SPIN-FREE ECONOMICS - Hardcover

BEHRAVESH

Hardcover

ISBN 10: 007154903X ISBN 13: 9780071549035

Publisher: McGraw Hill, 2008

Synopsis

With technology and globalization advancing at breakneck speed, the world economy becomes more complex by the day. Activists, politicians, and media enablers―conservative and liberal, left and right, informed and just plain wrong―consistently seize this opportunity to present woefully simplistic explanationsand hype the latest myths regarding issues affecting the economy. Their purpose is not to educate but to advocate and, in many cases involving the media, manufacture outrage to drive ratings higher. So, where can you find the truth about today’s economy and how it affects you? Turn off the TV, put down the magazine, log off the Internet―and read this book.

Spin-Free Economics places the current economic debates where they belong: in the middle of the road. With no political ax to grind, Nariman Behravesh takes a centrist approach to explain how today’s economic issues affect individuals and businesses. Along the way, he debunks myths regarding the effects of immigration, unemployment, regulation, productivity, education, health care, and other headline issues. Spin-Free Economics answers today’s most pressing questions, including

• Will more regulation prevent financial crises?
• Are outsourcing and foreign ownership good or bad for Americans?
• Should we fear or embrace Asia’s emerging economic powers?
• Is aid or trade the solution to global poverty?

The vast majority of economists, Behravesh points out, are independent analysts who are in agreement on many of today’s issues. Unfortunately, the subject has been taken over by opportunists, whose answers to the questions above invariably fall along partisan lines. Spin-Free Economics is a breath of fresh air for those seeking an alternative to the chatter of ideologues and cynics. Rejecting the manipulative approach of “sound-bite economics,” Nariman Behravesh uses facts and insight tempered by clearheaded reason to present the most accurate assessment of the subject to date.

About this title

About the Author

Nariman Behravesh is Chief Economist for Global Insight, an economic and financial analysis firm. He previously served as Chief International Economist at Standard & Poor's.

Excerpt. © Reprinted by permission. All rights reserved.

SPIN - FREE ECONOMICS

A No-Nonsense Nonpartisan Guide to Today's Global Economic DebatesBy NARIMAN BEHRAVESH

The McGraw-Hill Companies, Inc.

Copyright © 2009 Nariman Behravesh
All right reserved.
ISBN: 978-0-07-154903-5

Contents

Chapter One

PART I Markets Know Best

Markets and Trading Are Hard-Wired into Humans

It is tempting to think of markets as modern, sophisticated institutions. In fact, commerce is one of the oldest types of human interaction. Anthropologists have uncovered evidence of trading activity in settlements that are between 30,000 and 60,000 years old.

Markets have sometimes been described as brutal and inhumane. In reality, successful markets, both primitive and sophisticated, embody some of the purest and best aspects of human society, including lack of coercion and the opportunity to pursue one's own self-interest—in other words, the freedom to choose.

So, markets are one of the quintessential human institutions. While far from perfect, they have been immensely successful in delivering a huge variety of goods and services and leading to a dramatic increase in living standards, as we will see in subsequent essays.

Stone-Age Arbitrage

Trading seems to be hard-wired into human beings. Recent studies have uncovered a very sophisticated system of barter among the aboriginal tribes of northern Australia, which practiced this form of commerce from the dawn of humanity to as late as the nineteenth century. These tribes were true hunter-gatherers, with no farming, no government, no rule of law, no money, and no science. They also could not read or write. Nevertheless, the system of trading that they developed was truly ingenious and, in many respects, very modern.

Two of the items traded were spears tipped with the barbs of sting rays, which were produced along the coastal areas, and polished stone axes, which were produced hundreds of miles inland to the south, near stone quarries. The tribes producing the spears and those producing the axes did not trade directly with each other. Rather, they were linked by a long chain of other tribes that were part of the barter system, and that lived in the vast stretch of territory in between.

As the spears were traded by successive tribes and moved south (away from where they were produced), their value relative to that of axes rose. Similarly, the value of axes rose as they moved north. This gave the middlemen (the tribes in between) the chance for profit. For example, a tribe in the middle of the chain could buy an axe from its southern neighbor for five spears and sell it to its northern neighbor for six spears. Even though the middlemen did not produce either spears or axes, the profits from this trading system allowed them to own both.

