Tag Archives: Economics

The Undercover Economist

The Undercover Economist
(Exposing Why the Rich Are Rich, The Poor Are Poor — And Why You Can Never Buy a Decent Used Car)
Tim Harford
Oxford University Press: 2006

This is an enjoyable book that explains the basics of how economics works, which is to say, how the world works. Mr. Harford doesn’t go into any technical detail at all, so there are no charts and graphs to decipher (although a very few are used for illustration), and there are no mathematical formulas.

Mr. Harford seems to believe more than I do that government may need to step in and correct some types of market failures. All in all, though, I agree with almost everything Mr. Harford writes.

In one chapter, Mr. Harford correctly assesses the current U.S. health care payment system as a mess. What he proposes as a solution is health savings accounts, where a low cost (about $1,500 per year) insurance policy to cover catastrophic charges is combined with individually owned health care savings accounts. People manage their own health care savings accounts. They get to keep what they don’t spend, so there is an incentive to spend wisely and reduce the need for health care through prevention.

Mr. Harford, with slight modification, believes in the random walk theory of security prices. I don’t think I would trust an economist who doesn’t.

In a chapter titled “Why Poor Countries Are Poor” he explains, using his trip to Cameroon, how terrible a plague political corruption is. That alone, he says, is the most important reason why most poor counties stay poor. He didn’t mention lack of formal property systems as described in Hernando De Soto’s book The Mystery of Capital.

A chapter on globalization explains relative advantage and how it contributes to the increased wealth of nations that participate in free trade. A quote:

Contrary to popular belief, it is simply not possible for trade to destroy all of our jobs and for us to import everything from abroad and export nothing. If we did, we would have nothing to buy the imports with. For there to be trade at all, somebody in America must be making something to sell to the outside world.

He explains the Lerner theorem, which says that a tax on imports is exactly equivalent to a tax on exports. Another interesting insight:

Trade can be thought of as another form of technology. Economist David Friedman observes, for instance, that there are two ways for the United States to produce automobiles: they can build them in Detroit, or they can grow them in Iowa. Growing them in Iowa makes use of a special technology that turns wheat into Toyotas: simply put the wheat onto ships and send them out into the Pacific Ocean. The ships come back a short while later with Toyotas on them. The technology use to turn wheat into Toyotas out in the Pacific is called “Japan,” but it could just as easily be a futuristic biofactory floating off the cost of Hawaii. Either way, auto workers in Detroit are in direct competition with farmers in Iowa. Import restriction on Japanese cars will help the auto workers and hurt the farmers; they are the modern-day equivalent of “frame breaking” [what Luddites did to mills and machines in England].

(Perhaps Mr. Harford has never been to Iowa, because in my experience, Iowa wheat fields are rare. Corn, however, is abundant.)

The problem is that the change that trade brings about affects different groups in different ways. Politicians love trade protection measures because they generally help a small, well-defined group immensely, at a lower and perhaps unnoticed cost to the rest of the people.

This book, combined with a few others such as Thomas Sowell’s works and Common Sense Economics: What Everyone Should Know About Wealth and Prosperity (all reviewed on this site) will work to increase anyone’s understanding of how economics works.

AirTran subsidy is harmful

(This is a longer version of my opinion piece that appeared in The Wichita Eagle last week.)

From the beginning, we in the Wichita area have been told each year that the AirTran subsidy was intended as a temporary measure, that soon AirTran would be able to stand on its own, and there will be no need to continue the subsidy. Mayor Mayans said as much last year, and so did City Manager Kolb this year.

But State Senator Carolyn McGinn, R-Sedgwick, on a recent television program, may have made a revealing slip when she referred to the AirTran subsidy as a “pilot program.” Now that the subsidy appears to be a permanent requirement, funded locally and perhaps statewide, we should ask ourselves if this subsidy is in our best interests.

The benefits of the subsidy are regularly overstated — and sometimes by huge amounts. In 2004, the Chairman of Fair Fares claimed that the Fair Fares program was worth $4.8 billion in economic benefit to the state. No reasonable analysis could make a conclusion that the benefit is as large as this.

Last year, the present Chairman of Fair Fares spoke before the Wichita City Council and equated what Wichita is doing to pricing in the airline industry with the role that Kansas played in the years before the Civil War. It hardly seems worth noting that one struggle was against the immoral institution of slavery; the other is a taxpayer-funded effort to override the natural workings of free markets.

Yes, it is undeniable. Low airfares are preferred over high airfares, and it is probably true that airfares are lower than what they would be without the subsidy. But the airline industry is changing. As an example, carriers tell us they have eliminated or reduced the very high fares for walkup ticket purchases. We simply do not know what airfares would be in Wichita if there had not been the subsidy, so any estimate of how much has been saved is merely a guess.

The harm the subsidy causes reveals itself in several ways. We may have less air service in Wichita due to the subsidy. Last year Delta canceled seven important daily flights. Was this in retaliation for Wichita’s decision to not subsidize Delta, as some claim? Or was it the law of supply and demand expressing itself: that when the price of something is lowered (lowering prices is the desired effect of the subsidy), less is supplied. There are fewer daily flights supplied to and from Wichita, from 56 last year to 42 today. As the subsidy lowers the price that airlines may charge for tickets but doesn’t do anything to reduce the costs of providing service, we should not be surprised to see more reductions in service.

