Here are two totally intuitive common sense arguments:
"New products only benefit the inventor—the money he receives necessarily reduces the money available to other producers."
Both are intuitive and common-sense. Both are wrong. Both illustrate an additional fallacy—that economics is "just common sense." The fallacy in the two statements is the equating of money with prosperity. They are not the same. What we care about isn't the number of green pieces of paper with pictures of dead statesmen on them. It's what the pieces of paper buy. The fallacy is to see voluntary exchange as necessarily zero-sum. It is not. It is positive-sum. Understanding this is perhaps the single most important and basic lesson of economics. It is also one of the hardest to learn.
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"The fallacy in the two statements is the equating of money with prosperity."
Stay tuned for a strong inverse relationship between money and prosperity.
Russ,
Are the two statements intuitive and "common sense" as much as they are in fact "conventional wisdom"?
Common sense is not something that just springs into existence, in my opinion. Common sense is something developed through education, which includes observation, evaluation, and reasoning.
Conventional wisdom is just something one has heard from others and accepted without any investigation.
I am sorry, I should have added that my experience is that almost all conventional wisdom is wrong.
Frequently disasterously wrong.
See compulsory application for an SSN, for instance.
Voluntary exchange is positive-sum. Two people exchange a value for a value at a profit for each. Both sides gain in the exchange. That is certainly common sense. It seems so simple my four year old granddaughter should understand it. But for some reason many people can't grasp the concept. As you said it's one of the hardest lessons to learn.
Russ, do you have any idea as to why that is so? It remains one of the unfathomable mysteries of life, and it is the source of much of the turmoil in the world.
"But for some reason many people can't grasp the concept."
Understanding isn't the problem. The first problem is from those people who can't bear to watch others engage in mutual profit. The second problem is from those who can't bear to risk losing their voluntary partner in profit.
Understanding this is perhaps the single most important and basic lesson of economics. It is also one of the hardest to learn.
The problem is not the principle per se. Everyone over the age of roughly two learns the concrete applications of the principle. That's why trades and dealing arise spontaneously even among very young children, and in any other situation. It's not like the very idea of any one particular trade being mutually beneficial is hard to grasp. If it were, people would rarely trade, rather than, as is the case, trade so spontaneously and often that the problem of blocking "undesirable" trading (cutting in line, scalping tickets, black markets, whoring, et cetera) is usually much harder than starting trading.
The problem is understanding the principle in the abstract. Everyone grasps why, when he wants to buy a car, he should be allowed to do so freely, and the vendor from whom he wants to buy the car should be allowed to sell it freely. What is much harder to understand is that this principle has value in the abstract, i.e. when applied to everyone in a blind faith kind of way. That is, I should assume, absent other evidence to the contrary, that allowing someone else to buy or sell a car freely is good for me, too, in some indirect way.
Of course, why and how allowing other people to trade freely benefits me indirectly can be difficult to see. Sometimes it takes careful study, a careful disentanglement of influences, a PhD in economics plus a gift for abstract thinking and modeling, to trace the mechanism.
So for most of us it has to remain rather an article of faith. You should maybe give people some credit for the fact that despite their own inability to follow the logic, and the barrage of anti-free-market propaganda they swim in, they mostly do hold to this article of faith.
Adding to Russ's point, just think of how often we hear it "revealed" that the inventor of some famous thing never really did get rich off of it, or conversely, that some famous maker of an item didn't actually invent it, he was just the first to make a fortune from the device.
Such tidbits are usually in the context of the cheated inventor or the greedy fortune maker.
With all due respect, Vickingvista, I think understanding IS the problem. I'm a businessman, not an academic. I'm involved in voluntary exchanges about a dozen times a day. I can't tell you how many times my "exchange partners" believe that a business deal involves winners and losers. They think if I profit from the deal they have somehow left some money on the table. Many times I have to couch the deal in such a way that they can't see my profit. If they saw that I also profited in the deal they would assume they had somehow lost. They don't recognize that I can't stay in business unless I profit. I wouldn't be around for them to profit off me next time, unless I profited off them this time. It is one of the most baffling aspects of life, and it is something I ponder continuously. I wish I knew the answer!
It is one of the most baffling aspects of life, and it is something I ponder continuously. I wish I knew the answer!
This is due to the subtle indoctrination of socialization. Thanks to the intentional prodding of the left, profitmaking is commonly viewed as inherently evil.
"They think if I profit from the deal they have somehow left some money on the table."
They likely know whether or not their dealings with you grow their bank accounts. What you are describing is someone who feels like they have lost, not because they have actually lost, but because they also want what you have gained. It is much the same as the bystander resenting they he is not profiting from the deal between the two guys across the street.
And of course his coveting your gain is usually taken to reflect YOUR greed.
If there is anything that people do not understand, it is when to mind their own business.
"New products only benefit the inventor—the money he receives necessarily reduces the money available to other producers."
I can't say I've ever heard that argument. The real life story is as, R. Gardner said, the inventor made little to no money – the producers of the product did. (And there are plenty of Libertarians who say "as it should be".)
This is one of those instances when economists seem to come from a different planet.
