Misguided Mercantilism Hurts Solar Energy Consumers

The Obama administration has acted to protect Americans from cheap access to solar energy, imposing tariffs of 31 percent and even 250 percent on solar cells and panels imported from China.

As I noted previously, this case echoes one of the most famous documents in the history of free-trade literature, Bastiat‘s famous ”Candlemakers’ Petition.” In that parody, the French economist and parliamentarian imagined the makers of candles and street lamps petitioning the French Chamber of Deputies for protection from a most dastardly foreign competitor:

You are on the right track. You reject abstract theories and have little regard for abundance and low prices. You concern yourselves mainly with the fate of the producer. You wish to free him from foreign competition, that is, to reserve the domestic market for domestic industry.

We come to offer you a wonderful opportunity. . . .

We are suffering from the ruinous competition of a rival who apparently works under conditions so far superior to our own for the production of light that he is flooding the domestic market with it at an incredibly low price; for the moment he appears, our sales cease, all the consumers turn to him, and a branch of French industry whose ramifications are innumerable is all at once reduced to complete stagnation. This rival … is none other than the sun.

Read it at Cato @ Liberty
Next, the Sun
By David Boaz
(h/t Don Boudreaux at Cafe Hayek)

This move has to be disheartening for those parties interested in moving the US away from oil and coal towards more 'green' energy. In order to support domestic solar producers and possibly add a few jobs in that industry, the Administration has raised the price of solar to consumers. This move is therefore also a win for oil and coal producers who are spared the tougher competition from Chinese solar companies. Imports represent real benefits, but that notion is all too often forgotten by both political parties. This is just one more example to add to the list of misguided mercantilism.

Points of Public Interest

1. In America, the shale gas revolution is creating jobs and growth. It can here too - Matt Ridley explains the importance of cheap energy in creating jobs.
2. Free Trade Ad Nauseam - Jagdish Bhagwati makes the case against increasing protectionism.
3. Why bother with microfoundations? - Noah Smith reasons that micro-founded models may only occasionally be better than aggregate-only models. This offers some good background on the potential misuse of current models for determining public policy.
4. Corruption and Politics - The motivation behind crony capitalism stemming from a highly centralized government.
5. JKH On Saving And Sector Balances (WONKISH) - MMR continues to illuminate flaws within the prescriptive portion of MMT, based on slight adjustments in meaning. Read the comments on the site to see much of the new insights being hashed out.
6. Warren Buffett: Baptist and Bootlegger - One of the all-time great investors has been as savvy in political calculation/courtship as he has been in picking stocks.
7. He Had Moves Like Jagger - Steve Horwitz praises the economic rhetoric of Frederic Bastiat.

Quote of the Week

...from The Economic Consequences of the Peace by John Maynard Keynes:

“Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some.”

“Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

In this book Keynes discusses likely consequences of the peace treaty signed after World War I. Keynes shows remarkable foresight in recognizing that the burden of restitution placed on Germany and Austria-Hungary was so great that it would lead to further war in the future. There are many timely concepts within this book which are important for a peaceful resolution to the current European crisis. The passage above, however, is interesting given the recurring requests in the US for the Federal Reserve to implement higher inflation targets.

Although many people today may be quick to write off any ideas stemming from Lenin, this description of inflation is particularly telling and was accepted by Keynes. As I noted in Higher Inflation Displays Bad Economics, “it should be apparent that inflation encourages the accumulation of debt and benefits those possessing and producing goods.” A policy of higher inflation may therefore exacerbate the current wealth disparity that many proponents of this policy consistently argue against. Frédéric Bastiat, in Essays on Political Economy, observed that inflation is a policy for which the “immediate consequence is favourable, [but] the ultimate consequences are fatal.” Problems with the US economy clearly still exist, but I remain convinced that Inflation is NOT the Answer.

Points of Public Interest

1. What’s MMT About Anyway and is the Job Guarantee Crucial to the Project? - Pavlina Tcherneva discusses the subjective policy recommendations that necessarily give Modern Monetary Theory value and offers her view on the recent debate among MMTers about the importance of a Job Guarantee.
2. How Egalitarianism Increases Inequality - Bryan Caplan makes an argument for praising the 1%.
3. The Right Kind of Hope - John Hussman highlights the poor prospects for long-run returns across asset classes and provides an update on the continually worsening European crisis.
4. Does the free market corrode moral character? - Michael Walzer compares the effects of competition on moral character within politics and markets.
5. Bastiat's Insight on Government Inaction - David Henderson explains why disapproving of government subsidies for an action is not the same as disapproving of the action itself.
6. A Challenge for Libertarians Against Federal Recognition of Same-Sex Marriage - Steve Horwitz offers his view on why supporting same-sex marriage “is fundamental to classic liberalism.”

