wonder whether more people would understand if I used the example of a household.

Let’s illustrate by imagining a middle-class household with $50,000 of expenses and $50,000 of income. I’m just making up numbers, so I’m not pretending this is an “average” household, but that doesn’t matter for this analysis anyway.

Expenses                                                        Income                                  

Mortgage           $15,000                        Wages                $40,000

Utilities               $10,000                        Bank Interest       $1,000

Food                     $5,000                        Rental Income      $8,000

Taxes                  $10,000                        Dividends             $1,000

Clothing               $2,000

Health Care         $3,000

Other                   $5,000

The analogy isn’t perfect, of course, but think of this household as being the economy. In this simplified example, the household’s expenses are akin to the way the government measures GDP. It shows how income is allocated. But instead of measuring how much national income goes to categories such as consumption, investment, and government spending, we’re showing how much household income goes to things like housing, food, and utilities.

The income side of the household, as you might expect, is like the government’s national income calculations. But instead of looking at broad measures of things such wages, small business income, and corporate profits, we’re narrowing our focus to one household’s income.

Now let’s modify this example to understand why Keynesian economics doesn’t make sense. Assume that expenses suddenly jumped for our household by $5,000.

Maybe the family has moved to a bigger house. Maybe they’ve decided to eat steak every night. But since I’m a cranky libertarian, let’s assume Obama has imposed a European-style 20 percent VAT and the tax burden has increased.

Faced with this higher expense, the household – especially in the long run – will have to reduce other spending. Let’s assume that the income side has stayed the same but that household expenses now look like this.

Expenses                                                       

Mortgage           $15,000

Utilities                 $9,000        (down by $1,000)

Food                     $4,000        (down by $1,000)

Taxes                  $15,000        (up by $5,000)

Clothing               $2,000

Health Care         $3,000

Other                   $2,000        (down by $3,000)

Now let’s return to where we started and imagine how a financial journalist, applying the same approach used for GDP analysis,  would cover a news report about this household’s budget.

This journalist would tell us that the household’s total spending stayed steady thanks to a big increase in tax payments, which compensated for falling demand for utilities, food, and other spending.

From a household perspective, we instinctively recoil from this kind of sloppy analysis. Indeed, we probably are thinking, “Spending for other categories – things that actually make my life better – are down because the tax burden increased!!!”

But this is exactly how we should be reacting when financial journalists (and other dummies) tell us that government outlays are helping to prop up total spending in the economy.

The moral of the story is that government is capable of redistributing how national income is spent, but it isn’t a vehicle for increasing national income. Indeed, the academic evidence clearly shows the opposite to be true.

Let’s conclude by briefly explaining how journalists and others should be looking at economic numbers. And the household analogy, once again, will be quite helpful.

It’s presumably obvious that higher income is the best thing for our hypothetical family. A new job, a raise, better investments, an increase in rental income. Any or all of these developments would be welcome because they mean higher living standards and a better life. In other words, more household spending is a natural consequence of more income.

Similarly, the best thing for the economy is more national income. More wages, higher profits, increased small business income. Any or all of these developments would be welcome because we would have more money to spend as we see fit to enjoy a better life. This higher spending would then show up in the data as higher GDP, but the key thing to understand is that the increase in GDP is a natural result of more national income.

Simply stated, national income is the horse and GDP is the cart. This video elaborates on this topic, and watching it may be more enjoyable than reading my analysis.

America 2050: Forget the Forgotten Mode

Half truths, innuendo, and pseudo-science form the basis of a response to my recent Cato paper, Intercity Buses: The Forgotten Mode. The response is produced by America 2050, a project of the Regional Plan Association, a New York City–area regional planning organization. The response’s basic thesis of the response is that intercity buses have a role to play in a “balanced transportation system,” but they are “no replacement for high-speed rail.”

Of course, my report never argued that buses were a replacement for true high-speed rail. But it did show that existing bus schedules in many corridors are faster, more frequent, and charge far lower fares than Amtrak in the same corridors. Of course, there is a “replacement” for high-speed rail: it is called “air travel” and it is far faster and costs about a fifth as much per passenger mile as Amtrak’s Acela.

In any case, America 2050 says my report ignored “one of the most powerful arguments for rail: providing an alternative to highway congestion.” I didn’t address that argument in the paper on buses because, as I’ve shown in other papers, it’s a bad argument. Highways move about 85 percent of all passenger travel and more than a quarter of all ton-miles of freight in this country. If they are congested, maybe we should relieve that congestion rather than spending hundreds of billions of dollars on an elitist rail network that won’t relieve congestion and won’t carry more than a tiny fraction of the number of people (and none of the freight) moved on the highways.

