How's life in the wonderful market economy?

In the fifth post of this series, I have to admit I somehow grew attached to the characters of my wife's and mine alter-egos, in Sousolandia and I think I could use them to further explore the effects of such a radical economical change. Forgive me if you just find the whole thing dumb.

So this post will find me a couple of years down the road from that incredible time when we changed our country from a Government controlled economy to a free market economy. And things could not have turned out better. This is it. We love it. We have reached the Nirvana of the economic paradigm, prosperity for all has arrived and the end of hardship. Ok, maybe, I should admit that we still work hard, but at least now we can get a lot of good stuff for it, stuff I never even dreamed I'd be needing, but without which I cannot live anymore (Whisky is among them).

How did we get here? So you'll remember that Cap, Cap Italist, the great foreign agriculture expert, came luckily our way, and out of his immense generosity offered to help us with the production. My wife, of course told him, she'd gladly accept it, but that he should always keep in mind that she was dictating the rules, and that of course she counted on my advice, because she didn't want things to somehow turn bad for me or the baby (the one we found on a basket), she loved us immensely of course. Oh yes, the baby has been growing fine, beautiful boy, he needs even more stuff than I do. My wife adores him. The funny thing is that some years before, when things had been going relatively OK, I had even proposed we'd get some of our own, which she then found that it wasn't such a good idea because we wouldn't be able to feed them on such low crops. Funny how things turn out.

Cap was fine with it, in fact he said he loved our rules, and even propose to suggest some of his own which could help improve things even more. He called them Reforms. First of all, he said Sousolandia sounded very old fashioned and that the outside people would not associate it with a modern fruit exporting country. So he came up with a beautiful alternative, Chitita, the Banana Republic. I raised my arm and told him, that in fact, we were neither a Republic, nor did we produce bananas. To which he smartly retorted that "one has to look into the future, my boy". I liked Sousolandia, but Chitita was just as fine.

With a name like that many more people came and we all got work down at the plantation. We even had to expand it. So we started to cut down parts of that useless forest that was surrounding our farm, sure it was beautiful, with all those birds, and flowers, and lake, but it was completely useless, nothing really worth anything was being produced there. I thought I'd miss the times when I was a child playing in those woods, but then again I'm not a child anymore, and we need to increase production. By then we were producing so many tomatoes and oranges, which we were using to trade for everything else that we realized that it was such a burden to carry them around to do business, so Cap suggested the Monetary Reform. That is for each tomato and orange we produced, which for us were worth more or less the same, my wife, the government, would issue a little paper saying "I'm worth an Orato" (that's what we called our currency), and then we just needed to use those papers to trade instead of fruit. Because we started carrying lot's of paper, she then made some which said "I'm worth 5, 10 or 100 Oratos".

The neighbour did the same and created the Chikollar, which was worth a chicken. So in order to trade with him we had to maintain a table to convert Oratos to Chikollars, depending on the level of production and exporting of either country and how appreciated those products were in the market, which oscillated with the fashion. Then we figured out that everybody else was doing the same and we had to expand our table to foresee all possible conversions from all currencies to all currencies. This also turned out to be complicated then one country said that they produced something that was worth more than anything else in the planet, diamonds, and that we should all just calculate the worth of our currency with respect to that (he was right, I'd seen one of these diamonds in the neck of my wife, a little present from Cap, to celebrate their everlasting friendship, it seems it had cost him a few thousand tomatoes and oranges). That made life easier; we all indexed our currency as a fraction of a diamond. Now doing business was really smooth. I hardly ever really saw a tomato or orange again, but some one must have been buying them because our papers were always worth something. Sometime we could tell that the selling was not going well because all of a sudden the paper value would drop, and you'd need more of it to buy something, and they called that inflation. Oh yes, Cap was giving us paper money for our work at the plantation, a fixed amount, which he adjusted every year so that we didn't feel so much this inflation (my wife had to push him to do so, but never mind).

The other thing Cap proposed was to buy the right to plant the land. He said that the land would still belong to the country, but he wanted to own the right to plant it how he saw fit, because if others would be coming to interfere this could make things very inefficient, and after all if he was going to invest most of his possessions in it, he wanted to be sure he wasn't going to get ripped off, dispossessed of his most valuable belongings and expelled once the plantation was yielding lots of fruit. My wife agreed to it, they signed a contract which she swore to honour and we received a few diamonds in return. So we had the Privatization Reform. But he didn't stop there. He asked my wife: "Why is it that you only take loans from the neighbour? You know he's always ripped you people off, he asks too much interest.” we had never really thought about that one. He was after all the only other person we knew until then, and even if he was not entirely fair, we at least trusted him. But Cap said that now we were trading with all kinds of other people and if we trusted them to trade and balances our currency; why not trust them with loans? In fact there'd be so many others offering nice loans that we would find much better interest rates, and use the money to invest in the plantation. How can you argue against that? My wife immediately started the Liberalization of the Capital Market Reform. Cap was very pleased with us, and told us how smart he thought we were to come up with all these nice reforms. It was very nice of him to say so, especially since most of these ideas were actually his.

