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Keynes, Macroeconomics, and Traffic

Orlando Roncesvalles (oroncesval4@gmail.com)

Back in 1936, a smart aleck named Keynes (John Maynard, or just Maynard) cooked up something he called The General Theory of Employment, Interest, and Money. He thought of unemployment as something to be solved, possibly in the same way that Albert (surname Einstein) thought “relativity” was the mystery to get fixated on. The parallels stop pretty much there despite the historical fact that failed mathematicians sought to infuse physics into economics, a project that took a long time to be discredited (not until 2008 anyway, when the Great Financial Crisis finally put paid to the misconception that physics and economics can mix, the latter having the muddle-like consistency of dirty motor oil and the former the empirical clarity of replicable experiments).

The genius of Keynes was in his insistence that the short run mattered more than the long run (when we would of course all have died). In that short run, slack in an economy (or unemployment) could be dealt with by public works. This idea was nothing new — even the Roman emperors knew that public spectacles kept people employed (even entertained). Keynes came up with the idea that in the short run, aggregate supply (or output, later standardized into GDP or gross domestic product) would have to adjust to what he called aggregate demand, whose components included consumption, investment, and government expenditure. Textbooks would later call this equality between aggregate demand and supply as “goods equilibrium.”

But Keynes then married the idea of goods equilibrium with something we might today call “asset equilibrium”— a situation wherein people are content to hold the quantity or amount of money in their pockets.

Asset equilibrium meant that peoples’ “liquidity preference” was satisfied through the movements of the interest rate as the price of credit and the opportunity cost of holding money. Money demand was driven by GDP and the interest rate, while money supply was a policy variable in the hands of the central bank. The equality of money demand with supply would be at the market-determined interest rate. Recognizing such an equilibrium was a way of bringing in the workings of the money and banking system into a fuller explanation of the gyrations of the business cycle. After all, the money markets determined interest rates, and these rates in turn drove business investment, which of course is a component of aggregate demand in the goods market.

The essence of Keynesian thinking was and remains the workhorse of macroeconomics (that specialty within economics that concerns itself with the short run determination of GDP and interest rates).

After Maynard, everyone then had a field day. The business-cycle savants focused on the confidence-based elements of aggregate demand (consumption and investment); the politicians latched on because government spending was their domain and Keynesian economics provided cover for influence and corruption; and the bankers were very much in on the act of determining interest rates. Macroeconomics caught on as the thing to know before one can say anything about the national or global economy.

It turns out that the apparatus of macroeconomics can be tweaked to help us understand the relationship between GDP and traffic.

Recently, a noted legislator reiterated the idea that prosperity (a growing GDP) was behind our traffic woes. I interpret what the legislator said to mean that without the heaven of a business boom, we wouldn’t have the hell of traffic. We should sit back and no more challenge him and his ilk to take public transportation because of course he already knew the answer: We are prosperous, so that we should just grin and bear it!

A critical but opposite view has nonetheless come forward. It is the idea that traffic is a brake on prosperity. The more severe the traffic, the less the GDP.

So, which is it? Is it a positive correlation between GDP and traffic? Or a negative one?

Keynes would likely scoff at the seeming contradiction. The negative correlation is the working of goods equilibrium if we realize that the severity of traffic negatively impacts aggregate demand. Bad traffic keeps consumers from traveling to malls, and smart businesses would likewise invest less if traffic drags down sales projections. Bad traffic kills GDP.

The positive correlation is something else. As GDP grows, the more we want to acquire transportation assets, such as cars and motorcycles. But in the short run, there is only so much roadway for all, and traffic problems arise.

The two disparate relationships – goods equilibrium and “traffic equilibrium” – are synthesized in the macroeconomics apparatus. Smart students will see that the thought experiment is the same as that of the infamous IS-LM apparatus of macroeconomics, where IS represents goods equilibrium and LM represents assets equilibrium; we now simply replace assets equilibrium with traffic equilibrium. Traffic equilibrium, by itself, reflects the positive influence of GDP on the severity of traffic problems, though it also suggests that the less the traffic, the more that people will demand transportation assets (this is the analog to the idea that the lower the interest rate, the more we would prefer liquidity or hold money).

