DRI-334 for week of 5-5-13: Economics and Geography: The Case of Africa

An Access Advertising EconBrief:

Economics and Geography: The Case of Africa

Economics is the social science dealing with human choice. Geography is the physical science that deals with the above-ground features of the Earth’s surface. The two are seldom mentioned in the same breath. Yet they work hand-in-hand. The subject matter of geography forms the objective physical, structural parameters with which economics must cope. Geography’s brute facts can mold, shape and manhandle economics to a stunning degree. No better example could be cited than the effect of Africa’s geography on its economic history.

The Geographic Dimensions of Sub-Saharan Africa

The continent of Africa encompasses a geographic kaleidoscope. The “Africa” of popular imagination and special economic interest lies to the south of the Sahara – the world’s largest desert whose land area exceeds the size of the continental United States. Sub-Saharan Africa stretches to the tip of the Cape of Good Hope, north of the Antarctic Ocean. It abuts the Indian Ocean to the east and the Atlantic Ocean to the west.

The adjacency of oceans on three sides suggests that African economic history should be a tale of international maritime trade. Just the opposite – although at least three important trade lanes developed between Africa and the rest of the world, international trade was not a tremendous engine of economic development and growth in Africa. The noted economist Thomas Sowell found the source of this apparent paradox in two geographic drawbacks. First, winds and ocean currents near the African coast were (and are) among the world’s trickiest and most variable. Throughout most of world history, the expertise necessary to cope with them was absent.  Second, the African coastline was and is mostly smooth and shallow, thus unsuitable for harbors. Ships had to anchor offshore and transfer cargo by boat – a time-consuming, cumbersome and costly method. This gave rise to one of the great economic-historical ironies, noted by Sowell: As a large fraction of world international trade passed back and forth from Asia around the Cape of Good Hope to the New World, it passed within hailing distance of the African sub-continent – but seldom stopped.

It is hard to overrate the importance of these factors for Africa’s economic development. (And while for most other purposes we would need to analyze African economic development by separating the continent into its constituent nations, this geographic analysis is better conducted by treating the sub-continent as a unitary whole.) These days, many people treat foreigners and foreign trade as unwelcome intruders in economic life, but throughout human history international trade has been the key to a better life for most people and nations. Many of the great nations, from Rome to Greece to Carthage to Phoenicia to Egypt to the modern European nations, were either trading civilizations or encouraged trade beyond national borders. Trade allows nations to consume a broader range and larger volume of goods than they individually produce. It also increases the amount, scope and accuracy of human knowledge. When deliberately imposed from within, trade deprivation is a form of self-starvation.

In Africa’s case, the effects of geography are directly analogous to those of anthropogenic taxes and quotas. Those effects were not limited to the coastlines. They were even more pronounced in the interior. To appreciate their effects, we can compare them with the effects of geography on economic development here in the U.S.

From the arrival of Europeans in North America just prior to and after 1600, rivers were the transportations arteries of choice for north-south (and some east-west) travel. Barge, keelboat and canoe were media of transport. Cities sprung up at the confluence of rivers and at convenient landing points. Today, the history of the nation’s major cities is writ in their rivers. Despite the plethora of new transport media, ranging from planes to trains to automobiles, river transport is still an important secondary source of freight transportation for goods whose ratio of bulk to value is high.

Africa has always has even more and bigger rivers than North America. But they have been a much smaller boon to her economic development, which has been drastically curtailed compared to that of the New World.  The problem has been that African rivers are often unnavigable. Hard-core movie fans are familiar with the 1951 film The African Queen, starring Humphrey Bogart and Katharine Hepburn. The movie follows the adventures of a hard-drinking, World-War I era ship’s captain and a spinster missionary who set out on a long river journey aimed at locating and sinking a German steamer in Central Africa. The two must traverse the length of the unnavigable UlangaRiver (also called the Bora) to reach the Kenyan lake where the steamer resides. The formidable river hazards they surmount form the basis of the movie’s plot. These include rapids, plagues of swarming insects, river animals such as hippos, inclement weather and the river itself – which eventually becomes so choked with reeds and vegetation that they have to climb in the water and pull their weatherbeaten old tub of a tiny craft through the muck. Hollywood films are legendary for mangling the truth, but in this case the screenwriter (and novelist C.S. Forester, on whose book the film was based) hit the nail on the head.

In addition to above-mentioned hazards to navigation, African rivers suffer the drawback that African geologic structure is often mesa-like – plateaus followed by sharp dropoffs that form a falls. (Indeed, sharp changes in altitude hinder mobility on land as well as water over most of the continent.) The result is navigational nightmare; traversing a falls is not merely awkward but downright dangerous. The Zaire River is 2,900 miles long and contains a volume of water second only to that of the legendary Amazon River. But the Zaire’s succession of falls and rapids prevent entering ships from getting very far. This is typical – according to Sowell, “no river in sub-Saharan Africa reaches from the open sea to deep into the interior.” We must travel up the Mediterranean coast to the Nile to find a river that stretches inland. While the 1,500-mile total length of navigable water in the Zaire is impressive, this is not a continuous stretch, but is rather comprised of many discontinuous stretches. For several centuries, a map maker attempting to travel the river’s entire length would have had to make repeated portages across land to bypass the unnavigable parts of the river. This was typical of Africa’s waterways.