My wife in the meantime got very busy attending to the needs of everybody in the country, we had grown now to a considerable size in population, most of them Foreigners, but now some were having their own children here, which I guess makes them nationals. She had to make sure everybody stayed more or less healthy, but unfortunately there was no more hot water bottle in bed and herbal tea as before, everybody was just getting an Aspirin, and had to pay money for his or hers. She had to make plenty of rules for how people should behave, because everybody was accustomed to something else from the places they come from. She also had to teach them all to speak our language. To sponsor all these things, health, justice, education and others she needed funding. Before in the old days when it'd been just her and me and Waldy, she would take all of our production and basically decided how much each would get in oranges and tomatoes and use the rest as she needed and that was it. Now she wasn't in control of the plantation anymore but she had to make sure to get some funding out of it somehow. So she came up with her own reform, the Tax Reform. She decided that since Cap was making so much money out of our production she would tax a percentage of the profit he was making. He thought that was again a very smart idea and agreed, but he convinced her that most of that money could be better used if re-invested on the plantation to make it even bigger, and that he could think of a number of other ways to get tax. Namely he said "Look at all those people in your country, they're earning such big wages, that's basically all profit, because they don't have to invest any money in tools and fertilizers, I do that for them, so why don't you also tax their enormous profits? And since you have all this trouble in issuing money to match the production why don't you also tax all the sales to cover your expenses. This way you can lower my taxes, I produce more, and everybody gets a salary raise and then you can tax them more. All so logical and simple. And that's how she introduced wage tax and sales tax, and lowered the tax on the food corporation profits.

All these reforms were not easy to introduce, there was always so much protest all the time about everything that she started to get really fed up. People were just used to the old ways and would not accept easily change, even if for the better. And so she started dreaming of her old job, when she was planning the production. Now the whole enterprise was so big and interesting that surely the job must be fantastic. She kind of mentioned her anxieties to Cap (who she now considered to be a kind of spiritual Guru) and he told her that in fact, he'd been thinking of making her his own personal assistant, to oversee the production locally while he had to be away so often to do international business. She asked "But what about the government? Who takes care of the people?". He said, in his infinite wisdom, that the people would take care of themselves, that in fact this would be a fantastic opportunity for them. After all, weren't they always complaining of how you did things? So they probably think they can do it better. Some of them were even calling my wife a despotic tyrant. Could she believe it? She did. She would not be talked of, in the outside world, as a tyrant. She loved her people more than anything in the world, me, the baby, and all the people who came afterwards, and their children as well. So she decided to do what was best for all, and for her as well (she was earning more as an assistant to Cap, then as the head of the Government) and let the people decide for themselves. And she created the greatest of all of the reforms, the Democratic Reform. This was a beautiful day, and everybody congratulated our country for joining the train of the progressive countries of the free world, and we pledged to every year commemorate this day with big parades. We called it Freedom day. We were now all free to decide for ourselves who'd represent us. A marvellous thing.

So the next day a big bunch of us decided to stand for election and become the new President of the Republic. We knew not much of what the job entailed, but it seemed like the smart thing to do. Maybe we could follow on the footsteps of my wife who'd been offered such a great job after she left the government in the corporation top management. After a while it seemed unlikely that all of us would get elected so we started debating to see if we could find the guy with the best ideas to represent us. So a guy stepped up and proposed that if we all voted for him, he would trash the contract where we sold the planting property rights to Cap, and we could kick him out of the country and take over from him the control of the food plant, and make money for ourselves. His name was Com, Com Unist. Nobody took him serious, because we all knew we had neither the international connections nor the money or the skills to manage this thing as Cap did. So another guy stepped up and said he would rather convince Cap to share a bit more of his profits with all of us, since we were doing most of the hard work, and demand some benefits like vacation and a pension scheme. We all thought that was more reasonable, and we chose him. And that's how Cor, Cor Uptible, became the first president of our free Republic. Long live the Republic.

Everything was just grand, Cor is much less strict than my wife used to be, and we basically can do what we please. The only one who wasn't much happy these days was Waldy, our old Münsterländer. His services had not been needed much lately, since we did not have to repel anybody anymore. In fact the barb wire around the whole farm had been removed and roads appeared from all directions. Waldy kept barking, mostly at foreigners, but he wouldn't scare anybody. We gave him the task to patrol the streets and bark at drunken people, but even that was starting to be too much for old Waldy. He never really did like Cap either, strange dog.

Now, can this get any better? That I hope will be the topic of the next post.

How do you go from a controlled to a free market economy?

I know i promised to blame somebody for the problems of free market economy on the previous post, but maybe its a bit early for that just yet, it's not nice pointing fingers, so I'll leave it for later. If you just came across this post, this is the fourth of a series, it's best to read the others to know what I'm talking about, unfortunately, they're rather long...