What does all this mean? Can we now have a “clean” sorting out of the two disparate influences – the one of GDP on traffic and the other of traffic on GDP?

The answer is this. As an economy grows so of course does GDP. If the traffic infrastructure is left “as is,” traffic problems worsen, and governmental neglect is the culprit. This is because the traffic infrastructure (like monetary policy) is in the hands of the economic authorities. The infrastructure is in fact a public good. Still, the hapless citizens aren’t exactly helpless. They can move closer to where they work or work closer to where they live. They can drive less and consume less, and coincidentally lessen their carbon footprint. As a modern Marie Antoinette might say, let the travelers have their air-conditioned “me time.” Except that the peasants don’t eat cake or have their James (the proper name for chauffeurs of Rolls or Benz automobiles). Apparently there is no free lunch, and traffic is here to stay. Embrace it.

But if we were to solve the supply side of the transport asset equation, we reduce the severity of traffic, and the GDP boom continues or strengthens.

How to improve the traffic infrastructure is then the key. It is the magic but elusive password. Our legislators are perhaps simply not up to the challenge. Boot them, but don’t use the Denver boot. It won’t work because they’re too self-important. They’ve so far set things up so that they don’t suffer the inconvenience of public transport. Instead, they tell the ordinary citizen that it’s his fault because he enjoys a prosperous economy. Nuts.

A Winter’s Day

In a bleak and dreary November found me in the ‘burbs of Washington, DC. To the cognoscenti, that’s that famous place that is of course the center of the universe. I do not exaggerate.

Some days ago, the DC baseball team, the Nationals, won the World Series. That’s evidence number one. Two, it has been unseasonably cold, almost freezing, almost unheard of before Thanksgiving. That’s a portent of momentous events as well as palpable evidence of climate change. No self-respecting center of the universe would be left out of the climate change debate, and even if Greta Thunberg preferred to land by sailboat in Frank S’s New York, she sandwiched a protest visit to Washington, making the latter a competitor to the title of the Definite Place To Visit. Three, and most importantly, the Washington Post still shows up on my driveway, once a week at least, although slimmed down measurably with the advent of competing news and advertising sources online. It doesn’t matter, this competition thing, so long as we embrace the philosophy of no more driving to the shopping because of course Amazon.com not only reads your needs but also delivers in One Day Prime. Finally, for nostalgia more than anything else, there’s still The Old Ebbitt Grill; go there for the oysters and crab cakes.

There are certain perennials about the American capital. The Redskins have only the remembrances of things past (to evoke Marcel Proust, Doug Williams, and Joe Gibbs). The Washingtonian Magazine is still around, especially where you go for a haircut. Reagan National is still the airport of choice for Movers and Shakers. The traffic, yes the traffic, still competes with La-la land. The visitors still visit the White House and the great museums, of which the Smithsonian is still the best. The Kennedy Center still has free performances (at 6pm, Monday to Friday).

But there must be things that are new. As a creature of habit, I can report not much. This is due more to my inaction than anything else. But I checked around and came up with certain nuggets, if only to help guide out-of-town visitors. For the museum-hungry there’s a $1 bus called The Circulator. The Washington Monument has re-opened after closing for a renovation in 2016 (get your tickets in advance). The lure of Atlantic City has dimmed, replaced by nearby casinos in Baltimore and at the National Harbor, for the visitor who likes slots and tables. For Filipinos the restaurant scene has grown like mushrooms in a rain forest. In my neighborhood there’s a Kuya Ja’s Lechon Belly (4.5 on 473 reviews at Yelp).

What do the French say? Plus ca change, plus c’est la meme. Mao jud. I visit but not in the extremes of winter and summer; for then, there’s Dumaguete.