Backers of the subsidy claim it is necessary to keep businesses from leaving and to attract new businesses to our area. We should consider the converse: have businesses considered Wichita, and seeing a meddlesome local government, one that picks and chooses winners and losers, decided not to locate here?

Local lawmakers abandon their principles to back the subsidy. Last year a Sedgwick County Commissioner assured me that he was a “free market” thinker, but was backing the subsidy nonetheless. Local business leaders, some who consider themselves believers in free markets, back the subsidy and have even formed private fundraising efforts to augment the subsidy.

Consider this: if a subsidy is good for economic development, why shouldn’t we try the subsidy approach with other businesses? If we feel that, say, advertising rates in Wichita are too high, why doesn’t the city select one local television station and subsidize its operations, thereby compelling other stations to match the subsidized price? Or to help people with something that really hits home, why not grant a subsidy to one chain of grocery stores so that other stores have to lower their prices? Or in the case of a monopoly such as a local daily newspaper, why doesn’t the city or county fund a startup to supply competition? I think most Wichitans would consider these measures extreme and contrary to fairness. I find it difficult, though, to differentiate these actions from the AirTran subsidy.

Whether to continue funding the AirTran subsidy is a bright line that we can choose to cross or not. On one side we see low airfares, and those airfares are highly visible. What we may not see as easily is the cost of a permanent expansion of government, government that intrudes increasingly on our lives and liberties. We also may not notice the loss of valuable information that prices in a free market supply, and without those price cues, we will not recognize the misallocation of capital and resources that follows.

On the other side of the line is the harsh realization that Wichita has factors such as low population that work against low airfares. On this side, however, we will find liberty and free markets. You will find me on this side, lonely though it is.

The Mystery of Capital

The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else
Hernando De Soto
Basic Books, 2000

The problem with most third world countries, Mr. De Soto tells us, is not that there is no capital, it’s that the capital is dead. Dead in the sense that it can’t be used to its full economic potential. It can’t be mortgaged, it can’t be divided into shares, and it simply can’t be used in the same way we make productive use of our assets in the West.

What is the difference between the West and the third world? The answer is formal property systems that allow the economic potential stored in property to be put to work. Until these poor countries develop the type of formal property systems that Western countries did, mostly during the 19th century, they are destined to remain poor.

The obstacles in the way of development of formal property systems are many, including social, political, and legal issues. One interesting fact is that third world countries do have property systems, in the sense that it is possible to know who “owns” property, but that knowledge is extralegal and local. It isn’t as valuable as the knowledge contained in formal property systems, but it is there nonetheless.

We see advocates for poor people in third world countries constantly calling for more aid or debt relief for these countries. It is sadly true that many people are hungry and in poor health, and formal property system that unlock capital won’t help these people tomorrow. But until poor countries start the process of developing formal property systems, they are unlikely to change and develop economies that can support themselves.

Unfortunately, everyone does not hold capital and private property rights in high regard. In 1992 Libya burned all land titles. Former socialist states are reverting to their former ways. In America, not all people agree that capitalism is good.

This book contains some interesting history of how private property systems developed in the United States.

Common Sense Economics: What Everyone Should Know About Wealth and Prosperity

Common Sense Economics: What Everyone Should Know About Wealth and Prosperity
James D. Gwartney, Richard L. Stroup, and Dwight R. Lee
St. Martin’s Press, 2005

This is a wonderful book that can teach anyone what is important to know about economics. It teaches the insights that people can use to understand and evaluate the mechanism of our economy and government themselves. It is not a textbook with charts, graphs, and formulas. It requires no special prerequisite from the reader.

The book contains four parts: The ten key elements of economics, seven major sources of economic progress, economic progress and the role of government, and twelve key elements of practical personal finance.

This book promotes a restricted role for government. From page 80: “A government can promote social cooperation and enhance its citizens’ economic welfare primarily in two ways: (1) by providing people with protection for their lives, liberties, and properties (as long as the properties and liberties were acquired without force, fraud, or theft) and (2) by supplying a few select goods that have unusual characteristics that make them difficult to provide through markets.” Later, in the section titled “Government is not a corrective device” we read, “When thinking about government, it is important to recognize that there are fundamental differences between political democracy and markets. When a democratic government levies taxes, it does so through coercion. Dissenting minorities have to pay taxes regardless of whether they receive or value the goods that the taxes supply. … There is no such parallel coercive power in the private sector. Private firms can charge a high price, but they cannot force anyone to buy. Indeed private firms must provide customers with value or they will be unable to attract consumers’ dollars.”

We also learn that when decisions are made through the political process, it is the majority that wins and sets policy, and the minority must yield to the majority. But when decisions are left to the market, each person can choose what they want. If they want something different from what the majority wants, they can get it without also having to pay for what the majority decided on.

This part of the book also explains how special-interest groups are usually able to get the government to implement laws and policies that benefit the group at the expense of the rest of the country. An example is the sugar tariff, which is very valuable to a small group of people. They focus tremendous energy and money on getting politicians to keep the tariff in place. The average American may not be aware that the sugar tariff costs them an additional $20 per year in the form of higher prices for products containing sugar, and even if they are aware, well, what’s the use of getting worked up over $20? Even the employees of American candy makers who have moved out of America to somewhere where they can buy sugar at world market prices may not know who to blame for the loss of their job.