But we can’t fix highway congestion, says America 2050: “providing additional road space does not solve congestion; in fact it creates additional demand for driving.” That’s another bad argument, for four reasons. First, my bus paper never advocated building new roads, and if asked, I would have suggested relieving congestion using congestion pricing of roads before building new capacity.

Second, the idea that building roads creates demand is totally absurd. As my friend, Wendell Cox, says, it is akin to saying that building maternity wards leads people to have more babies.

Third, those who argue that we shouldn’t build roads because people will drive on them are effectively arguing that government shouldn’t provide anything that people will use; only what they won’t use (such as high-speed trains). If that’s the case, government should just get out of the transportation business entirely and leave it to the private sector.

Finally, most congestion is in cities, not between them, so building rail lines between cities isn’t going to help much. Of course, planners don’t want to relieve congestion anywhere because they hope congestion will persuade a few people to stop driving.

America 2050 goes on to say that “one railway with a single track in each direction has the capacity to transport as many people per hour as sixteen lanes of highway.” While I could dispute that number, even if true, capacity doesn’t matter unless people actually use that capacity. Amtrak has 6 percent of the passenger market between Boston and Washington; highways, mainly Interstate 95, have 80 percent. Interstate 95 and parallel roads probably have less than 16 lanes, yet they carry 13 times as many passenger miles.

“High-speed trains allow passengers to bypass this congestion,” America 2050 goes on to say, “bringing passengers directly into center cities.” Yes, but who wants to go directly into center cities? Less than 8 percent of American jobs and less than 1 percent of America’s population lives in city centers (which is why I call high-speed rail “elitist”). In many, if not most, urban areas, more people and more jobs are located near airports than near train stations, and virtually everyone is near a highway.

America 2050 then challenges some of my numbers that it says are “flatly incorrect.” “To count passenger miles,” says the article, “O’Toole uses the American Bus Association’s 2005 Motorcoach Census, which counts passenger-miles logged by intracity airport shuttles, sightseeing tours, and private commuter buses, amongst other categories that are not making cross country or intercity trips.” America 2050 clearly did not read my paper carefully: first, I used the 2007 Motorcoach Census, but, more important, I counted only those passenger miles (about a quarter of the total) attributable to scheduled intercity buses.

When comparing bus to rail safey, “O’Toole counts passenger miles only for Amtrak trains, while counting fatalities for all passenger trains, including commuter rail,” says America 2050. Again, America 2050 did not read carefully. National Transportation Statistics reports that commuter trains suffered about 20 to 60 fatalities per year over the past two decades; the fatalities I reported ranged from 3 to 24 per year (except in 1993 when there were 58), which obviously does not include the commuter rail fatalities. That 1993 number may have skewed my data upwards; but rail fatalities are nevertheless higher than bus fatalities per billion passenger miles.

America 2050 then goes into the topic of subsidies, noting there are large subsidies to highways. “Recently, the Highway Trust Fund has received bailouts of $8 billion in 2008, $7 billion in 2009, and $20 billion in 2010.” As I’ve noted elsewhere, those bailouts were not subsidies to highways; they were subsidies to pork barrel. If Congress had not diverted a third of gas tax revenues to non-highway projects, and then mandated spending on those projects even if gas tax revenues fell short, the bailouts would not have been necessary.

Admittedly, there are highway subsidies, mainly at the local level. But when compared with highway usage, which is on the order of 4 trillion passenger miles and 1 trillion ton miles of freight per year, the subsidies are trivial: about a penny per passenger mile at most. Since intercity buses operate with about twice the occupancy rates of other vehicles, subsidies to them are probably much lower (and were taken into account in the numbers my paper cited). By comparison, subsidies to Amtrak are close to 30 cents a passenger mile and subsidies to most high-speed rail lines will be much more.

America 2050 concludes by saying, “Intercity buses provide a valuable service and are an important part of a complete and balanced transportation system.” Who can argue with “balanced”? With respect to buses, America 2050 would give the high-use transport corridors—the cream of any transport service—to subsidized rail, leaving the dregs to buses (which would then require subsidies to serve those dregs).

The question is: How do you measure “balanced”? Apparently, America 2050’s answer is “balanced means taking the fees you pay to drive and spending them on my favored mode of transport while you sit stuck in traffic.” By contrast, my answer is: if it can be done without subsidies, it is balanced. Let’s just end the subsidies to all modes of transportation and see what happens.

