Asymptosis

Update:  “Lord Keynes” provides a great explication of Kaldor’s theoretical work on this subject.

Back in the day when I was running a high-tech conference company, we had a favorite (and actually rather cruel) interview question:

“What’s the best price for a conference?”

There was only one right answer:

“The price that makes us the most money.”

That answer encapsulates the position of almost every business trying to sell real goods and services. You have to choose a price, and you have little or no idea what sales differences will result from different choices. The implications are enormous — no other decision affects profits so powerfully — and you’re basically shooting in the dark.

Every business or product-launch plan I’ve ever seen has a huge dartboard right in the middle of it: How much, how many, will we sell? (“Well, it depends what we charge…”) In some businesses there are ways to do controlled tests of different prices and see how sales respond — Amazon being a brilliant example, and we did a a bit of it using direct mail with split runs — but most businesses (i.e. all of Amazon’s producers/suppliers) don’t have that luxury. You have to just choose a price with your best guess, based on various scraps of hard-to-interpret historical-sales and market data. It’s incredibly frustrating.

Which brings me to the point of this post: most producers are dealing (at least in the short term whose length varies with the type of business) with a fixed-price market. Once they’ve set their price, they can’t go changing it all over the place.

So: They’re not receiving any of the market’s supposedly informational price signals. They’re receiving quantity signals. That’s the information that producers derive from the market. Then maybe they change the price, and get more quantity signals. But again, those signals are always hard to interpret because you don’t generally have a controlled test to know whether the price is what drove quantity changes, or whether it was something(s) completely other.

Price is fixed, while quantity is very flexible. i.e. Analysts expected Apple to sell five million iPhone 5s in its first weekend. They sold nine million. Did the price go up? No. They rousted workers out of bed in China and filled the goddamn orders. When one of our conferences wasn’t selling well we couldn’t just lower the price, cause we’d piss off everyone who’d already signed up. If sales were good and it looked like we might sell out (there was simply no more room for hotel employees to place chairs), the last thing we were going to do was raise the price and risk stomping on that success. It’s very difficult for producers to derive prices signals from the market.

This is utterly unlike the market for financial assets, where price is infinitely and instantaneously flexible, while quantity — i.e. the number of Apple shares outstanding — is pretty much fixed and unchanging. (When you buy my Apple shares, the quantity or supply of saleable Apple shares is unchanged.)

In the market for financial assets, the price signal is (almost) everything. In the market for real goods and services, the quantity signal is (almost) everything.

There are lots of places to go with this thinking, but I’ll leave that to my gentle readers for the moment.

Thanks to Mike Sankowski for prompting this post.

Cross-posted at Angry Bear.

Mike Sankowski has been banging his spoon on the high chair about this forever. And rightly so.

Repeat after Mike. And keep repeating it to anyone who will listen. The “higher-corporate-profits = jobs” meme is perhaps the most pernicious falsehood in political economics.

How Business Owners Think

For almost ten years I was co-founder and CEO of a rapidly growing seven-figure company: thunderlizard.com (now sadly defunctified by the folks who bought it in 2000). My partner and I made a very conscious decision early on: Don’t get bigger. Get more profitable. (This was not our genius. The Aha! moment came from one of our employees. Thanks Toby!)

We decided to maintain our current staffing levels (10-12 of us), and throw all our efforts at generating more profit with those same folks — building killer-efficient management and organizational systems, developing world-class direct-marketing and customer-tracking tools and methodologies, etc. (Plus requiring everyone to document all those systems; we all hated that part but we had to do it.)

It worked brilliantly. This meant that 1. Our employees were able to do more creative, thinking work rather than administrative drudgery, and 2. We were able to pay them well. They did well in the buyout as well.

Our biz: we created, owned, and ran high-tech professional conferences around the country. (“Conferences with Content.” Catchy, huh?) The only way we “hired more” was when we sold a lot of seats at our events, so the hotels/trade centers/etc. had to bring on more staff for all the lunches, receptions, and such. More demand, more sales, resulted in more hiring. Our profits had nothing to do with it.*

And no: higher profits didn’t spur us to produce more events. That would have required hiring more staff (who we’d have to manage…). By the end, we were making all the money we wanted or needed, and then some.

A note to “incentive” fetishists: as profits grew, we had less incentive to work more or harder. One day near the end stands out. We had two events running simultaneously — one of them the biggest, best, and most profitable we’d ever run. And…wait for it…my partner and I were lounging on his boat in the middle of Lake Washington, on a glorious summer day. Ask yourself what you’d do in that situation.

As another former CEO, Nick Hanauer, says (1:50): “Everyone who’s ever run a business knows, hiring more people is a course of last resort for capitalists. It’s what we do if and only if rising consumer demand requires it.”

