Four More Years of Economics #3 and #4 Sacrifice / Thick Analysis / J Curve

Four More Years of Economics #3
Sacrifice and the ends of conservation

September 30, 2005

Dear Abhay,

As I expect you noticed, this week, for the first time in his presidency which will soon mark its fifth year, George W. Bush suggested that Americans consider conservation of gasoline. We could trace the complex series of events – hurricanes pummeling refinery areas, mishandled federal responses, escalating legal scandals – that backed him into the political corner from which he felt compelled to talk about conservation. I am more inclined, however, to focus on the moment of the statement, a moment I find as difficult to render as it is commonplace for this President. Nearly all descriptions, reporting, references to what he said, even verbatim transcripts of the words, seem to me to overstate the utterance. Only a sound recording, devoid of the visual documentation of concerned facial expressions, captures the stuttering sense with which he stumbles into the words as he says them, and the feeling that they, as Seymour Hersh has said, are just words to him. They don’t really mean the meanings that we who value words attribute to them. I would say he suggested conservation; he did not call on Americans to conserve. He said one might consider not driving if a trip is not really necessary, or perhaps taking a bus instead of a car. While “don’t drive if you don’t have to” is certainly an odd piece of advice for hurricane survivors, the suggestion of taking mass transit altogether contradicts his policy decisions, which included zeroing out Amtrak funding in his proposed budget, and even excluding trains from evacuation planning. But for the sake of this correspondence, let’s give him the benefit of the doubt and take him at his word. He promoted conservation. What can we make of this? Let us note that he never used the word sacrifice. Sacrifice, perhaps, was not on his mind.

By contrast, Jeremy Rifkin has written a powerful commentary, which I saw published in the Chicago Tribune and the Guardian in the UK, arguing that the storms directly resulted from the carbon dioxide emissions of American vehicular traffic. The effects of global climate change brought on by these emissions, he argues, have first taken effect in the Caribbean, with a documented increase in Category 4 and 5 hurricanes. Rifkin advocates conservation as well, but of a structural nature, replacing combustion engines with fuel cells, or cars with mass transit – alternatives considered in light of a distinct historical teleology; the goal of reducing carbon dioxide emissions to the point of elimination. Most American drivers would no doubt see this as a sacrifice, and would have a difficult time identifying the positive aspects of these replacement technologies when confronted with slowness, cost, and restricted convenience; or of imagining the broader economic position from which Rifkin reasons – the position that my SUV caused a hurricane that destroyed my house and took away my job. But if we accept his premise, it appears that Rifkin does not call for sacrifice either, unless one considers change a sacrifice of the status quo.

I suspect that the President’s stammering circularity around the word conservation stems from an entirely different economic model, and a much simpler one, of supply and demand. In his equation (and this is just a speculation leading to a question for you) motorist demand has remained roughly constant, while hurricanes have disrupted distribution, reducing supply. This has caused a national spike in costs, which might in turn prompt consumers to recoil and curtail travel plans (conserve). Such conservation would reduce profits. So the President, with profits in mind, made a pre-emptive strike: a suggestion that we don’t drive if we don’t have to, or take a bus. He hopes this might bring demand back into balance with supply, which would ultimately lower prices, and bring about an increase in purchasing and ultimately in profits. Profits only remain consistent in supply/demand balance; imbalance threatens them. In other words, when it becomes impossible to increase supply, one must reduce demand for the same effect. So the teleology, the ultimate goal of his words, is not one of advancement toward a changed environmental relation, or even one that takes hurricane disasters into account in any way other than as supply-reducing factors, but rather one seeking an economic balance. In this regard he is calling for a short-term consumer sacrifice, to maximize producer profits. We could further suggest that his words, and even their stammering quality, had a calculated effect on the oil producers, who would understand that the conservation he called for is precisely not structural but temporary. They might read this as a political necessity, as exactly a President backed into a corner and forced to express caring he does not really feel. Would it be going too far to suggest his statement thus contained for them a coded encouragement of price gouging?

In any event, here’s my question, in three parts.