Politics, economics, rice

The paradox of advantage

The production, consumption, and importation of food (rice or grains) have posed contentious as well as analytically difficult issues even when economics was still in its infancy. In the early 1800s, David Ricardo came up with the idea of comparative advantage to explain why countries trade. On its face, it presented a paradox because comparative advantage suggested that a poor country (one endowed with limited technology) should export a good such as rice even if it didn’t have an absolute advantage in its production (it just needed to have a comparative advantage). Ricardo was also not one to advocate self-sufficiency as he was pretty much a proponent of free international trade. Today’s debate on the merits of rice tariffication presents conundrums and even unanswered questions, though the latter have perhaps more to do with politics than economics.

Bread and circuses

But even earlier, when economics was not yet a social science, kings and despots already knew that to survive insurrections, they made sure that the price of bread or grain (or any food staple) was affordable to the masses. The Roman poet (Juvenal) considered on or around 100 AD that political stability required whoever was in power to provide bread, as well as circuses! Forget the Romans. The Bible has its share of stories where kings had the burden of protecting their subjects from suffering in times of famine. Closer to home here in the Philippines, when the price of rice spiked in 2018 and became part of an inflation scare, there was a fair amount of wrangling on what to do.

Tariffs in international economics

The conventional wisdom today in economics, particularly in the textbooks on international economics, hasn’t changed much in the last two hundred years. Free trade, because it is voluntary and anchored on the concept of comparative advantage, was (and still is) a good thing. And yet, here we are in today’s age of wondrous innovations dubbed as the “fourth” industrial revolution, fulminating at the specter of rice prices remaining high for the consumer but falling to penury-inducing levels for rice farmers. What has gone wrong?

Lawmakers as villains

The twitter-verse has focused on a conspiracy theory based on an impending demise of domestic rice production. The story is that we have a heartless and gutless set of legislators who pushed what is known as Rice Tariffication, which has by now had the effect of making rice farming unprofitable (requiring all kinds of governmental intervention to support the poor rice farmers), thus also forcing the price of rice land to the levels of a song for real estate developers who know how to convert such idle lands into houses and lots. This state of events runs afoul of the Emersonian and romantic view of the idyll of (rice) farming in the hinterlands (so, planting is not a joke but it is both honorable and upright, especially if food self-sufficiency is a nationalistic priority). It is of course easy to blame the “rich capitalists” who dominate the real estate industry for the plight of the poor farmers.

The lessons of history

There is nonetheless more to the story. The historical record traces the timeline of rice farming as a battle towards high productivity and self-sufficiency that didn’t get anywhere. One study states that the Philippines imported rice from 1885. Although we had a brief heyday of self-sufficiency in the late 1960s and 1970s, the Philippines has since become the world’s second largest rice importer (next to China). The official line has been that we aimed for the three goals of self-sufficiency, high incomes for rice farmers, and affordable prices for consumers. What has been unsaid is that these goals are basically incompatible. Without a gigantic leap in domestic productivity, only the last of these goals could be attained, and only if the rice-exporting countries (such as Vietnam and Thailand) were to sell rice on the cheap.

And more. We had a commitment to the international community to abide by free trade rules (apparently, the nameless bureaucrats at the World Trade Organization believed that what was good for the world was good for us), but like a stubborn-headed child we dug in and said, no, we want to “protect” our domestic rice farmers. We opted also to engage in this protectionism by applying quantitative restrictions on rice imports (also known as quotas). The persistent WTO gave us this leeway while suggesting that an equivalent restriction through tariffs might be a better idea. So, with the apparent fiasco today, should we blame the WTO?

The Catch-22

Back to the drawing board of international economics. If outright free trade is best, what could be the second-best? Is it quotas? Or tariffs? Here, our economic managers have been caught in a Catch-22 bind. A Catch-22 is a unique situation. Applied to the tariff-quota controversy, it goes roughly as follows. Both tariffs and quotas can result in the same domestic price – higher than the world price; and the same level of domestic production (but higher than if we had free trade) and imports (at the same level as if we had simply applied quotas). But there are differences. A tariff generates government revenues, which can be collected and then misused. A quota results in “windfall” profits for those given import licenses, and is said to be a major source of corruption. In short, either way, tariffs or quotas, we face the same inevitable temptations for the abuse of public office for private gain.

