August 15, 2003
From the desk of Jane Galt:Stupidest thing yet heard about the blackout
"This will stimulate the economy -- think of all the money people will make cleaning up after the blackout!"
That was a talking head on some radio show I listened to for about three minutes before hurling the radio across the room in sheer horror at the
a) rampant partisan silliness
b) stunning technological ignorance
c) egregious economic illiteracy
of the guests, all of whom seemed to have been picked because they knew nothing about anything relevant to a discussion of power blackouts, hated George Bush, and had low, slow, mellifluous voices. From the general tone of things, one would have thought that George Bush had snuck out of the White House and snipped the power lines in two with a pair of pinking shears, just to be spiteful.
But hey, partisan silliness is what radio is for. (Apparently.) It's the economic illiteracy that really sets my hair on fire. I've heard versions of this same illogical trope from many people. Environmentalists arguing that expensive new environmental regulations create wealth because, gee, look at all the new jobs we got making catalytic converters!* Big government types arguing that pouring money down a rathole on their pet project isn't really a waste of money, because now we've increased GDP by however much we've spent on rathole operators and expensive rathole pouring machines designed by 100% American engineering talent. Hawks who argued that the war in Iraq was just the medicine to cure our ailing economy, because, well, look how well World War II turned out!
No, no, and no.
Wait, that's too timid. NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO!!!!!!!!!!!!!!!!!!!!!!!!
Except in rare economic conditions, which may or may not exist depending on which school of economics you follow, and which we certainly aren't enjoying right now, spending money on wasteful projects like, say, shutting down everything in the Northeast, does not increase GDP. On the contrary, it decreases it.
As Henry Hazlitt, author of Economics in One Lesson, put it, if you carry this thought to its logical conclusion, one could theoretically put the economy through the roof by hiring millions of people to dig holes and then fill them up again.
But that's silly, you say; who will run the trains?
My friend, you have just discovered the concept of opportunity cost. Opportunity cost is the value (monetary and non-monetary) of the best alternative use of your time, money, or person.
The classic example: you have two job offers. One pays $120k (hey, why not? It's just an example.) The other pays $100k. The opportunity cost of taking the first offer is $100k -- the value of your best alternative. The opportunity cost of taking the second offer, conversely, is $120k. In other words, in this simplified example where all jobs are equal and none carry intangible benefits, the opportunity cost of taking the lower-paid job exceeds the value of the job. This tells us that, economically speaking, it's a bad deal and you shouldn't do it.
Governments and economies have opportunity costs too. If they are doing something with their capital and labor, it comes at the expense of doing something else. A government with a fixed budget must choose how much army, social work, public library, and so forth it wants to have, because in this world of limited resources, it cannot have as much of everything as it would like. More library means less social work or soldiery.
So everyone who was spending time speculating about possible causes of the blackout, sitting in the park drinking beer, walking miles and miles to get home, or trying to find something to sleep on superior to the steps of the post office, was also not doing something else. Something that we, as a society, presumably feel is more valuable, since we will not pay them to do it ordinarily, and they generally don't take it upon themselves to go for eleven-mile hikes through the streets of Manhattan.
All the food that was spoiled will have to be replaced, which means that we'll spend resources on making food instead of something else we might like, like making the Jetsons-style videophones for which I have been waiting all my adult life. All the equipment that was broken will have to be fixed, which means some resource sacrifice by someone: repairmen who will have lost valuable leisure time, or utilities which will have less to spend on new power sources to make our electricity cleaner and cheaper, or companies which will do less of whatever it is they do in order to cover expensive repairs.
Just as in the examples above, where those arguing for their version of economic silliness look only at where the money is being spent -- not where it now isn't being spent, on things we might value much more than whatever it is they're urging. Their may always, of course, be independent reasons of social or political policy that we should spend money on their project -- but not because the mere act of spending the money is somehow a net gain to us all.
On a personal note, I've spent today redoing several hours of work that I did yesterday, and lost when the power went out. I'm not getting those hours back.
So the blackout is going to be bad for the economy. How bad? I couldn't guess. But with the first signs of a recovery just creeping into the data, this was absolutely the last thing we needed -- not, as these silly arguments would have it, the first.
* I know that there are other economic reasons to think about environmental regulations, such as negative externalities. I am not saying that there are no economic reasons to be an environmentalist; indeed, I believe many of the economic arguments for environmental action. But this argument in favor of environmental regulation is badly wrong.