1: First, the obligatory one: Is this a sensible economic formulation?

2: If so, (since I know you are very forgiving in what you consider a “sensible economic formulation” from me) how do we distinguish between conservation to maximize profits and conservation to alter structure? I understand that the President’s conservation might be temporary, with the idea that consumption will return to a normal level soon, whereas Rifkin’s conservation might be permanent. But setting that point aside for now, what is the difference today? If Jeremy Rifkin and George W. Bush are riding a bus side-by-side at this moment, how do their modes of conservation differ?

3: To sacrifice, literally, means to make sacred; to make sacred an event, an object, an action, even a life, through its elimination. Something becomes imbued with a double life, a physical existence on earth and a symbolic, transfigured existence in a celestial plane, through its deliberate and perhaps ritualized removal. Sacrifice also demonstrates a teleology; in fact it is a teleological act – an action precisely to bring about a goal, or catalyze a movement toward an end. I suppose this part of the question has occurred to me independent of the above Rifkin/Bush contrast: In economics, is there such a thing as sacrifice?

As always, I look forward to your response,
Matthew

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FMYOE #4
Thick analysis in the shape of the J curve

Feb 6, 2006

DALLAS - Exxon Mobil Corp. posted record profits for any U.S. company on Monday -- $10.71 billion for the fourth quarter and $36.13 billion for the year -- as the world's biggest publicly traded oil company benefited from high oil and natural-gas prices and solid demand for refined products.—Associated Press, Feb 6 2006.

“I think that basically, the price is determined by the marketplace and that's the way it should be.” —George W. Bush to an AP reporter.

My dear Matthew,

My most sincere condolences to you.

1.
Soon after the President’s recent (and brilliant) State of the Union address, I was approached by representatives of the Esteemed Establishment of Economics demanding that I make a sacrifice. Having little on my person at the time save your last letter to me, I dutifully handed the letter over to them as a gesture of sacrifice.

2.
The French naturalist Jean-Baptiste Lamarck was, until recently, widely ridiculed for his idea that characteristics inherited during an organism’s lifetime can be passed on. His views were supposedly inconsistent with the views of modern genetics.

3.
You can imagine my surprise when the most Esteemed Establishment wrote a reply to your letter and sent it to me demanding some answers from you. I hasten to forward you excerpts of their letter, wanting no part in your ill-advised questioning of our President.

4.
The older rebuttals of Lamarckian views were simplistic: One researcher cut off rats’ tails and showed that their progeny were not born tailless. Others argued that centuries of circumcision of men among certain communities had not led to the withering of foreskins of their men.

5.
The most powerful operational use of sacrifice in economics is Marx’s concept of Surplus Value. It is the ultimate sacrifice made by that invention of industrial-capitalist society: wage labor.

Labor in a capitalist society earns a fraction of what it creates. Most products and services command their value-in-exchange. Hence a product utilizing twice as many resources will usually cost twice as much. However labor only commands its value-in-use. It is paid what is needed to reproduce itself, what Marx called the subsistence wage. The remainder, which is the bulk of the value created, is what Marx called Surplus Value, all of which flows to the owners of capital.

6.
We are sorry to report, Mr. Goulish, that your economic analysis has been subject to a quick and quite unnatural death. The Esteemed Establishment of Economics has already pronounced your letter of September 30, 2005 to be classified in the category of Most Difficult to Mathematically Misrepresent and Hence Most Dangerous If Allowed to Remain Alive.

7.
The economics department at the University of Notre Dame, that last remaining refuge of free and independent thinkers succumbed to the powers of the Esteemed Establishment. Actually, the department has been allowed to continue. But only as an undergraduate department (whatever that means). A brand new graduate economics department is being created under the close supervision of the Esteemed Establishment of Economics.

8.
We ask, no command, you to immediately sacrifice your most troubling economic analyses in league with the other trouble-maker Mr. Ghiara. We thought we had eliminated the menace of Ghiara when he dropped out of Graduate School after spending seven years fighting the Esteemed Establishment of Economics at Northwestern University.

