Comment on Carpe Diem’s quote of the day

This is a response to  Carpe Diem’s quote of the day: http://mjperry.blogspot.com/2012/09/quotation-of-day-fallacy-of.html

The major problem today is the way in which redistribution occurs.

As Give and Take Economics shows us, to maximize wealth, personal total cost and personal total benefit must always be coupled – our current systems break this bond and weaken wealth building for everyone.

Taxes shouldn’t be tied to income or consumption. They should be a combination of evenly distributed flat taxation for services utilized by everyone (such as defense) at a level voted on directly by the majority, supplemented by user-fees (i.e. bridge tolls) where direct use can be determined. To ensure transparency, taxes should be gathered for specific programs, not just swept up en masse.

For those that can’t afford their allocated share of taxes to support the infrastructure of society, there needs to be an opportunity to ‘pay taxes’ by providing services to society–working on road repair crews, administering government programs etc. Realizing that most government jobs should be such workfare roles vs. ‘careers’, removes the biggest redistribution that deteriorates wealth domestically.

On a different level, the biggest redistribution problem today is that the West has signed up for imbalanced trade with China. The result is the massive redistribution of wealth to the East and a hollowed out middle class with no jobs at home. Balanced trade is required immediately. Any trade other than balanced trade distorts and reduces wealth in the long-term.

The Editor,
EconomicsReinvented
www.economicsreinvented.com

Share

A Excellent Dialogue with Smiling Dave on His Blog

Dave, Thanks for sharing excellent thoughts. Our formal economics training heavily leans toward the Austrian school, so we are significantly aligned. A few follow-on comments have been added in this post. Your comments are in blue and our responses are in red and underlined.

They asked me for input, for which I am honored. I have some questions indicating I have not grasped what they are saying, and am hereby requesting clarification.  Quotes from anyone in italics, Smiling Dave in regular font.

1. Give & Take Economics redefines the model of how individuals make decisions. It replaces the idea that they solely balance external prices and quantities in a scarcity-driven trade-off with the notion that they make an internal psychological trade-off of how much cost they’ll bear to obtain benefit. On this intuitive foundation, decisions are modeled with a pragmatic Leaning X diagram. The theory goes much further however, to also redefine the way individuals interact with each other. It expands the classic supply and demand curves into give and take curves, which places all social agreements (including economic transactions), within this context of individuals mutually balancing personal total cost (PTC) and personal total benefit (PTB). [Source]

I’m not sure what exactly is new or different in their basic approach from that of AE [ = Austrian Economics]. Didn’t Mises already write that people act to better themselves, doing what they think will get the job done? Didn’t he already write that bettering yourself doesn’t have to mean have more money? Aren’t the concepts of opportunity cost and risk used all the time by Austrians?

We agree with you that Give and Take Economics heavily relies on Austrian economics and that opportunity cost, risk and non-financial motivations have been previously captured. Give and Take Economics drives things forward by replacing the entire ‘economic’ decision with an overarching internal psychological one. The balancing of prices and quantities becomes secondary to the balancing of personal total cost versus personal total benefit. Elements such as ego, personal biases and favoured relationships all significantly and directly impact decisions. Existing models do not capture this reality in their formal frameworks. Give and Take Economics does—formalizing it in individual decision-making via the leaning X diagram—and when people interact via give and take curves. The theory also significantly leverages the formal modelling of Cumulative Prospect Theory.

To illustrate the difference with an everyday scenario, consider a person deciding whether or not to embark on an exercise program. Contemporary theory would model this person’s decision as one where they faced outcomes of either weight gain or weight loss with various probabilities. In contrast, Give & Take Economics models this as a decision where the person faces a choice of how much ‘pain’ (certain & uncertain PTC) they are willing to take on in pursuit of ‘gain’ (certain & uncertain PTB). A person doesn’t face alternatives of either being thin or overweight; they face the alternative of being thin while having to avoid excess calories or that of being overweight and enjoying lots of great food. The decision isn’t across a ‘lottery’ of outcomes either good or bad. The decision-maker bears both the PTC (the effort required) and the PTB (improved weight on the scale) in each scenario – a concept we call matched outcomes.

2. This new framework has major implications. It makes equilibrium impossible and explains how booms/busts and fads/counter-fads occur—something that current theories can’t address.