This part of a book also contains a section titled “Unless Restrained by Constitutional Rules, Legislators Will Run Budget Deficits and Spend Excessively.” This is certainly the case with the recent Congress, and in the state of Kansas too, except that our state can’t deficit spend. The root of the problem is this: “Legislators like to spend money on programs to please their constituents. They do not like to tax, since taxes impose a visible cost on voters. Debt is an alternative to current taxes; it pushes the visible cost of government into the future.” The solution, we are told, is political modifications such as a constitutional amendment requiring a balanced budget, or supermajority requirements for spending proposals.

The book concludes with a good section on personal finance. The authors strongly recommend, as I do, that investors use low-cost stock index funds instead of actively managed funds or individual stocks.

This book is very easy to read, and contains a great deal of valuable information. I strongly recommend it to people just starting to learn about economics, and to people like me who had some college training in economics, but didn’t really learn how economics and its relation to government affects our wealth, prosperity, and freedom. If you couple this book with Thomas Sowell’s two recent books Basic Economics: A Citizen’s Guide to the Economy, Revised and Expanded Edition and Applied Economics: Thinking Beyond Stage One you will have an excellent understanding of how our economy and government work.

Wal-Mart. More hypocrisy.

Writing from Jackson, Mississippi

Currently it is quite fashionable to criticize Wal-Mart as the starting point for everything evil about American business. Critics allege that Wal-Mart earns too much profit, pays its employees too little, doesn’t provide its employees health insurance so they have to rely on the government, it exploits low-paid workers in China, and might even be responsible for avian flu, for all I know.

There is no doubt that Wal-Mart is a powerful force in the economy. The Wall Street Journal on December 3, 2005, wrote “Wal-Mart employs about 1.3 million people, about 1% of the American work force. Its sales, at around $300 billion a year, are equal to 2.5% of U.S. gross domestic product.”

But bigness doesn’t necessarily translate to profitable: “It is not, however, an especially profitable company. Its net profit margins, at about 3.5% of revenue, are broadly in line with the rest of the retail industry. In fiscal 2004, Microsoft made more money than Wal-Mart on just one-eighth of the sales.”

Is Wal-Mart bad for poor people? Writing in The Washington Post on November 28, 2005, Sebastian Mallaby wrote: “Wal-Mart’s critics allege that the retailer is bad for poor Americans. This claim is backward: As Jason Furman of New York University puts it, Wal-Mart is ‘a progressive success story.’ Furman advised John ‘Benedict Arnold’ Kerry in the 2004 campaign and has never received any payment from Wal-Mart; he is no corporate apologist. But he points out that Wal-Mart’s discounting on food alone boosts the welfare of American shoppers by at least $50 billion a year. The savings are possibly five times that much if you count all of Wal-Mart’s products.”

That’s a lot of money saved for consumers. Critics alledge, however, that Wal-Mart suppresses wages. It does, as it turns out. From The Washington Post article again: “Set against these savings for consumers, Wal-Mart’s alleged suppression of wages appears trivial. Arindrajit Dube of the University of California at Berkeley, a leading Wal-Mart critic, has calculated that the firm has caused a $4.7 billion annual loss of wages for workers in the retail sector.” Compare that with the amount that Wal-Mart has saved consumers. “Indeed, Furman points out that the wage suppression is so small that even its “victims” may be better off. Retail workers may take home less pay, but their purchasing power probably still grows thanks to Wal-Mart’s low prices.”

As for health benefits, John Tierney in The New York Times on November 29, 2005 writes: “Wal-Mart is often denounced for getting ‘corporate welfare’ because some of its employees rely on Medicaid for health care and on other government aid. But so do some employees at other companies or at government institutions like public schools. Wal-Mart offers health benefits that are generally comparable to what other retailers offer.”

For those who claim that Wal-Mart receives corporate welfare in any form, I think that readers of this website know my feelings on that. Corporate welfare is wrong.

From The Wall Street Journal again: “But suppose Wal-Mart did look more like the company its detractors would like it to be, with overpaid workers, union work rules, and correspondingly higher prices on goods. It would not only be a less attractive place to shop, and hence a considerably smaller company. It would drive up the cost of living for the millions who shop there, thus hurting those in the bottom half of the income-distribution tables that Wal-Mart’s critics claim to be speaking for. One might expect this fact to trouble the anti-Wal-Mart forces, except that their agenda is very different from what they profess it to be.”

John Tierney of The New York Times again: “It’s easy to understand the motives of some of Wal-Mart’s enemies. Local merchants don’t want to match its prices. Labor leaders know that they’ll lose members and dues if unionized stores suffer. But why would anyone who claims to be fighting for social justice be so determined to take money out of the pockets of the poor?”

Whatever your feelings, Wal-Mart operates in the relatively free marketplace, so it must meet the needs of its customers, or it won’t last very long. From The Wall Street Journal again: “To the extent that mom-and-pop stores are threatened by Wal-Mart, it’s because the same people who supposedly so value their Main Street hardware store find that Wal-Mart’s selection, or prices, or parking lot — something about it — is preferable.”

