DRI-305 for week of 3-17-13: What is Behind the New ‘Sharing Economy?’

An Access Advertising EconBrief:

What is Behind the New ‘Sharing Economy?’

The once-distinguished British weekly The Economist highlights a new Web-based economic phenomenon in a recent (03/9-15/2013) issue. The name assigned by the magazine to this activity is the “sharing economy” – a dreadful misnomer that conjures up images of 60s counterculture and communes. But however misnamed, the transactions it denotes are a sign that cannot be ignored.

In his Wealth of Nations, Adam Smith explained the growth of markets by citing man’s innate “propensity to truck, barter and exchange.” Ever since, these words have received both veneration and ridicule. Smith’s admirers saw in them a beautifully realized portrait of human nature. Opponents of free markets have scoffed. They long since rejected whatever validity Smith’s “higgling and haggling of the marketplace” might have had in favor of Thorstein Veblen’s picture of “shadowy figures moving in the background;” they see corporate power, not voluntary exchange, as the dominant motif in the market. Since 2008, the Left has pooh-poohed the notion of rational choice by citing the financial collapse as proof of the irrationality of crowds and the infeasibility of deregulated markets.

But now comes The Economist to point out that even as world financial markets were imploding, unregulated private markets were springing up to enrich the daily lives of billions of the world’s citizens. Alas, the magazine itself misses the significance of its own reporting.

The “Peer-to-Peer” Rental Market

Every night some 40,000 people around the world rent rooms from a service that operates throughout the world – 192 countries, 250,000 rooms in 30,000 cities. The customers choose their rooms and pay online. But the provider is not a commercial business chain like Hilton, Marriott or even Motel 6. Instead, a San Francisco-based firm called Airbnb matches up customers with rooms in homes owned by private individuals. The company has operated since 2008, attracting roughly 4 million customers. Room renters choose and pay for their rooms online.

This is perhaps the largest business in the “peer to peer” rental market. Individual consumers rent assets like beds, boats, and cars directly from other individuals rather than from businesses. The rationale for these practices is quite straightforward. You may wish to cut your automotive transportation costs by earning income from giving rides to people whose destinations coincide with yours. Or, viewing the same situation from the other side of the market, you may wish to cut your costs by paying a peer to chauffeur you to a common destination rather than calling a taxi or riding the bus.

Boat ownership is commonly likened to owning a hole in the water into which you pour money. One way to offset this outflow is to rent the use of the boat to peers. The intermediary and clearinghouse for all this activity is the World Wide Web.

Observing and noting this market is easier than pinning a descriptive label on it. The Economist calls it “the sharing economy.” This is surely wrongheaded, if only because we do not associate “sharing” with commercial transactions. Carpooling arrangements, for example, involve a spatial arrangement for the pooling of transportation services. Participants “share” a common space inside a single vehicle for the purpose of reducing joint transportation expenses. But each vehicle’s owner is commonly responsible for fuel purchases. Pooling equalizes travel responsibilities and costs among participants; the net exposure should be zero. The benefits are symmetrical, both in quantity and kind. This is sharing in a true, meaningful sense; the benefits are objectively equal and depend on the shared use.

Charity is another conventional form of benefit sharing. The owner of income or assets shares it (them) with others with no reciprocation except, perhaps, a “thank you.” The mutuality derives from the satisfaction gained through helping.

But the peer-to-peer market is simple commerce, unlike the genuine sharing examples just cited. There is an exchange of money for goods-or-services. The buyer gains the usual consumer surplus – the excess of the maximum price he or she would have been willing to pay over the price actually paid. The seller gains better utilization of existing capacity, whether the capital good is a personal automobile, spare bedroom or pleasure boat. Sellers are no more “sharing” than are taxi drivers, motel owners or charter-boat skippers. Indeed, a better descriptor would be the “utilization” or “capital-utilization” economy. Of course, this clinical language lacks the warm and fuzzy feel of “sharing” but it compensates in accuracy.

The Economist also tosses out the term “collaborative consumption,” which is just as inapropo as “sharing.” Fairness and full disclosure require noting that the terms “sharing economy” and “collaborative consumption” date back several years. They are particularly associated with left-wing authors like Rachel Botsman, whose communitarian views are hostile to capitalism and private property. But The Economist, of all publications, should know that private ownership is essential to the preservation and maintenance of capital goods, without which the peer-to-peer market would vanish into thin air.

Come to think of it, why not follow current buzzword practice and adopt digital vernacular, using The Economist‘s own phrasing? Call it the P2P market.

The Key Role of the Internet

Where has this new economy been all our lives? Did it take over a century for people to wake up to the possibility of using their cars as taxis or rental cars? Was there an epiphany, a la Bell and Watson, when a restaurant habitué decided he could pay his bill by ferrying his fellow diners back and forth for a fee?

Actually, P2P has been operating in the background all along. It ran on word-of-mouth or classified advertising, using referrals as its primary security. This guaranteed that its importance would remain marginal. It took the Internet to turn it into a $26 billion annual, growing enterprise.

First, the Internet gave P2P the reach it lacked heretofore, allowing sellers to reach an unlimited audience at extremely low cost. Second, the Internet provided the security necessary to both sides of the market. For example, taxi drivers lead a notoriously precarious existence at the mercy of their passengers. But insecurity runs in both directions when the driver is not a business owner or employee, operating a highly visible vehicle. On the Web, though, the platform fulfills the role otherwise played by the business in vouching for its representatives. Follow-up reviews and ratings ensure that bad trips are not repeated.

The surest sign that P2P really works is that commercial businesses want a piece of the action. The Economist reports that Avis, GM and Daimler have all acquired their own piece of P2P; e.g., acquired P2P assets or entered the market de novo. The magazine speculates that the acquisition may enable the parent to list its excess capacity-assets on the P2P firm’s website. This looks like a clear case of evolutionary adaptation rather than creative destruction; P2P does not rate to destroy its competing industries but rather to modify their operations for the better.

Last April, The Wall Street Journal reported on the hottest extension of P2P in the financial realm – P2P lending. For roughly a decade, at least two P2P firms – Prosper Loans and Lenders Club – have offered individuals a chance to lend directly to their peers. The loans are extended versions of the payday/high risk loan that has long been a staple of the low-income and pawn-loan credit market. These P2P loans have terms of up to five years and principal amounts ranging up to $25-35,000. They are unsecured and assigned a risk rating based on the borrower’s creditworthiness.

The success of these P2P firms has now attracted the attention of Wall Street. Fund managers have started funds organized along similar lines, offering investors the chance to pool investment capital into funds offering the same types of high-risk, unsecured loans. Risk spreading and high returns make these funds an attractive alternative to current low-yield, fixed-income investments. The high risk means that their fraction of the total portfolio should be low. Naturally, the increase in lending activity will improve terms and outcomes for borrowers.

Lessons Learned

Even if we accept that P2P is an adaptive rather than a disruptive force, this should not obscure the powerful message it conveys. The rise of P2P overturns the conventional thinking that had prevailed since the financial crisis of 2008 and the ensuing global recession. That dominant view has been that market participants do not act rationally. They act emotionally, even hysterically. They are stampeded by mob psychology and incapable of gauging their own interests. Without the wise guiding hand of government regulation, free markets will inevitably devolve into chaos.

To be sure, this view is itself hysterical. It offers no clue as to why or how regulators themselves escape the emotional distractions that sway market participants. It doesn’t explain how regulators regulate markets without actually substituting their own decisions for those of markets. It also doesn’t tell us how regulators are able to perceive the interests of market participants who (supposedly) cannot discern their own interests. Nonetheless, this regulatory view won out (essentially by default) in 2008-2009.

Every major regulatory agency in Washington – OSHA, EPA, FDA, SEC, FTC, DOT, DOE, FMCSA, et al – has presided over a reign of terror for the last four years. If federal-government regulation were the key to safety, America would now be the safest nation on Earth by far. There is no logical or empirical case for this regulatory full-court press, other than the fact that the Democrats won the last two Presidential elections and the Republicans did not. Still, asking Democrats not to regulate is like asking a horse not to eat hay.

P2P offers the perfect test case for the new conventional thinking. Here we have both supply and demand sides essentially pioneering a new market all by themselves. According to today’s party line, this is a sure-fire recipe for disaster. After all, taxi regulators in New York
City have spent decades warning consumers to beware of “gypsy [unregulated] taxicabs.” Riders might be placing themselves in the hands of robbers, rapists or even worse. Unfortunately, New York City hasn’t approved the issue of a single new taxi license (they are issued in the form of medallions) since World War II, so its citizens have conditioned themselves to ignore these admonitions. They actually want to get somewhere without waiting for a bus or walking. Well, if an unregulated commercial vehicle is this unsafe, just imagine how risky P2P must be!

No, according to The Economist, “the remarkable thing is how well the system usually works.” Then again, P2P “is a little like online shopping,” where “15 years ago…people were worried about security. But having made a successful purchase from, say, Amazon, they felt safe buying elsewhere.” And there was eBay, which began essentially as P2P and morphed into a vehicle for professional sellers.

Well, gol-l-l-l-l-e-e, Sgt. Carter, could it be that old Adam Smith was right – not just about mankind’s inherent affinity for trade but also about the self-adjusting character of mutually beneficial voluntary exchange? So it would seem.

Yet The Economist‘s liberal knee cannot help jerking towards regulation. “The main worry,” they declare gravely, “is regulatory uncertainty.” Yes, politicians in America have cast lascivious glances at Internet trade for years, longing to tax it under a guise of benevolent regulation. Since The Economist sails under the banner of …er, economics – where a tax discourages the taxed activity, creates a welfare burden and reduces the well-being of the taxed – it should come out forthrightly against Internet taxation, right?

