Basic Economics

by Sowell, Thomas

  Disaster relief from the government differs from private payments from insurance companies in another way. Competition among insurance companies involves not only price but service.

  When floods, hurricanes or other disasters strike an area, insurance company A cannot afford to be slower than insurance company B in getting money to their policy-holders.

  Imagine a policy-holder whose home has been destroyed by a flood or hurricane, and who is still waiting for his insurance agent to show up, while his neighbor’s insurance agent arrives on the scene within hours to advance a few thousand dollars immediately, so that the family can afford to go find shelter somewhere. Not only will the customer of the tardy insurance company be likely to change companies afterward, so will people all across the country, if word gets out as to who provides prompt service and who drags their feet. For the tardy insurance company, that can translate into losing billions of dollars’ worth of business nationwide. The lengths to which some insurance companies go to avoid being later than competing insurance companies was indicated by a New York Times story:

  Prepared for the worst, some insurers had cars equipped with global positioning systems to help navigate neighborhoods with downed street signs and missing landmarks, and many claims adjusters carried computer-produced maps identifying the precise location of every customer.{516}

  After the catastrophic hurricane Katrina struck New Orleans in 2005, the difference between private and governmental responses was reported in the Wall Street Journal:

  The private-sector planning began before Katrina hit. Home Depot’s “war room” had transferred high-demand items—generators, flashlights, batteries and lumber—to distribution areas surrounding the strike area. Phone companies readied mobile cell towers and sent in generators and fuel. Insurers flew in special teams and set up hotlines to process claims.{517}

  The same difference in response time was observed in the recovery after Katrina:

  In August, 2005, Hurricane Katrina flattened two bridges, one for cars, one for trains, that span the two miles of water separating this city of 8,000 from the town of Pass Christian. Sixteen months later, the automobile bridge remains little more than pilings. The railroad bridge is busy with trains.

  The difference: The still-wrecked bridge is owned by the U.S. government. The other is owned by railroad giant CSX Corp. of Jacksonville, Fla. Within weeks of Katrina’s landfall, CSX dispatched construction crews to fix the freight line; six months later, the bridge reopened. Even a partial reopening of the road bridge, part of U.S. Highway 90, is at least five months away.{518}

  The kind of market competition which forces faster responses in the private sector is of course lacking in government emergency programs, which have no competitors. They may be analogized to insurance but do not have the same incentives or results. Political incentives can even delay getting aid to victims of natural disasters. When there were thousands of deaths in the wake of a huge cyclone that struck India in 1999, it was reported in that country’s press that the government was unwilling to call on international agencies for help, for fear that this would be seen as admitting the inadequacies of India’s own government. The net result was that many villages remained without either aid or information, two weeks after the disaster.{519}

  Chapter 15

  SPECIAL PROBLEMS OF

  TIME AND RISK

  The purpose of capital markets is to direct scarce capital to its highest uses.

  Robert L. Bartley {520}

  Perhaps the most important thing about risk is its inescapability. Particular individuals, groups, or institutions may be sheltered from risk—but only at the cost of having someone else bear that risk. For a society as a whole, there is no someone else. Obvious as this may seem, it is easy to forget, especially by those who are sheltered from risk, as many are, to varying degrees. At one time, when most people were engaged in farming, risk was as widely perceived as it was pervasive: droughts, floods, insects, and plant diseases were just some of the risks of nature, while economic risks hung over each farmer in the form of the uncertainties about the price that the crop would bring at harvest time. Risks are no less pervasive today but the perception of them, and an understanding of their inescapability, are not, because fewer people are forced to face those risks themselves.

  Most people today are employees with guaranteed rates of pay, and sometimes with guaranteed tenure on their jobs, when they are career civil servants, tenured professors, or federal judges. All that this means is that the inescapable risks are now concentrated on those who have given them these guarantees. All risks have by no means been eliminated for all employees but, by and large, a society of employees does not live with risks as plainly and vividly seen as in the days when most people worked on farms, at the mercy of both nature and the market, neither of which they could control or even influence. One consequence of an employee society is that incomes derived from risky fluctuations are often seen as being at best strange, and at worst suspicious or sinister. “Speculator” is not a term of endearment and “windfall gains” are viewed suspiciously, if not as being illegitimate, as compared to the earnings of someone who receives a more or less steady and prescribed income for their work.