Atlas Shrugged Comes to Detroit

In a perverse way, I’m glad that there are places such as Greece and Illinois. These profligate jurisdictions are useful examples of the dangers of bloated government and reckless statism.

There also are some cities that serve as reverse role models. Detroit is a miserable case study of big government run amok, so I enjoyed a moment or two of guilty pleasure as I read this CNBC story about the ongoing decay of the Motor City. Here are some excerpts:

Detroit neighborhoods with more people and a better chance of survival will receive different levels of city services than more blighted areas under a plan unveiled Wednesday that some residents fear may pit them against each other for scarce resources.

…[T]he boundaries of the 139-square-mile city aren’t receding. The plan also backs away from forcing the redistribution of what’s left of the population into areas where people still live and where the houses aren’t on the verge of caving in.

…Detroit’s population of about 713,000 is down about 200,000 from 10 years ago, according to U.S. Census figures, and has fallen more than 1 million since 1950. Some areas have fewer occupied homes than vacant ones.

…A 2010 survey found Detroit had 33,000 vacant houses and scores of empty, weed-filled and trash-cluttered lots.

How predictable, I thought. This is what happens when vote-hungry politicians adopt policies that reward people for riding in the wagon and punish the folks who are pulling the wagon.

But there was also something about this story that rang a bell. It took a few minutes, since I’m getting old and decrepit, but then I realized that “blighted areas” was an eerily familiar term. Didn’t Ayn Rand use that term in one of her books?

Indeed, she did. Thanks to the miracle of Google Books, here is one of several passages in Atlas Shrugged that references Detroit—oops, I mean “blighted areas”:

No railroad was mentioned by name in the speeches that preceded the voting. The speeches dealt only with the public welfare. It was said that while the public welfare was threatened by shortages of transportation, railroads were destroying each other through vicious competition, on “the brutal policy of dog-eat-dog.” While there existed blighted areas where rail service had been discontinued, there existed at the same time large regions where two or more railroads were competing for a traffic barely sufficient for one. It was said that there were great opportunities for younger railroads in the blighted areas. While it was true that such areas offered little economic incentive at present, a public-spirited railroad, it was said, would undertake to provide transportation for the struggling inhabitants, since the prime purpose of a railroad was public service, not profit.

Many people say that Atlas Shrugged is not very good literature, despite the amazing sales figures. Others say Ayn Rand’s philosophy is flawed, despite the profound influence of her writings.

I’m not competent to comment on those debates, but I can say that Atlas Shrugged does an amazing job of capturing the statist mindset and it tells a compelling story of how excessive government is self-destructive.

Fifty years ago, the book was viewed as a dystopian fantasy. Today, Greece, Illinois, and Detroit are making Ayn Rand seem like a prophet.

‘Madder Than Mosquitoes In a Mannequin Factory’

Just for fun, and because it’s a summer Friday afternoon, here’s the text of a court order handed down July 19 by Kentucky judge Martin Sheehan in the case of Kissel v. Schwartz & Maines & Ruby Co. (ScribD, h/t Nicole Black and Daniel Schwartz):

ORDER
…the parties having informed the Court that the herein matter has been settled amicably and that there is no need for a Court ruling on the remaining motions and also that there is no need for a trial;

And such news of an amicable settlement having made this Court happier than a tick on a fat dog because it is otherwise busier than a one legged cat in a sand box and, quite frankly, would have rather jumped off of a twelve foot step ladder into a five gallon bucket of porcupines than have presided over a two week trial of the herein dispute, a trial which, no doubt, would have made the jury more confused than a hungry baby in a topless bar and made the parties and their attorneys madder than mosquitoes in a mannequin factory;

IT IS THEREFORE ORDERED AND ADJUDGED by the court as follows:

1) The jury trial scheduled herein for July 13, 2011 is hereby CANCELED…

If you’re curious to know more about Judge Sheehan, a quick Google search indicates that he’s a judge who’s thrown out a lawyer’s libel suit against a critic (a prosecutor!) on the ground that it was constitutionally protected opinion; that he’s adopted civility rules to keep lawyers from beating up each other and each others’ clients over much in his courtroom; and that he struck down as unconstitutional an overreaching state law that retroactively sought to restrict where past sex offenders could live. Better and better….

This Week in Government Failure

Over at Downsizing the Federal Government, we focused on the following issues this past week:

Follow Downsizing the Federal Government on Twitter (@DownsizeTheFeds) and connect with us on Facebook. We have a new poll up on the Boehner budget plan.