Wrong. “People who rent out rooms should pay tax, of course [of course!], but they should not be regulated like a Ritz-Carlton hotel. The lighter rules that typically govern bed-and-breakfasts are more than adequate.” Mere readers – being only consumers, humble recipients of The Economist‘s sunbursts of illumination – needn’t expect any illuminating insight on why tighter regulation of Ritz-Carltons is either necessary or beneficial, because none is forthcoming. The editorial’s anonymous author has the wit to notice that incumbent taxi firms are even now mobilizing the forces of regulation to protect their monopoly position. But the magazine’s leftist editorial stance is so ossified that it cannot permit that admission without an accompanying qualification that “some rules need to be updated to protect consumers from harm.” Taxicab regulation is probably the most notorious textbook example of regulatory harm to consumers in the history of economics, but The Economist is bowing its knee to it. (Elsewhere, the magazine laments the absence of even more Keynesian stimulus spending policies to create jobs.)

This is an old story. A precursor to P2P sprang up in black communities throughout the U.S. during the early and mid-20th century. Taxicab service was often sparse in these areas, not merely because of racial discrimination but also because high crime posed serious risks to drivers. Taxi regulation typically prevented black taxicab companies from entering the market or expanding to meet demand. It became common practice for private individuals to frequent grocery stores, barber shops and other high-traffic areas in order to provide “car service.” This service consisted of informal, unmetered charges (sometimes on a flat-rate basis) in return for carriage to and from shoppers’ homes. Carrying of bags and escort duties were usually included in the service.

Researchers have applied the term “jitneys” to the unregistered, unlicensed vehicles used to provide this service. Research is conclusive on two points: Consumers benefitted unambiguously from the service, and jitneys were legally hounded by taxi and bus companies in their jurisdictions. They were made illegal because taxi and bus owners feared and resented the competition and loss of income that this low-cost alternative form of transportation inflicted on them. Amazingly, jitneys still survive today in inner-city America; they are the “missing link” connecting modern P2P with its ancestral forebears.

When the worst that The Economist can cite is that “an Airbnb user had her apartment trashed in 2011,” you can rest assured that today’s P2P system is working extraordinarily well. It is a measure of our times that even a single complaint instantly triggers the demand for more regulation. When abuses occur despite the presence of tight, heavy regulation – as in financial markets – it should be clear that regulation is the problem rather than the solution. When complaints are rare, it hardly suggests a need for regulation.

The word “regulation” itself has become a rhetorical refuge of first resort precisely because its meaning is so vague. There is no clear-cut theory of regulation to explain why it is necessary, exactly what it does or how it does it. To a bureaucrat, this may constitute a highly desirable sort of flexibility. But it is not conducive to favorable outcomes.

All the News That’s Fit to Decode

Readers of The Economist should probably be grateful that the magazine deigned to notice P2P at all. The fact that we have to hack our way through the magazine’s ideological bias and occupational ineptitude to glean any value from the article is a journalistic scandal. Still, these days students of economics have to take our good news where we find it and our sources as we find them.

DRI-285 for week of 11-18-12: Twinkie Recipe: Separate Politics from Economics, Bake Cheaply and Deliver Efficiently

An Access Advertising EconBrief:

Twinkie Recipe: Separate Politics from Economics,

Bake Cheaply and Deliver Efficiently

Contemporary economic theory is now so heavily formalized by high-level mathematics and statistics as to be inaccessible to non-specialists. This has many drawbacks. Among them is the difficulty of integrating the effect of politics on markets. This is one of the few points of agreement between left- and right-wing commentators, who insist that we have a system of political economy rather than a system of markets as such.

Both sides are correct. Unfortunately, this realization causes them to neglect economics rather too much and concentrate on politics too heavily. Faced with a controversy, they tend to choose sides as if engaged in a war – by looking at the political uniform worn by the participants. Their most recent skirmish has attracted national attention. The baker, snack-food and confectioner Hostess, Inc. has filed for bankruptcy after a protracted dispute with its unions. One union in particular, the bakers’ union, has drawn the focus of attention.

The Decline and Fall of Hostess

Hostess was formerly Interstate Brands Corp., of Kansas City, MO, producer of over 30 brands of breads, cakes and snacks. These include legendary names like the Twinkie, Wonder Bread and Hostess Ding Dongs. The current dispute between Hostess and its unions is only the terminal event in a decades-long history of gradual decline. Hostess’s bankruptcy is its second; the first resulted in reorganization and the name change from IBC to Hostess. How could a company with such a distinguished roster of popular brands have fallen so low?

Some of the decline is due to a change in consumer tastes. High-calorie, high-fat, high-sugar snacks have lost favor. The realization that carbohydrate consumption carries just as much danger as fat consumption, if not more, has dampened the American enthusiasm for bread and cake. This is only part of the explanation for Hostess’s problems, though.

The longtime popularity of brands like Twinkies and Ding Dongs allowed the company to endure some highly uneconomical labor practices. The Teamsters Union – one of 12 unions operating under more than 300 collective-bargaining agreements with Hostess – forbade drivers from helping to load and unload their trucks. A stocker had to be employed to drive to the store and stock retail shelves with products transferred from storage. Some brands, such as Wonder Bread, could not share space on trucks with others.

When the falloff in brand popularity hit, Hostess could no longer subsidize this sort of inefficiency. The company has operated in bankruptcy reorganization for most of the preceding decade. The final crisis occurred within the last week, when Hostess announced that it had asked for contract concessions from the baker’s union, having already received concessions from the other 11 unions. It could not operate under the current contract and the law forbade operation without a contract. Thus, it announced that unless the bakers agreed to a deal, Hostess would once more file for bankruptcy and this time would proceed to liquidate the company’s assets.

The bakers refused. The company filed for bankruptcy. A federal judge intervened with by demanding that the parties undergo mediation. That process failed, and the bankruptcy and liquidation will now proceed.

The Left-Wing Reaction

The response on the hard left-wing, particularly among union proletarians, is that once more a company was undone by “vulture capitalism.” Private-equity firms took over the firm and ran roughshod over the rights of honest workers, raping and pillaging the firm’s assets. These commentators are doubtless fortified by the election returns, which suggest that the campaign of career-character assassination against former Bain Capital CEO Mitt Romney worked well enough to secure re-election of a fairly unpopular President.

The commentators looked at the day-to-day uniforms worn by the managers of Hostess and saw “venture capital” emblazoned thereon. Had they looked behind the scenes, however, they would have noticed that many of the particular venture capitalists involved with Hostess were closely associated with the Democrat Party. That’s right – the party of compassion, of equality and fairness, of comparable worth and social justice and the 99% and share-the-wealth and soak-the-rich. How could this be?

Actually, the real question is: How could it be any other way? Take-over artists and private-equity managers are primarily engaged in turning around businesses, not liquidating them. A liquidation is a fire sale, in which assets are generally sold at rock-bottom prices. That is why potential buyers tend to wait out dramas like the Hostess episode rather than riding to the rescue like the Lone Ranger. The rate of return on an asset depends crucially on the price paid for it. Who wouldn’t rather pay a low price rather than a higher one? Private-equity managers are business experts, right enough, but there’s no such thing as an expert in getting a high price at a close-out sale. Ask any business owner who ever went bust or any grieving son or daughter who ever liquidated their parent’s possessions at an auction. It’s pretty tough to profit from this process and it’s just as tough to earn fees from producing outcomes like this, since nobody has an incentive to pay the fees.

No, the people who bought Hostess bought it in order to run it, not break it up. Their record shows they usually succeed in doing that. They’re liquidating Hostess now because they failed this time and there’s no point in throwing good money after bad by failing to play their hole card. That card is the fact that Hostess’s 30+ brands still have considerable market value. In fact, their individual market value – outside the company and freed from the dead weight of union presence – probably exceeds its collective value inside Hostess.

The link between private-equity and the Democrat Party is eminently logical. It is economic, not political; that is, it has no necessary connection with the political sympathies of the vulture capitalists involved. Takeover targets are failing companies that have the potential to succeed. Why does a potentially successful company fail? Answer: it is being dragged down by unions, just as Hostess was. How to overcome this roadblock? Answer: persuade the unions to cease and desist from their uneconomic practices for their own good as well as the good of the shareholders. The best people to do this are not card-carrying Republican Party members or Ayn Rand sympathizers. They are fellow Democrats, who can at least gain the ear of the union bosses and perhaps retain a shred of credibility with the rank and file. And look what happened here – Hostess’s managers succeeded in keeping the company going for over a decade and persuaded 11 of the 12 unions to sign off on their latest resuscitation plan.

So much for the standard left-wing boilerplate view of the Hostess affair. Alas, the view from the right wing is not much more cogent.

The Right-Wing Reaction

Somewhat surprisingly, the right-wing view has gained considerable momentum even in mainstream media. The baker’s union suffers from false consciousness, say the mavens of talk radio. They stubbornly cling to their high union wages and benefits at the cost of their own jobs – and the 18,500 other jobs at Hostess in the bargain! How selfish can you get? Just one more case of what “union bloody-mindedness…at work.”

Wall Street Journal columnist Holman Jenkins (11/21/2012) provides a refreshing antidote to the stereotypical thinking of both right and left. He reveals that the Hostess story is a tale of two unions, not just one. It is the Teamsters who are the stereotypical hard-liners, insisting on featherbedding work rules that have driven Hostess’s product distribution costs into the stratosphere. The bakers (the Bakery, Confectionery, Tobacco Workers and Grain Millers International Union) have made repeated concessions, to the point where production costs hardly exceed industry norms.

From the bakers’ standpoint, they are being asked to make even more concessions now in order to protect the current status of the Teamsters, whose work rules are still hamstringing the company. No matter what you may have heard, solidarity is not “forever” – that is merely a song lyric.

As organized under laws mostly passed in the 1920s and 1930s and reinforced by labor regulations handed down for decades by the federal government, a labor union is a cartel. It is analogous to cartels set up by businessmen who sell products and services. Cartels strive to emulate the outcome of a monopoly, which is to thwart the competitive process and attain the same collective profit-maximizing outcome theoretically open to a pure monopoly seller.