  Many think that the government should intervene when business earnings deviate from what is, or is thought to be, a normal profit rate. The concept of a “normal” rate of profit may be useful in some contexts but it can be a source of much confusion and mischief in others. The rate of return on investment or on entrepreneurship is, by its very nature and the unpredictability of events, a variable return. A firm’s profits may soar, or huge losses pile up, within a few years of each other—or sometimes even within the same year. Both profits and losses serve a key economic function, moving resources from where they are less in demand to where they are more in demand. If the government steps in to reduce profits when they are soaring or to subsidize large losses, then it defeats the whole purpose of market prices in allocating scarce resources which have alternative uses.

  Economic systems that depend on individual rewards to get all the innumerable things done that have to be done—whether labor, investment, invention, research, or managerial organization—must then confront the fact that time must elapse between the performance of these vital tasks and receiving the rewards that flow from completing them successfully. Moreover, the amount of time varies enormously. Someone who shines shoes is paid immediately after the shoes are shined, but a decade or more can elapse between the time when an oil company begins exploring for petroleum deposits and the time when gasoline from those deposits finally comes out of a pump at a filling station, and earns money to begin repaying the costs incurred years earlier.

  Different people are willing to wait different amounts of time. One labor contractor created a profitable business by hiring men who normally worked only intermittently for money to meet their immediate wants. Such men were unwilling to work on Monday morning for wages that they would not receive until Friday afternoon, so the labor contractor paid them all at the end of each day, waiting until Friday to be reimbursed by the employer for whom the work was being done. On the other hand, some people buy thirty-year bonds and wait for them to mature during their retirement years. Most of us are somewhere in between.

  Somehow, all these different time spans between contributions and their rewards must be coordinated with innumerable individual differences in patience and risk-taking. But, for this to happen, there must be some over-all assurance that the reward will be there when it is due. That is, there must be property rights that specify who has exclusive access to particular things and to whatever financial benefits flow from those things. Moreover, the protection of these property rights of individuals is a precondition for the economic benefits to be reaped by society at large.

  UNCERTAINTY

  In addition to risk, there is another form of contingency known as “uncertainty.” Risk is calculable: If you play Russian roulette, there is one chance in six th
at you will lose. But if you anger a friend, it is uncertain what that friend will do, with the possibilities including the loss of friendship or even revenge. It is not calculable.

  The distinction between risk and uncertainty is important in economics, because market competition can take risk into account more readily, whether by buying insurance or setting aside a calculable sum of money to cover contingencies. But, if the market has uncertainty as to what the government’s ever-changing policies are likely to be during the life of an investment that may take years to pay off, then many investors may choose not to invest until the situation becomes clarified. When investors, consumers and others simply sit on their money because of uncertainty, this lack of demand can then adversely affect the whole economy.

  A 2013 article in the Wall Street Journal, titled “Uncertainty Is the Enemy of Recovery,” pointed out that many businesses “are in good shape and have money to spend,” even though the economic recovery was slow, and asked: “So why aren’t they pumping more capital back into the economy, creating jobs and fueling the country’s economic engine?” Their answer: Uncertainty. A financial advisory group estimated that the cost of uncertainty to the American economy was $261 billion over a two-year period. In addition, there were an estimated 45,000 more jobs per month that would have been created, in the absence of the current uncertainty, or more than one million jobs over a two-year period.{521}

  Such situations are not peculiar to the United States or to the economic problems of the early twenty-first century. During the Great Depression of the 1930s, President Franklin D. Roosevelt said:

  The country needs and, unless I mistake its temper, the country demands bold, persistent experimentation. It is common sense to take a method and try it; if it fails, admit it frankly and try another. But above all, try something.{522}

  Whatever the merits or demerits of the particular policies tried, this approach generates uncertainty, which can make investors, consumers and others reluctant to spend money, when they cannot form reliable expectations of when or how the government will change the rules that govern the economy, or what the economic consequences of those unpredictable rule changes will be. The rate of circulation of money declined during the uncertainties of the Great Depression, and some have regarded this as one reason for the record amount of time it took for the economy to recover.

  TIME AND MONEY

  The old adage, “time is money” is not only true but has many serious implications. Among other things, it means that whoever has the ability to delay has the ability to impose costs on others—sometimes devastating costs.

  People who are planning to build housing, for example, often borrow millions of dollars to finance the construction of homes or apartment buildings, and must pay the interest on these millions, whether or not their construction is proceeding on schedule or is being delayed by some legal challenge or by some political decision or indecision by officials who are in no hurry to decide. Huge interest payments can be added to the cost of the construction itself while claims of environmental dangers are investigated or while local planning commissioners wrangle among themselves or with the builders over whether the builder should be required to add various amenities such as gardens, ponds, or bicycle paths, including amenities for the benefit of the general public, as well as for those to whom homes will be sold or apartments rented.