I thought AE gives a very nice account of booms and busts. And their explanation is mysterious. All it says, as I grasp it, is that the lemmings decide to run in one direction, because they think they’ll make money, then decide to run in the other direction. I don’t see where there is any predictive value in this explanation.

AE, on the other hand, does predict business cycles, to a certain extent, in that it claims that whenever you get a huge increase in the money supply, a boom followed by a bust is sure to happen within a few years.

So my questions are, what do they see wrong with AE’s explanation? What is the predictive value of their explanation?

Austrian theory is very accurate in its prediction that money supply increases are the most prominent source of boom/bust cycles, however ‘capital structure lengthening’ does not hold up in today’s service driven economies. Give and Take economics explains the type of bubbles we do see in today’s real estate and equity markets; bubbles tied to greed and fear emotions rather than ‘fundamental’ financials. Give and Take economics predicts bubbles whenever rapidly higher risk levels are taken on. This can involve the printing of money, media buzz etc. Beyond boom and bust cycles, Give and Take Economics is able to predict success or failure of other social policies—in welfare systems, tax policy, crime and punishment etc. Many examples are provided at http://www.economicsreinvented.com/?page_id=19. It can also be used to predict much simpler individual situations—such as whether someone will be successful in losing weight etc.—by identifying the PTC and PTB associations that individuals make.

3. Rothbard critiqued this lemming theory long ago. May as well quote him, from America’s Great Depression:

OVEROPTIMISM AND OVERPESSIMISM

Another popular theory attributes business cycles to alternating psychological waves of “overoptimism” and “overpessimism.” This view neglects the fact that the market is geared to reward correct forecasting and penalize poor forecasting. Entrepreneurs do not have to rely on their own psychology; they can always refer their actions to the objective tests of profit and loss. Profits indicate that their decisions have borne out well; losses indicate that they have made grave mistakes. These objective market tests check any psychological errors that may be made. Furthermore, the successful entrepreneurs on the market will be precisely those, over the years, who are best equipped to make correct forecasts and use good judgment in analyzing market conditions. Under these conditions, it is absurd to suppose that the entire mass of entrepreneurs will make such errors…The prevailing optimism is not the cause of the boom; it is the reflection of events [=money printing]that seem to offer boundless prosperity.

There is, furthermore, no reason for general overoptimism to shift suddenly to overpessimism; in fact, as Schumpeter has pointed out (and this was certainly true after 1929) businessmen usually persist in dogged and unwarranted optimism for quite a while after a depression breaks out.[30] Business psychology is, therefore, derivative from, rather than causal to, the objective business situation. 

My question is, how do they reply to Rothbard’s critique?

Rothbard is a great economist, however, this critique shows why he is certainly not a psychologist, nor a historian. Economic decision-making is an element of psychological decision-making, which is also emotionally driven. Booms and busts are not ‘errors’. They are deliberate manipulation. It is completely rational to both start a hyped-up boom and to jump on to an ongoing boom attempting to profit, trying to bail out early. There’s an entire industry devoted to it – equity speculators. There is also a very good reason that optimism suddenly turns to pessimism—the instinct of fear. Market collapses are always faster than market run-ups. We all agree that the printing of money provides extra liquidity for speculation, and inflation in consumer prices and assets. This being said, it is likely true that Give and Take Economics adds less to our understanding of market cycles than it does as a broad framework to analyze and predict all social coordination issues.

4. It also produces a powerful tool that we can use to immediately determine the effectiveness of policies and institutions—coupling analysis—based on the notion that most social problems result from social coordination failure, where PTB and PTC are decoupled across individuals and populations.

I agree with this. But isn’t it a well known concept, what economists call moral hazard? In short, if you are gambling with other people’s money, you will take wild risks. My question is, what is new here?

Moral hazard is about risk and it is an element of decoupling. Decoupling includes risk and fully certain misallocations. For example, the entire concept of taxing income is a decoupling that we have all internalized as logical, even though it is not. If society needs all of us to ‘pitch-in’ to provide a service, such as policing, then the cost of policing should be distributed across citizens evenly. This keeps the cost of services associated with those that benefit. When costs are decoupled from benefits and funded disproportionately by some ‘other rich guy’. Costs for all social services escalate to out of control levels, like we see today, and the ‘other rich guy’ ploughs more efforts into lobbying for tax relief to counter. All because everyone is passing off cost to someone else, rather than paying their share.