In practice, a pure monopolist cannot even approach that theoretical outcome without the aid of government in restricting competition. That is even truer of cartels and much truer of labor unions. That is why the federal government has conferred their coercive powers upon unions. Unions operate to raise wages above the level that would otherwise prevail in a free labor market. The only ways to do that are to artificially hold wages high or to artificially restrict the supply of labor to the market. Unions do one or the other, depending on circumstances.

Both of these practices reduce employment in the unionized sector. This drives workers into unemployment and/or into non-unionized sectors, thereby driving down wages there. Union workers have no particular incentive to sacrifice on behalf of other union workers, who are after all merely workers like the ones whose interests have already been harmed by the union cause.

Jenkins points out that the bakers had a strong case for not agreeing to Hostess’s offer. Why not “hold back further concessions, let the company liquidate, and try their luck with a new owner or owners who might materialize for its bakery operations. These new owners presumably would be in a position to invest cash in marketing and promotion… They would benefit from the deluge in free media that has befallen the Twinkies brand this week. All the more so given that Hostess plans to close or sell some of the bakery plants anyway, that unemployment benefits are generous, that bakery jobs have become crummy-paying thanks to previous givebacks, that the government-run Pension Benefit Guaranty Corp. will be assuming the Hostess pensions in any case.”

So it seems that the bakers are not dumbbells after all. They are pursuing their own interests rationally given the cards they were dealt under a system they didn’t design. The right wing is repeating a frequent mistake of blaming victims of progressive socialism for acting in their own behalf. The right should instead expend all its energies working to change the system.

Jenkins observes that “one could always ask about the wisdom of a labor-law structure that causes companies like Hostess to drag on for decades without adapting to their marketplaces.” Indeed. This is a structural consequence of the substitution of politics for economics.

The Vocabulary of Political Theater

The medium of political theater employs a vocabulary of perception rather than one of real meaning. Words are assigned a political meaning unrelated to their substantive economic impact. One such word is “corporation.”

A corporation is a set of meanings that assign claims to various assets. But the political meaning of the word “corporation” describes a personified entity that is “large,” “wealthy,” “powerful,” “insensitive,” and “evil” when remotely viewed, or “paternalistic,” “secure” and (still) “wealthy” when viewed up close – say, from the perspective of an employee. All these traits are those of individual human beings; the political view of a corporation equates it to a person.

When a corporation goes out of business, it closes – often declaring bankruptcy – and its assets are liquidated. When a person goes out of business, he or she dies. A person cannot undergo “asset liquidation” even though a person’s assets can be liquidated. Thus, a person is not a corporation. But because politics views a corporation as a person, bankruptcy is viewed as akin to human death, even though it is not.

Bankruptcy is a process of evaluating the business to determine whether, and in what form, the business should go forward. That evaluation will gauge whether the business’s assets are worth more in combination or singly. This determination is a vital social process because your welfare and mine suffers if business assets are misused. True, we may not be owners of the business, but the real beneficiaries of a business are consumers, who benefit from what the business produces. That, after all, is the whole purpose of businesses – to produce goods and services for consumption.

When companies like Hostess die lingering deaths of a thousand union and bureaucratic cuts, all of us experience imperceptible losses. We pay more for government regulatory and bureaucratic functions. We pay more for the goods and services those businesses produce and we get less. Perhaps we are able to buy less in the coin of a depreciated currency.

Bankruptcy is in no sense analogous to human death. If an analogy is absolutely necessary, the “burnoff” of dead, accumulated brush that occurs in nature would be a good one. This pruning away of dead, useless stuff enables the remaining ecosystem to thrive.

One of the most destructive of all political terms is “economics,” which means “macroeconomics.” Currently, there really is no such coherent economic theory. Even less is there a set of valid, generally recognized policy prescriptions that could be grouped under that heading. The only valid meaning for the term “economics” would be described by the sub-head “microeconomics,” with the proviso that this would include the specialty of monetary theory and the study of business-cycle dynamics. One of the two sub-disciplines of microeconomics is the theory of the firm. That logic is of more help in understanding Hostess than anything provided by the Council of Economic Advisors.

A politico-economic term that has no meaningful economic referent is “job creation.” The purpose of economics is not to create jobs but to create value. Human labor is the key means of doing that, but it is the value, not the labor itself, that is the desired end product. Totalitarian regimes are wonderful job creators; there was no unemployment in ancient Egypt or in Soviet Russia or Communist China under Mao. The trick is not putting people to work; it is getting the most out of the work they do. That is what the “labor-law structure” referred to by Holman Jenkins completely overlooks.

Whither Twinkies, et al?

A few observers are sheepishly acknowledging that maybe we haven’t seen the last of Twinkies after all. The current owners of Hostess intend to sell the rights to produce all those branded products, which portends a bright future for any brand not encumbered by the same union rules that felled Hostess. And it may well mean a brighter future for many of those in the baker’s union as well.

DRI-364 for week of 9-23-12: Revisiting the DRI and Related Economic Indices

An Access Advertising EconBrief:

Revisiting the DRI and Related Economic Indices

Periodically this space has revisited Access Advertising’s Driver Recruiting Index (DRI). This index tries to estimate the real-time ex ante demand for commercial drivers. It samples the classified ads placed to recruit drivers in 32 geographically dispersed major-metropolitan newspapers throughout the U.S. Every now and then, we place the DRI alongside other trucking, transport and freight indices and gauge its movements in relation to indices of overall income and employment.

The DRI in the 2nd and 3rd Quarters

Like the overall economy, the DRI got off to a reasonably fast start after a promising end to 2011. But it soon became clear that, like the U.S. economy, the DRI was going to fall short of expectations (let alone hopes) in 2012. The Index pierced the 200 barrier for the only time so far this year on March 25, flirting with a raw score of 500 (an achievement it exceeded 14 times in 2011).

After that, it has been all downhill. Year-over-year comparisons have occasionally fallen over 20% short of 2011; 10% shortfalls have been commonplace. Driver demand has never really caught fire, peaking in late spring and skipping both the normal summer high and the fall upturn.

Second-quarter GDP growth was also disappointing, ending up at a tepid 1.7%, even below the moderate 2% in first quarter. Although unemployment has now declined fractionally to 8.1%, this reflects only the decline in the size of the labor force. The number of new jobs created has continued to languish.

The only good news has been a Wall Street rally engineered largely in response to the latest quantitative easing by Ben Bernanke’s Federal Reserve. This is probably responsible for a recent upsurge in consumer confidence in the economy.

The DRI as Economic Indicator

If the DRI’s disappointing performance has mirrored that of general economic indicators, this very congruence speaks well for the DRI’s performance as an economic indicator. Trucking handles some two-thirds of all freight by volume and about 80% by value; many production inputs and final goods travel the nation’s roads and highways. We expect changes in trucking activity and driving demand to track overall trends in production, income and employment. (Whether the DRI is or should be a leading, coincident or lagging indicator is a complicated question that will be broached later.)

The DRI continues to display other desirable properties as well. One of those is (relative) stability. The very ubiquity and prominence of trucking strongly suggests that we should not expect to find the Index fluctuating widely from week to week. While trucking firms ordinarily experience high rates of turnover, this is a long-term phenomenon, responsive to demographic factors (average age, cultural shifts) and cyclical variables (wage changes, politico-regulatory changes). A particular trucking firm may well experience a sudden, substantial need for drivers, but this will usually represent a geographic shift of demand that is offsetting in the aggregate. Significant increases or decreases, when they occur, are usually persistent, cyclical changes in trend, not random fluctuations.

For a concrete illustration, compare the DRI with TransCore’s DAT North American Freight Index, which compiles data from the company’s load board network in the U.S. and Canada. Neither the DRI nor the NAFI is seasonally adjusted, but the contrast in variability is stark. Earlier in 2012, NADI racked up this record of month-over-month fluctuations: March 2012 – up 40%, April 2012 – up 3.5%, May 2012 – up 1.7%, June 2012 – down 2%, July 2012 – down 20%, August – up 1.1%. Monthly fluctuations of 20% in the DRI would be observed only at a seasonal or cyclical peak or turning point, and a 40% monthly change is unheard of.

The DRI and Comparable Economic Indicators

Given the importance of trucking in the production chain, it is surprising that the DRI is one of few time-tested, reliable trucking indices – and the only one to track driver demand. A rundown of the others reaffirms our understanding of what makes for a good index and confirms the DRI’s recent congruence with its brethren.

The Cass Freight Index compiles data from the expenditures of 350 of the largest freight shippers. Early in the year, the Index flexed its muscles with a 2.5% increase in February 2012. Then, along with the economy at large, it began to lose vitality. Increases diminished to 2.1% in March, 1.9% in April, 1.8% in May and 1.3% in June. In July, the Index turned negative with a 0.1% decrease, followed by a 1.1% fall in August. Sponsors and analysts cited a buildup of inventories, a fall in international trade and recent declines in manufacturing output as recorded by the Institute of Supply Management’s index, which had fallen for three straight months.

The American Trucking Associations are the Establishment of the trucking industry and Chief Economist Bob Costello is the voice of starched, high-collared authority. The ATA Truck Tonnage Index is perhaps the most widely cited trucking index, not only by private-sector analysts but even by the federal government. Although the ATA’s respect for authority imparts a big-government bias to its occasional obiter dicta, its economic data are accorded the utmost respect.

The TTI’s recent numbers paint the same by-now-familiar picture of a stalling, sluggish trucking sector. March saw a 0.2% increase, April improved to 1.1% but May backtracked to 0.9%. June went back up to 1.1% but July was unchanged. Typically, Costello’s public comments wrapped the language of an economist inside the rhetoric of a politician. He depicted “…an economy that has lost some steam but hasn’t stalled.” The ATA’s corporate commentary was more telling, noting that “…the index… has been moving mostly sideways in 2012.”