But there’s a mystery that accompanies the Catch-22. Theoretically, the situation of the rice farmer is the same under either tariffs or quotas – he produces at a level higher than under free trade, and benefits from a domestic price that exceeds the world price (by the size of the tariff, which today is set at 35%). What has happened, and this has been documented by both the proponents and opponents of Rice Tariffication is that rice farmers earn less under tariffs. The unanswered questions are: Why? Is the 35% tariff too low to make its effect equivalent to that of the quota system? Is it because there is a local cartel that can dictate a lower farm-gate price under tariffs than under the old quota system? If there is such a cartel, is it engaged in a form of retaliation because they lost some lucrative opportunities under the quota system? Can such a cartel continue to operate? What if there were a political will to dismantle such a cartel?

No way out?

What seems not in dispute is that Rice Tariffication was aimed at achieving “parity” between farmers’ incomes under the quota system and under the tariff. We can perhaps argue that good intentions are not good enough. The hard question is what should be done?

My personal view is that tariffication (or quotas) was never the answer. (Neither was self-sufficiency.) It is, after all, a second-best form of protectionism that allows inefficient domestic producers to continue as they have done for almost fifty years, or even longer. We should now consider whether “creative destruction” (an idea from the economist Joseph Schumpeter) should be allowed. Let the rice farmers find other higher-value crops. Let the government support them in any way it can, especially in the provision of public goods in the form of extension services, better farm-to-market infrastructure, and a “clean” bureaucracy. But why create a P15 billion kitty (from the rice tariff) that would tempt politicians the way that pork makes them giddy with cholesterol?

As to the doomsday story that rice lands will end up becoming subdivisions, that is one for those thinking about land use policies and legislation. That is altogether another story.

Equity in economics – a series

(This is a first post, focused on where equity fits in the world of economics.)

Economics somehow defined

By Orlando Roncesvalles 

Economics was once said to be the study of the “ordinary business of life.” Today that definition seems to falter if only because many now can’t or won’t accept “ordinary business” as just getting up everyday to work and then going home to eat, rest, and watch tv.  There must be more to life than that. Otherwise, the only specialties in economics that matter would be labor economics, the economics of food and shelter (agricultural economics, urban planning), and the economics of entertainment. Okay, so we need to sleep and that presupposes elements of conscience and health, which should make economists also study the economics of health and spiritual care.  

It’s no longer about ordinary business

That’s not what happens. Economists are a wily bunch. Somehow they’ve embedded “work” into the conjunction of human and physical capital, which has then led to serious questions about saving and investment, and thus we have all sorts of controversies about the “macroeconomy,” business cycles, monetary economics, and the role of  “finance.”  The scope of “life” itself took on deep meanings about households functioning as “agents” so that the time horizon of economic decisions could encompass overlapping and future generations. In short, economists worked up models where economic actors didn’t even die!

So where do we now go with  economics? I don’t know. It certainly is not about the universe, and mathematical economists emulating the physicists are now pretty much in disrepute. The good economists turn to math or just plain-vanilla logic, not for window dressing but as necessary cogs for weeding out bad theories. At least, Occam’s Razor still lives. The even better economists camp out with historians to explain the past, while humbly admitting that the future can only be seen through a thick fog. Economists cannot make time travel, nor make easy profits. They let fantasies stay within the bounds of Hollywood and Ponzi artists.

Then, it was a case of choice

The discipline of economics remains then a study of human behavior, but differentiated from anthropology, sociology, psychology, psychiatry, political science, history, or literature. Where to draw the line seems a mystery but it’s in there somewhere.

This leads to another view on economics as, grandly, the study of human choice. The emphasis here is on the element of choosing. We choose because we’re not dogs, or (pet) rocks, or robots.