9.
In the 1970s during the last oil crisis, the great economist E. F. Schumacher, father of humanistic economics, discussed the problem with economic policies concerning oil production and conservation. He pointed out something very simple: Economic policies were (and continue to be) formulated to treat oil and other natural resources as income rather than capital.

10.
During the autopsy of your aforementioned letter, the Esteemed Establishment of Economics has found the following disturbing heretical organs:

a. In the very first sentence of your so-called analysis, you question the very bastion of the Esteemed Establishment: Supply and Demand. And you dare suggest (we now paraphrase) that a reduction in effective demand may actually allow companies to keep their profits high! May we remind you that a reduction in demand would ensure, through the workings of the Invisible Hand, a lower price and lower profit. The President is willing to allow profits in the oil industry to actually fall if it is the will of the marketplace!

b. The suggestion that the President may take action to attempt a balancing of supply and demand forces is preposterous! Every Econ 101 student is taught that the forces of Supply and Demand follow natural laws. Just as the pendulum seeks balance, the marketplace automatically and consistently seeks balance.

c. The idea that an autonomous inducement to conserve would allow profits to remain high is unsound! A reduction in supply as a result of war or other disruptions in the stream of production raises prices simply to make up for the higher costs of production. If Robinson Crusoe found that weather conditions made it twice as expensive (in terms of time and effort) to catch fish as before, he would trade half as much fish for the firewood Friday collects but his overall state of welfare or profits would certainly be unchanged! Similarly, the oil companies have raised prices simply to reflect the higher costs of production. Their profits do not increase with the higher prices.

Seeing no future in your ill-conceived views, the Esteemed Establishment pronounces your letter DEAD.

Sincerely,
The Esteemed Establishment

PS: The economist Paul Krugman whom you so respect drives a SUV. And he does not carpool. Sacrifice Goulish, sacrifice!

11.
Lamarck was, contrary to his critics, making a much more subtle point. He never believed that gross injuries or mutilations would count as acquired characteristics. Instead he forwarded the theory that function precedes form. When an organism develops a functional characteristic, it is able to pass it on, on a cellular level, to its offspring. This Lamarckian view has recently been accepted by the biological field of study called epigenetic inheritance.

12.
In a social accounting matrix, the simple error of treating capital as income would eventually lead to the draining of natural resources without a viable replacement of existing resources. If a private fund manager were to treat the stock of his or her portfolio of assets as current income it would be considered not only inappropriate but also criminal. As trustee of our natural resources our government has been acting in like manner for five years.

13.
The J curve is an important concept that was developed to explain a seemingly confusing empirical observation in currency valuation and its effects on international trade. Economic theory suggests that a drop in the value of the dollar, for example, would improve America’s trade position: The cheaper dollar would make American goods appear cheaper to foreigners, thereby stimulating our exports. At the same time, a lower purchasing power of the dollar would make Americans pick the now cheaper American goods over foreign goods. So imports should drop. Overall, since exports rise and imports drop, our trade position improves.

The problem has always been that while that is precisely what happens in the long run, in the short run the opposite seems to hold true. That is, in the short run, when the dollar depreciates, the trade position worsens! Economists explain this seeming contradiction using the shape of the letter J to explain the inner workings of this mystery. Writing the letter J involves a small but distinct loop in the downward direction before moving its trajectory upwards if the letter is written from left to right. In the short run, the physical amounts of exports and imports do not change. After all, it takes a while for people to notice changes in exchange rates and respond to them. So in the short run, since the prices of our exports are seemingly lower when the dollar drops, but the physical quantity of our exports is unchanged, the dollar value (that is price times quantity) of our exports drops. Similarly, in the short run, the dollar value of our imports is actually higher. Thus the J curve describes a movement of our trade position first towards deficit (in the short run) and then towards a surplus (in the long run).