The Truck Tonnage Index is an important component in the federal government’s Transportation Services Index (TSI), which is published by the Bureau of Labor Statistics (BLS). For most of 2012, this index has alternated back and forth with little net increase to show for the year. In February, the TSI rose 0.5%, but it fell back 0.8% in March. April brought a modest rebound of 0.2% but in May the Index was unchanged. June and July saw offsetting 0.1% changes.

These indices display the bedrock virtues noted above: stability and congruence with general economic activity and with each other. One of the rising economic forecasting stars of recent years was the Ceridian Pulse of Commerce Index (PCI), compiled by respected econometrician Edward Leamer of UCLA. After recording some lackluster increases earlier this year, the Index ceased publishing somewhat mysteriously following its May release. Ceridian has responded to queries by saying that although the Index does not now publish its results, it is contemplating a return on a subscription basis and is soliciting indications of interest among potential customers.

Is the DRI a Leading, Lagging or Coincident Indicator?

Undergraduate students of economics are taught that economic indicators come in three flavors – leading, coincident and lagging. These indicate whether changes in the indicator lead, accompany or lag changes in the general level of economic activity. Since the unknown future preoccupies our attention, leading indicators are especially studied and prized.

There has long been a casual presumption that trucking indices are, or at least should be, leading indicators. Disruptive phenomena like layoffs and unemployment are presumably necessitated by the accumulation of unsold goods. Since trucks carry goods and the inputs necessary to produce them, freight shipments should register the incidence of cutbacks in production and materials. This is the sort of logic that supports the categorization of trucking as a leading indicator.

Early in its life, though, the DRI was observed to be a lagging indicator. We rationalized this as the caution of recruiters, who – unsure and suspicious of the depth and duration of any increases in freight supply after the Great Recession – waited to verify the persistence of demand before incurring the fixed costs of hiring. In fact, similar behavior had been recorded in connection with the Index of Classified Advertising, an economic index that bears a strong family resemblance to the DRI.

Since leading and lagging indicators are at opposite poles, this plants a seed of skepticism about the traditional taxonomy of economic indicators. Further consideration should nourish that thought.

The inherent logic of leading economic indicators says that they can be used to predict the economic future – or at least the turning points of business cycles. And this is simply impossible.

Anybody who can accurately predict the future onset of a recession – or, for that matter, the end date of one – can earn a fortune by so doing. Anybody who can repeat the performance reliably can become fabulously rich. Business forecasters are not fabulously rich. Ergo, they cannot predict the beginning or ends of recessions. Not reliably, anyway.

This must mean that leading economic indicators do not really lead. Maybe they don’t even indicate. In any case, something isn’t quite kosher. The question is: what?

The Theory of the Business Cycle – Such As It Is

Something else that all undergraduate students of economic statistics and econometrics learn is that economic theory and logic form the basis for all empirical work. Without theory, we cannot know what data to collect or what relationships to posit between the variables that make up the data. So an economic model is borrowed or created to embody the relationships upon which data is collected. Only then can the data gathering and testing begin.

But in business forecasting that runs us smack up against a formidable obstacle. There is no generally accepted business-cycle theory. The categories used by the National Bureau of Economic Research to codify episodes of the business cycle – expansion, peak, contraction and trough – were developed by institutional economist Wesley Mitchell in the early 1900s, based on years of observation and study of past recessions. Unfortunately, observation is not theory.

The national income and product accounts used to compile U.S. economic data were developed later, based largely on the economic categories developed by English economist John Maynard Keynes in his influential work The General Theory of Employment Interest and Money. But Keynes explicitly denied that the General Theory contained any theory of the business cycle. He simply declared that capitalist economies suffered from a chronic shortage of aggregate demand – e.g., private spending by households and producers. He never said why the shortage existed. Government should make up for this shortfall, Keynes maintained, by running budget deficits that increased the aggregate total of aggregate demand or spending. Essentially, government should commit to purchasing whatever volume of output is left unbought by households and producers, so as to insure full employment. Keynes didn’t supply a theory to account for the business cycle, only a purported remedy to cure the symptoms.

Without knowing where the shortfall in spending lies, we cannot predict where to look for leading indicators at any stage of the business cycle. There is one school of thought whose business-cycle theory offers general advice on this point. That is, it doesn’t offer a list of specific industries, sectors or indicators as such, but instead provides advice about where to look for them in general cases.

The Austrian theory of the business cycle pinpoints monetary expansion by government – probably supervised by a central bank – as the proximate culprit behind recessions. By driving interest rate below the “natural rate of interest,” the rate that would equate the saving households and producers want to do, the money creation will make interest rates artificially low. This makes long-lived, capital-intensive production processes artificially attractive to producers. In turn, this creates a “bubble,” or artificial excess prosperity, in the sector thus favored. While it lasts, this bubble can seem deliriously prosperous, almost too good to be true. That is because it is too good to be true, as the drawn-out period of housing prosperity in the U.S. proved. But when the bubble bursts – owing either to a rise in interest rates or a rising burden of debt – the artificially-prosperous sectors are the first to crash. They are the leading indicators of the coming recession.

In general, then, leading indicators are those pertaining to the sectors receiving the artificial encouragement. In the U.S. during the 1990s and early 2000s, this would have been the housing sector. But this does not mean, as many have implied or outright insisted, that the housing sector should be the first to recover its balance. And it does not mean that nobody can recover until the housing sector does. Indeed, the reverse is more nearly true – housing should be the last sector to recover fully. It also means that the stubborn attempts to stage-manage recovery in housing by holding interest rates low and artificially raise housing prices through government purchases of mortgages and securities are counterproductive. After all, this is exactly the process that caused the problem in the first place – repeating it merely enlarges the backlog of adjustments that must occur before recovery can take place.

An Austrian Look at Economic Indicators

The effect of this theory on forecasting practice is striking. Housing becomes a leading indicator for the downturn phase because it is a long-lived production process, extremely sensitive to interest rates. But it is a lagging indicator for the upturn; it cannot recover until all of the bad investments made during the bubble phase are liquidated and their resources reallocated.

What about trucking? Well, trucking feeds the housing industry its materials and some of its manpower, so trucking shares this dual forecasting status. Sometimes it will be a leading indicator, sometimes a lagging one. Moreover, trucking feeds other industries as well, so it simply cannot be pigeonholed by a simplistic taxonomy. A sophisticated approach to business cycles requires us to abandon our primitive definitions of economic indicators. First, we must classify industries and sectors according to their status in the production and consumption hierarchy. Second, we must recognize the difference between recession and recovery.

We have still not exhausted the reserves of analysis, since there is still the possibility of inherent cyclical movements in economic activity that are not driven by monetary mistakes made by the authorities. The fact that money substitutes for barter in allowing human beings to trade the product of their labors solves huge problems, but it also creates smaller ones. These subtle problems may well mean that we have to live with an unavoidable element of cyclical instability in our economic life. And this may demand still more adjustments in the terminology of forecasting.

Progress Report on the DRI

The DRI is completing its fourth year of operation. It has passed the standard tests of stability, reliability and usefulness that apply to economic indices. Of course, it has not unlocked the door to wealth and fame available to any economic index that could actually forecast the future – but, as we have seen, that is a chimera. Explaining the past and recognizing the present is tough enough and a worthy goal for any economic index. Many a worthwhile aspirant has fallen short of even this limited objective; Ceridian’s PCI may be the latest addition to this list.

Nearly four years in, the DRI is still trucking.

DRI-416: ‘Recession Ride Taxi’ is the Epitome of Capitalism

“We are all of us teachers,” was Nobel laureate-economist Milton Friedman’s thumbnail sketch of his profession. Teachers are continually on the lookout for real-life illustrations of their subject. Last week, National Public Radio (NPR) provided a dandy.

Apparently NPR saw no need to interpret its facts with the use of economic logic. Fortunately, we can remedy that monumental oversight.

Eric Hagen’s “Recession Ride Taxi”

In a June 26, 2012 story, NPR introduced its audience to Eric Hagen, a taxicab owner-operator in Burlington, VT. Like many a taxi driver, Hagen traveled a roundabout route to his profession. Laid off his job as a Wall Street banker during the Great Recession, Hagen next worked for the American Red Cross – a job that would presumably earn the approval of Barack Obama and the NPR audience. Unfortunately, it didn’t earn enough money to pay Hagen’s mortgage.

So, like millions of Americans before him, Eric Hagen found himself pushing a hack to pay his bills. But unlike his predecessors, Hagen had both the institutional freedom and the native instincts to sell himself and his service to the public.

For upwards of a century, taxis have priced their services using taxi meters that recorded both mileage and time. Eric Hagen’s method for determining his taxi fares is: “Whatever the passenger can afford.” He names his business “Recession Ride Taxi.” Not surprisingly, his stated business rationale is that many people can’t afford to pay traditional taxi rates because they are experiencing hard times. Listeners are cordially invited to the conclusion that he is being kindly and altruistic by letting each passenger set the fare.

But don’t passengers double-cross him by low-balling their rates – or even stiffing him completely? “People know there’s value in a service,” Hagen replies, “and they’re generally not going to try to get over on you.”

Never has NPR accepted a businessman’s rationale so unblinkingly. “At a time when former colleagues on Wall Street continue to feel public scorn,” the station intoned piously, “Hagen says Recession Ride Taxi is running on trust.”

And Now for the Rest of the Story…

At this point, the late Paul Harvey might have intervened with: “…and now it’s time for the rest of the story.” It begins with the recognition that Hagen is not practicing altruism, but rather the most calculated kind of economic logic. His technique dates back at least to 19th-century railroads and country doctors. Airlines have used it for decades. It underlies the success of Priceline, among other online companies.

It is called price discrimination. A seller charges different prices to different buyers (or groups of buyers) for the same good or service at the same point in time. The different prices are not functionally related to different costs of serving the different buyers or buyer groups.

