Market-Based Management®

Markets Fail When You Make Them

Ok, I made a bad prediction in my previous post about gasoline coming to Georgia in the wake of Hurricane Ike. I know it was a bad prediction, because I drove to Atlanta Airport on Sunday and did not see a single gas station with petrol (although news reports say about half do). So why was I wrong, and why has the market appeared to fail? First of all, my prediction was based on the premise that the market would be allowed to work. Gas can be found in the Southeast—just not in Atlanta. Why did every station I saw in rural Mississippi and Alabama earlier this week have gas, while those in Atlanta did not? The answer is that it would be illegal to sell the gas available in the country or suburbs in Atlanta proper. The American gasoline market is not a single unified market, but a deeply fragmented patchwork of markets where federal clean air mandates dictate what types of gasoline (called boutique fuels) can be sold where. Because of its air pollution problems, only a special boutique fuel can be sold in Atlanta. After hurricanes Katrina and Rita, the federal government wisely suspended these fuel mandates and momentarily recreated a national market for gasoline. While this measure did have a temporary effect on air quality, it prevented many of the shortages that we now see today. Unfortunately, the feds did not follow this policy after Ike, but kept the mandates in place, which is the reason that Atlantans wanting to fill up either have to wait for scant fuel deliveries or dive to the suburbs or country.

Another curious going on is that when there is gas in Atlanta, prices do not appear elevated and are roughly on par with those before the hurricane. So why with all this scarcity, are gas stations charging prices close to pre-hurricane levels? The answer probably lies in the overt threats from state and federal officials that they will go after price “gougers” for selling gasoline at high prices. As I mentioned in the previous post, the Georgia price “gouging” law is fairly toothless and not even currently applicable (the governor has to declare a state of emergency for the statute to come into force). I erroneously believed that the benign nature of this law would not impede rises in Georgia gas prices and subsequently encourage conservation and supply. However, most gas station owners are either only vaguely aware of this or think the feds will get them instead. The effect has been a de facto price ceiling on gas prices in the Atlanta area, which gives motorists the incentive to snap up gas when it is available, rather than weighing much higher prices (say $8 a gallon) and buying only a few gallons at a time. This is exactly what I—and everyone else ay my neighborhood station—did when a gasoline shipment arrived. As a result, folks who would otherwise drive around with half or quarter tanks fill them up (and top them off) whenever possible. I am running with a full tank right now but would have left more for my fellow Atlantans had the price been higher. Unfortunately, the situation has unleashed my (and apparently everyone else’s) inner speculator.

Why there will be Gas in Georgia

With the approach of Hurricane Ike, I started to wonder if I should fill my gas tank prior to the inevitable disruption in the nation’s refining network. However, a quick google search revealed that Georgia (where I am) has a very tame anti-price “gouging” statute, which only comes into force when the governor declares a state of emergency (unlikely considering the state of emergency is in Texas). At the same time I noticed that those states neighboring Georgia (primarily Tennessee, South Carolina, and Florida) have more strongly worded statutes, and their public officials have been making noises about enforcing them come the inevitable spike in prices. In a market economy, prices provide the knowledge governing production, distribution, and consumption. If you monkey with this system by implementing a de facto price control in the form of an “anti-gouging” law, then you recreate the foolishness of the price controls of the early and late 70s. Of course, the full impact depends on Ike, but even if some shortages occur in Georgia; we will certainly fair better than our neighbors to the north and south.

Creating Jobs by Breaking Windows

Like anyone who grew up playing with GI Joes, I still find military hardware neat—an enthusiasm tempered only by the massive costs involved. Most folks are familiar with the mental model of “guns or butter,” but this idea was plainly lost on the BBC in this article on the two new aircraft carriers to be laid down in Scotland. According to the BBC, these two great efforts will “create” thousands of jobs. Simply put, they will do nothing of the sort. True, we will observe thousands of Scots heading to the yards, but what we will not see are the thousands of others who would have been going to work somewhere else, had a portion of society’s scarce resources not been redirected towards these floating behemoths.

