How flawed arguments can cost you money

GE wants your tax money for wind power.  But they promise you will get it back because wind projects more than pay for the tax credits they receive through creating new jobs, and generating company profits and taxes for the government.  Using similar logic, T. Boone Pickens is championing domestic ethanol.  Producing it instead of buying foreign oil will “recirculate the money in the country, (rather) than have it go out the back door on us”.   Sounds good?

Well let’s see.  What would happen if GE doesn’t get the tax credit.  Would all that economic activity disappear?  No.  Either someone else gets the tax credit, or taxes go down, or the government borrows less.  Each of these eventualities have positive economic effects.  In the first case should wind power get the money, or are there other projects which would create even more jobs, profits and tax revenue.  If the money is returned to taxpayers, how much of these would be created by more consumption and investment?  The proper comparison is therefore between resources spent on wind or other projects, not wind or nothing at all.  If spending on wind our best option?  Well the fact that a tax credit is needed, when other business don’t need it to be profitable, seems to argue no.  In this specific case one could argue that its just levelling the playing field because of all the subsidies given to oil and coal.  This is true, but not what GE is arguing.

T. Boone’s “recirculation” also leaves out part of the puzzle.  It seems like our choice is between spending, say $100 on oil, or $120 for the ethanol equivalent of energy, but in the ethanol case we get back most of our money because it goes to domestic corn farmers and ethanol processors.  What’s missing?  Well those domestic producers are consuming some bundle of labor, land, fertilizer and other resources.  Those resources don’t get recycled, they get flushed down the toilet.  They could have been used instead to feed cows to produce beef for export, for instance.

To flesh this out, say we had $200 and resource bundle A which is what it takes to produce the equivalent of $100 in oil in ethanol.  Say resource bundle A costs $120, but those costs get “recirculated”.  If we buy $100 of oil from abroad we are left with:

$100 cash, $100 of oil, and resource bundle A

If we produce ethanol we get:

$200 cash, $100 equivalent of oil

Which is better?  When we buy from abroad we have $100 less cash but resource bundle A.  Which is worth more?  Well the fact that those resources cost $120 seems to indicate that that’s what its worth.  Maybe some beef farmer can turn that into beeef which he can sell for at least that amount.  So domestic ethanol loses us at least $20.

I find it amazing that a businessman as accomplished as T. Boone Pickens could make an argument as flawed as this.  Don’t be fooled.

If the Government doesn’t fund it, it won’t get done!

If the Government doesn’t fund it, it won’t get done.

We hear this justification for government spending on a host of things.  The biggest most recently is probably ethanol.  Is it a good reason for the government to step in?

Well, we might notice first of all that lots of useful products got developed with little or no government assistance: cars, airplanes, computers, the I-Phone, for instance.  When things are useful, people tend to be willing to pay for them.  When they are absolutely critical, people should be willing to pay a lot for them.  So it seems odd that the government needs to step in for some product its proponents claim is so critical.

Let’s look at how things work in the private sector.  Someone decides the world needs a new product to solve some problem.  Why?  For the glory, for the money, or maybe they just wanted to build a better mousetrap.  There are many motivations out there.  They now need resources which means they have to convince a venture capitalistic or bank to fund them, or reach into their own pocket.  What happens if the idea doesn’t work out?  The funding gets cut off.  Is that a bad thing?  Not if the idea was a bad idea. If it was a good idea, chances are someone in this technologically rich world with venture money sloshing around will rediscover it (or something even better).

Now let’s look at how things work when the government fund development.  Some product gets developed and if it works, then society gets some benefit though one may question whether that free money might not encourage producers to produce more than people want.  If it doesn’t work, or after the good has outlived its usefulness (as is often the case), then you have special interests who say they now need more money to keep things going.  And you also have a group of politicians closely tied to those special interests because they gave them money the first time.  Both groups now spend resources protecting their perk (i.e. access to your tax money), so they can profit even though they are losing money for the economy in general.

It is this failure to respond to the market telling you that your product sucks, or is no longer useful, which makes government funding really wasteful.  Farm subsidies may have served some limited purpose during the Depression (though I doubt it), but 68 years and billions upon billions of dollars later, they don’t today.  Ethanol probably never served a useful purpose, yet we are saddled with it and probably will be for years to come (definitely under Obama and maybe even under McCain if the overriding of the farm bill veto is any indication).  The private sector was saying for a long time that ethanol was an idea which wouldn’t fly.  It would have been better had we listened.

Wow maybe this trade thing isn’t all that bad

Trade’s many enemies like to portray a world of evil multinationals moving jobs to third world countries where they take unfair advantage of the natives and foul up the environment.  As shown in the following article this is not necessarily the case.

Get your green pants here

Some may complain this is only one factory and in general trade exploits foreign workers, harms domestic workers and ruins the environment.  I’m sure there are cases where this happen but in the aggregage where is the evidence.  Presumably if foreign workers had worse prospects at multinationals, they wouldn’t work there.  Economic evidence seems to indicate multinationals pay better than domestic firms and provide other benefits (one example study).

Since trade lowers prices and greater variety of goods it is unequivically beneficial to consumers.  But does it hurt domestic workers?  If a factory moves offshore and its workers are laid off then it MAY hurt them.  Some may find better jobs however.  It is likely also that decreased costs to others will great other jobs.  If for instance the price of steel dropped by half, prices of cars and appliances would drop.  When prices drop people buy more and more workers are needed to produce these goods.

It is true that there are other countries with laxer environmental standards than ours.  Are there are some with stricter.  When trade gets restricted (such as the steel safeguards), the distinction is rarely made.  As the above article shows, productions of individual goods abroad is not necessarily going to be dirtier than here is the US.  If you really favor restricting trade for environmental reasons, then it should be on a targeted basis with clear analysis as to what the total environmental costs are there and here.  And also keep in mind that as countries get richer, their citizens tend to require a cleaner environment.  Making countries richer through trade is probably be a good way to make them cleaner too.