Why would a seller choose this strategy in preference to the simper one of charging a uniform price to all? To earn larger total revenue and profit. It won’t always be either feasible or desirable to discriminate on the basis of price, but the potential advantage in doing so lies in the possibility that different buyers differ in their sensitivity to price. The term economists use to denote sensitivity to price is price-elasticity of demand.

Two prime sources of demand for taxis in large urban markets are out-of-town visitors (tourists and business travelers) and low-income natives. The visitors have fewer and less satisfactory substitutes for taxi travel and tend to have higher incomes. Thus, they are less sensitive to price and more willing to pay higher prices than are natives, who can acquire their own cars or beg a ride, take a bus or subway or simply walk. In the vernacular, we say that visitors’ demand is more price-inelastic (less price-sensitive). Thus, it is in a taxi owner’s interest to charge differential prices, the higher one being assigned to visitors.

Even within groups of buyers whose price sensitivity is broadly similar, there will still be individual variations in price elasticity. The dream of a taxi owner would be to somehow charge each rider the highest price he or she would be willing to pay for the trip – what the economist calls the reservation price. That would constitute the practice of perfect price discrimination and would result in the maximum collection of revenue. Of course, this is only the stuff of dreams; no seller has enough individualized information about customers to realize their dream.

Now the method in Eric Hagen’s seeming madness starts to take form.

Crazy Like a Fox

The knee-jerk response of most people would be that a seller who allowed his customers to set the price is crazy. But Eric Hagen is really allowing individual customers to tell him what price they will accept – information he can’t get any other way. His modus operandi has the general appearance of a system of perfect price discrimination, except for one thing – he can’t be sure that the price they pick will be their reservation price. In fact, he can be pretty sure it isn’t.

Still, he has gained a great deal compared to the standard, taxi-meter-determined, single-price model. Consider the comments of one regular customer, sous chef Alan Flanders. “I’d be walking to work this morning if it weren’t for Eric.” That sounds pretty extreme, but NPR pointed out that “in most cabs, this ride would cost more than $20.” But because “Hagen takes whatever amount Flanders can afford, today it’s $12.” From the consumer’s standpoint, a 40% discount on a daily commute is a stunning saving.

We have a reflexive tendency to compare the $12 Hagen collects with the $20+ he “could” have collected from a regular taxi-metered ride. Wrong, wrong, wrong. Mr. Flanders makes it clear that at a price of $20, he was walking to work, not taking a taxi. Hagen’s alternative take was $0, not $20+. The genius of Recession Ride Taxi is that it brings customers into the market who otherwise wouldn’t ride taxis at all. A taxicab driver’s competition consists not merely of his fellow cab drivers, if there are any. It also includes subways, buses, shuttles, walkers, self-drivers, people who oblige hitchhikers – every alternative means of transportation. (In Burlington, VT, the second-most-popular commuting method is walking.) His most expensive input isn’t gas or repairs – it is time. His worst enemy is an empty cab.

No wonder that the motto of veteran cab drivers has always been “keep the meter running.” In this case, Eric Hagen has taken that excellent axiom to its logical extreme. He has realized that the best way to keep the meter running is to throw the meter away.

The Implications of Profit Maximization

Not long ago, President Barack Obama made headlines by stating that profit maximization by business owners served their interests at the expense of the general societal interest. This has long been an article of faith and a general principle on the left wing. Adam Smith founded the modern study of economics in 1776 by observing that trade proceeded on the principle of mutually beneficial voluntary exchange. The left has treated this concept with a mixture of incredulity and disdain, but mostly as if it were a deus ex machina invented to excuse the excesses of capitalism.

Members of the right wing and economists have responded by citing the role played by profit in allocating resources. It is fluctuations in profit, the argument runs, which allow consumers to direct the activities of producers – increasing profits cause producers to redirect resources toward goods and services in high demand, falling profits draw resources away from things for which demand is waning. This thinking is correct and conclusive, as far as it goes. But, as the example of Recession Ride Taxi suggests, it doesn’t go nearly far enough.

Eric Hagen is admittedly and avowedly utilizing a particular pricing technique. An economist recognizes this technique as price discrimination, which is practiced by sellers expressly to increase their total revenue and profit. In the great American tradition of motivational deception, he disavows a desire for personal gain while seeking exactly that. But the overarching significance is that his customers gain from his pursuit of profit maximization and his gains in total revenue and profit.

A layman will be persuaded of this result by hearing the testimonials of Hagen’s customers. The economist is used to hearing people lie about or rationalize their actions, but expects people to act in their own interests; the proliferation of Recession Ride Taxi’s customers means that buyers are better off riding it than not. Hagen claims that he averages 20 trips per day, the average fare running somewhere between $10 and $15. That works out to an annual income in the $50-75,000 range. Not Park Avenue territory, but not bad for low-skilled labor.

The presumption that the interests of buyer and seller are inexorably at odds is utterly false. Adam Smith’s dictum has found its practical expression – unwittingly unearthed by NPR, the unlikeliest of sources.

The Implications for Regulation

The agency of NPR isn’t the only improbable feature of this case. Economists would have quoted heavy odds against the taxi business being the locus of innovative entrepreneurship. For nearly a century, in most cities and towns of the U.S., taxicabs have been stifled under a choking blanket of regulation.

Early in the 20th century, the taxicab began to threaten the streetcar as a means of commercial passenger transport. Because of relative easy of entry into the business and low labor-skill requirements, taxis were plentiful, cheap and competitively attractive to riders. Streetcar companies combined with the largest taxi companies – usually Yellow Cab – to cartelize the taxi market by tightly regulating taxi fares and entry into the business. Fare schedules – soon replaced by taxi meters – and strict limitations on the number of taxi licenses issued combined to prevent effective competition among taxi firms. This raised profits for incumbent firms but harmed consumers. In New York City, where the number of taxi licenses has not increased since World War II, the monopoly profits capitalized into the price of a (transferable) taxi license (called a medallion) have raised its value to over six figures.

Strict regulation has been another hallmark of the Obama administration. The tacit premise has been that markets are not self-regulating, beneficial mechanisms, but rather treacherous, double-edged swords that cut safely only when their every move is guided and supervised by appointed regulators. (Where these regulators acquire the moral wisdom and practical knowledge required to manipulate markets is never specified.) One might have supposed, then, that a story on NPR about mutually beneficial success in the taxi industry would have featured regulators as the prime movers and market principals as passive reactors.

The truth is just the opposite. Eric Hagen is a lone entrepreneur who succeeded by discarding the most sacred tool of taxi regulation – the taxi meter. Indeed, in most American cities, what he did would be illegal. Even if it were technically permissible, owners of airport buses, municipal buses, shuttles, and competing taxi firms would throw a fit about it – which leads us to still another field of significance.

Implications for Antitrust

Traditionally, the practice of price discrimination is viewed with ambivalence by economists. On the one hand, when different consumers within a particular geographic market face different prices for the same good, this is inefficient. Each consumer will maximize his or her utility by arranging consumption so as to equate personal willingness to sacrifice alternative consumption with the objective rate of tradeoff offered by the marketplace, where the latter is embodied in the price paid. Suppose, for example, that one consumer faces a $5 price for good X and another consumer faces a $3 price. The first consumer’s personal marginal valuation of X is $5; the second consumer’s personal marginal valuation of X is $3. Give each the opportunity to trade in X at a price of $4 and both will do so – the first would gain by buying more X and the second by “selling” (consuming less) X. That tells us that the initial position was inefficient.

Carrying this logic to its ultimate end requires that all consumers in a given market face equal prices of a good or service, in order for consumption to be efficient – that is, for all consumers to get the most satisfaction.

The theory of equilibrium price formation studied by students in their college price theory courses brings about just this outcome. The problem is that the underlying assumptions behind this theory are seldom spelled out fully enough for the students to appreciate its highly abstract character. In fact, it often seems that economists (and lawyers) are often unaware of it. Goods are assumed to be homogeneous; each seller is assumed to supply an infinitesimal fraction of the total market amount; all buyers and sellers are assumed to possess all relevant information about available goods, costs and future contingencies.

Undoubtedly, this accounts for the prima facie structure against price discrimination in the Clayton Act, one of the earliest antitrust enactments. Price discrimination is inefficient, according to the textbooks. Those same textbooks also describe a perfectly competitive industry as one in which no seller possesses any power over price – but price discrimination couldn’t exist in this environment.

A price-discriminating seller must have some discretion over price. He must also be able to segment or divide his market into identifiable groups or individual buyers and prevent them from re-selling the good or service – otherwise, the low(er)-price buyers could themselves re-sell the good to the high(er)-price buyers at a slightly lower price, thereby spoiling the would-be discriminator’s party.

Real-world markets are a good deal messier than textbook ones. The information assumed by textbooks can only arise from a market process, and the equilibrium outcome proudly touted is an ever-receding goal. Recession Ride Taxi displays the opportunistic tenor of true capitalism – regulation strands sous chefs without a ride to work and the free market comes riding to the rescue with an improvised solution – imperfect, but a major improvement on the status quo.

This has always been true. Consider our early historical examples. A railroad often provided the only timely means of getting farmers’ crops to market, and the railroad magnate would sometimes charge farmers more for a short haul on which he faced no competition than for a long haul served by one or more competing roads. Outrageous! The first federal regulatory agency, the Interstate Commerce Commission (ICC), was created to remedy just such excesses. And so it did – by raising the long-haul rates into equality with the short-haul rates! This ended the price discrimination but it worsened the exercise of monopoly pricing power.

Country doctors often served sparse, strung-out populations that were unattractive markets. In order to increase their total revenue, country doctors charged much higher rates to wealthy patients, whose price-elasticity of demand was much lower than their poorer neighbors’. Communities encouraged this as a means of attracting physicians. Doctors rationalized it as favoring the poor; this inaugurated the practice of treating physicians as noble, self-sacrificing healers rather than ordinary businesspeople.