That’s the free market — people voting with dollars rather than professed feelings — at work.

Hypocrisy over oil profits abounds

Writing from Orlando, Florida

The recent swell of criticism over oil company “windfall” profits, some even coming from people who should know better, is truly remarkable in its hypocrisy.

It seems that the critics feel that oil companies did nothing extraordinary to earn these profits. Therefore, they don’t deserve them.

What’s wrong with this criticism? First, I don’t think we want to let the government get in the position of deciding who deserves to keep the profits they earn. It does enough of this already.

Second, most people would be delighted to find themselves in the position of the oil companies: owning something that is scarce and in high demand. And, a lot of people are in that position, made huge profits, and did little to “deserve” the profits other than being in the right place at the right time. Who are these windfall profiteers that I speak of? They’re homeowners in hot real estate markets, who, by chance, happen to own property that other people are willing to pay high prices for, thereby generating huge windfall profits for those lucky homeowners. Has anyone proposed a windfall tax on these profits?

(A further irony concerning profits from the sale of one’s own home is that the profit, which is a capital gain, is taxed at rates lower than most people pay on income. Homeowners don’t pay any tax on the first $250,000 (or $500,000 for married taxpayers) of profit, and the rest is taxed at the capital gains tax rate of 15%, and only 5% for those with low incomes. These rates were reduced in 2003. A cut in the capital gains tax rate is usually criticized as a tax cut only for the “wealthy,” but it turns out that many regular people will benefit. I suppose, though, that if your residence that you bought 25 years ago for maybe $50,000 is now worth over a million dollars, you have become “wealthy.”)

Third, prices are the best way we have to allocate scarce resources. Every other way doesn’t work. But many people forget the lessons of history and think that somehow government can suspend the law of supply and demand.

Finally, consider who owns these oil companies. If you own any mutual funds, especially index funds, you probably own a piece of these companies.

Employer-paid health insurance

In the past I have written on how the system in America where almost everyone gets their health insurance through their job (Let’s Pay for Our Own Health Insurance) does not serve us well. Now I have become aware of even more evidence as to why we should all choose and pay for our own health insurance.

A Harvard study (Illness And Injury As Contributors To Bankruptcy) concluded that of families that declared bankruptcy, about half cited medical bills as the reason. Of those, 76% had medical insurance at the time they became sick. Some of the problem is that when people become seriously ill, they can’t work. After they lose their job they have no income, and they can’t pay the premium to continue their existing coverage.

Many types of insurance, and some health insurance policies, I have found, offer an option called “waiver of premium.” This option, if selected and paid for, pays the policy’s premiums when the insured can’t. This would help in the case where people are too sick to work and can’t afford their premiums. They would still be covered.

If your employer, through whom you get your health insurance, doesn’t offer this waiver of premium option, you realistically have no way to obtain it. But if we all chose and paid for our own health insurance, those who wished to could have this option. This is just one more reason why the current system of employer-provided health insurance does not work well.

Prices ration scarce goods

As the price for gasoline rises, politicians hear increased calls for regulation of gas prices. We hear news stories of hotels increasing prices for victims of hurricane Katrina, and prices for needed goods in the destructed area could rise, too.

In Wichita, when gasoline prices rose rapidly, someone told me that this was price gouging, because the price the gas stations pay for gasoline hasn’t increased yet. I’m sure that’s true, their cost hasn’t increased yet, as they’re still selling gasoline they already bought some time ago. This analysis, however, doesn’t consider the most important role of prices: to strike a balance between supply and demand. That’s what prices do.

Consider what the economist Walter E. Williams wrote about plywood prices:

Windfall profits are indeed profits far beyond what’s necessary for an entrepreneur to stay in business, but windfall profits also play a vital role. Windfall profits signal that a human want is not being met. Resources emerge to meet that want. For example, when Hurricane Andrew devastated parts of South Florida, plywood prices skyrocketed. Florida’s attorney general threatened actions against companies for price-gouging.

Those windfall profits conveyed messages to the rest of the economy. Let’s say that pre-hurricane plywood prices were $10 a sheet and afterward they were $20. That profit potential created a powerful signal. Instead of plywood manufacturers selling their plywood inventory to, say, Pennsylvania wholesalers for $8 a sheet, they were more than happy to ship them to Floridian wholesalers for higher prices. Wholesalers in other states were happy to sell their plywood to Floridians for higher prices. Since plywood supplies were moving to Florida, plywood prices elsewhere rose.

From a social point of view, this is wonderful. Say I planned to spend a Saturday afternoon building a house for my dog. I go to my neighborhood lumberyard in Pennsylvania expecting to pay $10 for a plywood sheet, and get there and find out it’s $18. I say, “The heck with the dog; let him sleep in the rain!” I have voluntarily made a plywood sheet available for a more valuable use — rebuilding the house of a human.

None of these and other voluntary actions making plywood available to Floridians would happen if price controls were slapped on plywood making the pre- and post-hurricane prices the same. Freely fluctuating prices, including the potential for windfall profits, encourage people to do voluntarily what’s in the social interest.

In free and open markets, profits are to be praised — not scorned, as economic and political charlatans would have us do.