Update (1): Responses to Two Objections to My Challenge - Steve Horwitz responds to a couple comments on the above post.

Update (2): The Job Guarantee, Kleptocracy and Blogging - Edward Harrison posts a follow-up to Pavlina Tcherneva’s comments on the Job Guarantee.

Liquidity Traps: Refuting the Irrefutable

In a recent article at Cato Unbound, titled Tim Congdon on Liquidity Traps vs. Portfolio Rebalancing, Robert Hetzel says: (emphasis mine)

If the public is sufficiently pessimistic about the future so that asset prices are low and the demand for money is high, the central bank might have to create a significant amount of money to influence the expenditure of the public. The institutional fact that makes a liquidity trap an irrelevant academic construct is the unlimited ability of the central bank to create money. One can make this point in an irrefutable manner by noting that the logical conclusion to unlimited open-market purchases is that the central bank would end up with all the assets in the economy including interest-bearing government debt, and the public would hold nothing but non-interest-bearing money. Because that situation is untenable, individuals would work backward from that endpoint and begin to run down their money balances and stimulate expenditure in the current period.

Hetzel is trying to demonstrate that the Federal Reserve can still influence aggregate demand even when the interest rate is against the lower bound (0%). Unfortunately, his irrefutable, logical conclusion is actually quite refutable and illogical. In Hetzel’s theoretical world, individuals willingly part with all of their assets (food, clothes, shelter, etc) in order to receive non-interest-bearing money from the government. Since the central bank owns all of the assets, individuals are then forced to purchase goods back from the central bank. (An aside: How does the central bank choose the price to charge?) While this certainly does stimulate expenditure, since individuals could not otherwise survive, history and logic suggest this moment could never arise. Using the same basic premise, here is a different possible conclusion:

A central bank decides to engage in unlimited open-market purchases. After parting with many/most of their assets, individuals realize that without food (assets) they will be unable to survive. These individuals resist exchanging their remaining sustenance for non-interest-bearing money. Working backward from that endpoint, individuals will begin to hoard physical assets. As other individuals try to purchase goods with money, the money price of assets will rise dramatically (money is devalued). The central bank’s actions will stimulate expenditure until individuals are no longer willing to accept money as a means of exchange.

Although both examples initially result in increasing expenditures, the second example is far from desirable for any economy. Based on this more realistic conclusion, some level of open-market purchases will likely pressure individuals to refrain from participating in the exchanges. An unlimited amount would therefore completely undermine the value of non-interest-bearing money.

To be clear, I am not suggesting that open-market purchases are inherently bad. My example simply makes clear that open-market purchases may have stimulative effects on short term expenditures, but longer-term costs that far exceed those benefits. As the great Frédéric Bastiat noted many years ago: (emphasis mine)

In the department of economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to a series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously with its cause--it is seen. The others unfold in succession--they are not seen: it is well for us if they are foreseen. Between a good and a bad economist this constitutes the whole difference--the one takes account of the visible effect; the other takes account both of the effects which are seen and also of those which it is necessary to foresee. Now this difference is enormous, for it almost always happens that when the immediate consequence is favourable, the ultimate consequences are fatal, and the converse. Hence it follows that the bad economist pursues a small present good, which will be followed by a great evil to come, while the true economist pursues a great good to come, at the risk of a small present evil.

Bastiat, Frédéric (2005-05-31). Essays on Political Economy (Kindle Locations 485-491).

Roberts: The Microeconomics of the Broken Window Fallacy

As a DC resident, last week I experienced both an earthquake and a hurricane. Thankfully neither resulted in significant injuries within the impacted areas and property damage was also less than some might have expected. These experiences have provided opportunity for several economists to once again discuss the economic effects of natural disasters. Earlier this year, when Japan was hit by a terrible earthquake and tsunami, numerous economists and market "experts" noted that the destruction would be positive for economic growth due to rebuilding efforts. Similar comments sprung up following Hurricane Irene's treacherous path across the eastern seaboard.