Clearly, price discrimination could be a good thing when it promoted competition and enabled consumers to enjoy a good or service that otherwise would not be provided. And regulations against it were no panacea for improved consumer welfare. Economists took this lesson to heart by qualifying their disapproval of price discrimination to cover only those cases where it harmed competition and promoted monopoly. It is perfectly obvious that Eric Hagen has enhanced both competition and consumer welfare with his Recession Ride Taxi.

Can We Generalize the Example of Recession Ride Taxi?

It may occur to the reader to wonder: If Eric Hagen’s Recession Ride Taxi is a boon to consumers and a specimen of marketing genius, where has it been all our lives? Why hasn’t it swept all before it over the course of one century of taxicab-industry history?

The short answer is two-fold. First, it’s been there all along, right under our noses. Second, it is right for some market circumstances and wrong for others. Most American cities represent intermediate cases, in which a mix of Hagen’s technique and conventional techniques are currently optimal. But the best approach would be to junk all forms of taxicab regulation and give the “Hagen System” full scope to operate.

Veteran taxicab drivers in virtually all American cities have utilized a species of the Hagen System by engaging in informal negotiation for taxi fares. Although variation of fares by time of day is typically illegal, it is common practice among business travelers and longtime drivers to vary airport fares by time of day. This helps travelers by securing passage and gaining discounts. It helps drivers by increasing capacity utilization during slack periods of demand.

A more comprehensive allegiance to Hagen’s methods is practiced by drivers who develop a personal clientele, which they service to the exclusion of radio calls and street hails. This tends to evolve naturally into a system of tailored fares, negotiated informally between driver and customer. (Depending on circumstances and the letter of the law, the taxi meter may or may not be engaged during the trip, but its reading is irrelevant.)

The central principle of Hagen’s Recession Ride Taxi – customer-chosen fares – practically requires this kind of repeat-customer format. Hagen may give lip service to “trust” in his customers, but he wants and needs the freedom to drop the occasional customer who stiffs him or intends to repeatedly shortchange him. He undoubtedly does this not by explicitly refusing to carry, which is illegal in most cities, but by “inadvertently” lengthening his response time to the deadbeats until they drop him. (This highlights a subtle but important aspect of the business – that the taxi fare is determined not just by the monetary fare but also by the time taken for the cab to show up.)

Why hasn’t this approach – developing a personal clientele – utterly overshadowed the visible taxi market of radio calls and street hails? Much taxi business is opportunistic, arising from unique and unforeseeable circumstances that cannot be handled in a personal, repeat-customer framework. Even more telling is the fact that the repeat-customer system requires the driver to incur substantial dead mileage and time wastage in servicing what often amounts to a predetermined route. In densely packed cities with large, continuous taxi demand like New York City, Las Vegas and Washington, D.C., drivers can operate much more efficiently “on the radio” and the street by taking their next call at the closest location.

But small towns like Burlington, VT face a taxi problem not unlike the old country doctor scenario. With around 40,000 people and no other close metropolitan areas, Burlington needs to generate a critical mass of driver income in order to get any taxi service at all. Price discrimination is the tried-and-true means of accomplishing this. Economic theory predicts that the Hagen System will predominate in this setting.

Most American cities fall in between these two clear-cut cases. They are oppressed by taxicab regulation and high meter rates that have suppressed or virtually killed off demand among low-income and minority populations. (Sometimes this demand is services by informal car or bus service provided by jitneys – vehicles owned by private individuals not affiliated with a business.) The climate is favorable for the Hagen System, but it is employed only at the cost of violating the law. Big government has created so many laws, almost all of which are counterproductive and contain innate incentives for violation, that governments cannot begin to enforce most of them. Thus, enforcement is lax to non-existent.

Nonetheless, the case of Recession Ride Taxi sharpens the case against taxicab regulation. Taxi meters are not valuable ipso facto; neither are newer computer systems for automatic dispatch that have largely replaced human taxicab dispatch. Technology should be judged according to the economic value it creates for consumers. The only way to do that is to allow the market to value technology and govern its use. The illusion that sellers set price is just that – an illusion, a mirage. Pricing is a negotiation between buyer and seller and either should be free to initiate the process. When regulation interferes with that freedom, it harms those it is ostensibly set up to protect.

Thanks, NPR

We have discovered that the simple case of a single taxicab driver in Burlington, VT is, in reality, a microcosm for capitalism at work. How much of the panorama we unfolded above was dealt with by NPR in their report on Eric Hagen’s Recession Ride Taxi?

None of it. NPR ignored every relevant economic issue, presenting the case as if it were nothing more than what the late Richard Nadler satirically called “caring and sharing.” Still, we should be grateful to NPR for at least reporting the news. There is no precedent for expecting this station to produce an incisive interpretation.

DRI-420: It’s Official: The Recovery is Receding

Coping with change is famously difficult. The first stage of the adjustment is recognition. It’s hard to adjust to something when you don’t realize – or won’t acknowledge – its reality. That is the problem most people have adjusting to the current state of the economy. They can’t or won’t acknowledge that we are undergoing an unprecedented transformation rather than merely another business cycle.

We periodically review the performance of Access Advertising’s Driver Recruiting Index (DRI) as a tool to gauge the ex ante demand for commercial drivers. We juxtapose it alongside other indices of trucking and transportation to review their performance and assess the state of the economy. Two salient points emerge from our latest review.

First, the economy in general and the transportation (and trucking) sector in particular are caught in a limbo that is neither recession nor expansion. Second, experts who have been slow to recognize this fact are now belatedly doing so.

The DRI’s Spring Plateau

In 2011, the DRI began its annual climb up the ladder in mid-January, then took off sharply in February. It plateaued in April and May, only to accelerate again in June and July. Total upward movement from January to July was dramatic.

This year, after one of the warmest winters on record, the DRI began with its usual vigor in February. But in early March, it reached a plateau from which it seldom deviated through mid-June – a most unusual seasonal performance under any circumstances and even more so now. The index never came within hailing distance of last year’s spring highs and remains mired at least 10% below the values on comparable dates last year.

It is not unusual for the DRI to increase at certain times of the year or in appropriate circumstances, or for it to decrease at other times. But plodding consistency during a season and circumstances in which rapid increase would be expected is unusual. Moreover, this mimics the DRI’s trance-like behavior early last fall, when the increases in trucking activity normally associated with preparation for the end-of-year retail rush did not materialize.

Our recognition of this uncharacteristic lassitude by the DRI and the economy in general is on record. Now, however, we are part of a chorus of mainstream commentators on transportation and the economy.

The ATA Gets on Board

A longtime trucking bellwether is the American Trucking Associations’ (ATA) Monthly Truck Tonnage Index. This seasonally adjusted index of trucking volume backed up its 1.1% decline in April with a 0.7% fall in May.

ATA’s Chief Economist Bob Costello is a reliable go-to guy for a quote on the economy in general and trucking in particular. He is reliably mainstream in his views – which are favorable to big business and big government. He is consistently cautious in his projections – which is to say, not given to dramatics or overstatement.

So when Costello calls the Truck Tonnage Index’s recent dips “reflective of the broader economy, which has slowed,” you need look no further to discern the consensus of the forecasting fraternity. Costello’s lineup of suspected culprits for the slowdown is predictable – Eurozone turmoil and U.S. electoral uncertainty. This double whammy clouds crystal balls and turns corporate planners into chickens who sit clucking atop cash instead of hatching new investments.


The Transportation Services Index (TSI) of the Bureau of Labor Statistics is another familiar index of transportation activity. The Truck Tonnage Index is a component of this broader survey of the overall transportation picture, compiled under the auspices of the Department of Transportation.

Not surprisingly, the federal government moves slower than the world it governs. Consequently, the most recent month available for the TSI is April, during which the freight index rose at the snail’s pace of 0.2%. The DOT summarized recent movements of the index thusly: “Plateauing of the freight TSI since January appears to reflect slowing growth in the general economy.”

The Cass Index

The Cass Index is yet another transportation index of long standing. It compiles separate indices for volume and expenditures. The volume index has increased throughout 2012, but the increases have been steadily decreasing in magnitude – 2.5% in February, 2.3% in March, 1.9% in April and 1.8% in May.

Commenting on this record in the June 5, 2012 posting of Logistics Management, industry analyst Jeff Berman observed “…a dearth of people that truly have real confidence in the economy,” noting that “volumes are still not close to 2007 [e.g., pre-recession] levels.” The economy, he concludes, “remains in teeter-totter mode.”

The Ceridian PCI

The Ceridian Pulse of Commerce Index (PCI) is the brainchild of UCLA econometrician and forecaster Edward Leamer. It captures real-time data on the diesel-fuel consumption of over-the-road trucks at some 7000 locations across the U.S. from the transactions cleared through stored-value card provider Ceridian.

Like most transportation indices, the PCI has registered slowing growth in early 2012 – 0.7% in February, 0.3% in March and 0.1% in April. At first glance, May seemed to reverse this trend with 0.8% growth. But there are reasons to take even this modest piece of good news with a grain of salt.

For one thing, as pointed out by Jeff Berman in Logistics Management on June 7, the May figure still represented a year-over-year decline of 0.6%. Even more telling is the fact that the volume of diesel-fuel purchases reacts strongly to diesel-fuel prices. These, in turn, depend on oil prices and the health of diesel-dependent economies like China and India. Recent downturns in both the above indicators are good news for diesel-fuel consumption specifically, but they are something of a mixed blessing for overall U.S. economic activity.

A decline in oil prices caused by an increased supply of oil is an unambiguous benefit for us. This increases the amount of resources available for production purposes, and the reduction in oil prices translates into lower costs for countless production processes in which oil is an input. But if the decline results from a reduced demand for oil at home and abroad, it is a harbinger of recession. The lower demand will result in less oil being purchased and used in production, leading to less output of derivative goods and services. Moreover, less demand for oil abroad means lower incomes and less demand for U.S. exports, which will ultimately lower our incomes and imports as well.