We might consider the prices for hotel rooms. As families evacuated before (or after) Katrina struck, they needed hotel rooms. If the usual price for a hotel room was, say, $50, and hotel operators can’t increase their prices, there will be a shortage of hotel rooms. Why is this? Think of the Jones family with children. At a room price of $50, the Jones family might take two rooms, one for the parents, and another for the children. If the hotel operator is allowed to increase prices, the room price might rise to, say, $100. At that price, the Jones family might decide they could all stay in one room. That makes the second room, the room the Jones family children would have occupied at a price of $50, available for the Smith family. Otherwise, the Jones family children would be in the second room, and the Smith family is on the street, or has to drive farther to find a room.

Yes, the Smith family had to pay $100 for a room when they would prefer to pay only $50, but if the price is $50, there is no hotel room available for them.

Some people might object that the hotel operator is unjustly enriched by being able to sell hotel rooms for $100, when normally they fetch only $50. But what is the alternative? Is there anyone who has the power to say to the Jones family that they should all stay in one room, leaving a room free for the Smith family? Or, in the case of gasoline prices held artificially low through price controls, someone has to judge whose use of gasoline is more valued.

But if the prices of hotel rooms, plywood, and gasoline are allowed to fluctuate, each person is free to make their own judgment as to how much they want to consume. If the Jones family really wants two hotel rooms, they can have them. If Dr. Williams really wants to build the doghouse, he can. But people acting as they do — demanding less of something as its price rises — there will be more hotel rooms or plywood available for others. If the price of plywood in Florida is controlled so that it can’t increase, the cost of plywood in Pennsylvania will likely be the same $10 as it always is. So plywood is used in Pennsylvania to make doghouses as people in Florida need plywood to patch the roofs of the homes so that they can stay dry.

That’s what is important about prices. They represent people voluntarily — and that’s a very important word that Dr. Williams used — adjusting their behavior. The alternative is shortages, gas lines, rationing, government control, and commissions deciding who gets what at what price — all the signs of a planned economy. That does no one any good.

In the case of my friend in Wichita, who was going to make a weekend trip that would require about 100 gallons of gasoline in a vehicle that gets 12 miles per gallon, I suggested renting a car that gets better fuel economy. That’s what he did. In the end, he’s saving about $100, even considering the cost of car rental, and he’s making about 50 gallons of gasoline available to someone else. That’s the power of prices in action.

What to do about gasoline prices

Almost anything the government does in response to the recent high gasoline prices is bound to fail. The easy political solution is to place price controls on gasoline, as Hawaii has done. Basic economics tells us that when a price is held artificially low through price controls, demand will be higher than what it would otherwise be, and supply will be less than it would otherwise be. What does that spell? A shortage, as was the case the last time there were price controls on gasoline. The misery of dealing with lines at gas stations was much worse than slightly higher gasoline prices.

As Thomas Sowell wrote in a recent column: “The last time we had price controls on gasoline, we had long lines of cars at filling stations, these lines sometimes stretching around the block, with motorists sitting in those lines for hours.

That nonsense ended almost overnight when President Ronald Reagan, ignoring the cries of liberal politicians and the liberal media, got rid of price controls with a stroke of the pen.

What happened is what usually happens when government restrictions are ended: There was more production of oil. In fact the 1980s became known as the era of an ‘oil glut’ and gasoline prices declined.”

In an article titled “What’s the Answer for High Gasoline Prices? Absolutely Nothing” by Jerry Taylor & Peter VanDoren, published last October in National Review, we read:

“… consumers have a right to make their own decisions about trade-offs between higher gasoline prices and conservation without the government whacking them over the head with higher taxes, constrained choices in the vehicle market, or extracting their earnings for the benefit of corporations engaged in making cars or fuels that consumers presently don’t want to buy. Simply put, individuals know better how to order their personal affairs than do politicians or bureaucrats no matter how well meaning they might be.

At the end of the day, the best remedy for high gasoline prices is…high gasoline prices, which provide all the incentives necessary for motorists to conserve, for oil companies to put more product into the marketplace, and for investors to look into alternatives fuel technologies. Government has never demonstrated an ability to do better.”

There are also unintended consequences of any action. When government requires higher fuel economy quickly (as many are calling for), automakers will find that the easiest way to comply is to decrease the weight of cars, since weight is the most important determinant of fuel economy. As Dr. Sowell wrote: “Many of the same people who cry ‘No blood for oil!’ also want higher gas mileage standards for cars. But higher mileage standards have meant lighter and more flimsy cars, leading to more injuries and deaths in accidents — in other words, trading blood for oil.”

News stories tell us of SUV drivers considering trading for vehicles with more efficient usage of gasoline. Anyone who is considering such a move needs to do a little arithmetic first. Figure out the cost per mile, considering gasoline only, for the two vehicles. Then consider the costs of ownership of a new vehicle. Sales tax alone on a new $25,000 car (that’s about the average price now) in Wichita is $1,825. If you trade a 15 mpg vehicle for a 25 mpg vehicle, with gas at $2.60 per gallon, you’re saving about $.173 per mile in gasoline costs. That seems like a lot, but you’ll need to drive 10,549 miles just to “save” what you paid in sales tax. For many people, it might take a year to drive that many miles.