However I thought of an analogy which may help visualize what pushes an economy to abandon government controlled economy for a free market one. I apologize already for the inaccuracy and extreme simplification of this example. But just bear with me and even if you find it bullshit, you may find it somewhat funny.

Imagine this little country, out in the middle of nowhere called Sousolandia, and it has 3 inhabitants, that's my wife and I, and our dog Waldy. Our country is actually a farm, where we produce tomatoes and oranges, the basis of our nutrition. So we're not rich, but we're honoured. We're well protected from foreigners because we barb-wired the place and we have Waldy.

We are a government controlled economy, my wife is the government and she also controls the main corporation of our country, the food plant, I'm the working class, the middle class and rich when I'm lucky. Waldy is the army. Every year she tells me how much of the land to fill up with tomatoes and then in the rest we let the orange trees grow. She's no big agriculture expert, so she looks roughly at what we've been producing for the last couple of years and gives her best guess, and I just do it, and then we just hope the weather is going to be nice on our tomatoes. So every year we get a crop of tomatoes and oranges which is most of the time plenty for us to eat, and when we have some exceeding we try and sell it to our neighbour.

Oh yes, our neighbour, I forgot about him, he's the only other country we contact with and he's also a farm one day walk away from ours. He produces chickens and beer. When we have exceeding we go there and try to change our oranges and tomatoes for a few chickens. Normally a couple of oranges and a couple of tomatoes are enough to get one chicken. He claims to be a believer in free trade, but the matter of fact is that he then claims that since his cousin is also producing some oranges and tomatoes, he doesn't feel too good about receiving ours, so we often offer him double, which he then happily accepts. So he's effectively taxing us. That's why when he comes around to ask for our products when his cousin fails to deliver, my wife also asks him double. Reciprocation. And those beers? My wife strictly forbids me of having any, she won't have a drunken husband in the house. So I bring along some of my own food to trade secretly for a couple of beers which I smuggle in my pants. The neighbour really rips me off on those beers, but they're worth every orange and tomato I let him have for it.

So our little economy had been going wonderfully for a number of years, everything was smooth, except for the odd year when the weather wouldn't help and we'd hold on to our stomachs over winter. Often if nothing serious happens, systems like this may remain stable for ages. In mathematical terms they are in equilibrium in a local minimum. This means that in the terrain of all possible solutions to have a stable economy we've came to rest in a little snowy tall valley between two high peaks. We found stability, but any push may drive us over one of the peaks on either side and we can find ourselves rolling down the slope in an ever growing snowball.

And that's exactly how we came to be today a free market economy. So let me tell you how that happened.

One fine year, not too long ago, a number of things happened or developed that took our little economy out of balance. We'd been having 5 very mild years in a row, and our production had been running at a good output level. We were happy and confidently planned the new year counting on another wonderful crop, we did not think it necessary to store reserves and clearly this trend of good weather was here to stay for ever. The work itself had no real secrets to me anymore, and I eventually even found myself with lots of spare time on my hand, I'd water the plants in the morning, a couple of strokes on the land to plough after lunch, and then wait for it to grow and the time to pick up the results. In fact I had so much free time that I would often indulge in some of that beer I had stacked away and imprudently appear drunk before my wife. She started suspecting I was getting lazy and irresponsible, and that I had too much time on my hands, on a few occasions she actually caught me totally pissed, my pants wet, snoring away under the orange trees. She got into a rage and saw this as a serious social problem in our country and decided that I was actually under employed. So she thought of a fantastic project to guarantee me full employment, which she thought was her moral duty. I was to build new cupboards for the house, cupboards in every room, even in the cellar, where we don't need cupboards. Well she should know better, after all she's the government.

So I started the challenging task of building cupboards. To do this I had to borrow some tools from the neighbour, which actually was costing us additional food, and I decided I'd cut some of the orange trees for wood, and I had to clear some of the tomatoes for space to have the workshop. And I worked a lot on those cupboards, I hardly had any time to enjoy a little beer, and I was getting exhausted of accumulating the tasks. I simply wasn't used to it. So much work.

On top of it, April came, and with it came the rain. And it rained and rained and rained and it flooded a good portion of the remaining of our tomatoes. With the parts I took out for workshop and the trees we lost to cupboards, the crop was miserable. I was discouraged and blamed my wife for her incredibly bad planning and lack of foresight. How could she not have seen this coming? Does she think good weather really lasts forever? Shouldn't we have made reserves (or preserves) for such a case, instead of filling the cellar with cupboards?

When in August we went to our neighbour to trade some of that dripping fruit for some tasty chicken (and hopefully a little beer), we had another surprise coming our way. The neighbour had invented a miraculous grain that doubled the production of chickens and had built a road to other countries who were all dying to eat some of those chicks and drink some of his beer, so he was trading it for exorbitant prices. When we showed up with our meagre fruit, he laughed and so we came back with a very few dirty small sick chickens, and not a single beer in my pants, and feeling distraught. When we got home, Waldy was barking wildly, there was something at the door steps, a basket. We thought, oh great, could it be that someone came by and dropped some aid in the form of food? Would some foreigner be that generous?