14.
I would describe, my dear Matthew, your complex but elegant analysis of the current oil crisis as a Thick analysis (in the tradition of the philosopher Gilbert Ryle and anthropologist Clifford Geertz) whereas the Establishment Economics formulation used by the President may be described as a Thin analysis. Permit me to translate your Thick analysis into economic terms:

The idea of Surplus Value can be extended to the use of natural resources such as oil. These natural resources, as we have seen, are properly considered as capital rather than income. However, in a capitalist society with little Government regulation, the treatment of natural resources must be in the form of income. That is because if natural resources were to be treated as capital, it would be impossible to extract a surplus value from it! Capital will always command its full value-in-exchange.

Income, on the other hand, is another matter altogether. Income, like wage labor, is the product of the rise of industrial capitalism. If I own the land that oil is obtained from, and treat it as income, I must simply pay for it its value-in-use: what it takes to reproduce itself. In other words I can keep pumping oil as long as I take care to ensure that the equipment I am using can pump as much oil tomorrow as it can today. I add to that the going subsistence wages for labor and the remainder is my Surplus Value or profit.

The capitalist socio-economic structure ensures that natural resources are continuously treated as income without a need for coercion: incentive structures are laid out in such a way that each atomistic capitalist treats his or her share of natural resources, whether publicly owned or not, as income rather than capital.

Under such a formulation it is easy to see that the kind of conservation the President has called for makes absolutely no structural change to the issue of oil and other natural resources. Had the President’s words meant a genuine change in the government’s treatment of oil from income to capital, we would have observed a corresponding sharp decline in the profits made by the oil companies as Surplus Values were drained.

My four month lag in replying to your letter from September has provided us with a wonderful chance for empirical validation: Which scenario was the President really representing? One where the government’s policy seriously shifts the economy from treating oil as income towards treating it more as capital or one where the status quo is maintained under the apologist veneer of what I have called the Esteemed Establishment of Economics?

15.
You can not have incentive structures clearly laid out to encourage an automobile-based economy and seriously expect individuals to then not follow those very incentive structures. A Lamarckian approach to the issue of oil would require us to rethink our approach to the economics of oil and natural resources. The conservation policies that the President is suggesting amount to gross and nonfunctional changes that are not likely to effect inter-generational changes much as cutting off rats’ tails do not lead to future generations of tailless rats. As Lamarck stated, function precedes form. What we have here from our President is form (in the form of conservation policies) without a corresponding function. A call for conservation under such circumstances is disingenuous.

If we postulate that the J curve may explain more than the balance of trade on currency markets, that the J curve may in fact describe more general movements of economic magnitudes (involving prices and quantities) from the short to the long run, we can explain why the President would favor his version of conservation while his administration’s policies are clearly pointed in a diametrically opposed direction. The J curve requires the administration to move consumers in one direction in the short run only to ensure a sustained movement in the opposite direction! That is precisely what your brilliant Thick analysis of the current situation indicated.

And so, my dear Matthew, my heartiest congratulations to you,

Abhay

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Epilogue: Impose Pain

March 25, 2006

Dear Abhay,

The conservative talk show host Laura Ingraham recently asked Vice President Dick Cheney to comment on proposals to increase gasoline tax in order to encourage the use of energy-saving vehicles. The Vice President responded:

“Well, I don’t agree with that. I think – the president and I believe very deeply that, obviously, the government has got a role to play here in terms of supporting research into new technologies and encouraging the development of new methods of generating energy … But we also are big believers in the market, and that we need to be careful about having government come in, for example, and tell people how to live their lives …This notion that we have to ‘impose pain,’ some kind of government mandate, I think we would resist. The market place does work out there.”

To my knowledge, Laura Ingraham did not ask follow-up questions about why, if the market place “does work out there,” the administration seeks to influence it by lowering taxes, but not by raising them; about why the administration’s 2005 energy act contained roughly $2 billion in tax breaks for oil companies; or about the decision, historically unprecedented, to enact wartime tax cuts, thus financing a war by raiding our children’s social security.

Thank you, Abhay, for the clarity of your statement: that we have come to treat natural resources as income to be devoured rather than as capital to be conserved. Now it appears we have begun to treat the future that way as well.

Matthew