Consider the other costs. Since cars depreciate at about 2% per month, a $25,000 vehicle depreciates about $500 its first month. The vehicle you already own that’s worth, say, $10,000 depreciates just $200 the same month. That difference of $300 requires 1,734 miles of driving to pay for (but will decrease each month as the new car rapidly loses its value). If you borrow money to buy the new car, you’re paying interest that needs to be allowed for. Add it all up, and you may not be saving as much as you thought you might. Then, if the price of gasoline drops, you may not save anything at all.

Book Review: Basic Economics: A Citizen’s Guide to the Economy

Basic Economics: A Citizen’s Guide to the Economy
Revised and Expanded Edition
Thomas Sowell
Basic Books, 2004

This book is a general introduction to economics written in a non-technical way. It provides excellent coverage of many introductory topics in economics, and you don’t have to be a mathematical sophisticate to understand it. It is very readable by anyone who is interested in this topic.

One of the best things the author does in this book is to distinguish between what politicians want to happen and say they are doing when they implement economic policies, and what incentives are actually created. Often there is a big difference between the two.

One of the most important things to learn from this book is the importance of prices, and what goes wrong when governments interfere with prices. As the author says: “Prices play a crucial role in determining how much of each resource gets used where. Yet this role is seldom understood by the public and it is often disregarded entirely by politicians.” As an example: “The last premiere of the Soviet Union, Mikhail Gorbachev, is said to have asked British Prime Minister Margaret Thatcher: How do you see to it that people get food? The answer was that she didn’t. Prices did that. And the British people were better fed than those in the Soviet Union, even though the British have never grown enough food to feed themselves in more than a century. Prices bring them food from other countries.”

The example of rent control illustrates how what politicians intend to do may not be what actually happens: “In short, a policy intended to make housing affordable for the poor has had the net effect of shifting resources towards housing affordable only by the affluent or rich, since luxury housing is often exempt from rent control.” What lower-priced housing that remains is in short supply (since less is supplied at a lower price), is in high demand (because more is demanded at a lower price), and is in poorer condition than it would be otherwise (since housing is in a shortage, landlords have an easy time finding tenants, and there is little incentive to maintain their housing stock). In fact, rent control often leads to rental housing being taken off the market, or, especially in New York City, entire buildings being abandoned when the (artificially low) rent that comes in isn’t sufficient to provide city-required services to the tenants.

But because there are more tenants than landlords, Dr. Sowell explains, rent control is often a political success. It is easier for the average person to look at the situation superficially, to see that politicians are looking out for them by protecting them from landlords who would otherwise gouge them on rent.

You can learn all this and more just by reading through page 40 of this nearly 400 page book. I highly recommend this book.

I, Pencil

I, Pencil
Leonard E. Read (Click here to read the article.)

Do you think there exists a single person who knows how to make a lead pencil? In this article, Mr. Read shows us how there is no one who knows even a small fraction of what is necessary to produce even this simple, everyday item.

How, then, does a lead pencil come to be manufactured? Through the uncoordinated actions of many people, each exchanging their own small amount of knowledge for something else they want.

The absence of a master mind, of anyone dictating or forcibly directing these countless actions which bring me into being. No trace of such a person can be found. Instead, we find the Invisible Hand at work. This is the mystery to which I earlier referred.

Later on we read this:

the configuration of creative human energies–millions of tiny know-hows configurating naturally and spontaneously in response to human necessity and desire and in the absence of any human master-minding! Since only God can make a tree, I insist that only God could make me. Man can no more direct these millions of know-hows to bring me into being than he can put molecules together to create a tree.

It is free expression of creative human energy that makes economies work at their maximum potential. Attempts by governments to interfere are bound to fail, as even the coordination of the production of a simple lead pencil is beyond the comprehension of any single person, agency, or computer program.

The downside of Being the Air Cap

Harry R. Clements of Wichita contributed this article, which is a summary of a larger study he performed. Click here to read the full study in pdf format.

Mr. Clements’s article makes a striking conclusion as to why airfares in Wichita were so high. I would be curious as to whether any of our government leaders have read the study. We should also ask why our government leaders are not performing research like this when they propose to spend large sums of taxpayer money.


Wichita State’s Center for Economic Development and Business Research recently placed a guest article of mine on their website. It concerns a statistical study based on the level of air travel generated at Wichita’s Mid-Continent Airport compared to five other cities in the region, in which the data shows Wichita is ranked dead last, and an attempt to figure out why we do so poorly in this type of “competition.” It further questions whether our city’s substantial airline subsidy is worth the money spent. Since the article was written for consumption by professionals and is based on what might be considered obscure econometric techniques, it isn’t very suitable for reading by the lay readers of this paper. But I think the results are important enough that they should be seen by our town’s citizens, the decision making politicians that represent them, and the local media that should air such issues.

The cities compared are Des Moines, Oklahoma City, Kansas City, Omaha, Tulsa and our own, over a recent six year period. The important factors affecting airline traffic generation were determined by slimming down a list obtained from the airline industry’s primary trade organization, the Airline Transport Association, with a couple of additions that together with theirs explain the greatest part of the differences in passenger results among these cities. These most important factors are population and per capita income (the more the better for these two) and a novel one, the number of pilots in the city’s population (in this case the lower the better). Wichita not only ranks next to last in population and income among the six — not favorable — but has an astounding more than twice the number of pilots, per capita, than the other cities’ which is really unfavorable. If Wichita were, so to speak, more like these other cities we could expect our airline passenger traffic to double. This is certainly a reason why other cities in our region do not have to rely on subsidies to generate their traffic.