While a society certainly needs protecting, and the freedom of the seas is essential to global prosperity, such projects do not “create” jobs—they simply redirect them from somewhere else. Economists classify the BBC’s mistake as the fallacy (sometimes parable) of the broken window. In the fallacy of the broken window, some punk kid breaks a baker’s window. A bystander quickly remarks that the damage is a good thing, stating authoritatively that the breaking of the window will boost employment by providing work for a glazer. What the bystander does not see are all the other things the baker may have done with the resources now dedicated to re-glazing. You are probably thinking that this makes perfects sense (and that is because it does). However, as you listen to the news coverage of the aftermath of Hurricane Gustav or even the presidential race (politicians love to talk about “creating” jobs), I can guarantee that some candidate or pundit will count the devastated homes and commit the fallacy of the broken window. The fallacy of the broken window is translated into MBM through our mental model of opportunity cost. Opportunity cost defines the cost of something not as mere dollars and cents, but whatever else could have been done with the time or resources at hand. Every “created” job must be paid for with another job (or jobs) somewhere else. Unfortunately, the victims never know what has happened to them, nor do they see the broken window that has put them out of work.

When No One is Accountable

There is a fantastic post by former Treasury Secretary Larry Summers over at Creative Capitalism (HT: EconLog’s Arnold Kling) on the bubbling problems at Fannie Mae and Freddie Mack. I will let the post speak for itself, but for decades politicians have trumpeted the idea of public-private partnerships, as a sort of “third-way” where the supposed deficiencies of markets and government cancel one another out. Unfortunately, as evidenced by the growing troubles at Fannie and Freddie, this combination of conscience and profit is probably responsible for much of the trouble. What does one of these partnerships tell its private shareholders when there are no profits? It tells them that the company’s social obligations are to blame. What about when the partnership fails in its social obligations? The company explains that it has done so in order to fulfill its obligations to profit its private shareholders. As for the shareholders, should they keep an eye on the company’s books or question its debts and lending practices? Why bother, since the partnership’s debts are guaranteed by the government. In the end, we are left with a perfect storm of unaccountability—be careful of mixing two worlds, you may get the worst of both.

Not from the Onion but it belongs there

At first I thought Don Boudreaux over at Café Hayek had a hold of my leg with this post about the Onion Futures Act of 1958—until I noticed that he had linked to this Wall Street Journal article and a quick Google search turned up that there really is an Onion Futures Act of 1958. The Onion Futures Act bans futures trading in onions, and came into effect after onion farmers blamed “moneyed interest” and “speculators” for volatile onion prices. The act still remains on the books, and (as far as I know) no other bans on commidity futures exist. So with folks blaming oil prices on “moneyed interests” and “speculators,” what would a ban on oil futures do to the price? Of course onions ain’t oil, but since no other commodity has suffered the same ban, it remains the only example we have.

Despite the ban, onion prices continued to remain volatile. Actually, they became even more volatile after the prohibition of futures trading. Contrary to what had been believed, onion futures trading had actually helped to stabilize prices. Futures are an excellent hedge on risk and a valuable knowledge process. They encourage traders to do their homework and collect and vet mounds of information on what might be the future price. This allows consumers and producers to plan on these prices and respond accordingly. Hopefully, decision makers will come to understand the valuable knowledge provided by futures market and not repeat the onion mistake.

Creative Destruction Threatens Snail Shortage

Where have all the good snail collecting jobs gone? The answer appears to be nowhere—the problem is finding people willing to fill them. Snail gathering is hard work, but someone has to do it—otherwise Europe’s gastropod lovers (the French in particular) will go without escargot. Unfortunately, relatively high wages in France and the extension of protections to some species of snail nudged the French snail industry into slow decline some years ago. Fortunately, the demise of the Berlin Wall brought a flood of slimy molluscans from Eastern Europe, as impoverished villagers in Poland and Bulgaria proved only too happy to perform the dirty work and keep the escargots flowing.