We took a closer look, and a noise came out of it, a shriek, it turned out to be a baby... with a paper on it saying that it'd be happy if someone would take care of it... Not only these foreigners don't help, but they still impose. I told my wife, we could not possibly have another mouth to feed in this country, we don't have enough food. My wife took to the child immediately and would not hear of it. I said it was too much, I wouldn't have it, I wouldn't have any smelly immigrant coming into our house, and I’d strike and make things even worst if she didn't listen. Not only this bum baby would not help a bit with all the work, but it would literally be taking food out of our mouths into his. I felt so outraged that my mind was filled with thoughts of revolt. I wanted civil war, I wanted to get Waldy on my side and together over throw her and make her go and plough those fields herself to see what it's like, and let the planning to me, after all I'd been working those fields myself, who knows more about it than me? That next winter was the coldest and hungriest of our lives, and all through it Waldy and I conspired in the cellar for the Revolution that was to come soon. We hardly spoke to my wife anymore, and I hated that baby.

It was then, as winter was fading, that she had a fantastic idea that could actually save us. She said: "Why don't we do like our neighbour?", I said: "What? Make beer?", she said: "No stupid, build a road and start trading with other countries? We will not tax them like we do to the neighbour, so they'll have more incentive to buy from us, and I tell you what, if you don't like my planning skills, we'll let an expert foreigner come in and plan it for us, he'll make this farm produce so much that you'll be able to get as much beer as you like, and if you don't complain about the baby, I'll make the beer legal, so the neighbour cannot rip you so much", "How do you know the neighbour has been ripping me off on the beer?", I asked, "His wife told me, now what do you say? We don't have a choice, this is just going to get worse, we'll never eat chicken or drink beer again". What could I have said the prospect of infinite cool beer, sounded just well to me. Maybe those other countries would even have other stuff that was as cool as beer, I'd heard rumours of the existence of a television, a sports cars and smelling cosmetics, and those sounded all just super awesome to me.

So we told the neighbour we would not be taxing him anymore if he wouldn't tax us, he had no problem with that since now he was also selling exceeding tomatoes and oranges to other countries so he was free to take as many from us as from his cousin, so we asked him for a loan and we built ourselves a road which connected us to other countries and we invested again in our farm, we expanded the production to include other fruits and vegetables, way beyond our own needs, such that we could trade for lots of other cool stuff. This was not easy, and demanded a lot of work, so now i wasn't so concerned about having other people in the house and we actually put out a sign on the road that we'd give free boarding a food for help in the farm, and a few foreigners came by to offer their services, some of them looked very hungry, and poor, I was often afraid they'd rob us or kill us during the night, well, some were really weird, I tell you. But they turned out to be nice people in the end and we welcomed them. One day a foreigner came who claimed to be an expert in agriculture; my wife blinked to me and invited him in. He said he'd be glad to take over the burden of planning the crops, he had good knowledge of the needs in the outside world, and he happened to have some valuable possessions which he'd be willing to trade in for more tools and fertilizer. Can you imagine? Fertilizer? So we could never go wrong, he'd make sure our production would be just optimal. His name was Cap, Cap Italist. My wife gave him a big kiss, which I found totally unnecessary, and she gave him my room to sleep in and sent me off to sleep in the barn, since the rest of the house was already packed. And that's how we came to be a free market economy. So far I can't complain, I don't really like sleeping in the barn but at least i don't get to hear the baby cry, but I hardly ever see my wife anymore, she often has business dinners with Cap, she claims he's explaining the new agricultural methods, which are going to make us rich! She started drinking beer herself. I told all this to the neighbour and I made also my own private loan which I traded down the road for cheap Whisky. Whisky!! Man, life is good in the free market world! Next year I'll pay back the neighbour and get a whole lot of new stuff including an I-Pop, or whatever that is.

So you see one day you're in a tall snowy valley, cosy but often cold, and then something crazy happens, and you find yourself rolling down the mountain in a snow ball and you think you're going to crash and die, but eventually the snow melts, you find yourself in a warmer valley, better than the one before, all is well, and that my friend I call Progress!!

Would you like to know how life in the new free market economy is? That I hope will the subject of the next post.

Now, what's the problem with this new model?

Well, none, if you happen to be on the right end of the game. For some (a growing majority) on the wrong side, things have progressively been getting worse, and for them there are one or two inconvenient problems. We'll get to that later.

First, who invented this fantastic free market system? I honestly don't know, some of the prophets of this new branch of the economy religion were Milton Friedman and Friedrich Hayek, but I can't tell much more about them and the others. But, to me, there's nothing remarkably new about it. Free markets, where the government regulation and taxation are minimized and Offer miraculously matches Demand have always existed. They used to be called Black Markets. And they used to appear everywhere where there was a chance to do some business which was not well seen by the rest of society, or where there was a chance to do it without paying taxes. In Europe there are still black markets for Polish plumbers or Portuguese brick layers, or more frightening, black market for foreign women as sexual slaves.