Wichita’s effort to maintain its aircraft industry and attract other high income new businesses — for instance bio-technology, but not call centers and specialty retailers — will tend to increase per capita income, and population, but is it possible for an airline subsidy to overcome that which comes with being the Air Capital of the World — a high concentration of pilots, with charter and corporate fleets available, able to fly people wherever they need to go? Should we, if we could figure out how, have a policy to decrease the number of pilots? That problem is the downside of being the Air Cap.

Stretching figures strains credibility

I recently read that the Wichita Airport’s economic impact was estimated at $1.6 billion per year. I thought this seemed high, so I investigated further.

I became aware of this study prepared by the Center for Economic Development and Business Research at Wichita State University, available here: Wichita Mid-Continent Airport Economic Impact.

By reading this study I learned that the employees of Cessna and Bombardier — 12,134 in total — are counted in determining the economic impact of the airport. Why? To quote the study: “While it might appear that manufacturing businesses could be based anywhere in the area, both Cessna and Bombardier require a location with runways and instrumentation structures that allow for flights and flight testing of business jet airplanes.” This is true, but it is quite a stretch to attribute the economic impact of these employees to the airport.

For one thing, if we count the economic impact of the income of these employees as belonging to the airport, what then do we say about the economic impact of Cessna and Bombardier? We would have to count it as very little, because the impact of their employees’ earnings has been assigned to the airport. This is, of course, assuming that we count the impact of these employees only once.

Or suppose that Cessna tires of being on the west side of town, so it moves east and starts using Jabara Airport. Would Cessna’s economic impact on Sedgwick County be any different? I think it wouldn’t. But its impact on the Wichita airport would now be zero. Similar reasoning would apply if Cessna built its own runway.

Or it may be that someday Cessna or Bombardier will ask Sedgwick County for some type of economic subsidy, and they will use these same economic impact dollars in their justification. But these dollars will have already been used, as they were attributed to the airport.

To its credit, the WSU study does provide some figures with the manufacturing employees excluded. The impact without the manufacturing employees included is estimated at $183 million, or about 11 percent of the $1.6 billion claimed earlier.

It is a convenient circumstance that these two manufacturers happen to be located near the airport. To credit the airport with the economic impact of these companies — as though the airport was involved in the actual manufacture of airplanes instead of providing an incidental (but important) service — is to grossly overstate the airport’s role and its economic importance.

Of course the airport is important to Wichita. We should seek to measure its impact sensibly instead of stretching to attribute every dollar possible to it. When advocates of any cause manufacture figures like the $1.6 billion economic impact, it casts doubt on other arguments they advance.

Links referred to: Wichita Mid-Continent Airport Economic Impact

Let’s Pay for Our Own Health Insurance

Having most people obtain medical insurance, and therefore their healthcare, from their employers is a peculiar tradition that leads to several less-than-optimal situations.

I would venture to guess that most employees don’t know the cost of their insurance. They probably pay a portion of the cost through a deduction on their payroll checks and they know what that amount is, but that is a long way from knowing the total cost. Knowing — and having to pay for — the entire cost of something is a good motivator for controlling its cost.

It makes no more sense for employers to provide health insurance than it does for employers to provide auto or homeowners insurance.

With employer-provided coverage, when people change jobs, they likely lose their coverage.

At most companies, employees are not rated according to their likely healthcare expenditures. There may be a cost for a single employee, another cost for an employee and spouse, and another cost for employee with spouse and children. Never have I seen a case where the cost to the employee was based on how many children there were in the family, even though each additional child adds a predictable risk and associated cost. Other types of insurance, such as auto and homeowners, are priced very carefully based on the characteristics of the driver, auto, and property being insured. This illustrates that present health insurance plans are not so much insurance against catastrophic loss as much as they are pre-paid healthcare plans that cover every little cost. But even then, they aren’t priced very carefully according to their likely cost.

Having employers provide healthcare removes choice from employees. If an employee doesn’t like the plan offered by their employer, they are certainly free to purchase one they prefer. But this will likely be more expensive, partly because of the fact that employer-provided plans are paid for with pre-tax dollars. A plan that is privately purchased would be paid for with after-tax dollars.

Removing the ability to choose health care plans from most people also removes competition amongst health care plan providers. Introducing competition to the marketplace is good for consumers.

The fact of employer-provided health insurance creeps into issues such as same-sex marriage. Advocates of same-sex marriage or civil unions point out that same-sex partners are denied the employer-provided health coverage that their partner enjoys.

What if we decided to stop employer-provided health coverage? There are a few obstacles.

Currently, since health insurance is often paid for with pre-tax dollars, people would pay more in tax. This could be overcome, of course, by lowering tax rates.

It may be that employers, since they often purchase insurance plans for large numbers of employees, are able to get price discounts based on volume. Wholesale purchasing, so to speak. I do not know how this would impact families purchasing plans one at a time. There may be significant sales costs. Certainly families would face choices and would have to think about them. But being more informed is better.