That was until economic development in Eastern Europe brought better things to do, and would-be snail gatherers have moved on to more rewarding occupations. Now there is consternation in France that foreign supplies of snails may dry up and deprive Frenchmen of their beloved escargot. The pending snail crisis is an example of newer and better jobs crowding out the old—a process the great economist Joseph Schumpeter popularized as “creative destruction”. By providing greater opportunities, the rising tide of Eastern European prosperity is simultaneously destroying its snail industry. This is a telling reminder that, while we are bombarded with tales of this or that industry failing or moving oversees, the truth of the matter is this is often a symptom people of a country finding better things to do. At the same time I fear not for the French. I am sure they will get their snails from somewhere, as the nations of Eastern Europe pass the torch of snail gathering to peoples with lower opportunity costs, who will be delighted (and much better off) for receiving it.

The Importance of Vetting Knowledge

MBM talks a lot about collecting and sharing knowledge. However, we sometimes don’t stress the need to understand exactly what that knowledge means. Often what appears a clear connection is really quite meaningless. I was reminded of this by an article in today’s Arizona Republic (HT: Coyoteblog). The article complains that consumers are being “gouged” by faulty gas pumps. Apparently, about 9 percent of Arizona’s inspected gas pumps failed tests by the State’s Department of Weights and Measures. The article is full of innuendo and numbers implying there is something rotten in the state of Denmark (or at least Arizona). Despite the tone of the article, the fourth sentence begs some curiosity:

Half of those [pumps] were malfunctioning to the detriment of customers.

Faulty pumps are not good, and people getting ripped off is not good; but if half of the malfunctions cause detriment to customers, then what about the other half? Are some of the good people of Arizona getting a little free gasoline? Of course, I do not doubt the need for governments to standardize and inspect weights and measures (the practice dates to the Magna Carta (clause 35) in the Anglo-American tradition), but the little nugget on the impact of these inaccuracies tells us that this situation is probably happenstance or, at worst, neglect on the part of the pump owners. Interestingly, the article also mentions that it can cost up to $800 to recalibrate a pump, which considering the thinness of margins in retailing gasoline (only a few pennies on the gallon), is probably incentive enough to recalibrate infrequently—as opposed to deliberately fiddling the pumps. Furthermore, as the fine for a first time offense is only $300, it makes perfect sense for the gas station owners to have the state come out and do the inspections for them (paying the fine and fixing the affected pumps should be much cheaper than constantly re-calibrating of all of them). So, while malfunctions of 1 out of 11 inspected pumps causes us to quickly jump to conclusions, a little vetting of information reveals nothing more than perhaps the nature of pumps, happenstance, poor incentives, or the combination of all three—meaning only a few lines tell the whole story, and they don’t match the rest of it.

American Charitable Giving Tops $300 Billion for the First Time—Few Notice

Good news doesn’t sell, which is probably why every generation thinks the world is in constant motion towards hell (although the trend for the last 200 years has been quite the opposite). Despite high gas and food prices and falling home values, Americans gave away a record $306 billion last year—an increase of $11 billion from the previous record year (2006). Of course, the few media outlets covering this story chose to focus on increased need, rather than supply (and charity is likely driven by supply), but we should take what positive news we can get.

I will defer mostly to my earlier post on charitable giving, but this milestone reminds us that prosperous societies are also generous ones. Some folks bemoan economic progress and rising prosperity as crises of overproduction or rank materialism. However, rising prosperity is really just the producing of more goods and services valued by more people, which also includes giving. Interestingly, it is rising prosperity that makes both voluntary giving (charity) and involuntary giving (welfare) possible. Public and private welfare are as much creatures of market economies as banks, factories, ports, and shopping malls. Anyway, this story serves as a reminder that if the market can stimulate a culture of prosperity and giving, then bringing market mechanisms into the firm can accomplish the same.

Entrepreneurs and Disaster

Last week ago, I was struck by this Wall Street Journal article recommended by Jamie Peterson at INVISTA. The article concerns the sprouting of entrepreneurship in the aftermath of the recent devastating Sichuan Earthquake in China (unfortunately, reading the full article requires a Wall Street Journal subscription).