Posted by Jane Galt at August 15, 2003 02:50 PM | TrackBack | Technorati inbound links"As Henry Hazlitt, author of Economics in One Lesson, put it, if you carry this thought to its logical conclusion, one could theoretically put the economy through the roof by hiring millions of people to dig holes and then fill them up again."
Sort of like the Superconducting Super Collider? ;-)
Super!
Posted by: Mark Bahner on August 15, 2003 04:51 PMMakes me think of the scene in "The Fifth Element" where Gary Oldman's character is explaining to the priest that "life...comes from destruction"...
ZORG Follow me.. Life, which you so nobly serve, comes from destruction. Look at this empty glass. (Zorg pushes the glass with his finger.)
ZORG Here it is... peaceful... serene... but if it is... (Zorg pushes the glass off the table. It shatters on the floor.)
ZORG Destroyed... (Small individual robots, both free-wheeling and integrated, come zipping out to clean up the mess.)
ZORG ...Look at all these little things... so busy all of a sudden. Notice how each one is useful. What a lovely ballet, so full of form and color. So full of..life!
CORNELIUS They are robots! (A SERVANT comes in pours water in another glass. Zorg tosses a cherry into it.)
ZORG Yes but... by that simple gesture of destruction. I gave work to at least fifty people today. The engineers, the technicians, the mechanics. Fifty people who will be able to feed their children so they can grow up big and strong. Children who will have children of their own, adding to the great cycle of life! (Cornelius sits in silence.)
ZORG Father, by creating a little destruction, I am, in fact, encouraging life! So, in reality, you and I are in the same business!
CORNELIUS Destroying a glass is one thing..killing people with the weapons you produce is quite another.
ZORG Let me reassure you Father..I will never kill more people in my entire life than religion has killed in the last 2000 years.
"From the general tone of things, one would have thought that George Bush had snuck out of the White House and snipped the power lines in two with a pair of pinking shears, just to be spiteful."
Most of the Democrats east of the Rockies just got blacked out, so obviously it must be the Republicans' fault somehow. It couldn't have something to do with the Democrats running those areas that got blacked out, of course. (sarcasm off)
Posted by: markm on August 15, 2003 08:20 PMmarkm:
Democrats, I suppose, like George Pataki - he seems to be the one most p1ssed off about the blackout. (we won't mention Mike Bloomberg - poster bit for RINO)- unfortunately, regional blackouts affect everyone in their area, regardless of party affiliation - except, of course, for members of the Bush Energy Cabal, snug in their fully backed-up, off-grid penthouse bunkers, sipping their well-cooled champagne while they figure out to ride the anger of the public at losing their power to a nice fat new set of federal/state programs to prevent the NEXT blackout (Not due till 2023 or so: so no need to stock up on batteries just yet)
http://bastiat.org/en/twisatwins.html
(autrement dit)
Posted by: "Fast" Freddie Bastiat on August 16, 2003 12:01 AMGood point, Jane.
Part of the reason for the confusion is that these activities do add to GDP, which takes no account of depreciation or value destroyed. If I wreck my car and buy a new one GDP is one car higher than it would otherwise have been, even though there has been no net benefit to the economy.
Posted by: Bernard Yomtov on August 16, 2003 11:42 AM"It's the economic illiteracy that really sets my hair on fire."
Then your own simplisitic thoughts about economics must have left you bald long ago. Perhaps you ought to stick with clubbing antiwar activists.
Posted by: Anon on August 16, 2003 05:01 PMYes, the old "broken window" fallacy (i.e., that riots are good for the economy because of all the jobs produced repairing broken windows).
The version of this one in the space community that I'm always fighting is the defense of NASA, because "we don't send the money into space, it's spent right here, down on the ground..."
NASA is, in fact, a testament to the belief in this fallacy, because many (perhaps, sadly most) people don't understand the difference between creating jobs, and creating wealth.
And you just gave me an idea for next week's Fox news column...
Posted by: Rand Simberg on August 16, 2003 05:40 PMWhat version of "The Fifth Element" was that quote from? It certainly wasn't the movie.
Posted by: DensityDuck on August 17, 2003 03:01 AMWhat version of "The Fifth Element" was that quote from? It certainly wasn't the movie.