Take the drugs market, do you know of a drugs dealer that pays taxes on his profit? Do you know any law that regulates how this dealer should sell his stuff, how to pack it, and at what price? Maybe the drugs dealers have some sort of code of conduct that I'm not aware, but traditionally it's a very Free market, very black market (no pun intended). The dealer is free to trade the product with the consumer without strong regulation and taxation. Now is it an efficient free market? Will the consumer  get a reasonable price for what he or she gets? Traditionally not. This market is often dominated by cartels, which means they have a monopoly and charge more because of that, competition which could bring down the price is strongly discouraged often with violence, plus restrictions on importing and the risk of police crack down puts the product at a premium. 

Now let's look at another innovative aspect of these free markets, the possibility, via free financial markets, where capital flows globally, to invest in goods anywhere in the world. You can actually put your money on a fund, which will use it to buy tons of rice in say Vietnam, because a big tsunami destroyed all the rice fields in Thailand, and you believe the price of the rice will go up, and therefore these tons will be worth double when sold, and by keeping them stored somewhere you actually contribute for the shortage of rice which will also ultimately make that rice price climb (now for the sake of this example, never mind the indians who'd love having that rice at least one bowl a day, who'll be hearing strange noises in their stomachs). Now what did you normally call it when you put your money on something you believe has a good chance of returning you a profit, without you needing to actually make an effort to earn it? Gambling? I don't know, I mean gambling is for example when you bet (invest?) on a horse who has a chance to double your money... does it sound familiar? What do you call it when you bet on a horse, which you know has been given a nice doses of steroids to win? 

Now, having said that, I have nothing particularly strong against black markets and gambling. I mean, apart from the slaves and drugs and such, in other black markets you can get some really good deals (my mother used to take us to the gipsy market in Carcavelos, close to where we lived, all the time to buy clothes, there was so much competition there, and so little regulation, that you could get some really attractive Levi's look alike pants or fake Lacoste shirt for peanuts), and nobody really gets hurt. And gambling, I mean, if you do it at your own risk and don't bother others with your debts who am I to judge you... but gambling with food? go gamble on gold, who cares if the rich can't afford it, but food? Doesn't it sound just a little bit more distasteful than a horse race addicted person.

So we basically legalized some concepts which were already there, but were considered distasteful, because some economists realized that these often worked more efficiently than what we had, and now we consider it very tasteful indeed. Keep in mind that Efficiency does not relate directly to Fairness.

So are these new bla... pardon me, free markets really that efficient? According to Tim Harford, in The Undecover Economist, a market is efficient when you can't make somebody better off, without making someone else worse off. What does this mean?

It means this, if I'm a drug dealer and I'm charging an enormous premium on my cocaine, and ripping the hell off of a regular junky, and then i decide to lower it a bit, I'm not making my position any worse off because at that new lower price I may even sell it to the poorest of all the junkies who couldn't afford it before, and make some additional income,  but I will certainly make both those junkies better off (worse in terms of health of course). That means my market was not efficient in the first place, and by lowering the price I made it more efficient. Now if by lowering more I cannot cover my importing cost, then I'll be worse off and the market was already efficient before. Or if instead I raise the price and my regular junky cannot afford it anymore, then I don't sell it and he doesn't consume it and I've wasted a selling opportunity, then the market was again already efficient before. This potential of reaching an efficient point is what makes free markets so interesting, they are like self-control mechanisms. If the government had interfered and fixed the price of cocaine, then the market would not be free and could not adjust in such a situation.

According to that same economist there are 3 factors which reduce the efficiency of free markets, and they are:

1. Scarcity power - being the only one that can deliver the product, the boss of the drugs cartel
   
2. Asymmetry of information - when I know more about the cocaine ingredients, namely the amount of flower in it, than the junky
   
3. Externalities - the impact that the junky stealing money from people on the street to buy my cocaine will have on those people
   

Such a market plagued by all these factors is inefficient, not to mention highly unfair. If you were the government how do you fight these issues (I mean how do you improve the market, not how you arrest the dealers)?

1. Allow markets to be highly competitive to reduce scarcity power - let all the gangsters in on the game
   
2. Allow access to information to all parties to reduce asymmetry - force them to put a label on the cocaine bag
   
3. Identify and charge taxes on each market's externalities - apply fines on junkies who steal or their dealers and give that money to the victims.
   

So the problem with the new free market model, is basically this: The economists would love that the free markets were highly efficient distributing benefits to all in it, low prices for consumers and enough profit for the producers to stay in business, so they keep coming up with new recipes involving any combination of some of the medicine above, but most of these markets not only are highly inefficient but are highly unfair, and what's more they don't want to be efficient. And who's to blame? Well, that I hope will be the topic of the next post.

Was our economy always like that?