These discussions are precisely when better definitions of economic growth are needed apart from GDP. Based on my understanding, if someone's car was destroyed and they choose to replace the vehicle by purchasing another, that purchase adds to GDP, while the lost vehicle subtracts nothing. From a real world perspective, the person whose car was demolished is now worse off, since they still own only one car but are now out a significant sum of money. Meanwhile, the car salesman is only better off by the amount the other individual spent. On the whole the economy is not better off since the amount of goods remains the same. GDP therefore fails to account for the depreciation or destruction of asset value, which plays a significant role in establishing wealth and economic well-being.

Russ Roberts of Cafe Hayek, who helped create the "Fight of the Century" videos (linked below), provides a wonderful example of what's known as the broken window fallacy. His counterpart on the website, Don Boudreaux, also had a humorous retort to Peter Morici (Professor at University of Maryland) regarding this fallacy and his willingness to destroy property for payment in order to benefit others (http://cafehayek.com/2011/08/open-letter-to-peter-morici.html). I urge those not familiar with the argument to read the articles and determine which theory is more compelling.

The Microeconomics of the Broken Window Fallacy:
The Keynesian defense of breaking windows or the economic virtues of hurricanes would go something like this:

Yes, breaking windows is destructive. Yes, it reduces wealth. But when there are large amounts of unemployed resources, say in the glass business, then breaking windows is close to a free lunch. In a world of unemployed glaziers, breaking windows can jump-start the economy by putting the unemployed back to work. They will spend the money they receive for repairing the broken windows.

When confronted with the claim by those of us who like Bastiat, that the money to repair the windows will now be unavailable to spend on something else, the Keynesian responds like this:

But people are sitting on money that is doing nothing. The insurance company that will now pay back the homeowner whose house was damaged by the hurricane was sitting on piles of cash. That cash was sitting in the bank where the bank has excess reserves not being lent out, not being invested. So yes, breaking windows can improve the incomes of glaziers and start a process of recovery.

What do we respond, those of us who are enamored with Bastiat and who think he’s right?
I would re-state the Bastiat story and tell it a little differently than it is usually told. The usual point is that the money has to come from somewhere–we see the repaired window but ignore the things that don’t get built or bought. But I think a better way to tell the story is to point out that the RESOURCES have to come from somewhere. The hurricane increases the demand for glaziers and that is good for glaziers. But that is good for all glaziers, employed and unemployed. It pushes up the price of glass repair. That discourages some folks from having glass work done who otherwise would have done it. So there is some offset of the hurricane’s impact on glazier employment. And as the Hayek character says in “Fight of the Century“:
You see slack in some sectors as a “general glut”
But some sectors are healthy, only some in a rut
So spending’s not free – that’s the heart of the matter
Too much is wasted as cronies get fatter.
So while glaziers (and carpenters) may be unemployed, other sectors (such as the wood market) may not be having such problems. The hurricane has a big impact on the price of wood, discouraging a bunch of would-be demanders of wood from buying as much as they did before. Again, there’s an offset. The point is that “aggregate demand” doesn’t tell the whole story.
But the real problem with breaking windows is that it’s not productive. I know. That’s obvious. But think about what the words mean. Right now, there are a lot of unemployed construction workers. What does a hurricane do? A hurricane IS good for carpenters and glaziers and roofers. But it’s unproductive work. It gets the home owner back to the status quo. It doesn’t create anything new or valuable. I’m not saying the production is wasted. I’m saying it’s a repair. Why is that important?
Imagine a world where there hasn’t been a hurricane and I want to help the unemployed carpenter. Here are two ways to do so. One is to burn my house down and then call the carpenter and give him $100,000 to rebuild my house. Here is the second way. I call the carpenter and say, I feel bad that politicians artificially increased the demand for housing at the end of the 20th century, pulling you into an industry that cannot be sustained at its current leve. I feel bad that you’ve been unemployed for three years. So I’m going to give you $100,000.
Which of those two policies would have the bigger stimulative effect? The charity should have a bigger effect. No offsets from pushing up the price of lumber and so on. But giving people money doesn’t change the underlying problem that there are more carpenters than work available for them. Creating temporary work either by burning down houses deliberatively or accidentally through a hurricane doesn’t change the fact that there are too many carpenters and glaziers relative to demand.
So the hurricane will put carpenters back to work. But it would be even better if there had been no hurricane and people had just given them a check. Charity is more productive than destroying stuff and paying people to get back to square one.
But the charity approach is what we’ve been doing for the last few years. It’s called unemployment insurance. I know, it’s supposed to be stimulative but there’s no sign that it is. Why would it be? It doesn’t solve the problem that there are too many carpenters.
This is related what Arnold Kling calls “Patterns of Sustainable Specialization and Trade.” Repairing houses damaged by a hurricane isn’t sustainable. And if I just give carpenters money because I feel sorry for them, that isn’t trade. That’s charity. Both have the same stimulative effect–very little, because they don’t get at the underlying problem. Prosperity is the way we specialize and serve each other, creating products and services that we each value. Destruction cannot be the source of prosperity.

