Monday, September 22, 2014

Distorting Reality Part 1: Confirmation Bias

In his magnum opus, History of Economic Analysis, the great economist Joseph Schumpeter said that the first thing a man will do for his ideals is lie.

However, I think it would have been more accurate to have said that the first thing a fool will do for his ideals is lie.  A man of even average intelligence need not lie.  All he needs to do is to filter the facts to suit his own needs.

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And God knows that people of all ideological stripes do this.  The difference is that some do so deliberately while most do it for the innocent reason that some facts, when taken in isolation, confirm their biases.

One of my favorite examples of this is when people who support raising the minimum wage cite a statistical study that seemingly supports their views.  For instance, a few days ago, an American friend of mine, a dyed-in-the-wool progressive Democrat, whom I like to spar with every once in a while, sent me a link to one of his favorite websites – Think Progress – that purported to support his views about the benefits of raising the minimum wage.

My friend ended the email with a quip – “Coincidence?  I think not.”

Sometimes, a coincidence is really just a coincidence.
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(In case there is any doubt, I do not support the minimum wage for reasons that I have posted here.  And no, it's not because I think that hiking the minimum wage will cause the economy to collapse.  I have heard many people who are supposedly on my side of the argument make such claims and I think it's ridiculous.)

I wish I could say that it had been the first time I had seen that link my friend had sent me.  It had been making its rounds all over the media ad nauseum by the time he had sent it to me.

The article that my friend sent me cited a report that was published in the Center for Economic and Policy Research, which in turn cited a simple evaluation that was conducted by Goldman Sachs.  The analysis found that the thirteen U.S. states where the minimum wage went up on January 1st 2014 had shown faster employment growth than the other states where the minimum wage remained at its 2013 level.

However, this study had some serious problems.

For one thing, people who claim that the minimum wage hike caused the greater increase in employment are making a fallacious argument.  That is because the statement is a clear violation of ceteris paribus (i.e., all other things being equal or held constant), which is at the core of any good analysis.

In order for the claim to have any merit whatsoever, all the states that raised their minimum wage rates and those that did not must be identical in all other respects.  In other words, the increase in the minimum wage must have been the only economic condition that changed.  This is clearly not the case.  For example, some states have better quality education; some have more open and friendlier immigration policies; others have higher tax rates; some states have higher concentrations of hi-tech jobs while others have higher concentrations of low-tech jobs, etc. etc. etc.

Due to the violation of the principle of ceteris paribus, it is just as valid to claim that employment figures in those states improved despite the minimum wage hike!

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Another thing that people ought to have noticed about the report was that it was posted on June 30th 2014.  The study was based on data that was collected only for six months!  Six months is hardly long enough to make any kind of credible statement about the economy.  Years of data are required to truly calculate the effects of minimum wage legislation or subsidies or changes to immigration law or tax breaks (and such a study does happen to exist!).  That is because both producers and consumers adapt to changing market conditions by varying speeds and varying degrees.

And have you ever considered how many economic transactions take place in any country at any given moment?  Millions, if not billions, of economic transactions are made at any given moment in time.  Even the most well-trained econometrician who looks at merely one of those data points will be able to come up with only one conclusion – the market is chaos!

This study doesn't even take economic inertia into consideration.  What that means is that not everyone responds to changing economic factors instantaneously.  For example, if you are an owner of a small construction company and you are contractually obligated to build a house within a month, and the government increased the minimum wage by 50%, you're not going to slash your workforce by half the very next day.  You still need to finish building that house within the month.  After you've met your contractual obligations, you might want to rethink your hiring practices, but not before then.

This study alone is hardly proof that the minimum wage leads to job growth.  In fact, considering the unsound structure of the study, even if those states had shown negative job growth, the study would not be an indictment of the minimum wage either.  In order to prove or disprove the benefits of the minimum wage, much more data is required.  Regardless of how these states performed, this study is nothing more than a meaningless statistic.