Well, according to this book I'm reading (The silent take over, by Noreena Hertz), it was a bit different. Until about 30 years ago (before Thatcher and Reagan came into power in late 70's, early 80's), in most of western countries, including most of Europe, the heavy industry (the big corporations, like steel, energy, transport, oil, even food) were state-owned. This meant the state decided how much to produce and at what price to sell. This worked well, especially during the war when basically production was required at a maximum rate and there was social cohesion towards a common goal.

In democratic countries, politicians who wanted to stay in power had the incentive to please the electorate (government by the people, for the people). And they had the incentive to stay in power because they were in control of an enormous machine, the main bulk of the national economy (according to S.Levitt/S.Dubner, in Freakonomics, humans respond extremely well to incentives), and power made them happy. So workers conquered a lot of benefits in those days, which were not there before (payed vacation, unemployment benefits, retirement pensions, health care, better education, and so on). These were nevertheless hard-fought battles with a lot of striking and protesting, leading up to major confrontations, like the 68' student movements. That economic model was based on the economic theories by John Maynard Keynes, who advocated that government should intervene in the economy to guarantee full-employment and welfare. This model resulted from the analysis of the American Great Depression, when a vicious cycle of under-spending lead the economy into a negative spiral, such that many people lost their jobs. The idea was that if under-spending lead to recessions, than a lot of government spending would solve it.

So governments and their associated industries grew to become enormous, heavy monsters, which provided work for many people, but became extremely inefficient. Governments had to plan production for the year and they would do it by looking at figures from the past 5, 10 years, which would not always apply to the circumstances faced in the new year (aging of population, changes in preferences, bad weather or other catastrophes, or like in my country the fact that many people returned from the ex-colonies in the mid 70's). Often production was too low, causing the country to have to import (at high costs since the economies were protected with trade tariffs) and inflation would ramp, or was too high, and the producers could not sell the exceeding because the prices were fixed (i remember as a kid watching on TV farmers dumping excessive tomatoes they'd been asked to produce on the streets of our capital because they couldn't sell it). Subsidies would be put in place, taxes raised, purchase power reduced, international loans asked, debt increased, more taxes raised, and so on, down the drain. In very small countries, or countries which are rich in valuable resources (like oil) this government controlled economies may work, but as economies grow in complexity it tends to become highly inefficient, and government cannot plan it anymore (this is what lead to the collapse of the Soviet Union).

It could have happened to other European countries as well, if democratic alternating had not allowed for experimenting with other models. And this is what happened when Thatcher became elected in Britain in 1979, and Reagan in the US shortly after. The Keynes theories were abandoned and replaced by new ideas which embraced the concept that private and free markets tend to regulate themselves. That is offer will equal demand in some magical way. This magical way relies on the fact that private enterprise will aim at maximizing profit, therefore reducing waste, increasing efficiency and optimizing production. The governments saw an opportunity to cash fresh money by selling their enterprises, thus relieving the tax payers, improving the efficiency of the economy, thus making life better for all in it. Some of the reforms required to liberalize the markets were painful because in the transition periods a lot of people got worse off (for example massive lay-offs because private corporations require less workers, more competition for your job, less security, etc.), this made some of these right-wing governments unpopular, but, once this radical change started and economies became more dynamic, there was no stopping it. It was a domino effect, either you were in or you were out at the risk of seeing your economy collapse, like it did in most of Eastern Europe. Even the left-wing governments that followed (Blair, Schröder, Chirac) could not (and had no desire to) do anything to prevent it, in fact they pursued it even harder.

One more note: what lead to the collapse of the Eastern Europe economies was, i believe, more the fact that the economy of the rest of the world grew so much in production (GDP) that the money of these economies became worthless (they had little or no exports to make it worth anything to others) and vital imports (food, energy, parts) extremely expensive, when considering on top the trade tariffs that came with it. So they collapsed, not so much because they were communists, but because they didn't grow as much. It's the difference that causes the problem, not the absolute size.

And that's how we arrived at the model I described in the previous post. So from a starting point where governments were ruling the economy to a point where corporations now control the economy.
Now what's the problem with that? It all sounds efficient and fantastic. And that i hope will be the topic of the next post.

Macro-Economics, what is that?

I found the diagram above in Wikipedia, and I think I'll spend a few posts making considerations on it. First i should try and explain what it means. I have no real knowledge on Economics, but it doesn't seem so difficult. This picture depicts the way our national economies work today. It is like a machine with its different parts, and the economists, which are the engineers of these types of machine love to oil it and make it run better and faster and bigger. So how does it work?

There are 3 national players and an international one, and 3 markets where transactions occur.

The first player consists of the households, the families (or as we are also known, the consumers), of which some work, some are retired, some are too young, and some are sick, and some are hard working, and some are lazy, some are smart and some are less. It's us. Out of those that can and will work we offer labour to the workforce market. In return we receive wages. With these wages we consume goods and services from the commodities market, or we make savings and investments in the financial market expecting to receive interests in return or we make loans for our private consumption (buying a house or a car).