In the modern jargon of economics and finance, this type of trading is called arbitrage: in other words, buying something where it is cheap, selling it where it is more expensive, and pocketing the difference. It has been the basis of commerce for millennia, and it is practiced every minute of every day in global financial markets today.

What is truly remarkable about stone-age arbitrage is that it developed on the basis of interpersonal relationships and trust, but without government or laws—in other words, there was no Uniform Commercial Code, no Federal Trade Commission, and no World Trade Organization.

Trade: The Lifeblood of Great Civilizations

As human society evolved, the development of urban centers—and, later, civilizations—went hand in hand with that of commerce. Trade needs a market, and markets need a critical mass of people. Markets were the very heart of many ancient cities. After all, the Roman forum was first and foremost a marketplace (which is what the word forum means in Latin).

Most of the greatest civilizations and empires in history (Phoenician, Persian, Greek, Roman, Chinese, Venetian, Florentine, Portuguese, Spanish, Dutch, and British) flourished as successful traders. As these societies became more advanced and their governments more powerful, they built roads and ports, which boosted trade (and also helped them to move their armies and navies around). Early civilizations also issued coins, which greatly facilitated commercial transactions by reducing the need for barter.

Unfortunately, during much of human history, property was owned (and tightly controlled) by kings, nobles, and religious leaders, who also imposed heavy taxes on anyone engaged in commerce. Despite this type of predatory behavior on the part of those in power, however, business continued to thrive. Nonetheless, it was not until the end of feudalism in Europe and the rise of representative governments that trade, in the way we know it today, began to really prosper. The success of the merchant classes was greatly helped by the establishment of legal structures that protected property rights and allowed those engaged in commerce to keep much of their wealth.

The emergence of modern-day capitalism also benefited greatly from the evolution of banking and finance, first in Italy during the 1400s, and later in other parts of Europe. Moneylending has existed since biblical times. But these lenders typically charged usuriously high rates of interest, much of which was turned over to those in power. In reaction to such practices, many religions (notably Judaism, Christianity, and Islam) banned moneylending of all kinds. As monarchies and the church lost power in Europe during the Renaissance and Reformation, though, and as banking families (such as the Medici in Florence) came up with creative ways to circumvent the church's ban on charging interest, the symbiotic relationship between finance and trade became a major force in the world economy. Financial and legal innovations such as double-entry bookkeeping, equity ownership, and limited liability companies also played an important role.

From its very early days, capitalism was global in nature. For example, fifteenth-century bankers in Florence provided financing for English sheep farmers and wool merchants. Two hundred years later, the English and Dutch East India Companies, with their vast global trading networks, became the world's first multinational businesses.

Among the many blemishes of capitalism, two should be mentioned in the context of this brief history (others will be covered later). First, many of the great trading empires of the last few centuries were also colonial powers. The trade between the ruler and the ruled was not voluntary, and was often little more than exploitation of the colonies. This situation did not improve until after World War II, when the great empires of the nineteenth and twentieth centuries were, by and large, dismantled. Over the last 50 years, global trade and finance have exploded under the auspices of a voluntary system of rules and regulations, overseen by a number of multinational organizations such as the World Trade Organization, the International Monetary Fund, and the World Bank.

Second, the excesses of nineteenth- and twentieth-century capitalism (e.g., robber barons and colonialism) triggered a backlash in the form of Marxism and its practical incarnation, communism. While these experiments ultimately failed, the fact that these philosophies were practiced in large parts of the world for much of the last century underlines the deep unpopularity of unfettered capitalism.

The good news is that the essential features of free markets and trade have little to do with the excesses of the past (or the present). Moreover, in the last couple of centuries, capitalism has evolved in ways that make it more beneficial to everyone—although it is still far from perfect.

Markets Often Exist Where They Were Not Meant to Exist

One of the remarkable attributes of markets is that they spring up in the most unlikely places—and often where they are prohibited. One of the case studies that Economics 101 students read about is the spontaneous rise of market economies in World War II prisoner-of-war (POW) camps.