  Weighing the costs of these amenities against the costs of delay, the builder may well decide to build things that neither he nor his customers want enough to pay for otherwise. But pay they will, in higher home prices and higher apartment rents. The largest cost of all may be hidden—fewer homes and apartments built when extra costs are imposed by third parties through the power of delay. In general, wherever A pays a low cost to impose high costs on B through delay, then A can either extort money from B or thwart B’s activities that A does not like, or some combination of the two.

  Slow-moving government bureaucracies are a common complaint around the world, not only because bureaucrats usually receive the same pay whether they move slowly or quickly, but also because in some countries corrupt bureaucrats can add substantially to their incomes by accepting bribes to speed things up. The greater the scope of the government’s power and the more red tape is required, the greater the costs that can be imposed by delay and the more lucrative the bribes that can be extorted.

  In less corrupt countries, bribes may be taken in the form of things extorted indirectly for political purposes, such as forcing builders to build things that third parties want—or not build at all, where either local homeowners or environmental movements prefer leaving the status quo unchanged. The direct costs of demanding an environmental impact report may be quite low, compared to the costs of the delay which preparing this report will impose on builders, in the form of mounting interest charges on millions of dollars of borrowed money that is left idle while this time-consuming process drags on.

  Even if the report ends up finding no environmental dangers whatever, the report itself may nevertheless have imposed considerable economic damage, sometimes enough to force the builder to abandon plans to build in that community. As a result, other builders may choose to stay away from such jurisdictions, in view of the great uncertainties generated by regulatory agencies with large and arbitrary powers that are unpredictable in their application.

  Similar principles apply when it comes to health regulations applied to imported fruits, vegetables, flowers, or other perishable things. While some health regulations have legitimate functions, just as some environmental regulations do, it is also true that either or both can be used as ways of preventing people from doing what third parties object to, by the simple process of imposing high costs through delay.

  Time is money in yet another way. Merely by changing the age of retirement, governments can help stave off the day of reckoning when the pensions they have promised exceed the money available to pay those pensions. Hundreds of billions of dollars may be saved by raising the retirement age by a few years. This violation of a contract amounts to a government default on a financial obligation on which millions of people were depending. But, to those who do not stop to think that time is money, it may all be explained away politically in wholly different terms.

  Where the retirement age is not simply that of government employees but involves that of people employed by private businesses as well, the government not only violates its own commitments but violates prior agreements made between private employers and employees. In the United States, the government is explicitly forbidden by the Constitution from changing the terms of private contracts, but judges have over the years “interpreted” this Constitutional provision more or less out of existence.

  Where the government has changed the terms of private employment agreements, the issue has often been phrased politically as putting an end to “mandatory retirement” for older workers. In reality, there has seldom, if ever, been any requirement for mandatory retirement. What did exist was simply an age beyond which a given business was no longer committed to employing those who worked for it. These people remained free to work wherever others wished to employ them, usually while continuing to receive their pensions. Thus a professor who retired from Harvard might go teach at one of the campuses of the University of California, military officers could go to work for companies producing military equipment, engineers or economists could work for consulting firms, while people in innumerable other occupations could market their skills to whoever wanted to hire them.

  There was no mandatory retirement. Yet those skilled in political rhetoric were able to depict the government’s partial default on its own obligations to pay pensions at a given age as a virtuous rescue of older workers, rather than as a self-serving transfer of billions of dollars in financial liabilities from the government itself to private employers.{xxiii}

  Sometimes time costs money, not as a deliberate strategy, but as a by-product of delays that grow out of an impasse between contending individuals
or groups who pay no price for their failure to reach agreement. For example, a 2004 dispute over how a new span of the Bay Bridge in San Francisco should be built, after it was damaged in a 1989 earthquake, created delays that ended up costing California an additional $81 million before construction was resumed in 2005.{523} Construction of the new span was completed and the span opened to traffic in September 2013—24 years after the earthquake.

  Remembering that time is money is, among other things, a defense against political rhetoric, as well as an important economic principle in itself.

  ECONOMIC ADJUSTMENTS

  Time is important in another sense, in that most economic adjustments take time, which is to say, the consequences of decisions unfold over time—and markets adjust at different rates for different decisions.

  The fact that economic consequences take time to unfold has enabled government officials in many countries to have successful political careers by creating current benefits at future costs. Government-financed pension plans are perhaps a classic example, since great numbers of voters are pleased to be covered by government-provided pension plans, while only a few economists and actuaries point out that there is not enough wealth being set aside to cover the promised benefits—but it will be decades before the economists and actuaries are proved right.