The second player consists of the corporations, and they demand labour from the workforce market and resources (like energy) or raw materials in order to produce goods and services, which are sold to other corporations, households and government in the commodities market in return for profit. They obtain capital from the financial market in the form of loans or investment (shares) which they use to set up their logistics and improve their production capability. Banks which are corporations controlling the financial markets will often make investments in commodities for speculation (such as food, causing the prices to rise and some people to starve).

The third player is our government, these are some of our own kind which we elect to represent us, they collect taxes from wages and profits and transfer benefits or redistribute wealth and provide welfare (education, social subsidies, health, roads, justice, police, defense, etc.). They also provide laws to regulate private and corporate behavior. They make savings and investments in the financial market and often also require loans. They used to have also the power to manage money issuing to control inflation, but since the euro this capability is limited to the political power of each nation in the European institutions, so their influence in the economy is basically in tax policy, interest rates and regulation.

The forth player is represented in the picture as Foreign, and are all the other countries out there, with which we do business, that is we import and export goods and services, and we receive or supply capital via direct investment or aid through the financial markets.

Modern economic theories requires that regulations and protectionism in the functioning of these described markets be kept to a minimum, competition to a maximum, and information shared, such that they work fine. When this happens, then in some magical way, production will match consumption (when there is demand new companies will appear, when there is exceeding some companies will go bankrupt), prices will be kept to an acceptable value that consumers can afford and employment... well, no one can guarantee anything about that, but if the economy grows then there should be nothing to worry about.

To have an idea of how well the labour market is doing we look at unemployment rates. To have an idea of how well the commodity market is doing we look at GDP (Gross Domestic Product attempts at estimating how much a country is producing by calculating how much it consumes - from the magical formula Consumption = Production - GDP = Consumption + Investment + Government Spending + Exports - Imports) for size and inflation (the commodities price variation) for dynamics. To know how well the financial market is doing, well you can look at interest rates or the bank profit declarations, it's normally doing well except when you hear of sub-prime crisis (which means banks have lent money at high interest rates to people who can't pay back)!

So everything should be alright and everybody happy when unemployment and inflation are low and GDP and interest rates are high (if the central bank lowers interest rates it normally means it thinks corporations are in trouble and need to borrow money, and lowering will stimulate the economy). And how do you do that? What is the fuel that powers the engine? Well most people would claim it's to consume, consume, consume... corporations profits stay high and they employ more people, government collects more taxes, wages increase, there's more money around for people to spend, spending makes people happy, government collects more taxes and may decide to lower them, stimulating even further the economy, more corporations appear, prices lower, people consume more, and so on in a virtuous cycle, or so we wished... (but that's another post)

Did it always look like this, our economy? This will be the topic of the next post.

The paradox of choice

I found this video which, although a bit out of the subject of this blog, is nevertheless interesting as it discusses the society of masses we live in, and how the sheer amount of choice we have at our disposal can lead to paralysis. Hope you enjoy it!

http://www.ted.com/index.php/talks/view/id/93

A couple of months ago I had the problem of the mobile phone. The battery of my old and trusty nokia 3310 was letting me down, so I decided to get a new phone, only to spiral in the thoughts of looking for the cheapest and more basic phone and then realizing that I could get a little bit more phone for a little bit more money, and not wanting to feel like I had made the wrong choice. It took me 3 weeks to decide...
In the end I got a spare battery from a friend for my own phone, and I couldn't be happier!

Feeding themselves

The poor may be poor, but they are not stupid, certainly not any stupider than you and me. Here's an interesting note i found:

"You are absolutely correct that it is a mistake to define the main problem of the poor "as massive hunger, and hence the solution as providing food". But the optimum solution to tackle the cause of hunger is to give the poor and hungry that ultimate form of voucher: cash. Except in the rare cases of total market failure (like Darfur and North Korea), cash has huge advantages over food aid. Cash transfers are more than 50% cheaper to administer. They reduce the risk of dependency and disincentives; allow individual choice between consumption and investment; have multiplier effects on income and employment; stimulate markets by increasing purchasing power; and encourage the use of other social services such as health and education. That is why cash is predominantly used to help the poorest in OECD countries in the form of pensions, child benefits, disability grants and so on. Why not in developing countries too?"
by Nicholas Freeland, Regional Hunger and Vulnerability Programme, Johannesburg, in Economist, 12-04-08

Amazon an international patrimony

Every once in a while i get this text in a chain email, i thought i'd translate it, because i like it... i can't really prove its authenticity, nevertheless...

"During a debate in a university in the States (around year 2000), the then Brazilian Minister for Education, Cristóvão Buarque, was questioned about what he thought about internationalizing the Amazons (a topic that reoccurs often in some sectors of American society, and that bothers tremendously the Brazilians). A young American student asked this question, saying that he hoped to get the answer of a humanist and not that of a Brazilian. This was Mr. Buarque's answer:

In fact, as a Brazilian i would simply argue against the internationalization of the Amazons. As much as our governments don't show the proper care for this patrimony, it is ours. As a humanist, and feeling the risk of the environmental degradation the Amazons are suffering, i can well imagine its internationalization, as well as of everything else which is important for humanity.