Economic interactions in POW camps were primitive, and the range of goods was limited to Red Cross parcels and what could be obtained (illegally) from guards. Initially, a system of barter was practiced; trading was rough-and-ready, and there was no uniform set of prices that reflected the relative value of products. Fairly quickly, however, the prices of all goods came to be quoted in terms of cigarettes. There were good reasons for this evolution. Cigarette packs were included in Red Cross packages and gifts from home. They were inherently valuable, even to nonsmokers. They were also both divisible (there were 20 cigarettes in each pack) and durable (unlike food items). While there were some problems with the "cigarette standard" of commerce, it illustrates how ingrained market thinking is in most humans, even under conditions of duress.

The existence of clandestine markets in the former Soviet Union is another example of how instinctive exchange and trade are to humans. Under Soviet communism, the government controlled the production and distribution of goods and set their prices. Of course, the government was far from prescient (see the next essay) and could neither come up with the right prices (and keep adjusting them as market conditions changed) nor produce the right amount of goods. As a result, there was either too little or too much of most goods. The response to this highly inefficient (and often very wasteful) system was an extensive (and highly illegal) black market, where the true market values of goods were determined through either barter or monetary transactions. The prices of goods where there was an excess supply fell, and the prices of goods for which demand outstripped supply rose. For example, the black market exchange rate between the Russian ruble and the U.S. dollar was almost always lower than the official exchange rate, reflecting a glut of rubles and a shortage of dollars. It is remarkable that, in the face of severe punishments (including the occasional death by firing squad), such markets existed at all in totalitarian communist states. Today, in North Korea, one of the last holdouts of Soviet-style communism, there is a thriving black market along its border with China. Ironically, the dictatorship tolerates this because it provides a lifeline for a cash- and goods-starved economy.

Black markets also exist in today's most developed economies, including the United States. Take the case of human kidneys. Most countries ban trade in human organs. However, with most of us living longer on average, the supply of kidneys (from people who are willing to donate them, either while they are alive or after they die) has not been keeping up with the demand. As a result, between 5,000 and 6,000 people a year die while waiting for a donor (there are approximately 75,000 people on the kidney transplant waiting list). The result has been a burgeoning black market. Most of these kidneys are bought (via unscrupulous brokers) from poor people in poor countries—with no guarantees that the organs are disease free. A much better solution would be to legalize the sale of organs and regulate the market (including guarantees about the health of kidneys). While some people find the idea of selling organs repugnant, it does seem odd that people can effectively buy babies (from adoption agencies and surrogate mothers), but not organs that would save their lives.

eBay Is Just the Latest Example of the Urge to Swap and Trade

One of the most successful Internet companies has been eBay, the online auction house. Started in 1995, the company has a very simple business model. It operates a Web site, leases no retail space, and never handles any of the merchandise sold on its site. Its revenues are derived from listing fees and cuts on every item sold. The company has a very strict set of rules for buyers and sellers, which it enforces vigorously. This includes a system that rates both buyers and sellers. These ratings are posted as personal profiles that can be examined by anyone, providing a means by which traders can establish their credibility and good faith.

By 2007, eBay had more than 200 million registered users worldwide, generating more than $85 billion worth of transactions. This translated into about $6 billion in revenues and $1 billion in profits for eBay, making the company one of the largest retailers in the world. Its success has generated an "eBay community" and an "eBay economy." It has been estimated that several million part-time businesses are run on eBay, and that tens of thousands of people have given up their "day" jobs to make a full-time living selling on the company's site.

The biggest competitive advantage of eBay is its size and the networking effect that it creates. For a seller, it is the place with the most buyers. For a buyer, it is the place with the most complete price information.

The huge appeal and success of eBay can be directly attributed to its ability to facilitate one of the most basic forms of human interaction, namely, the desire to trade freely and voluntarily.

Yes, There Were No Bananas in East Germany: Why the Collective Wisdom of the Crowd Is Almost Always Greater than the Wisdom of Governments

It is easy to forget how awful command-and-control economic systems really were—and still are, in some parts of the world.