Whether we like it or not, humans do grapple with a task or choice all the time. That choice often involves division, something we intuit as a matter of taking a whole and breaking it down into parts or portions. That “whole” may literally be time, as in the question of what we do with our time. But why divide? Is it because time inexorably passes, but is finite because we are mortal? Is it because we say, “No man is an island?” Is it because we strive to solve the “economic problem”? We remind ourselves that the economic problem, according to the textbooks, is that of who should produce and use whatever it is that we decide to produce; this problem boils down to Adam Smith’s “division of labor” – the division of tasks – and also to the distribution or allocation of the things produced among those who wish to use these things. There are thus two sides to the economic problem. One shows how we make the economic pie; the other, how we divide it. 

There is thus no avoiding the idea that economics is about division. The positive side of economics looks at how we do the division; the normative side asks how we should do the dividing. 

But can it discover fairness?

The distinction is however not clearly cut. Imagine that we were given a certain or particular division to undertake. Suppose that we then ask if the suggested division is “fair.” Is that a fair question? It seems not because it would be a form of begging the question. But it also seems more correct to ask if the division was fairly arrived at, and fair is fair because division is first a process and then an outcome. There is no chicken-egg problem in analyzing answers to fair division questions. Still, we haven’t yet a clear idea of what fairness is.

The dictionary definition of fairness is interestingly hopeless. Merriam-Webster gives the one meaning of interest as “marked by impartiality and honesty: free from self-interest, prejudice, or favoritism.” In a way, it seems that fair is, like many primitive concepts, something more easily recognized than defined. The literature on fair division suggests that fairness is characterized by being “envy free.” Here, we get to define freedom from envy in a sense close to Rawls’s idea of justice. “Envy free” (or justice) means that we wouldn’t want to trade places with others. There is peace on earth, a secular Christmas.

There is no end

So there we are. Economics has traveled from the business of life to the choices we make, and we end with asking, “Is it fair?” I conclude from all this that economists are philosophers at heart, and pesky ones for sure.  They are incomprehensible much of the time, but that’s perhaps because thinking is hard, and because we still haven’t fathomed a bunch of other mysteries. One is about what choice really means in today’s age of artificial intelligence and robots. There are others: Where do machines end and humans begin? Is there a fundamental difference between machines and man? Do humans have souls? If they do, do animals also have souls? Are there alien civilizations out there who laugh at us humans for our propensity to engage in internecine wars? 

I stop.

****

Twitter: @ORoncesvalles

All is fair until we divide

FAIR DIVISION

[The following thoughts arrived this morning, February 28, 2019, after perusing a book on Fair Division (Brams and Taylor, 1996).]

Whether we like it or not, we humans grapple with a task or choice all the time. That choice involves division, something we intuit as a matter of taking a whole and breaking it down into parts or portions. That “whole” may literally be time, as in the question of what we do with our time. But why divide? Yes, why? Is it because time inexorably passes, but is finite because we are mortal? Is it because we say that “No man is an island?” Is it because we strive to solve the “economic problem”? (We may remind ourselves that the economic problem, according to the textbooks, is that of who should produce and use whatever it is that we decide to produce; this problem boils down to Adam Smith’s “division of labor” – the division of tasks – and also to the distribution or allocation of the things produced among those who wish to use these things.)

If economics is then the science dealing with the economic problem, there is no avoiding the idea that economics is about division. The positive side of economics sees how humans actually solve the economic problem. The normative side of economics asks how humans ought to solve the problem.

Given a certain or particular division, we then ask if it’s “fair.” Is that a fair question? It is not because it would be a form of begging the question. But it seems more correct to ask if the division was fairly arrived at, and fair is fair because division is first a process and then an outcome. There is no chicken-egg problem in analyzing answers to fair division questions.

The dictionary definition is interestingly hopeless. Merriam-Webster gives the one meaning of interest as “marked by impartiality and honesty : free from self-interest, prejudice, or favoritism.” In a way, it seems that fair is, like many primitive concepts, something more easily recognized than defined.