If the Amazons, under humanistic ethics, should be internationalized, then let us also internationalize the oil reserves of the whole world. Oil is as important to the well-being of humanity as is the Amazons for our future. nevertheless, the owners of these reserves, feel they are entitled to raise or lower its extraction and raise or not its price.

In the same way the financial capital of rich countries should be internationalized. If the Amazons are a reserve for all the human beings, then it cannot be burned by the will of one owner or one country. Burning the Amazons is as serious as the unemployment caused by arbitrary decisions made by global speculators. We cannot allow that the financial reserves are used to burn entire countries by the lust for speculation.

Even before the Amazons, I'd like to see the internationalization of all the great museums in the world. The Louvre should not belong to France alone. Each museum is the guardian of the most beautiful pieces produced by the human genius. We cannot leave this cultural heritage, like the natural heritage of the Amazons, to be manipulated and destroyed by the taste of one owner or one country. Not too long ago, a Japanese millionaire decided he should be buried with a painting of one of the great masters. Before that, that painting should have been internationalized.

During this meeting, the United Nations are holding the Millennium Forum, but some of the presidents of some countries could not attend due to restrictions at the US border. Therefore, i think that New York, as the home of the United Nations, should be internationalized. At least Manhattan should belong to the whole of humanity. As well as Paris, Venice, Rome, London, Rio de Janeiro, Brasília, Recife, each city, with its specific beauty, its world History, should belong to the entire world.

If the US want to internationalize the Amazons, because of the risk of leaving it at the hands of the Brazilians, let's then internationalize all the nuclear weapons of the US. Even because they have already demonstrated that they are capable of using them, provoking a destruction thousands of times bigger than the regrettable burns made in the Brazilian forests.

In their debates, the current candidates to the US presidency, have defended the idea of internationalizing the Amazons in exchange for the debt. Let's start using this debt to guarantee that each child of the World has the possibility to EAT and go to school. Let's internationalize the children, treating them, all of them, regardless of the country where they were born, as a patrimony of the entire world. Even more than what the Amazons deserve. When the leaders treat the poor children of the world as a Humanity patrimony, they will not let them work when they should be studying, that they die when they should live.

As a humanist, i accept to defend the internationalization of the World. But as long as the World treats me as a Brazilian, i will fight for the Amazons to be ours. Ours alone!"

Local storing of energy II - a solution

I've discussed this thing of storing locally energy at each house with my friend and colleague Norbert, and we came up with a nice recommendation for a viable solution.

Use a tank of compressed air!

The air can be compressed mechanically from a wind/water mill, or with a compressor powered by cheap electricity at night. Burying the tank to keep the air cool may increase the tank capacity, and also has the advantage of reinforcing the tank such that it withstands higher pressures.

To use the energy you let the air out through a turbine, which can in turn generate electricity from the same motor of the compressor (or a separate one, whatever). The heat generated by the spinning turbine, or heat collected from solar energy can also be recuperated to warm up the compressed air as it comes out of the tank to increase the pressure.

One just needs to calculate how big a tank is needed, depending on how much energy you want to store...

There already exists a car running on compressed air.
There exists also power plants which use compressed air to compensate the periods of high demand from the power grid.

As clean and renewable as it gets!

Local storing of energy

How about this? I'm not an expert in high power networks, but here's a typical load profile for an electrical network over a day (there are other seasonal fluctuations as well):



In theory a network needs to be dimensioned to satisfy the highest demand, and eventually to dump or store extra energy which is not used in periods of less demand (for example by pumping water into dams).

The difference between the highest and lowest peak in the load profile is 20GW, for this example, which i got from wikipedia). The problem I see is that the peak control is made at a macro-scale, requiring the network to be over-dimensioned to meet the demand (for example additional gas plants are required which can be fired quickly to meet sudden peaks of demand).

What if every building (including residences) were to consume and simultaneously store part of the energy they require to operate locally? They would store during periods when the overall demand was lowest, and at the time of high peaks they would use that energy, disconnecting from the electrical network, thus reducing the maximum load and the need for an over dimensioned network - resulting in balancing the load at a micro-level. There is clearly an efficiency problem in the losses due to energy conversion for storage and usage, but the benefit could exceed the loss (somebody should do the math...).

Eventually as new storage technology (batteries, hydrogen cells, nano-capacitors...) becomes available this could turn out to be a good solution to reduce the need for more power plants. Also an infrastructure that supports DC rather than AC might also help, to reduce the number of conversions, and the losses in the electrical distribution. Another advantage is that buildings making use of renewable energy collectors, could re-direct the energy from these sources to this storage system to complement the need for usage of network power.

The control of the charge/discharge cycles of the buildings could be done by digital data transferred to/from the network central, via internet, to the circuits on the buildings and each region could be controlled separately to balance the load as required. An intelligent system which knows the overall power demand, the storage capability of each building and acquires in real time rates of consumption could smartly and optimally manage the charge/discharges cycles. As I said, I'm not an expert, it's just a thought...