Your Teacher Said What?! (8 page)

For Progressives in search of a theory to back up their instinct that bureaucrats know best, this has been a godsend. Reviewing
Hayek
's
Road to Serfdom
(which he called “a grand book”), Keynes wrote, “What we want is not no planning, or even less planning; indeed I should say we almost certainly want more.”

Krugman, Paul.
American economist (1953–), professor at Princeton University and the London School of Economics and columnist for the
New York Times
. Winner of the 2008 Nobel Memorial Prize in Economic Sciences.

There are at least two different Paul Krugmans. One is a fairly wonky college professor who has specialized in the intricacies of international trade, written eloquently on the virtues of free trade, and attacked government intervention in the economy, including rent control, minimum-wage laws, farm subsidies, and “strategic industry” investment. The other one isn't.

The one who isn't has written a dozen books and more than eight hundred columns for the
New York Times
attacking conservatives in every walk of life. In these books and columns, he typically supports more governmental intervention in the economy (no matter how big the intervention, as with the $700 billion Troubled Asset Relief Program of 2008 and the multitrillion-dollar stimulus programs of 2009 and 2010, it never seems to be enough), policies to promote income equality even at the cost of income growth, and anything that lays the evils of the world at the feet of the Republican Party generally and George W. Bush specifically. This Krugman is an avowed welfarestate supporter whose worst collectivist instincts have been unleashed by his position at the
New York Times
(which shouldn't, after all, surprise anyone) to the point that his former support for open immigration and free trade has become so watered down that it is unrecognizable. Like most Progressives, Krugman-the-columnist is far happier spending time thinking how to divide the economic pie fairly than thinking how to make it larger.

Leverage.
Noun. The amount by which gains and losses may be multiplied in any transaction; verb (informal). The technique of multiplying gains and losses. Typical forms of leverage include investing with borrowed money and investing in
derivatives
. (Note: In corporate accounting, leverage is a measure of the relationship between revenues and net income—that is, how much difference a percentage-point increase in sales makes in a company's
profit.
)

The key measure of a banking system's health—or vulnerability—is the amount of leverage represented by the difference between its worst-case obligations and its best-case assets. See
Risk.

Monopoly.
Noun. (Blake: “This is not the board game.”) A business in which a single firm or individual is the only seller of a particular good or service; from the Greek
monos
, or “one,” and
polein
, or “seller.” A “monopsony” is a business with a single buyer; an “oligopoly” (or “oligopsony”) is one with only a few buyers or sellers. Absolute monopolies are virtually nonexistent, but the term “monopoly pricing power” is used to describe the freedom with which some businesses can set prices for their products.

The real reason that governments have laws to limit monopolies is the theory that monopolies can charge whatever they want for their product or service. However, the ability to charge a lot—that “monopoly pricing power”—is actually pretty limited. In a free market, when a company is so dominant that its profits head toward the stratosphere, it inevitably attracts a competitor with an eye on those profits. In fact, the
only
time this doesn't happen is when—you guessed it—the government itself discourages, or even forbids, competition. There may be times when this isn't too bad (once upon a time, AT&T owned a government-granted monopoly on phone service, under the theory that nobody wanted a competition for building the most telephone poles down every street), but it is always to be regarded with skepticism.

Price.
Noun. The payment made by one person to another in return for goods or services.

Prices don't have to be made in terms of money; barter, for example, can still serve to set a price for any particular exchange. Nor does a price have to be fixed. Auctions set prices based on the highest value that can be charged. Prices can be expressed as “nominal” (dollars and cents) or “real” (as compared to another good or service). They can be stated as the balance point between the marginal utility and the marginal cost of a particular object—the benefit or cost of the last one bought or sold.

However, in a free market, the real significance of price is that it is the way in which sellers tell buyers how much they want of something. The immense power of price signals, all by themselves, to “direct” business decisions, is the reason that free markets are both better organized and far more productive than controlled ones.

Profit.
Noun. An increase in wealth from any productive pursuit or investment.

You might think that “profit” is a pretty simple thing to define, whether you're running General Electric or a corner lemonade stand: revenue minus costs. But nothing is simple once economists get hold of it. “Cost,” for example, isn't just the five dollars you paid for the lemons and sugar at the supermarket; it's also the value of something else you might otherwise have done with the same five bucks. In fact, it's the value of the
most
valuable thing you might have done, which is what economists call your “opportunity cost.”

Which is why, when Blake and Scott assemble the ingredients for that hypothetical lemonade stand, their “normal profit” is not just the cost of the lemonade mix (the water, table, sign, and chairs aren't free, exactly, but are positive
externalities
) but the value they put on spending that money—and their time—on something else.

Regulation
and
deregulation.
Nouns. Regulation is the process of controlling behavior, usually economic behavior, by rules, or any individual rule designed to do so. Deregulation is the elimination of one or more such rules.

Though regulation can be voluntary (as when an association tries to get its members to abide by a particular behavior), the term usually refers to the kind of rules that have the force of law—the regulations imposed by government to ensure a particular outcome that wouldn't happen in an unregulated free market.

Even a hard-core libertarian recognizes the need for
some
government regulation, if only to enforce contract laws. But as always with any government activity, anything worth doing is, soon enough, worth overdoing, and the various levels of government in the United States currently regulate construction permits, professional licenses (for everyone from surgeons to cosmetologists), advertising, the nutritional components of food, and the prices paid for literally thousands of commodities.