When we generated great profits, yeah we were able to pay our employees more. But mainly, we banked it. We certainly didn’t think, “Oh gee, great! We can hire more employees!” That would be stupid.

Money-grubbing entrepreneurial capitalists like us may be many things, but we’re not stupid.

* We had a joke back then: “You know what we do with empty seats after a conference? We burn them.” Excepting some events that sold out, the “resource constraint” on supply consisted of asking the hotel to put out more chairs. As we sold more seats, the marginal cost of production dropped to laughably low levels, and marginal profit skyrocketed.

For our business, at least, the (neo)classical production function was an absurd parody of reality. Economists will tell you that modern economics is much more sophisticated than that, and it is, but still: most of them are still running the Econ 101 parody version in native mode in their heads.

Cross-posted at Angry Bear.

Okay, once again I’m going to sacrifice my body here, risk looking stupid by asking what seems to me to be a vexatious question. Here’s the setup:

When you exchange some of your money (bank deposits) for some shares of Apple stock, those shares aren’t removed from the supply of Apple shares. (Likewise your “money”; it still exists.) The stock-supply, at least, is unchanged.

When you buy some apples for consumption, they are removed from the supply — both stock and flow.

Can we model or think about these two markets in the same way? One is a circular flow in which supply is never consumed (that is the sine qua non of financial assets: they embody exchange value that can’t be consumed to derive human utility). The other is a conveyor belt, where the supply falls off the end and disappears (or magically transforms into “utility” via consumption), with real production/resource constraints at the beginning.

Related: Clower/Burshaw on the difference between “stock supply” and “flow supply.” Or peruse the literature here.

I’ve wrestled with this before, as have my thoughtful commenters therein.

But nobody has ever come back to me with thoughtful discussion of stock supply and flow supply, or satisfactorily answered the question at the end of that post (accompanied by a Holy Grail clip that is a propos). The question posed above leaves me even more perplexed.

Am I foolish to suggest that the central concepts of economics, supply and demand, are embarassingly un(der)theorized?

There’s a great example in this Felix Salmon post, discussing the difference between the global “supply” and “demand” for bonds — which here seems to mean “bonds issued” and “bonds purchased” (designated in dollars). Mustn’t these values as implicitly defined here be identical — at least when viewed ex-post — making a discussion of their difference conceptually problematic?

Cross-posted at Angry Bear.

Gentle Readers:

Sorry to be incommunicado for so long. I’ve been working hard on a couple of projects.

I built a spreadsheet for myself a few years ago to compare health-insurance plans — cost versus financial exposure/protection. I just built it out into a web app that others can use, and I’ve posted it here.

You enter premiums (after deducting any subsidy), deductibles, co-pays etc. for up to four plans, and it estimates your total outlays in different health/spending scenarios:

It’s especially good for ruling out relatively bad deals. For instance, why would anyone buy the purple plan here for an extra thousand dollars a year, instead of the green plan, which offers the same or better financial protection?

There are simply too many variable in health plans to compare them in your head. I’m hoping this app will be as useful to others as it’s been to me.

Farther afield, the second edition of my Hamlet book was just published, along with a fully hyperlinked ebook edition that I’m rather proud of. (Turns out it was a lot of work to create a really good ebook.) If you’re even one tenth as interested in this play as I am, you might find the book interesting and entertaining. Further insights into the true depths of this obsession at princehamlet.com.

Cross-posted at Angry Bear.

Simple explanations are always suspect. So do with this what you will. It’s my basic framework for thinking about how economies work. It of course doesn’t explain everything; the headline here is tongue-in-cheek. But I find it very useful in thinking about everything else.

This thinking clashes quite definitively with traditional economic teachings. But it conforms very nicely with economic understandings that have demonstrated those teachings to be bunk. (Think: the Cambridge Capital Controversy, wherein the traditionalist economic powerhouse, Samuelson, admitted that his model — the model that almost all economists and many others even today run natively in their heads — was “definitely false.”)

It starts with money.

There is a pool of financial assets, ownership claims, on real capital and its future output (so-called “financial capital”): Stocks, bonds, money (bank deposits and currency), deeds, etc. etc.

People and businesses can transfer those ownership claims between themselves — cash for a deed, stock for cash, etc.

Some of those transfers are in exchange for real goods and services (things that humans can consume immediately or over time to derive real human utility).

Some of those transfers are simply exchanges of one claim for another.

Transfers in exchange for real goods (“purchases,” “spending,” “expenditure”) spur production.

Production yields surplus. (That surplus is monetized through trade, supported over time by new financial-asset creation by banks and governments — allowing producers to turn their surplus into generalized claims, hence giving them incentive to produce.)

