Your Teacher Said What?! (5 page)

But there's a problem with cap and trade: There is no
real
market for CO
₂
emissions, which is why the government has to make one. And whenever governments try to do what markets do, which is essentially allocate resources efficiently through pricing, they stink. Just do the numbers: Even if you buy the prediction by the UN's Intergovernmental Panel on Climate Change of a worldwide temperature increase of 2.8 degrees Celsius by 2100, you also have to accept its estimate that an increase of 4 degrees Celsius would result in a reduction in worldwide economic output of around 3 percent (and if this sounds a little less dire than Al Gore wants you to believe, see the PR comment above). If the cap-and-trade system currently proposed by the U. S. House of Representatives were to be fully implemented, however, the temperature increase would be only one-tenth of one degree Celsius less than it would be if the system weren't implemented. The economic benefit to the United States of such a reduction is tiny: one-fortieth of 1 percent of GDP. But the cost is 0.08 percent of GDP: at least ten times greater. Progressives are notoriously bad at arithmetic, but this is ridiculous.

Capitalism.
Noun. A system in which a society's productive resources are privately owned and freely traded.

 

“Blake?”

“Yes, Dad?”

“Have you ever heard the word ‘capital' ” ?

“The capital of the United States is Washington DC. And the state capitol is in Trenton. We went there on a field trip.”

“Trenton?”

“That's the state capital, isn't it?”

 

It's probably too much to blame public education for preferring field trips to teaching basic economics. Most people have only a pretty sketchy idea about the basics of capitalism, partly because, in America at least, they don't really have anything to compare it with. The systems that preceded the idea that the best engine for economic growth (actually, the
only
engine for economic growth) was to allow capital goods—the land, factories, and patents that are used to make the goods people actually use: consumer goods—to be privately owned are long gone. The traditional systems of feudalism and mercantilism were actually intuitively pretty appealing for thousands of years because people thought all wealth was, finally, precious metal or land, and as a result, also thought that the total amount of it was finite.

Which, come to think of it, is the same argument used by Progressives to explain their eagerness to redistribute wealth from haves to have-nots.

CDO.
Noun. Abbreviation for collateralized debt obligation. An investment whose value is based on a package of other fixed-income mortgages, corporate bonds, and mortgage-backed securities, whose complicated nature has been blamed for much of the crisis of 2008. CDO risks and prices are calculated using a mathematical technique known as cupola modeling, a multivariate joint distribution defined on the
n
-dimensional unit cube [0,1]
_n
such that every marginal distribution is uniform on the interval [0,1].

I don't understand it either.

CEO.
Noun. Abbreviation for chief executive officer, the highest-ranking manager in a corporation, agency, or organization, who reports to the institution's board of directors. The Boss.

In 2009, the median CEO salary at America's five hundred largest corporations was about $8 million. This, we are told by Progressives, is a sign of the worst excesses of capitalism: CEOs taking home more than three hundred times what the average worker does, up from forty times that number thirty years ago. This is, like most such arguments, half information taken out of context, seasoned with a lot of envy.

The reaction to these more-than-generous incomes is pretty overheated. America's top five hundred CEOs earn more than Major League Baseball's 750 players and the four hundred (or so) members of NBA teams
combined
, and they don't offer nearly as much entertainment in return. However, there is less here than meets the eye. More than half of CEO compensation is in the form of stock and stock options, which means that the biggest reason they're paid so much is that the companies they manage have increased in value, which is a bargain that most shareholders probably applaud. It's also worth remembering that in 2009 the companies they manage generated more than $5
trillion
in revenues, and their total pay is barely a rounding error.

This doesn't, of course, mean that every CEO is worth what he or she is paid. Every year, some prove that they are clearly not up to the job, or even able to stay on the right side of the law. And it seems possible that lots of companies could get the job done just as well by someone willing to work for less (though I wouldn't like to be the one to explain the decision to save a few million bucks to the board of directors of a hundred-billion-dollar company). But it does mean that attempts to legislate limits on CEO pay have about as much impact on a large company's efficiency as removing the embossing from business cards, no matter how much better it makes everyone feel.

Competition.
Noun. In economics, the contest between individuals and companies to sell more goods and services.

Blake's feel for the rhythms of business may be a little erratic, but she understands competition. And she especially understands that winning—a race, a tennis match, a music competition—is a whole lot better than losing. The reason that competition is one of the basic principles of free-market economics starts from the same impulse but affects a lot more than a ten-year-old's self-esteem.

Adam Smith, the granddaddy of all free-market thinkers, was also the first to draw the link between free competition and increasing prosperity, pointing out that competition is the engine that allocates resources to their highest-valued use: If any business is good for the public, Smith wrote, “the freer and more general the competition, it will always be the more so.” This has been taught to generations of introductory-economics students as the notion of
perfect competition
, which includes a number of, well, unlikely characteristics. For a business to qualify as perfectly competitive, it needs an infinite number of sellers (and consumers), no barriers to anyone wanting to enter the business, and no transaction or information costs—that is, when I want to shop for a widget, I can compare all the widgets instantaneously without stirring from my chair. In such a consumer's Garden of Eden, all prices for widgets will eventually be only a tiny bit higher than the cost of making them.