Interestingly, entrepreneurs are often the first to swing into action following a natural disaster (the first trainloads of lumber for rebuilding arrived the very day after the Great Chicago Fire of 1871). However, sometimes the imposition of price controls and “anti-gouging” statutes quash these efforts by removing the incentives needed to induce the effort. Although price spikes following natural disasters are common, price controls only force the squandering of scarce resources within the affected area, while choking off flows of supplies from outside. If allowed to operate, the price mechanism usually forces prices back down fairly quickly and sometimes even gluts the market.

I wrote about this phenomenon a couple years back in the ABA's Journal of Natural Resources & Environment, and economist Russ Roberts has dedicated his latest work of economics-influenced drama to the topic. However, the overwhelming need for flexible markets following natural disasters is not the purpose of this post: it is that, despite decades of being told to despise entrepreneurship and other “bourgeois” values, in the wake of disaster, many Chinese discovered their inner entrepreneur. A lot of folks make silly comments like “markets are not compatible with _____ culture” (personally, I blame this false mental model on Max Weber’s attributation of capitalism to some vague notion of “Protestant work ethic”).

The Sichuan Earthquake reminds us that people are naturally entrepreneurial. Entrepreneurship is in our blood and no amount of cultural conditioning or even brute force can completely stamp it out (considerer the phenomenon of black markets). Of course, some countries exhibit greater levels of entrepreneurship than others, but this is because some countries do a better job of facilitating the human desire to benefit one’s self through the service of others. True, one’s inner entrepreneur maybe repressed by governmental, cultural, or overly bureaucratic corporate environments, but it is always there; and a little shove from within makes a much better catalyst than an earthquake.

Do You Have a Bad Job?

Of course, whether you have a bad job or not is not something I can answer, but luckily some folks think they have figured out as to what a “bad” job really is. This article in the Arizona Republic (HT: Coyoteblog and apologies as I basically parrot his post), cites an unnamed study, which classifies 35% of Arizona jobs as “bad,” because they pay less than $17 an hour and offer no benefits. On the other hand, 22% of Arizonans apparently have “good” jobs, which the study defines as making more than $17 an hour with health insurance, retirement plans, and various other unnamed benefits. Unfortunately, as there is no link or naming of this study, I have no way of determining the “goodness” or “badness” of the remaining 43% of Arizona jobs, which exceed $17 an hour but fail to include all the “good” job basket of mystery benefits (however, considering the percentages of insured/uninsured most of these “limbo” jobs presumably come with the big benefit—health insurance). The 43% would also include entrepreneurs and the self-employed who cannot technically offer themselves any benefits. This also begs the question as to whether any of those in "bad" or "limbo" jobs happened to fall under the benefits of parents or spouses with "good" jobs.

Confusion over percentages aside, the whole idea of measuring “good” or “bad” jobs is pointless. For starters, a person’s evaluation of his or her job is their own. I know lots of folks who make great money with fantastic benefits and positively despise their jobs. I know others, who make little and get by without health insurance (usually because they are young and healthy), who are overjoyed by their work and overall existence. Furthermore, as Coyote points out, retirees (and there are a few of them in Arizona) who work part time in leisurely, but relatively low-paying jobs, would still hold “bad” jobs despite possessing insurance coverage through Medicare and probably already well stocked in the retirement plan department. The same goes for teenagers or college students who may work part time while remaining covered under their parents’ health insurance with no real need for a 401(k) or employer subsidized life insurance. The best (see “bad”) job I ever had was in grad school, when I also happened to be flat broke—but living fairly well in my statistical poverty and misery.

There also remains the “compared to what” issue. Ten bucks an hour ain’t a bad racket if you have no skills and may not even speak the language. Had this study been conducted in China, it would have found nothing but “bad,” jobs even though Chinese factory workers may earn wages thirty times better than their previously “bad” job of starving peasant. The lesson here is the power of subjective value. Whether it is compensation, working conditions, music, movies, or dinner, different folks value different things differently, at different times, places, and situations; making defining “good” or “bad” jobs from the standpoint of a third party a waste of time and effort in addition to communicating little useful knowledge.