5. Decoupling results primarily when populations disengage enough to allow the formation of powerful intermediaries (including government and business); a situation that has resulted in our current strained models of capitalism, socialism and representative democracy.

Indeed, the problem with socialism and democracy is that you give one group control of another group’s money. But how did capitalism get in that list? And why do you say capitalism, aka a free market, is strained? If you hang around the msies.org website long enough, you’ll see how govt meddling [an unfree market] is the underlying cause of economic strains.

Good points. In the real world, capitalism generally means private enterprise as opposed to government, which is very rarely the same thing as free markets. We have lots of private enterprise, but very few free markets in the world. Many industries have aggressive lobbies restricting competition against their oligopolies. A telling example was the sub prime debacle, where Wall Street—the ‘bastion’ of the free market—ripped off the rest of society by socializing costs and privatizing the gains. Give & Take Economics shows us that it will absolutely happen again, as few executives had to pay anything back or went to jail. Sure, many industries are competitive, but all the big ones aren’t. They generally operate with the government in their back pocket through professional lobbies. The reason we say that capitalism has eroded (we likely should have said free markets), is that business competition has given way in so many markets to competition by lobbying, litigation and acquisition of competitors. Whether government or business, once power is amassed it will be deployed for the benefit of those that hold it. Free markets are strained for this reason. It’s really no different than how unions distort the free market through amassed power.

Summing up, I think these guys have their hearts in the right place. I think they do identify many problems the main stream pooh-poohs. They are not the guys you’ll see Smiling Dave attack mercilessly, like the many hacks and frauds that abound. But I do think their theory, and certainly all their conclusions that differ from AE’s, have some ‘splainin’ to do.

We hope this helps ‘splain’ a little. We’re all proponents of Austrian Economics, and feel that Give & Take Economics is an evolution on that strong foundation. We look forward to reading futher posts.

Cheers,

The Economics Reinvented Team

www.economicsreinvented.com

 

 

 

Share

How to Solve the Fiscal Cliff

Current discussions concerning the fiscal cliff are much like an argument over which type of bullet one should shoot him/herself with. Here’s a common sense reality check on what the framework for a solution needs to look like:

  1. Spending has to fall. It should always trail revenue. It’s that simple.
  2. Taxing the rich is not the answer. Flat taxes for specific programs and user fees are the answer. If programs are too expensive when allocated as a flat tax or user fees across all citizens that will benefit, then they are too expensive for society.
  3. Lobbies need to be neutralized since they are the major driver of out of control spending. There will be repeats of the fiscal cliff over and over again as long as lobbies—corporate, labour and social causes—control politicians. The free riding from the left and the right each need to be slashed.
  4. The size of the permanent government needs to be slashed, and services don’t need to be cut while doing so, since many government roles can be converted from ‘careers’ to ‘workfare’ opportunities.
Share

Is Give & Take Economics Left or Right Leaning?

As people try to place Give & Take Economics into a familiar category they typically first ask whether it is left or right leaning. On one hand it seems very right leaning, due to a focus on free interaction, both in markets and in political participation. On the other hand it seems very left leaning, with a strong focus on obligation of the individual to society and the will of the majority. It is both—not a passive moderate position—but an assertive balancing of both ends of the spectrum. Like most effective solutions in life, Give & Take Economics reflects yin and yang. It leverages the best of capitalist democracy and socialist democracy.

The best way to illustrate is to highlight by example where the theory falls on major economic, political and generally social issues. Here are a few summarized. They’re analyzed in other posts.

Right-Leaning

  • Balanced government budgets and nothing else.
  • Balanced international trade. If not balanced, don’t trade.
  • Benefits-driven versus revenue-driven taxes. Taxes aren’t tied to income or consumption, but levied as flat taxes and user fees across citizens toward a certain purpose.
  • Direct democracy by citizens with electronic issue-by-issue voting. No professional politicians and very few career bureaucrats exist.
  • Free markets and libertarian rights for individuals are vital and must be protected against significant breaches.
  • Tough legal sanctions tied to crime, including white-collar crime. Today’s approach of punishing only a few scapegoat fall guys must end.