While there is a rationalization for every one of these regulations—generally some amorphous conception of the “public good,” as when the City of New York proposed limiting the amount of salt in restaurant food—there are two profound free-market objections to regulation in general: First, governments are very bad at calculating the costs and benefits of regulation—not surprising, since the cost of regulation is almost entirely borne by businesses. This is why multimillion-dollar dams are hostage to the habitat of a single population of fish or birds, why the Food and Drug Administration tries to ban food colorings with a risk of one death in ten
billion
, and why
cap-and-trade
legislation is projected to cost about ten times as much as the benefit it might realize.

But there's another reason for libertarians—for anyone, really—to be suspicious of regulation, and that's the unavoidable fact that politicians make decisions, well, politically (see Nowhere, Bridges to). Regulation may be necessary—but it should always be regarded as a necessary evil.

Risk.
Noun. The probability that a future event will diverge from its expected value; the chance of a particular event occurring multiplied by its monetary (or other) cost or benefit.

It's a pretty short jump from the idea that people are irrational about risk (especially financial risk) to the idea that they need to be protected from it.

 

“Blake, I have ten boxes here. One of them has a dollar bill inside.” I move it to the left side of the table. “One of the other nine has a ten-dollar bill in it.” I move the other nine to the right. “Which one do you want?”

Blake picks one of the nine boxes on the right.

“What if there were twenty boxes on the right, and one of them had a ten-dollar bill in it?

She still picks one of the boxes on the right. Blake likes long shots.

 

Though risk is, technically, just as much a measure of positive uncertainty as negative, the popular understanding is overwhelmingly about the likelihood that bad things might occur; when people talk about the risk of global climate change, they aren't referring to the possibility that Siberia might become as fertile as California's Central Valley (though they would if they had a proper understanding of risk).

A good case can be made that the most important difference between today's economies and yesterday's is the degree to which we have developed tools to measure, and manage, risk rather than to fear it. This difference in the understanding of risk is one of the most dramatic differences between Progressives and free-market advocates. When a welfare state tries to remove the dangers of bad economic outcomes—and, to be fair, when businesses ask to be rescued by government from either bad luck or their own ineptitude—they are trying to
eliminate
the element of risk; when entrepreneurs start new businesses, they are doing their best to
manage
it. It's no accident that “risk” is derived from an Italian word,
risicare
, meaning “to dare.” Blake's attraction to the big payoff, even in the face of poor odds, is classic entrepreneurial behavior. John Nye, an economist at George Mason University, has made a career proving that
irrational
choices—what he calls “lucky fools”—are the foundation of real economic growth.

Scarcity.
Noun. Insufficiency or shortage of supply.

One of the most important lessons Penelope and I try to teach Blake and Scott is that they will always want more stuff—desserts, video games, musical instruments—than there is stuff available, which means that they have to choose. This is also the core of all economics, free market or otherwise: the idea that people always want more of things of which there are, at any moment, a finite amount.

Scarcity is what gives things value, but the way it does so isn't all that obvious. The first free-market economists thought that people valued things based on what it cost them—in pain or effort—to acquire. The bigger the nuisance you were willing to suffer, the more you valued whatever you were suffering for. Since the 1930s or so, value from scarcity has been generally defined (by a group of economists from Vienna, the so-called Austrian School, led by
Friedrich Hayek
) as an opportunity cost: not the effort or pain required but the “highest-valued alternative foregone.”

Not, you may think, the easiest concept to communicate to a ten-year-old.

 

“Blake?”

“Yes, Dad?

“What is the value of that new guitar you've been eyeing?”

“You mean, what does it cost?”

“Sort of. The value is what you're
willing
to pay for it, not what someone
wants
you to pay for it—though they can be the same.”

“I don't know, exactly.”

“Okay, let's say it costs as much as your field hockey stick—and you can keep the hockey stick or get the guitar. Which do you choose?”

“Not fair!”

 

Well, no one said it was easy. In fact, Blake was correct: Any decision by her parents to force her to choose is, by definition, arbitrary; we don't have to give up the hockey stick to get the guitar, and she knows it. By the same token, any requirement that she “earn” the guitar by doing chores around the house is also arbitrary, since she isn't creating anything of value that can be swapped for the instrument.

Even so, the lesson is real. And so are the implications, which have been torturing economics students for decades. The opportunity-cost model, for example, confuses a lot of people because it seems to require that the quantity of valuable things stay fixed and unchanging, but while we know that wealth can and does increase
over time
, at any given
point in time
—which is where we buy and sell stuff—it actually is fixed. If it isn't scarce in the short term, it isn't really valuable.

Teaching Blake and Scott about the inescapable reality of scarcity and the importance of choice—that they can't have their cake and eat it too—is one of the most important jobs Penelope and I have. Whenever it becomes too much of a challenge, we console ourselves with the thought that they will figure it out. And with one other thought: Since
everyone
has a different set of opportunity costs (Blake and Scott would rather have an ice cream than a dollar, but the ice cream shop would rather have the dollar), it stands to reason not just that choice matters but that choices made by individuals are light-years more efficient than those made by bureaucrats. Once Blake and Scott learn that, they'll be several laps ahead of virtually every elected official in the country.

Smith, Adam.
Scottish philosopher (1723–90) and the founder of the discipline of economics. Author of
An Inquiry into the Nature and Causes of the Wealth of Nations
.