Surplus from production is the source of aggregate “saving.” (Though for clarity I prefer to call it accumulation. National/world wealth is about accumulating real stuff, not claims on real stuff, a.k.a. financial assets).

Transfers in exchange for other financial assets may result in better allocation of real resources.

There is a declining marginal propensity to spend (on real goods) out of wealth. So a person with ten million dollars in financial assets will spend a smaller percentage of that each year than a person with ten thousand dollars.

If wealth is more concentrated, that declining propensity means there is less spending per the amount of financial assets; the turnover, or velocity, is lower.

So higher concentrations mean there’s less production for a given stock of wealth. And less surplus. And less income. And less saving/accumulation. And there’s less pressure/incentive for banks and governments to create and fund new financial assets, because there’s less surplus that needs monetizing.

Paradoxically, spending causes saving.

Arithmetically, more-equal distribution of wealth means more spending, income, production, surplus, accumulation, and wealth.

There are limits, of course. Perfectly equal distribution would result in seriously problematic incentive effects. But with the wildly unequal wealth distribution we see today, it’s not crazy to suggest that the straightforward arithmetic effects utterly overwhelm those incentive effects.

You can see a simple arithmetic model of this thinking here and here, and download the spreadsheet to play with it yourself.

Cross-posted at Angry Bear.

Lane Kenworthy has done some of the best work on this subject. Read all his stuff.

One great piece, on determinants of growth:

Institutions, wealth, and inequality

Only one institutional factor is strongly supported as a determinant of growth in prosperous countries, according to Lane’s really excellent statistical work: “corporatist concertation.”

Corporatist concertation is not what you think. It’s euphemistic sociologist-speak for labor having a strong place and voice at high-level bargaining tables — not just in labor negotiations, but in determining the institutional and policy structures that set the rules of the game.

Labor power is the strongest determinant of growth in prosperous, advanced countries. More labor power, faster growth.

I’d love to see equally well-executed statistical work analyzing labor-share of income and wealth relative to economic growth across prosperous countries.

Cross-posted at Angry Bear.

Larry Summers’ recent speech (and Paul Krugman’s paean to it) have brought the issue of secular, decades-long stagnation to the front of the econoblogosphere agenda. Tyler Cowen, of course, made it prominent some time ago. But he posited a tech cause: we’ve picked the low-hanging innovation fruit. Summers, Krugman, et. al. suggest that policies and institutions (fiscal and monetary) are much more central.

I’m with them. In the 70s we saw an economic correction for arguably overvalued labor wages, a painful correction the economy enforced via inflation and (with Volcker’s help) unemployment — driving down labor compensation both nominal and especially real. (Even Ed Lambert, commie pinko that he is, has found real compensation per hour was overvalued given the state of the economy back then.)

And just about the time that that imbalance was clearing out in the 80s, we saw the rise of policies and politics systematically designed and deployed to destroy and restrict real labor wages and compensation. Those policies have achieved exactly that proximate goal, brilliantly. They have not, of course achieved their purported ultimate goal: bigger pie, rising boats, city on the hill. All that rot.

Instead we’ve gotten thirty years of secular stagnation.

The eternal economic justification for those policies? The imbalance that existed, briefly, thirty years ago, and which mostly corrected itself.

But those policies and politics have continued for three decades, always justified by resort to “70s-stagflation” hysteria.

It doesn’t take long before a stopped clock is very, very wrong.

Cross-posted at Angry Bear.

For the moment, let’s go with old saw that “economics is the study of scarcity.” (Though I disagree with it; the proper study of economics is human reaction functions.)

What’s scarce these days? Certainly not supply. In an 80%-service economy suffering high unemployment and a unprecedentedly low labor/population ratio, higher demand for massages is not gonna slam against resource-supply constraints. And in the goods sector, there’s just-in-time inventory/supply chains (making it essentially a service industry). If Apple gets an extra million iPhone orders, supply constraints won’t prevent those orders being filled (or cause a price increase).

So what is scarce? Borrowers. Spenders. People to buy those massages and iPhones.

I’ve gone on at length about the shortage of loan demand, even in the depths of the so-called “credit crunch.” (See Related Posts at the bottom of that post for yet more.)

How about spenders? Let’s consider what it could be, could have been. If wages had increased since the 70s at the same rate as worker’s productivity, median wages today would be about $90,000 a year — nearly double what they in fact are.

You really gotta ask: would there be more spending (hence demand, hence production) if that reality were…today’s reality?

Would savers and entrepreneurs have more incentive to invest in risky ventures if hundreds of millions of Americans were enjoying those kinds of incomes, and spending to match?

As Francis Coppola, John Aziz, and others have been explaining at length of late, economics today should be concentrating on the study of abundance.

Cross-posted at Angry Bear.