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Now I am by no means saying that my friend, or all those other progressives who pointed at this study and went “Take that, Republicans/Conservatives/Libertarians/Capitalists!” are deliberately being dishonest.  I think the pundits and politicians who are using that statistic to gain political capital or popularity or ratings or profits are crooks; but the vast majority of laymen who have looked to that study with hope are mostly people with good intentions.

However, Milton Friedman's aphorism about judging policies and programs by their intentions rather than their results being a mistake holds true yet again.

The unfortunate fact of the matter is that many people do not think things through when they see “studies” that confirm their biases.  This is completely understandable.  Most people would rather be proven right than proven wrong.

Bias is a powerful thing, which no one can say one is truly free from.  It offers people a blanket vision that covers disparate things such as their views of human nature, politics, economics, society, religion, philosophy, etc.  So when a person comes across a narrative that fits his vision of reality – when he finds something that validates his opinions – he is content to stop and is unlikely to ask further questions.

And this is exactly how sacred cows are created.

(End of Part 1)

Monday, September 1, 2014

The War on Hoarders and Misers

According to this report from The Korea Herald, President Park Geun-hye is seriously considering levying a tax on corporations for holding on to its profits. To be specific, if corporations do not spend “enough” of their profits on investments, salaries, and dividends, the government will levy a ten percent tax on those profits.

How much would be considered excess profits and how long a corporation has to hold on to its profits before the taxes are levied have apparently not been hammered out in detail just yet.

On top of that, the Bank of Korea cut interest rates to 2.25 percent just recently, which is the lowest that it has been since November 2010. What's more, further interest rate cuts are expected and it is feasible that interest rates could fall as low as 1 percent. And about a month ago, the Korean government expanded tax deductions for debit card users.

In other words, the Park administration wants us to spend money. And preferably a lot of it.

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The government's rationale is that if business owners come to terms that their “excess” profits will be taxed, they will choose to pay higher wages, salaries, and dividends so that people will spend more money, thereby spurring economic growth. Furthermore, assuming that businesses increase workers' wages (instead of diverting more of their profits to off-shore shell companies and tax havens), coupled with low interest rates and tax incentives for debit cards, the government hopes that the people will choose to spend their money rather than save it (instead of investing their money in riskier but higher-yielding investments).

(It is my opinion that the government is either completely ignorant of the concept of unintended consequences or it is aware of the concept but simply does not give a damn about it.)

The government's rationale behind this series of decisions is that savings is deleterious to economic growth. It is an idea that was made popular in the twentieth century by the great (which does not necessarily mean “good”) John Maynard Keynes.

People who subscribe to this economic school of thought often compare money to some kind of metaphor that can be found in the natural sciences. For instance, only just recently someone mentioned to me that money is like water; that it's supposed to flow freely. But does money flow? The words “flow” and “circulate” are often used to refer to the movement of money within a given economy. It allows people to simplify money; something which is far more complicated than people actually think it is.

However, money does not actually “flow” or “circulate.” In fact, I think it is misleading to say that money “flows” or “circulates.” It implies that money is somehow spent independently of human will. Money does not flow or circulate. As boring as it may sound, money is transferred from one person's cash balance to anther’s. And this transference depends entirely on how much people are willing to hold on to their money at any given time.

Believe it or not, this does not happen in reality.
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The basic argument behind the government's series of policy changes is the assumption that “hoarding” money (something that more sober minded people refer to as “savings”) somehow causes economic stagnation. It assumes that if far too many households and businesses save money rather than spend it, the savings will stifle demand for goods and services, thus leading to an economic contraction.

Many Keynesian economists have therefore always urged people, and especially the government, to spend. Even when there is no money to spend.