Higher Inflation Displays Bad Economics

Friday provided an interesting litmus test for Bernanke’s views on further monetary stimulus and the market’s perceptions of his comments. Leading up to the statement, I warned that expectations were very high with markets awaiting a repeat of Jackson Hole 2010. When the first headlines hit, claiming no new stimulus, markets dropped 2 percent in a matter of minutes. As individuals parsed through the speech, a report from the Wall Street Journal’s Jon Hilsenrath, who often “speaks” for the Fed, suggested that Bernanke had all but guaranteed QE3 in September. An enormous surge of buying reversed the losses and by the end of the day equity markets were up 1.5-2%.

Using history as a guide, the next few weeks could very well see further gains in equity markets and commodities (especially oil and gold), while the dollar weakens further. If expectations were high for Jackson Hole, it appears they will be even higher for the next FOMC meeting. At the last meeting, Bernanke faced a rarity in three dissenting members. Considering inflation is already within the Fed’s target range, a surge in oil and food prices similar to 2010 is unlikely to encourage further support inside or outside the FOMC. Despite the failure of QE2 to positively impact the real economy, markets are now expecting QE3 and we must prepare for the potential consequences of such a policy.

Although I remain skeptical of the power of monetary policy in this current environment, several economists on the left are calling for further monetary stimulus through higher inflation targets. The idea behind this theory is that higher inflation will reduce the real value of debt, encouraging consumers to stop saving and increase consumption. Witnessing a pickup in demand will then spur businesses to build up inventories and hire more employees. These actions result in a self-fulfilling cycle that sparks higher GDP growth and speeds up the timetable for reclaiming trend line growth.

While this notion of higher inflation targets as a panacea for growth sounds promising in theory, the policy makes a critical error common to economics, highlighted by Frédéric Bastiat many years ago. (emphasis mine)

“In the department of economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to a series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously with its cause--it is seen. The others unfold in succession--they are not seen: it is well for us if they are foreseen. Between a good and a bad economist this constitutes the whole difference--the one takes account of the visible effect; the other takes account both of the effects which are seen and also of those which it is necessary to foresee. Now this difference is enormous, for it almost always happens that when the immediate consequence is favourable, the ultimate consequences are fatal, and the converse. Hence it follows that the bad economist pursues a small present good, which will be followed by a great evil to come, while the true economist pursues a great good to come, at the risk of a small present evil.”

Bastiat, Frédéric (2005-05-31). Essays on Political Economy (Kindle Locations 485-491).

Earlier, I mentioned that inflation is already within the Fed’s targeted range but several economists are suggesting initiating higher targets. Before delving further into this discussion, ask yourself, why do we have inflation targets at all? Why is inflation desirable? These questions are rarely discussed in today’s society but were frequently debated by renowned economists in previous decades and centuries. Many of the economists, including Bastiat, concluded that inflation was a prime example of a policy whose “immediate consequence is favourable, [but] the ultimate consequences are fatal.”

Understanding this view of inflation requires initially dispelling a frequent misconception. Most discussion of inflation these days tends to remark at the increasing price of goods. In reality, inflation is the devaluation of money. Although this may seem like unnecessary semantics, the difference is actually substantial. The critical difference stems from recognizing that the change in comparative values stems not from any difference in the supply or demand for goods, but rather from an increase in the supply of money. As Milton Friedman stated, “Inflation is always and everywhere a monetary phenomenon.”

Regarding inflation as a monetary phenomenon allows us to recognize some misconceived ideals relating to value. Although value may be thought of in terms of money, the truth is that money is only valuable based on the amount and kind of goods a given quantity can purchase. An individual earning $10,000 per year in the 1920’s would certainly have been much better off than someone earning the same amount today.

