Suppose I think it's going to be really sunny this Bank Holiday Monday. I fill a cooler with orange popsicles and head out to the Park to sell them for a profit. Unfortunately, it rains cats and dogs. My popsicles melt. I just lost my investment.
Does the story above pose any huge problem for conventional Economics?
No.
Investment is about making a guess about what the future will look like and then taking a punt. Some investments don't pay out. Some entrepreneurs go bust. But some investments do pay out and so some people experience Asset appreciation. Capitalism is about winners and losers- those who took bets which paid out vs. those who got screwed.
There is no problem for Social accounting in the above story. Okay, if you get a guy who consistently makes bad decisions we might say he isn't 'investing' but 'consuming'- i.e. this aint a business, it's a hobby.
Landsburg disagrees. He reckons that the Govt. should force people to buy my popsicles even though it's raining. Why? Coz otherwise those popsicles go to waste.
What if people only have enough money to either buy an umbrella or a popsicle? Because it's raining, people want the umbrella and don't want the popsicle. However, Landsburg would still insist that people get popsicles rather than umbrellas provided I bought the popsicles before anyone else laid in a stock of umbrellas.
Landsburg is a Maths guy who teaches Econ. He's not a Communist. Indeed, he's supposed to be Right Wing. Why does he want the Govt. to force us to eat popsicles rather than buy umbrellas when it's bucketing down?
The answer is that he thinks umbrellas and popsicles are 'gross substitutes' because everything is (at least in Math Econ 101 world). But, an umbrella could save me from pneumonia while, under the same circumstances, having to suck on a ice popsicle could have the opposite effect.
Okay, umbrellas and popsicles aren't really like each other.
What about 2 capital goods (i.e. stuff I only buy for a business purpose) that are almost exactly alike? Surely, they are 'gross substitutes'?
Let's suppose I'm a stock broker. I need to be signed up to the fastest optical cable network. Being signed up to the second fastest isn't a gross substitute- it's a fucking recipe for bankruptcy.
Still, suppose the existing system is a monopoly and a new system comes along which is faster. Surely, by banning the new system, the Govt. can save the investors in the old network? Nobody gets hurt, right? Not right. Business moves offshore, or goes underground, to where brokers have access to the fastest network or else you have a disintermediation event.
What if the Govt. can prevent the whole Globalized finance sector from accessing the fastest network? Surely that would work? Yes, and the Govt can also build a huge dome over the City and invest in huge artificial Sun lamps so that I don't lose money on my popsicles. However, everyone is now much worse off. As for Capitalism- Landsburg just killed it- again.
Paul Krugman is against the Spread Networks cable. His argument is that High Frequency trading is bad for the Economy. http://www.nytimes.com/2014/04/14/opinion/krugman-three-expensive-milliseconds.html?_r=0.
ReplyDeleteThe argument here has nothing to do with popsicles vs umbrellas.
Krugman has a view of the kind of America he'd like to see and condemns some investments and praises others on the basis of his own preferences. So, his argument is normative. He condemns the motives of the people behind the investment because they were catering to a market Krugman thinks is populated by bad people.
DeleteLandsburg isn't making a normative but a positive argument based on his misunderstanding of the theory of Externality.
As a matter of fact, the Spread Networks cable could have other a lot of other applications- even Medical and Defense ones so Krugman might, a few years down the line, decide that the network was a good thing. However, he could still condemn the motive behind it.
Landsburg on the other hand is just showing ignorance of Econ 101.
Landsburg isn't saying the Govt. should stop projects like Spread Networks. Instead he suggested a way to make it uneconomic by randomly delaying some trades.
ReplyDeleteThat's worse than even license-permit Raj style refusal of permission for a project because it represents wasteful duplication in a capital scarce country with inexperienced Entrepreneurs.
DeleteWhy? Well, it creates a signal extraction problem such that bad ideas and stupid entrepreneurs don't get weeded out as quickly as would otherwise have been the case. Indeed, this is the big problem with ad hoc Govt., or other Institutional, intervention to avoid waht appears to be a 'waste of resources'. The best way to reduce waste is to ensure that the wasteful get wasted by Market forces.