"Buying local is better than buying from a chain store—the money stays in the community" is an example of the failure to understand the positive-sum nature of voluntary exchange? No way.
The thought process runs like this:
"If I buy $1,000 worth of X from my neighbor (instead of buying it from somewhere else for $950), and he buys $1,000 worth of Y from me (also instead of buying it for $950 elsewhere), we'll each make $200 in profit that otherwise would have gone out of town, while only spending an extra $50. He and I both come out $150 ahead."
"If everyone in the community commits to act similarly, while we all also continue to fill orders from outside the community, we can increase revenues, profits, and real purchasing power significantly."
Do these people think voluntary exchange is a zero-sum game? No! They understand that the exchange of X for Y makes both parties better off. But just because the game is positive-sum doesn't mean that you can't grab a bigger piece of the pie through a beggar-thy-neighbor strategy.
If you want to persuade them to do otherwise, you'd better attack the prospects for the success of that strategy, not the zero-sum straw man.
"straw man" is the wrong term, but it's late. Maybe "red herring" would fit better.
"If you want to persuade them to do otherwise, you'd better attack the prospects for the success of that strategy"
I think Willie Sutton had a better understanding of the modern pirate mentality. BHO loots as much of the richest voter minority he can, not for any stated reason, but because (1) it maximizes his return, and (2) he can get away with it.
Then the question how is the transaction 'positive'? A growth in technology? A growth in well-being? Is there a presumption everyone will always go the high-tech, mass produced products? What does it mean when people voluntarily shun the hi-tech solution or buy locally or, even, go the way of the Amish? Are people unconciously engaging in 'negative-sums' when they voluntarily choose the 'quaint', 'natural', 'hand made', 'lo-tech', 'local', 'organic', etc.?
"If I buy $1,000 worth of X from my neighbor (instead of buying it from somewhere else for $950), and he buys $1,000 worth of Y from me (also instead of buying it for $950 elsewhere), we'll each make $200 in profit that otherwise would have gone out of town, while only spending an extra $50. He and I both come out $150 ahead."
You can bet your neighbor is getting his supply of X from the $950 out-of-towner, selling it to you for $1000, and pocketing the $50 middleman fee. He then spends his freed up time producing Z and selling it for even more profit.
You could've used that extra $50 as seed money to start a new W-selling business. But, you are no worse off I suppose as long as he keeps buying the $1000 Y from you. It's just that you're letting your neighbor get all of the benefit of the lower priced out-of-town X.
But if you're a protectionist, then you believe foreign trade is destructive of wealth (at least locally). So you don't believe that new Corvette your neighbor bought even exists.
This is kind of summary comment, and not addressed to any single post, but keep in mind that many of the more outspoken advocates of "buy-local" would force such a scenario on society if they could.
And that's why it's dangerous from a policy standpoint because it is a genuinely populist stance that many in both political parties can readily abuse. (Not to mention the "green" bloc and their influence.)
As an idea, it's a fine idea to support your local store owner if that's what you want, but if that local vendor doesn't give me the choices I need, then I need to also have the liberty to shop around.
We buy all of our bicycle equipment from a local store that has been in business for decades. One old guy, small shop, and I want him to stay because of all of the advantages that it gives me. He's a specialty shop – BMX/freestyle – he has what only speciality shops are going to have on hand, he's an expert that cares about his business as only a business owner can, and so on.
But I'm not as picky on clothes. I don't care where my Levi's are made, and if I'm forced to buy locally, what will I end up with? Either I won't have Levi's, or my Levi's will insanely expensive, and I'll most likely choose to forego Levi's altogether. (I can see George Will getting behind this movement now that I think about it.)
Finally! This is a framing of the problems of "buy local" that I can agree with! Much more accurate than the silliness about the Florida advertisements for buying locally.
I think Morgan has a good point – that it won't make a bigger pie but you can certainly get a larger portion of the pie from beggar-thy-neighbor strategies. Economists always have this tendancy to assuming that what's called the "objective function" has to maximize total utility. But who can say that for sure? Maybe humans' actual "objective function" maximizes relative utility (which would explain the preponderance of trade barriers after all!). So before saying something is "better" or "worse", it's always important to specify what metric we're using. Free trade may be a terrible policy if the metric is relative utility rather than absolute utility – I'm not sure.
"You can bet your neighbor is getting his supply of X from the $950 out-of-towner, selling it to you for $1000, and pocketing the $50 middleman fee."
Maybe, but his cost of production is $800, so he'd be forgoing $150 in profit by acting as a middleman instead. What's more, the choice is his, so it seems safe to assume that he ended up better off. And if he is better off, so am I (the situation is symmetric).
Basically, "our community" stays busier producing more stuff for which there is an existing demand, so we're objectively richer. Or so it would seem.
"Maybe, but his cost of production is $800, so he'd be forgoing $150 in profit by acting as a middleman instead."
The cost of production is $800 plus a full day's work. No he has $50 almost pure profit, and a free day. So instead of spending his day earning $200 profit, that same time can be spent earning only $160 profit (e.g. a lower paying job) and he still comes out $10 better off.