Returning to the concept of inflation, it should now be clear that a higher rate of inflation means increasing the supply of money, not the demand for goods. The most obvious effect of inflation is therefore to make people feel richer, despite the truth that a collective peoples’ wants can not be satisfied any more than previously. If individuals all started with an equal amount of money and goods, the consequences of inflation would not be so severe. However, this is obviously not the case and the unseen effects of inflation have very serious distributional consequences.



Second, let us consider the effects of inflation on possession of goods versus money. Inflation is caused by an increase in the supply of money. An individual holding savings in cash or money therefore loses real purchasing power over time as those holdings are devalued. On the contrary, an individual possessing non-perishable goods will experience an increase in the real value of their holdings, which could be exchanged for a greater sum of money. Further, those individuals owning the necessary supplies and means for production of goods will benefit as well.

From these examples it should be apparent that inflation encourages the accumulation of debt and benefits those possessing and producing goods. The reverse also holds true as inflation discourages saving by either delaying consumption or not accepting debt. Provided these insights, it becomes obvious that inflation also promotes poor investment of capital.

So why are many economists arguing for higher inflation targets? When initially implemented, an inflationary policy should create a debt financed and consumption led burst in economic growth. This economic stimulus marks the immediate and seen portion of the policy. Over time, however, poor investment and a lack of savings prove insufficient to maintain aggregate demand. The resulting excess supply of goods causes falling prices and corresponding losses on investment. If this outcome only resulted in prices falling back to normal levels, one might concede the merits in creating inflation. Unfortunately, over the entire cycle, a lack of accumulated savings and misguided investment results in less goods being produced by society and therefore lower economic growth. It is these consequences that are ultimately fatal and too often not foreseen.
 
The other reason economists may argue for higher inflation is due to excess household debt that currently restrains demand. On the notion that household debt is excessive and provides a headwind to economic growth, I certainly agree. What I cannot condone is the use of inflation to remedy this problem. It is important to remember that for every debt there must be a corresponding credit. An inflationary policy hurts those individuals who have wisely saved or been careful in their investments, while helping those who lived beyond their means or invested poorly. Not only does inflation unfairly impair certain groups of individuals, but it encourages a continuation of the past actions that resulted in the current economic malaise. If debt reduction is desired, a better plan would involve enacting policies that allow debt to be written off. Principal reduction on home mortgages offers a reasonable example. In this case, the losses would fall on banks or mortgage lenders that made the poor investment (provided the loan). This policy largely constricts the consequences to those parties directly involved and should discourage similar practices going forward.

One other consideration that seems often overlooked is the distribution of individuals within an economy and how inflation affects the varying classes. As mentioned earlier, the groups benefiting the most from inflation either have excessive debt, significant non-cash assets, or the means for production of goods. Although excessive debt may often be thought of in relation to lower income groups, I think this idea may be incorrect for our consideration here. Wealthy individuals often appear to pose the least credit risk and are therefore able to obtain loans at low interest rates. Due to the cheap cost of debt, wealthy individuals frequently accept significant sums of debt to expand investments. On the opposing end of the spectrum, many lower income households likely experience difficulty obtaining loans, constraining the amount of outstanding debt they can acquire. From this perspective, at best, it seems inconclusive that one income class benefits more than another. As for the latter two groups, it seems fair to say that households with significant non-cash assets or owning the means for production, largely fall in upper income classes. Based on this assessment, one could reasonably suggest that inflation benefits the wealthy class at the expense of less wealthy households.

A final consideration of inflation must consider the effect of such policies on the government’s finances. During much of U.S. history, the federal government has run budget deficits. Despite no longer being necessary to finance spending, since removal of the gold standard, the federal government still sells debt in the form of Treasury bills and notes. By instituting an inflationary policy, the federal government ensures that the real value of it’s future debt burden is reduced. Inflation therefore allows the government to hide the real value of its expenses and slowly capture a greater share of wealth over time.

For decades the Federal Reserve has maintained a mandate for generating inflation, which is now being questioned with regards to whether the target level is high enough. As Bastiat warned, it appears several economists are falling into the trap of only noticing those consequences which are seen and failing to acknowledge those which are not. Better policy making requires attempting to foresee those effects that are not immediately visible. While a higher inflation policy likely creates an initial debt-financed expansion, the ultimate consequences are almost certainly reduced long-term growth and greater inequality.