Posted by: DensityDuck on August 17, 2003 03:02 AMI don't know if the quote is precisely correct, but I recall that scene from the movie and thinking that it was an excellent example of the fallacy. And that the writer of the screenplay either bought it himself, or was presenting the priest as an economic illiterate as well, because he offered no rejoinder.
Posted by: Rand Simberg on August 17, 2003 11:40 AMJane,
Re: Opportunity Cost
As proof that virtually no-one truly understands the concept of opportunity cost, consider the following quotation from 1997 Economics Nobel Prize winner Robert C. Merton, et al, in the March 2003 issue of Harvard Business Review (For the Last Time: Stock Options Are an Expense) --
"...Even if no cash changes hands, issuing stock options to employees incurs a sacrifice of cash, an opportunity cost that needs to be accounted for. If a company were to grant stock, rather than options, to employees, everyone would agree that the company's cost for this transaction would be the cash it otherwise would have received if it had sold the shares at the current market price to investors...."
If everyone were to agree, then everyone would be wrong. Economic reality is NOT determined by majority vote, even if unanimous. Nor is it determined by the mere assertions of Nobel Prize winners.
While a truly complete definition of an economic opportunity cost is hard, if not impossible, to find, certain characteristics are logically necessary.
First, an opportunity cost must involve a resource which has an economic scarcity value to the entity that is exercising command over it.
Secondly, quantification of an opportunity cost must involve a positive, NET benefit for whatever second best action is being precluded.
When Merton, et al, effectively claim that stock given away by a company represents an opportunity cost equal to the market value of the stock, all of the requirements above for an opportunity cost are violated.
With shareholder approval, a company is free to create new stock without effective limit or significant actual expenditure. Thus stock does not represent an economic value to the company itself. This is entirely uncontroversial, as it is well known that a public stock company cannot effectively own itself.
When a company sells new stock onto the market, the shareholders are giving up partial ownership for cash, on a value for value basis. This certainly does not represent a net benefit of the total sale proceeds for the shareholders, and if we restrict our viewpoint to the company itself, claiming the total sale proceeds as a net benefit is merely confirmation that the shares given up have no value to the company.
While Merton, et al, are correct that the expensing of stock options IS logically tied to the expensing of stock itself, they fail to realize that it is the current accounting practice of expensing stock grants themselves that is an economic error. This error is the result of an improper and superficial application of the concept of opportunity cost.
If a company wants to sell new stock on the market, ideally for the benefit of shareholders, it is not prevented from doing so as the result of a previous stock grant. Every specific share of stock is just as good as any other share of the same class. Either stock grants or sales can be executed in any order without effective limit, if appropriate.
If selling stock on the market were really a net benefit equal to the total sale proceeds, and precluded by stock grants, then we would see stock continually sold onto the market on an hourly basis, subject only to refraining from making stock grants. This is not the case.
While there are plenty of problems involved with stock option grants, expensing them is just to pile error upon error. Stock and option grants DO have a real cost, but it is entirely encapsulated in the ownership dilution suffered by the existing shareholders when it is properly established.
Regards, Don
come on, think of all those flashlights sold! ka-ching! the recovery is on its way! and, in the second half of the year, as predicted!!
seriously, though, i remember that scene from fifth element.
Posted by: skippy on August 17, 2003 07:40 PMI remember that scene, but does anyone remember what happens right afterwards? Zorg chokes on that cherry and Cornelius says:
Where's the robot to pat you on the back? Or the engineer? Or the children, maybe? There, you see now, how all your so-called power counts for absolutely nothing now, how your entire empire can come crashing down because of one... little... cherry.
Right before performing the Heimlich on him. :)
Back on topic, is there anyway to drill the concepts involved with opportunity cost into those who propose public works projects? Perhaps by locking them in an capitalist-based economics lecture hall for a month...and then waiting for them to complain about wasting their time!
Posted by: Drizz on August 19, 2003 01:12 AMRand, in defense of the screen-writer, Drizz mentions the fairly elegant rebuttal argument in the movie. (If the "destruction creates wealth" idea is true, then destroying [killing] people would also be productive, but Zorg can clearly see that he's not better of dying.) Also (and remember, this is a movie, so rhetorical standards are low), the argument was made by the *bad guy*. Ipso facto, it is wrong.
:-)
Posted by: Tom on August 19, 2003 06:02 PMComments are Closed.