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However, these policies do more than to simply set the stage to get people to spend more money. It also tacitly makes villains out of people who wish to save money. Though the language used has thus far been benign, what has remained unsaid but expressed tacitly nonetheless was that those who do not spend their money are causing the economy to shut down. It assumes that businesses that choose to save money inevitably lead to reduced sales, which in turn leads to increased layoffs. Then as the total social income decreases, this leads to less money being made available for overall consumption. Then, as individuals begin to fear for their economic well-being, they too will begin to refuse to spend their money. The government's rationale is that hoarding begets more hoarding and that it causes the economy to sink ever deeper into a downward spiral.

In the end, what the government is actually saying is that people who save their money, these selfish hoarders, will eventually doom the economy into a permanent economic stagnation.

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But is there any truth to this viewpoint? I, for one, do not think so.

There is a question that we have to ask ourselves. Why do people even save their money in the first place?

There is only one answer to that question. People save their money so that they can insure themselves against an uncertain future. Think about it. If the future weren't uncertain, if each and every one of us had the gift of being able to accurately predict when and how much money we will need, none of us would need to save our money. We would simply spend our money and make the necessary investments so that we may receive the amount of money we need to spend on the day we need to spend it.

Fortunately or unfortunately, however, the future is uncertain. We do not know how or when or where we will face our next calamity or good fortune. And the more uncertain and fearful we are, the more money we tend to save. And considering the fact that Korea is the fastest aging society in the world, and further considering all the financial troubles that are associated with aging, Koreans have all the reason in the world to be fearful of the future.

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There is another reason why businesses save money. If businesses expect the value of money to fall in the near future, they will spend their money now while the money is more valuable. However, if businesses expect the value of money to rise, they will wait to spend their money later when it is more valuable.

Milton Friedman once said that there are four ways to spend money. One of the ways to spend money is for an individual to spend his/her own money. When people do that, people try to get the most for their money and tend to be more careful about how they handle their money. Therefore, for the most part, people's decision to save or spend their money tends to be based on very sound reasons.

The Korean government might think that its recent policy changes is for the benefit of the public. In the short-run, the Park administration might just be vindicated. But what happens in fifteen years when Korea becomes a “super aged” society (meaning that more than one-fifth of the population will be over the age of 65), when there will be more retirees, who will have minimal income and will therefore need more government handouts, than there are working people?

For those unaware, Korean subway cars reserve the seats at the end of each train car (where the two kids are seated) for senior citizens whereas the other seats are for everyone else.  This picture asks its viewers to imagine a future when those seats will be reserved for children instead of senior citizens.
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The idea that savings somehow impedes economic growth is a popular one, especially among politicians. However, just because something is popular does not make it right. Saving for a rainy day does not cause negative economic growth or economic stagnation. That is because savings don't take money out of the economy. Savings are an insurance. Therefore, savings is really just another word for deferred consumption.

There is, however, yet another rationale behind the government's series of policy changes. It is the presumption that the more money there is, the more wealth there is. As counter-intuitive as this may sound, that is just not true. The units of money that we have in our wallets or bank accounts do not matter. If such a thing actually mattered, Zimbabweans would be the richest people in the world!

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What people really want is not more money, but more bang for their buck. In other words, they want their money to be able to buy more things. Simply increasing the amount of money, which is all that the Korean government will be able to achieve with its policies (assuming that it is successful), will simply dilute the effectiveness of the money that people do own. It will not improve the people's standard of living.

The only thing that can make the money more valuable is for there to be a fall in prices aka deflation, which is the very thing that every government wishes to avoid. After all, although deflation is what people need, it is not what they want (whether or not deflation is a good thing is an entirely different topic that shall be dealt with on another day).

To be specific, people want the prices of all goods that they buy to fall. However, at the same time, they want the price of the goods that they sell to rise. Therefore, though nobody will actually claim to want it, what their actions often belie is that everyone actually wants inflation. And politicians are only too happy to give people what they want, rather than what they need.

It is possible that the Park administration's war on savings might lead to some short-term economic gains. After all, almost anything can be proven to be correct by resorting to clever statistics. But in the long run, I just don't see how it is anything but doomed to fail.

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