Some people, undoubtedly, would decide to forgo the purchase of health insurance, and therefore risk becoming a burden to us all if they become ill. This is a real problem because currently our healthcare system treats those who can’t afford to pay, sometimes with little concern given to if they will ever be able to pay. (Recently the New York Times and Wall Street Journal have given coverage to cases where hospitals have aggressively collected debts from poor people. The Times thought this a tragedy.) The fact is that the cost of care given to those who can’t — or won’t — pay is paid for by the rest of us who do pay. It would take a disciplined system to refuse to treat those who have chosen to forgo purchasing insurance.

In a Reason Magazine article titled Mandatory Health Insurance Now! we find this paragraph:

Why not just tell Americans they are responsible for buying their own health insurance from now on? If people couldn’t pay for medical care, either through insurance or out of pocket, they wouldn’t get it. “After people begin to notice the growing pile of bodies by emergency room entrances,” Tom Miller wryly suggests, “they will quickly get the message and go get medical coverage.”

The solution to the problem, the article says, is in the slogan for a proposal by The New America Foundation: “Universal coverage in exchange for universal responsibility.” All of us would have to purchase our own insurance plans. The employer-provided plans would end. The problem, of course, is that even a plan covering only catastrophic expenses for a family of four might cost $3,600 annually, which is out of the reach of many low-income families. So the rest of the taxpayers would have to subsidize the purchase of these plans. We already do this now, so does anything change?

Yes, I think things would change for the better. If we could truly enforce the “universal responsibility” part of the plan — everyone has to pay his or her own way — this plan has a chance.

Additional reading:
To Guarantee Universal Coverage, Require It
Health Insurance Required
Insurance Required
Universal Coverage, Universal Responsibility: A Roadmap To Make Coverage Affordable For All Americans (full report)

Prepare for sales tax-induced job effects now

Collecting the sales tax to pay for the downtown Wichita arena may produce unintended consequences.

A paper titled “An Assessment of the Economic Impact of a Multipurpose Arena” by Ronald John Hy and R. Lawson Veasey, both of the University of Central Arkansas, (Public Administration & Management: An Interactive Journal 5, 2, 2000, pp. 86-98) looked at the effect of jobs and economic activity during the construction of the Alltel Arena in Pulaski County, Arkansas. This arena cost $50 million. It was funded in part by a one percent increase in the county sales tax for one year (1998). The sales tax generated $20 million.

In the net, considering both jobs lost and jobs gained due to sales tax and construction effects, workers in the wholesale and retail trades lost 60 jobs, and service workers lost 52 jobs. There was a net increase of 198 jobs in construction.

The fact that jobs were lost in retail should not be a surprise. When a sales tax makes nearly everything sold at retail more expensive, the supply curve shifts to the left, and less is demanded. It may be difficult to estimate the magnitude of the change in demand, but it is certain that it does change.

Workers in these sectors, should the sales tax increase take effect, may want to reconsider their career plans. How many retail and service workers can make the transition to construction work is unknown. It is certain, however, that when workers lose their jobs it imposes benefits costs on the government — and the taxpayers.

The population of Pulaski County in 2000 was 361,474, while Sedgwick County’s population at the same time was 452,869, so Sedgwick County is a somewhat larger. Our sales tax will last 2.5 times as long, and our proposed arena is about three times as expensive. How these factors will impact the number of jobs is unknown, but I feel that the number of jobs lost in Sedgwick County in retail and services will be larger that what Pulaski County experienced.

It is interesting to note that the authors of this study, while measuring a positive net economic impact for the Alltel Arena, make this conclusion:

“The primary reason for this positive economic impact is that the state of Arkansas contributed $20 million to the construction of the arena. As a result, the economic impact of building the arena in Pulaski County is greater than it would be if the county had funded the arena by itself. A vast majority of the jobs that will be created will be in the service sector that frequently offers lower wages than jobs in other sectors of the economy.”

The proposed downtown Wichita arena does not have the advantage of having 40% of its cost paid for by outsiders. It may be that we feel even more strongly the negative impacts of the sales tax.

The value of economic impact studies

One of the factors that usually plays a part in an economic impact study like that used to promote the Downtown Wichita arena is the “multiplier,” which accounts for the fact that money spent once is spent again, and maybe yet again.

To quote from “Economic Impact Multipliers for Kansas” published in “Kansas Business Review” Vol 12, No. 3, Spring 1989, and available at http://www.ku.edu/pri/publicat/multipliers/multipliers.htm:

It sometimes seems that the bigger a multiplier is, the more often it is quoted. (1) In any case, some distinctly one-sided political and economic motives encourage the propagation of exaggerated multipliers.

In particular, economic multipliers are used to justify public concessions to private industry. Such assistance for business may include land acquisition, new roads and sewers, job training programs, subsidized loans, and tax incentives.(2) The extent of public concessions is determined through bargaining between government and industry, and in the course of the bargaining those who stand to gain most from the new enterprise have a natural tendency to inflate the relevant multipliers.(3)

The inflation of multipliers may stem less from venality than from an innate optimism, which seems to be necessary in the risky business of development. Since multipliers are costly to measure, of uncertain accuracy, varied in their meanings, and multifarious in their origins, a convenient range of multiplier values is always available; discriminating users are free to choose the best values for their purposes.