Sunday, November 16, 2008

Incentives

Economics is the study of incentives. If you enter academia and start learning about econometrics, you will begin to believe that it is the study of time series data, correlations, extrapolations, and other "ations" that may be somewhat relevant to economic performance. I always felt uncomfortable when my econ professors would point to data solely as the explanation of an event, citing correlations, variances, blah, blah, blah. While I found their explanations somewhat plausible, it seemed like they didn't look at the big picture.

The biggest problem was the idea that price inflation was OK. That sounded silly to me, and I feel like I've debunked that myth fairly well.

The next thing was the production model that is introduced in intermediate macroeconomics. It states that government is a component of GDP. This is silly because the government "produces" nothing. It must take from producers in order to redistribute what the producers made. And here is where it gets tricky.

The government creates incentives to act a certain way in order to hand out the money created by producers. The most notable one now is the TARP program under the Federal Reserve and Treasury. The TARP program is intended only for banks under the supervision of the Fed system. It allows the banks to apply for government money to save their asses. Here's the funny thing. There have been a lot of non-banks applying for bank charters. Insurance groups, credit card companies, investment banks; the list goes on.

These companies have found that if they simply change their business model to a bank, they can apply for "free money" from the treasury. So there is an incentive for companies to reorganize as a bank, take money from taxpayers, and apply it to their balance sheets to offset the huge losses from bad mortgage investments. These "banks" will not be able to begin lending money anytime soon because they are still hiding their losses and there are not many good investments out there. Even if they do find something, the massive deleveraging caused by these banks unloading assets to conform with leverage standards and reserve requirements will push asset prices lower and deflate the money supply. It is an ugly cascade that it probably unavoidable.

It is only logical that these smart companies will seek "free" money from the government. It's a smart strategic move for companies that want to protect themselves from takeovers and fund expansion. In a couple years they will amazingly not want to be banks because they have already defrauded taxpayers.

Next, we move to auto unions. The bailout package for these auto companies sucks. Taxpayers are simply paying salaries of overpaid union members, inept car designers, and their even more inept management teams. Mr. Obama wants to make it easier (read incentivize) for unions to organize and sap the energy and initiative of companies. Way to help the little guy. Isn't it obvious that the usefulness of unions has run its course? Unions have bankrupted dozens of airlines, domestic manufacturers, neighborhood groceries, schools, machining companies, and so on. If you pay people more than they deserve to be paid, a competitor with a lower cost structure and the ability to change its labor force quickly to adapt to the market will bankrupt the overpaying company. What happens to the union employees that are now unemployed? They simply move their parasitic organization to another unwilling host providing them with the same unpleasant experience. It's too bad these union members are just too stupid to realize what they are doing: dooming themselves while lining the pockets of corrupt union bosses. Unions are the biggest legalized racket of all time.

The biggest unlegalized racket is of course the drug trade. I was watching a special on gangs today. The reason many gangs exist is to traffic drugs. These gangs kill people so they can make money selling pharmaceuticals. How stupid is our drug policy? Are we too dumb to realize that a war against drugs incentivizes bad people to make a boatload of money peddling drugs. Let's look at it from a risk point of view. Most of these gang members/drug dealers have nothing to lose. They've made a lot of bad decisions and to them, jail or death are the only things to look forward to anyways. Therefore, they've almost completely eliminated any personal risk to getting in the drug trade. In the meantime, the government has made it illegal to traffic drugs, thereby eliminating any legal competition. This automatically makes the price of drugs rise. Drugs have become scarce and therefore expensive. So by making it illegal to traffic drugs, policymakers have incentivized organized crime to fill the void of demand and make a killing (pardon the pun) off of it. This does not mean that I condone drug use, quite the contrary. But I also do not condone murder or the promotion of murder which is what our drug policy does. Bluntly, drug use is suicide. The choice to use drugs is an individual one and those that partake in that activity should face the consequences. It would still also be illegal to interfere in the liberties of others, so the argument that drug use would cause increased crime would not necessarily hold much water. A rational drug policy should make drugs legal, but should require close monitoring of drug users. Choose a destructive path, face the consequences of fewer civil liberties. It's as simple as that.

From banks to auto makers to drug traffickers, economics can explain why people may choose to make certain decisions. Economic policy makers have the choice to interfere with how people make decisions, or let them run free. Our legislators are trying to feel important by writing silly laws that interfere in our decision making processes by making something more desirable than another thing in a naturally occurring state. Incentives make individuals tick. Now it's just a matter of determining where those incentives come from; a free unaldulterated market or a collectivist agenda dreamed up by a deity like figure called government.

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