Left Leaning

  • A significant social safety net such as employment insurance, social security and health care is mandatory and vital.
  • Completely stop printing money and eliminate monetary and fiscal policy.
  • Those unable to pay flat taxes and who need social support can contribute time and labour within the civil service. Workfare replaces welfare and most government careers.
  • Asset inflation ‘bubblation’ is as bad as consumer price inflation, being a tax on the poor and middle-class
  • Every citizen bears an equal allocated share of social obligations, including direct costs of programs as well as a prorated share of risk-sharing schemes.
  • Citizens should simply not be allowed to profit from any activity that hurts society.
  • The will of the democratic majority must take overall precedence in the functioning of society.
Share

How to REALLY fix the Economy in 8 Steps

Here are the eight highest priority actions required to get the world economy back on track, with a stable foundation and consistent long-term consistent growth. These actions effectively couple personal total cost (PTC) and personal total benefit (PTB) as presented in Give & Take Economics theory.

8 Primary Actions Required

  1. Balance government budgets: These must be a small proportion of national wealth and include a significant surplus cushion. This is the most urgent issue to tackle as the entire Western world. Debt and deficits are ALWAYS a spending problem, as spending must always be brought in line with revenue.
  2. Balance international trade: Trade must be explicitly reduced with offenders, because trade flows is the most significant determinant of relative long-term wealth and power. This is also of critical urgency from the perspective of the West, as it erodes its own political power.
  3. Stop printing money: This does nothing more than cause inflation (or asset bubblation), representing a large effective tax on the middle-class. As the developed world sits in a crisis of living beyond it’s means with massive debt, the solution our leaders are following is to do more of it, by printing massive amounts of money and further deteriorating our wealth.
  4. Enact benefits-driven vs. revenue-driven taxes: Core taxes must be flat and only collected on a transparent specific need basis (ex. If government pensions are to be increased, a tax must be issued for that). Costs (period taxes or user fees) need to be allocated to those that benefit as closely as possible). ANY other approach just creates a confusing government slush fund to be allocated across lobby groups. Citizens should be able to pay taxes in currency or in hours of service working for government.
  5. Revise the legal system: Today’s legal systems rarely tie PTC to PTB. Too often leaders of large institutions, whether Wall Street banks or government, are able to gain PTB without bearing any PTC. Gains are privatized and losses are socialized. Compensation and responsibility must follow individuals accountable for decisions and actions.
  6. Ensure free interactions (markets/government) with accountability: Free markets get all the attention, but markets and government are both just coordination mechanisms. They are both faltering today due to a lack of transparency that protects free riders. All social interaction systems must maximize individual freedom, provide meaningful access and enforce a level of social obligation determined by the majority.
  7. Reduce the number of professional politicians and bureaucrats: Professional politicians need to be eliminated over time, as the approach does nothing but disconnect people from the issues. Government jobs should for the most part not be ‘careers’, but rather workfare programs. This approach enlists citizens in service to society by coupling PTB and PTC.
  8. Transition to direct government: Citizens have to dig deeper than election sound bites to understand issues. People need to be directly educated and involved on major political and economic issues. Today’s democracies have outsourced decision-making and most citizens vote solely based on broad ideological concepts, not practical approaches. Gridlock ensues. Referendums need to be held on most issues through online voting. Majority decisions need to be implemented, not providing for endless challenges from minority positions.

2 Primary Barriers to Overcome

There are two barriers to such change, yet each requires tremendous persistence to overcome. The first is the current level of rampant vested interests, where existing intermediaries (government, corporate lobbies, unions, corporations, social causes etc. — left AND right) benefit at the expense of others. The second created the first; it is the disengagement of the public—you and I—which has became predominantly complacent and outsourced political decision-making.

Share

The Serious Need for a New Theory of Economics

The disconnect between today’s economic theories and what we see in the real world is stark and widely acknowledged. A series of major economic approaches—Keynesian, monetarist, new classical, and most recently the great moderation—have failed us with drastic consequences. We’ve hit a crisis point, with fiscal cliffs, bank bailouts, sovereign debt crises, massive deficits, widespread public demonstrations and deadlocked lobby-driven politics. More troubling is that we continue down the same road—because even our experts are relying on flawed theory.

It’s time to replace our way of thinking right from the basics. Models like expected utility, cumulative prospect theory and even the venerable supply and demand framework need major updating. The Austrian school of economics has provided us with significant insight, framing economics as a human rather than mechanical endeavour, but we still need to go further to explain our world. Here we introduce a new theory—give & take economics (also referred to as give & take decision theory or psychological economics). It’s a single pragmatic model which takes account of economic, political, sociological and psychological influences to a decision—and it’s boiled down to a simple construct, like supply and demand, that we can apply in business.

Share