To a lot of people the nonexistence of such perfectly competitive markets outside of introductory economics textbooks means that (a) free markets don't really work as well as described; and (b) governments have to intervene to make sure that
monopolies
don't grow where competition used to exist. Both ideas are favorites of Progressives. And both (surprise!) are wrong.

While perfect competition makes for neat equations, the fact is that even imperfect competition is pretty good. In fact, a little bit of competition is better than none, more competition is better than a little, and a lot of competition is better still. Monopolies (see below; actually businesses with some monopoly pricing power) will always emerge, as one firm or individual takes advantage of a superior idea or just plain luck. But in a free market, they don't last, as other firms, attracted by the profits that a monopolist earns, enter the business. The only monopoly pricing power that lasts, in fact, is the sort that is
created
by the government. As always, the Progressives have it exactly backward: Competition doesn't need government help; it generally only suffers from it.

Consumption.
Noun. The purchase of goods and services by end users, i.e., consumers, rather than businesses or government.

You'd think that economics could agree on a definition of consumption, which is, after all, their primary subject. You'd be wrong. In addition to the definition above, a lot of economists (and policy makers) measure consumption as every economic transaction that
isn't
either design, production, or selling.
John Maynard Keynes
, along with his many other dubious contributions, defined it as all income that isn't saved or invested, which leads to the notion that if you borrow money and then spend it, you've increased consumption without increasing income. Come to think of it, this explains how the national
debt
got to be so large that it now has fourteen digits.

Eventually,
consumption
of goods and services and
production
of goods and services have to even out. However, eventually can be a long time, which is why both households and governments frequently find themselves so far behind the eight ball. Some economists argue that the best way to improve things is to tax consumption rather than income, but the governments that listen to them inevitably end up taxing both.

Creative destruction.
Compound noun. The principle that, in a free market, innovation creates new businesses at the expense of old.

The idea that capitalist economies grow by killing off existing enterprises was not original to the Austrian economist Joseph Schumpeter, who named it the “perennial gale of creative destruction” in 1942. A century earlier, Karl Marx, of all people, was writing about the eternally disruptive nature of capitalism—a nature that didn't bother Marx all that much but sure gives fits to a lot of other folks: not just Progressives who reflexively think that any sort of economic pain is a sign of market failure but also conservatives whose real allegiance is to a society organized along the most traditional lines.

It isn't a very happy thought for your typical ten-year-old, either.

 

“It's just not fair.”

“What isn't fair, Blake?”

“The candy store, Dad.”

“What about the candy store?”

“It's closing, and that means that no one is going to sell those good vanilla-and-chocolate lollipops anymore.”

 

It's one thing that Blake has in common with the most reactionary
and
the most collectivist impulses: the desire to keep the forces of change at bay. The belief in some sort of “endangered businesses act” is understandable, at least for someone Blake's age. Free market capitalism
has
been an unmatched engine of prosperity for centuries, but that doesn't mean that it delivered that prosperity without any suffering along the way: Jobs vanish, companies and even entire industries disappear, and it speaks well for Blake's compassion that she isn't exactly cheering for it, even when it's only a corner candy store.

When that compassion turns into policies that protect jobs and industries that aren't going to survive on their own, however, the cost is economic decline. America had more than 100,000 harness makers in 1900, and more than 200,000 blacksmiths. Twenty years later, the country was a
lot
richer, but that doesn't mean that a lot of formerly prosperous families weren't suffering. Schumpeter made an analogy to evolution by natural selection—he called new “species” of business “industrial mutations,” in case anyone missed the point: Extinction was hard on the dinosaurs, but it was a godsend for the ancestors of all the mammals walking the earth today, including Blake.

Credit.
Noun. The transfer of something valuable from one person or firm to another, when payment for it is delayed until a later date.

It's not very hard to figure out how a word from the Latin root meaning “to trust or believe” ended up meaning both the recognition of an actor's work in a movie or play and the amount of money a bank is willing to lend. Blake doesn't quite get it:

 

“Dad?”

“Yes, Blake?”

“How does a credit card work?”

“When you use a credit card to buy something, you still have to pay for what you bought, but you do it later, instead of right now.”

“When I get extra credit for a project, is that later or right now?”

“There are lots of kinds of credit, Blake. What the two meanings have in common is acknowledging that something is owed.”

“Like when my name is in a concert program, they call it a credit?”

“Exactly: You are owed some recognition for playing the guitar. When you get extra credit, that recognizes that you did more than you needed to on a test. And when you buy something on credit, you're recognizing that you owe the person you bought it from.”

“Too many meanings, Dad.”

 

Well, maybe. The credit that means buying today and paying tomorrow isn't really unique to a free market—lots of
unfree
markets happily accept its benefits—but it does depend on trust: trust that someone will pay what is owed. Which is a lot easier than the other essential aspect of credit, which is understanding that a dollar tomorrow is worth less than one today.