We are experiencing both effects – the former due to improved recovery methods like fracking and horizontal drilling and sources like shale oil, the latter due to a myriad of influences including Eurozone woes, Chinese recession and our own slogging-through-molasses economic climate. At the moment, the bad tends to outweigh the good. In turn, this tends to mitigate the significance of upturns in the PCI.

Leamer himself is just as lukewarm about our prospects as other transportation forecasters. In Berman’s piece, he characterizes trucking as “soft generally” because “growth in the components of the economy that depend on trucking is not strong.”

Light Dawneth at Last

The current consensus has been slow in forming. In the three years since the official end to the Great Recession in June 2009, mainstream commentators like Bob Costello and Edward Leamer have continually insisted that prosperity was just around the corner. In effect, they have assumed that the United States was living through a typical business cycle, characterized by a downturn that eventually hit bottom, followed by an upturn that picked up steam until it became a full-fledged expansion. Cycles might differ in detail, with respect to trajectory of contraction or expansion and duration of recovery, but not in terms of their general character.

When the rate of GDP growth began to increase somewhat in 2010, Costello confidently asserted that growth would soon accelerate and unemployment would start to fall. After all, he reminded us, unemployment is a lagging indicator and usually is the last symptom of recession to abate once expansion sets in. Late last year, Leamer reacted to a favorable monthly PCI by reading into it the long-awaited resurgence of trucking that would lift the economy off the mud flats and into the whitewater of fast-track growth.

Few economic indicators are as volatile as housing starts, but the slightest upward blip in housing over the last three years has invariably been touted as a neon arrow pointing unerringly at the promised land of full employment. Despite all economic logic to the contrary, the presumption has been that because housing was the most severely affected sector during the Great Recession, it must of necessity lift the general economy up to recovery on its shoulders.

In view of this record, the question isn’t so much how or why we all abruptly find ourselves on the same page. Instead, we should wonder why it took so long.

Revolution and Crisis

The science of macroeconomics (an oxymoronic term that is nonetheless useful) has reached a watershed moment. In his landmark study, The Structure of Scientific Revolutions, Thomas Kuhn decried the conventional view of science. A scientific theory or paradigm is not formulated, tested experimentally and formally accepted or rejected. Instead, it is adopted on the basis of practical usefulness and retained until supplanted by a more useful theory. Replacement is not effected by testing but rather in response to a crisis – the failure of the reigning theory to perform the tasks that made it useful originally.

We are now in the midst of such a crisis.

The reigning theory of macroeconomics was developed by John Maynard Keynes over 75 years ago using a combination of old and new ideas. The principal old idea was that capitalist economies suffered recurrent insufficiencies of spending that gave rise to depressions and unemployment. The principal new idea was that government could and should remedy these shortfalls by spending money and/or inducing citizens to increase spending. Eventually, economists borrowed the term stimulus from behavioral science to characterize these policies. The government spending should be funded by either borrowing or money creation. Induced private spending should be funded by either tax reductions or money creation. Increases in private investment should be induced by artificially lowering interest rates via money creation. Increases in employment should be induced by exploiting “money illusion” of workers – that is, by lowering the purchasing power of wages by money creation, fooling workers into thinking their real incomes had risen while persuading illusion-free businesses to hire more workers at lower real wages.

For over forty years, this theory was subjected to rigorous theoretical and empirical scrutiny and extensive practical application. By roughly 1980, the results were in. The theoretical scrutiny was unfavorable to the theory: no tendency toward underconsumption and unemployment was inherent in the system, government action would be unavailing, unnecessary or even counterproductive; and “money illusion” did not exist. Empirical studies were either unfavorable or equivocal. Practical application of the theory was widespread and remarkably consistent; it failed whenever and wherever tried.

In retrospect, this should not have been surprising. By 1980, the American economy had endured over 30 recessions. It had recovered from all of them without the application of the theory.

Still, the theory was not abandoned.

Macroeconomists claimed that the theory was still useful because government policy would work faster than allowing markets to recover from recession and depression unaided. Why suffer for two or three or four years when we can cure the problem in a few months or a year with the aid of government stimulus?

A Kuhnian explanation would instead find other ways in which a demonstrably wrong theory might nevertheless be useful. Government gradually took on the role of problem solver of first resort, not just in economic policy but in every nook and cranny of society. It actually solved few, if any, problems, but it was required to look as if it were trying to solve them. Trying hard.

Democrats, who had been the first party to advocate tax reductions as economic stimulus, eventually had to repudiate this policy because it supposedly enriched the rich. Republicans could not endorse a policy of government spending for economic- policy purposes because it would enlarge federal-government budget deficits. Both parties desperately needed a way to look busy. By default, they turned to monetary policy; e.g., money creation.

Ironically, Keynesian theory had originally rejected money creation as ineffective, but its practitioners had to abandon that stance for tactical reasons. Now they were backed into the corner of having to rely on it almost exclusively.

The economic theory that had proven utterly bankrupt as economics now became the sole policy tool of both political parties, virtually by default. It had never worked. Nobody in Washington, D.C. really expected it to work. Nobody cared all that much whether it worked or not.

Keynesian economics was in the same position as medicine prior to the eighteenth century. Doctors had few remedies that worked, but they continued to use the ones they had even though they seldom, if ever, cured anybody. If the doctors had admitted the truth, they would have had to stop being doctors. Macroeconomics had established a secure beachhead in the economics profession, with course offerings at every level of instruction, dedicated scholarly journals, major research grants, government positions and a public mission to make the world safe for markets. Admitting the truth about the theory that had midwived all that would have forfeited their gains.

What Time’s the Next Revolution?

So much for politicians, bureaucrats and academic economists. Where does that leave the rest of us? Essentially, it leaves us pacing the streets, looking around nervously, waiting for the next revolution. What we need is the next scientific revolution, and a theory to take the place of the failure being propped up by the Washington, D.C. policy Establishment – a composite version of Frank Morgan in The Wizard of Oz.

Heretofore we have been in denial. We have been telling ourselves that we went through a bad time in 2008, but the worse is over and we’re gradually getting over it now. Only it is now beginning to dawn on mainstream pundits that we’re not really getting over it – that, in fact, we may be getting ready to repeat some of the worst all over again.

We’re starting to realize that hardly a man is now alive who remembers the famous days and years when unemployment wobbled between eight and ten percent for over three years with no sign of relief. Interest rates have never been this low for this long – and what has it accomplished? Amend that slightly – what good has that accomplished? When in peacetime has government debt ever loomed so large? When has regulation bound so tightly? When has freedom seemed so tenuous?

When at last we have mustered the courage to admit the truth, the next stage will be to face the fact that Keynesian economics had no theory of the business cycle as such. Keynesian theory never asked why aggregate demand declined. The question didn’t seem to matter because the answer didn’t affect our course of action, which was to spend ourselves silly until things got better.

Well, we’re silly and they’re not better. Now it’s time to ask what really causes the business cycle. Wisdom begins when we acknowledge that the only time we faced a climate of recurrent limbo such as this one was in the 1930s – after both the Hoover and Roosevelt administration tried every interventionist nostrum under the sun to artificially cure the recession that began in 1929. As Roosevelt’s Treasury Secretary, Henry Morganthau, admitted to his diary, they ended up in 1939 worse off than when they started. Only when FDR himself forsook “Dr. New Deal” for “Dr. Win-the-War” were the chains hobbling American business broken. After World War II, with Roosevelt dead and no sponsor for the New Deal, a Republican Congress and tax cuts ushered in the greatest one-year boom in U.S. economic history.

If we went to the doctor to be treated for a serious illness and he offered us a new drug, how would we react? Would we not ask if it had been tried out? Would we not expect to find a history of successful use? If we found just the reverse – a history of failure – would we not reject the drug? If the only rebuttal argument the doctor could muster was, “Well, we can’t just stand here and do nothing,” wouldn’t we at the very least have the gumption to fire back, “Oh, yeah? Why not?”

This much can be done by any intelligent layman. No Ph.D. in economics is required. Afterward will be the time to grapple with the complexities of intertemporal capital theory and dynamic adjustment, to penetrate the mysteries of the structure of production. You have to learn to crawl before you can walk.

DRI-451: The Trucking Disconnect: Is History Repeating Itself?

The big economic news in recent months has been the upturn in the national economy. Increases in various indices of economic welfare, such as gross domestic product, consumer spending, industrial production and employment have stimulated talk that the recovery is finally underway – nearly three years after its official beginning in June, 2009.

Buried beneath all the happy chatter lie a host of problems and potential problems. The housing sector – both in terms of new construction and sales of existing homes – is still “flat on its face,” in the words of a leading economic forecaster. Bank portfolios – stuffed with mortgage-backed securities – are steaming piles of fiscal matter. The Federal Reserve is still riding the tiger of its “zero interest rate policy,” dictated by the looming specter of a federal budget completely devoured by interest payments after a rise in rates.

It seems almost trivial to worry about something as pedestrian as the trucking industry. Yet it behooves us to remember that the Great Recession was preceded by a “freight recession.” By the time recession was officially declared in December, 2007 – actually, it was months later before the National Bureau of Economic Research made the announcement – truckers had already been feeling the pinch for well over a year.

Now trucking is in the doldrums again. The two newest and most promising indices of trucking activity are sending signals that diverge dramatically from the messages delivered by the Department of Commerce about income, production, spending and employment. What are we to make of this?

The DRI Disconnects from the Broader Economy

Access Advertising’s Driver Recruiting Index (DRI) compiles the number of driver-recruiting ads placed each week in a geographically diverse group of Sunday major-metropolitan newspapers. The underlying rationale is to approximate the economic, or ex ante,demand for drivers. Data collection began on January 2, 2009 – just over three years ago.