One of the more amusing anecdotes in the immediate aftermath of the fall of the Berlin Wall on November 9, 1989, was the complete lack of bananas in the former East Germany—and the run on food markets in the West German towns along the previously impassable border. Aware of the strong desire to consume this "exotic" fruit, the West German government handed out bunches of bananas to East Germans celebrating the collapse of communism in Berlin's Potsdamer Platz within hours of the Wall being pulled down.

Free Markets Give People What They Want—Not What Some Bureaucrat Thinks They Want—and Deliver Sustained Gains in Living Standards

The inability of communist command-and-control systems to deliver simple things like bananas has become symbolic of their abject failure. Not only were shortages of all goods widespread—people had to stand in long lines for food and other basics—but the selection was extremely limited (e.g., only white shirts and three flavors of ice cream), and the quality was very poor.

The Trabant, one of only two passenger cars produced in East Germany, was notorious for its poor performance, its smelly two-stroke engine, and the fact that it was virtually unchanged throughout its 33 years of production. Consumers often had to wait years to get one. The "Trabi" was the butt of many jokes about the dysfunctional nature of communist economic systems. Contrast the extreme lack of choice represented by the Trabant with the more than 600 different types of car models available (almost immediately) in the United States today, all of which are continuously being upgraded to reflect the latest consumer trends and safety requirements.

While he was president of France, the late Charles de Gaulle is purported to have asked in frustration, "How can you be expected to govern a country that has 246 kinds of cheese?" His challenge turned out to be far less daunting than those of his communist counterparts, who had far more trouble providing sufficient quantities of even a few types of cheese to the people they ruled with an iron fist.

These amusing stories about markets versus central planning do not, however, give the true measure of communism's failure. In 1950, soon after Central Europe was sequestered behind the Iron Curtain, Spain and Poland had roughly the same standard of living (as measured by per capita GDP). By the time communism collapsed in 1989, Spain, with its freer markets, had pulled far ahead of Poland, and its standard of living was more than 100 percent higher. Ironically, Poland was considered one of the more successful communist economies of Central Europe, and Spain for part of this period was under a dictatorship (though its economy was based mostly on free-market principles).

The failure of central planning becomes even more monumental when you consider that in 1950, each of the following pairs of countries had roughly the same standard of living: North and South Korea, East and West Germany, China and Taiwan. By 1989, the living standards of people in South Korea, West Germany, and Taiwan were at least five times higher than those of their communist brethren.

In retrospect, it is hard to believe that between 1950 and 1989, close to half of the world's population was living in command-and-control economies—the vast majority of it in China. It is equally hard to believe that communism lasted almost seven decades in the Soviet Union. Finally, it is easy to forget how popular Marxism, communism, and socialism were among left-wing radicals and many intellectuals—until the bitter end.

The durability of Soviet-style communism can be attributed to a few factors. First, it existed only under dictatorships (and still does in a few isolated countries, such as North Korea and Cuba). Second, the economic disaster that was the Great Depression turned many people against capitalism. Third, the ideological struggles that drove the cold war also "legitimized" the associated economic systems. Finally, communism was, arguably, successful in helping both Russia and China to rapidly (within a generation) make the transformation from agrarian to industrialized economies—although at a very high human cost, as we will see in the next essay.

In an attempt to understand the failings of communism and the success of free- market economies, Mikhael Gorbachev, the last leader of the Soviet Union, sent high-ranking officials to Europe and the United States to study how these economies were able to produce and distribute such a large variety of goods and services so easily and efficiently. When visiting a London food market, one of these officials reportedly asked, "Who is in charge of the supply and demand for bread?" The answer? "No one and everyone."

(Continues...)

Excerpted from SPIN - FREE ECONOMICSby NARIMAN BEHRAVESH Copyright © 2009 by Nariman Behravesh. Excerpted by permission of The McGraw-Hill Companies, Inc.. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Edition details

• Publisher: McGraw Hill
• Publication date: 2008
• Language: English
• ISBN 10: 007154903X
• ISBN 13: 9780071549035
• Binding: Hardcover
• Edition number: 1
• Number of pages: 384