The well known problem with your argument that is overlooked is that your neighbor's time is FREED UP TO DO OTHER THINGS. Since the cost of living is lowered by the out-of-towner's goods, your neighbor can do something else at less profit, and still be better off.
Now if you are going to assume that a person can only spend his time doing one thing, then protectionism might be of value. Fortunately people are more versatile than that.
vikingvista:
"The well known problem with your argument that is overlooked is that your neighbor's time is FREED UP TO DO OTHER THINGS."
Well, with that approach I think you've started to attack the psychology behind the "keep it in the community" ethos. But I don't think you're really to the point of successfully countering it.
Consider that with the "keep it in the community" ethos, my neighbor can choose to labor at his usual line of work, or to become a middleman and try to find something else to do with his time that is more profitable. Absent the ethos, he has no choice but to find something else to do to supplement his income, and may or may not succeed.
So which to prefer? We know that some people have a hard time finding new work. Most of us have even experienced this phenomenon at one point or another. Even if we convinced people that on average people within the community would be better off, they might still prefer to avoid the personal risks associated with it.
But I don't think we've even shown that people will on average be better off absent the ethos – in fact it hasn't been asserted. All we've said is that it is theoretically possible that at least some people in a "keep it in" community would be better off by switching to a middleman role and finding other work.
But without the "keep it in" ethos, that devolves to this: "Sure you will no longer be able to fill your time doing what you are best at and accustomed to doing, but it is possible that you'll find something that pays enough to make up for it – especially when you consider how inexpensive all that stuff from the outside is".
Not exactly likely to convince people. But can the case be (honestly) stated in a more convincing way? Can we even say that the community as a whole will "probably" be better off without the protectionist sentiment? Or is "some members might find a way to be better off, but the outsiders will definitely be much better off, and they're people, too" the best we can do?
Crud Closing italics.
Hmmm. Try again.
(I can't close them either)
Morgan,
Your point is well taken, but I think it is exaggerated. It hinges primarily upon the cost, and therefore fear, of changing productive activities. But good economy or bad, 4 million jobs are created and destroyed in this country EVERY MONTH. And surveys show that people change careers more frequently than ever.
Those numbers show great familiarity with American workers in changing jobs. I think there are many reasons–diminishing power of labor unions, defined contribution retirement plans, lower regulatory cost of hiring (compared to e.g. France), and not least of all the decline of protectionism. (Having health insurance attached to an employer is a definite drag on that mobility, but the freedom of workers to NOT have insurance mitigates that somewhat–a freedom I suspect the Obamunists would like to take away).
That's not to say that people hold less fear of job changing because they understand the systemic benefits of free trade. It is to say that the realities of those benefits have created an environment where people recognize a diminishing cost of changing jobs.
To connect this with our past examples, the reason those costs are diminished, is because your entrepreneurial neighbor is enriched by the lower costs of the out-of-town product, so that he can invest in producing product Z. And for that, he needs labor. The laborer doesn't need to make the product changing decisions in your metaphor–the entrepreneur does that for him. The laborer just follows the help wanted signs.
"Buying local is better than buying from a chain store—the money stays in the community."
This is true.
"The fallacy in the two statements is the equating of money with prosperity. They are not the same. What we care about isn't the number of green pieces of paper with pictures of dead statesmen on them. It's what the pieces of paper buy."
With a chain you buy into a legal fiction, called a corporation, that has no one responsible for the store or for the community. With an independent store you can buy into an individual or group of individuals who are responsible for their store and or their community.
"The fallacy is to see voluntary exchange as necessarily zero-sum. It is not. It is positive-sum. Understanding this is perhaps the single most important and basic lesson of economics. It is also one of the hardest to learn."
The question is where do you wish to place that positive-sum? Rewarding the individual or individuals who engage in capitalism entrepreneurship and hardwork ? Or rewarding those who engage in corporatism, corruption, and crime? By no means all chains/corporations are bad nor all independent shops good, but as a rule they tend to lean that way by their very nature. Corporations are corrupted if not by their complex imaginary nature that distances ownership from responsibility then by the government's regulation and taxation of them, and independents have to compete which leads to improvements and excellence.
"The question is where do you wish to place that positive-sum?"
No, that's not really the question. The question is whether New Yorkers would be better off buying locally-grown bananas or bananas from the tropics.
Bananas can be grown in New York, but only at great expense. Absorbing the cost of growing expensive bananas means everyone else lives less well so that a local guy can simply hold the job he wants, despite reality trying to send him a message that he should find some other line of work.
I absolutely love this post, Russ. Everybody thinks redistributing dollars redistributes wealth, but all it really does is wreak havoc on the dollar values of everything that can be bought.
Most significantly, this fallacy is the reason so many believe that taking money from the rich and giving it to the poor will not affect the middle class. It most certainly does. In fact, I think it is likely that the middle class pays the highest price — without losing a single dollar.
Question for Russ:
The understanding here is that wealth is not defined by money per se or even assets. It is defined by power to acquire value. This would make us all multi millionaires compared to a mere century ago.
So there is this economic phenomenon that makes everything just becomes less expensive with time. What is it?
Also, why are precious metals still well, precious? Why have they not been affected by this?