For most of its short life, the DRI’s variations have closely tracked movements in the broader economy – e. g., changes in national income, product, spending and employment. Usually the DRI has followed those movements rather than leading them. We may conjecture that the Great Recession has left companies chary of taking on the fixed costs of employees, and willing to do so only on the assurance that demand for their products is robust rather than ephemeral. Thus, recruiters hire in arrears of increases in production rather than ahead of them.

Beginning in September, 2011 – a season that is normally good for an uptick in freight carriage and driver hiring – the DRI suddenly went flat as a diving board for two months. The year-end holidays comprise a huge chunk of annual retail sales, and retailers typically prepare by beefing up inventories in the fall. This recent lacuna was all the more surprising because inventories had previously fallen to dangerously low levels. Yet the stony indifference displayed by the DRI suggested that trucking firms were meeting any increases in freight supply by squeezing more productivity from the existing driver force rather than by increasing their demand for drivers.

Throughout the holiday season, the DRI recorded yearly lows. All other things equal, this was to be expected; the year-end holidays are the seasonal doldrums for the trucking business. What was unexpected, however, was that the DRI showed no response to the steady stream of good economic news that continued into the New Year.

As the New Year progresses, the trucking engine turns over and roars to life. Construction projects begin. Harvested crops zoom to market. Sure enough, the DRI began to record increases. But these were puny in magnitude for an economy in the recovery phase of the business cycle. During a recovery, economic values should be seasonally high; they should exceed their previous-year values. In February and March, 2012, DRI index numbers fell short of previous-year values on comparable dates by nearly 20%. Even the 8-week moving-average year-over-year comparisons – explicitly constructed to smooth random weekly fluctuations – racked up record declines for the DRI’s 3-year history.

The clinching datum in this analysis is a dog that didn’t bark – or rather, howl. The previous winter was the mildest in decades, one of the warmest on record. This should have set the table for a banner spring trucking season.

The Department of Commerce said that the economy was beginning to hum. But according to the DRI, the nation’s driver recruiters didn’t know the words. And the trucking industry could hardly play a symphony without a full complement of musicians.

Supporting Evidence: the Ceridian PCI

One immediate reaction to the divergence between the DRI and indices of the overall economy might be to question the DRI’s veracity. Perhaps it is no longer doing its job of accurately sampling ex ante driver demand. One possible explanation for this might be a large-scale substitution of Internet job sites for newspaper classified ads as a means of recruiting drivers. Alternatively, recruiters might have turned to secondary advertising sources like smaller dailies, community papers, shoppers and alternatives in lieu of more expensive major-metro newspapers.

As it happens, independent corroborative evidence supports the DRI’s verdict of contrarian behavior by the trucking sector. The Ceridian PCI provides real-time data on diesel-fuel purchases by truckers at some 7,000 truck stops nationwide. It was devised and is monitored by longtime econometrician and forecaster Edward Leamer. Leamer’s recent comments sketch an outline of recent events that is both revealing and disturbing.

Leamer believes that when final GDP revisions are complete, they will likely indicate 4th-quarter growth that was closer to 2% than the 3% that was originally touted. On the basis of PCI data, he speculates that the difference is accounted for mostly by the failure of inventory growth to come up to expectations. Since trucking accounts for approximately two-thirds of all U.S. freight shipments, Leamer views PCI data as a still photograph of “inventories in motion.”

Movements in the Ceridian PCI Index since September are consistent with the pattern followed by the DRI; namely, one of decline once seasonal factors are taken into account. After small increases in September-November, the PCI decreased in December-February. February’s 0.7% increase cancelled out an equivalent decrease in December 2011, leaving a sharp 1.7% fall in January.

These two indices come at trucking from different directions but share a real-time perspective. Their convergence is highly suggestive. It makes a prima-facie case for taking their data seriously. Then the question becomes: How should we interpret that data? What explains the fact that trucking and the overall economy are seemingly “out of sync,” to borrow Edward Leamer’s description?

Some Possible Explanations

One explanatory element was pinpointed by Leamer himself. The forecaster complained that the U.S. housing market was still “flat on its back,” noting the conventional estimate of 17 truckloads of materials required to erect a house. When houses aren’t being built, those trucks aren’t rolling.

Another plausible factor in the relative decline of trucking is the increase in the relative price of diesel fuel. The average price per gallon was $3.81 last year at this time and is now $4.25. Basic microeconomics tells us that when a key input price rises, the “output effect” will cause the firm’s (and the industry’s) output to fall.

Another process at work involves competition from other forms of transportation. That process has under way for years with containerization, the combination of ship, rail and trucking transport of freight held inside metal containers. To the extent that this displaces functions previously performed solely by trucks, this might cause reduce trucking activity.

Each of these explanations seems plausible, but none of them seems strong enough to have put an industrial sector the size of trucking to sleep. For example, Leamer pointed out that imports of containers on the U.S. West Coast are down in recent months, so containerization is not a likely suspect in the current somnolence of the trucking industry.

What’s Up With the World Economy?

Americans are accustomed to what might be called a Ptolemaic view of international economics, with the U.S. as the sun around which the economies of other nations revolve. This is no longer accurate. Economies such as China, India and the European bloc now exert considerable quantitative force on world markets. This applies especially in energy markets, where the combination of huge populations and relatively inefficient energy use cause China and India to use vast amounts of oil and gas.

Economic growth is slowing to a crawl throughout the world, owing to high energy prices and the financial pressures exerted by the crushing debt burdens carried by Western nations. This makes the current American revival suspect and, in any case, likely short-lived. Rather than faulting trucking-industry indices for their incongruence with GDP and employment data, we should be inspecting the overall data with a jaundiced eye and a view toward uncovering its underlying weaknesses.

Here We Go Again

Conventional economic analysis of the financial crisis and the Great Recession mimics that of the stock-market collapse and Great Depression that began in 1929. The financial events are attributed to insufficient or maladroit regulation, while the real economic contractions are ascribed to insufficient aggregate spending by households, firms and government (!). Despite the repeated explanatory failure of both these paradigms, they remain dominant. No matter how bad a dominant theory is, Thomas Kuhn famously declared nearly fifty years ago, it will remain in place until supplanted by a more satisfactory alternative explanation.

The Austrian theory of the business cycle has been outlined previously in this space. It provides a skeletal explanation for why economic busts always follow booms that are artificially engineered by government creation. Austrian theory also explains why the ineluctable fact of radical human ignorance precludes government regulation and central planning as a substitute for free markets. These Austrian principles suggest that the trucking sector’s troubles are a canary in the coal mine, warning us of the poison fumes to come.

Despite abundant evidence that Federal Reserve money creation and artificially low interest rates midwived the housing bubble that lay at the heart of both crises, the Fed persists in its “zero interest rate policy” (ZIRP) to this day. Although Chairman Bernanke gives lip service to a rationale of economic stimulus, it is clear that government budgetary considerations are the real motivation for this. Alas, its effect is analogous to that of alcohol on the senses of a drunk suffering from hangover. We are now experiencing a brief, temporary period of euphoria as the money created by ZIRP belatedly wends its way through our economy. When the effects of that created money take hold, however, it will be déjà vu all over again.

The crisis period of an Austrian business cycle occurs when investments that were feasible and desirable only because created money and low interest rates made them appear so are revealed to be unsustainable. That crisis is often triggered by a rise in interest rates, but in this case Federal Reserve policy precludes that. Still, the Fed cannot dictate economic reality merely through the use of monetary policy and interest-rate pegging. Like a suitcase that is overstuffed, pushing the contents down one place merely drives them up somewhere else.

It seems likely that the crisis-trigger is commodity- and input-price inflation. In the classical Austrian business cycle, the competition for goods drives up prices, which ultimately drives up interest rates. Higher interest rates and loss of investment funds are what kill off the unsustainable investments, and this in turn produces layoffs and unemployment. In our current variant, excessive regulation and increases in commodity and input prices play the triggering role. Both the Fed and regulators continue to force-feed investment in residential housing. This time, however, the subsequent refinancing, second mortgages and other creative tools that extended the original housing boom are nixed by new financial regulations governing housing finance. The rising input costs and lack of demand are sufficient to prevent artificial resuscitation of the housing sector.

Meanwhile, the spillover effects to related industries have begun again, just as they did starting in 2006 and 2007 – only via somewhat different routes. Housing hardly had a chance to re-emerge as a factor in transportation markets; consequently, the current slump in trucking has been triggered by rising costs of diesel fuel and punitive regulation by the Obama administration.

If “inflation” is triggering a return to recession, why are its effects so selective? Contrary to popular belief, inflation is seldom if ever neutral in its impact on relative prices; some prices always go up more than others and some always rise faster than others. Since every price is income to somebody, the beneficiaries of inflation realize higher incomes, which they spend, thus driving up the general level of prices. Only gradually, as the contagion of bad investments, layoffs and unemployment spreads from sector to sector, do the effects become general. We are still in the early stages, when the spending generated by beneficiaries creates employment in some sectors while the unlucky sectors – like trucking – are among the first to feel the ill effects of higher prices and costs.

How Deep Is the Ocean?

Since the depth of the recession and consequent stringency of regulation limited the height of this latest “boom,” the double-dip into recession will not be as deep as the Great Recession. At least, not unless the extreme vulnerability of banks in Europe and the U.S. produces a wave of failures and our system-wide financial insolvency is exposed to the world. In that case, all bets are off.

Although the next recession may not be deep, the determination of the monetary authorities to preserve ZIRP will keep it long. Political factors – the necessity for government always to appear busy, even when its actions are in fact counterproductive, plus the necessity to restrain interest payments on debt from devouring the federal budget – make it impossible for politicians to follow a prudent economic policy.

Can it really be that all this follows from the divergence of trucking from the path followed by most other real economic sectors? As the saying goes, great oaks – and oafs – from little acorns grow.