The Convoluted Debate on Drones

The same week U.S. Defense Secretary Leon E. Panetta declared “we’re within reach of strategically defeating al-Qaeda”—an assessment that many believe reflects the efforts of seven years of CIA drone strikes—former director of national intelligence Dennis Blair called America’s “unilateral” drone war in countries like Pakistan, Yemen, and Somalia a mistake. “Because we’re alienating the countries concerned,” Blair said, “because we’re treating countries just as places where we go attack groups that threaten us, we are threatening the prospects of long-term reform.”

Given that our Nobel Peace Prize–winning president has drastically escalated the use of these flying, robotic hitmen, there seems to be some confusion at the White House.

Speaking to attendees at the Aspen Security Forum, Blair said drone strikes in Pakistan should be launched only when America had the full cooperation of the government in Islamabad and “we agree with them on what drone attacks” should target. As explained elsewhere, this author accepts the efficacy of America’s drone war, but with enormous reluctance. That said, part of Blair’s assessment seems wildly out of touch. Why would Washington wait for permission from Islamabad to hunt al Qaeda?

First, individuals either within or with ties to Pakistan’s spy agency have collaborated with insurgents that frequently attack U.S. and coalition troops in Afghanistan. That doesn’t speak well for Blair’s call for joint cooperation. Second, we’ve known for years that elements within Pakistan have thwarted — on several occasions — foreign-led attempts to find and take out terrorists. Even someone who is not wildly enamored with drones understands the argument for employing them unilaterally when confronted with uncooperative governments. Policymakers, however, should be weighing the ability to keep militant groups off balance against the costs of facilitating the rise of more terrorists, particularly in a country as volatile as Pakistan.

A statement even more out of step than Mr. Blair’s came from Michael E. Leiter, former head of the National Counterterrorism Center. Earlier this week at the Aspen Security Forum, Leiter contended that assessments that al Qaeda was on the verge of collapse lacked “accuracy and precision” and that al Qaeda’s leadership and structure in Pakistan “is still there and could launch some attacks.” He also raised concerns about the possible long-term effects of intensive CIA paramilitary operations on conventional espionage and analysis for issues like China: “The question has to be asked: Has that in some ways diminished some of its strategic, long-term intelligence collection and analysis mission?”

Leiter’s comments are troubling due to the basis for his concern about the effectiveness of counter-terrorism. To emphasize why the growing consensus that al Qaeda is “on the ropes” is premature, Leiter noted that the failed plot to blow up a vehicle in Times Square in May 2010 was carried out by an American trained by the Pakistani Taliban. This statement is misguided in what it implies. By no means can America ensure that terrorists never come from Pakistan, or anywhere else. Such an aim epitomizes our overreaction to terrorism. It gives planners in Washington not only a convenient justification to prolong the wars we’re already in, but also an open-ended rationale to intervene anywhere else. Let’s remember that the United States is already fighting wars in Iraq and Afghanistan, is threatening to launch a third against Iran, bombs remote villages in nuclear-armed Pakistan, and has expanded operations into Somalia, Yemen, and possibly elsewhere. This is especially concerning given the current construction of a not-so-secret U.S. air base in the Middle East for more targeted strikes in Yemen.

Unfortunately, the president’s choice to replace Mr. Leiter, Matthew Olsen, said at his confirmation hearing this week before the Senate Intelligence Committee that he would define the strategic defeat of al Qaeda as “ending the threat that al Qaeda and all of its affiliates pose to the United States and its interests around the world.” This, too, is problematic. U.S. policy toward “ending the threat” from al Qaeda has been mainly through wars and intervention, and one of the many unintended consequences of American intervention has been the radicalization of Western-born Muslims.

Take, for instance, Somalia, where Washington has repeatedly tried and failed to bring order. Over the past two years, as many as 20 Somali-American men have disappeared from the Minneapolis area. Many analysts fear these men were recruited to fight alongside al-Shabab (“The Youth”), the militant wing of the Islamist Somali government the United States and Ethiopia overthrew in 2006. In describing Shirwa Ahmed, a naturalized American of the Somali diaspora believed to be the first U.S. citizen to carry out a terrorist suicide bombing, FBI director Robert Mueller said, “It appears that this individual was radicalized in his hometown in Minnesota.” Somalia is a classic case of how American intervention is forever self-perpetuating.

Debates over drones should not be cut and dry. Scholars, no matter the subject, should be “intellectually honest.” Supporters of counterterrorism can and should feel comfortable having reservations about the tactics employed, given Washington’s tendency for threat inflation. Drones may well become America’s new permanent wartime footing. Sadly, we will have learned nothing from 9/11 if drones provide policymakers a more antiseptic avenue for satiating their endless appetite for intervention.

Cross-posted from The National Interest.

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