When water transport is unavailable or infeasible, animals are the historical second-best means of transporting people or goods. In the U.S., oxen and horses pulled wagons and carried travelers on the westward migrations beyond the original 13 colonies. African settlers made similar attempts to employ draft animals but were thwarted by the tsetse fly, an insect pest that carries disease that is deadly to animals. Animal populations were so ravaged that human beings often stepped in as beasts of burden. The stereotypes of African males as jungle bearers on safari and females carrying loads on their heads were born of this necessity. But the tropical climate was not much friendlier to humans. In the 20th century, some 90% of all deaths from malaria occurred in sub-Saharan Africa.

Bacteria tend to flourish in the tropics because of dampness. Oddly enough, the moisture content is favorable to disease organisms but less so to agriculture. Even though total rainfall seems adequate, the boom-or-bust pattern of rainfall – torrential rains alternating with sizable periods of drought – is hard on soils. Drought bakes and hardens soils, enabling heavy rains to wash them away. This destroys valuable nutrients, damaging agricultural prospects. The use of fertilizers was long hindered by the dearth of animals – yet another point of unfavorable contrast with North America, where animals were a plentiful source of fertilizer.

While it is true that not all regions of sub-Saharan Africa suffered all these deficiencies simultaneously, virtually all areas suffered at least one of them. Normally, when some areas produce some things but sorely lack others, trade can make up for this by allowing each area to specialize in its comparative advantage good and trade a surplus of its good for the other things it lacks. But when transport between areas is absent or highly costly, the value of trade is greatly reduced.

The effect of transport costs is exactly analogous to that of a specific tax. Suppose that it costs $10 to transport a good from point A to point B. This drives a wedge between the price paid by the buyer of the good (located at B) and the price received by the seller (at A). This holds true regardless of who pays the transport costs; in fact, the welfare of buyer and seller are unaffected by the identity of the taxpayer. Suppose, first, that the buyer is responsible for paying the tax and that the final market price is $90. That means that the buyer pays $100 (the $90 market price plus the $10 tax) and the seller receives the market price of $90. Alternatively, suppose that the seller is responsible for paying the tax. We previously established the buyer’s willingness to pay $100 for the same quantity of the good – this time the buyer pays it all to the seller instead of paying $90 to the seller and $10 to the government (collected at the sales counter by the seller). Now the seller receives a larger market price of $100, instead of the $90 market price in the first example. But the seller must subtract the $10 tax paid to the government, so the seller nets only the same $90 as before. In both cases, the buyer pays $100 net and the seller receives $90 net. In public finance, this is called the equivalence theorem. But the same logic applies to transport costs. Both tax and transport costs deter economic activity because they reduce the gain to the seller and increase the sacrifice made by the buyer.

Transport costs are ubiquitous. But they loom especially large in Africa. In African economic history, transport costs have been a figurative cross borne on the shoulders of the African citizen. They have severely limited both international and intranational trade.

African Trade

Northwestern Africa, including what eventually became the countries of Nigeria and Ghana, was least disfavored by nature and accordingly hosted several relatively prosperous civilizations. Because prospects for interior trade with other African nations were so poor, these nations increased their real incomes by regional warfare and international trade. Their higher standard of living allowed them to produce weapons of war with which to subjugate their neighbors and reduce their citizens to slavery. The Niger River provided one of the few navigable water routes leading to the ocean, which facilitated the export of slaves to Europe and the West Indies, whence they were often re-exported to North America.

Slaves were one of the few African export items because a slave was a very valuable capital good, capable of earning a decades-long stream of income for its owner. This future stream of income could be estimated, discounted to a present value using an interest rate and sold for a purchase price that capitalized that future stream of income into a current capital gain for the seller. This made it worthwhile to incur the sizable costs of transporting imprisoned slaves across a vast ocean. Consequently, the Nigerian coast acquired the appellation of the “slave coast.”

Another profitable export of this region was gold, which was mined in Ghana. Gold was (and still is) used for limited industrial and decorative purposes, but its primary value lies in its scarcity and acceptability as a medium of exchange and store of value. Investors bid up its price whenever money loses its value in exchange. Even today, the world’s entire physical stock of gold would fit into a single sanitary landfill. Mined gold resembles dust. This means that gold has an extremely high value relative to its physical bulk – the perfect kind of good to overcome the barrier erected by high transport costs. It is not surprising, then, that the Ghanaian coast acquired the nickname of the “gold coast.”

The third of Africa’s famous “coasts” was its “ivory coast,” located to the west of Ghana in Northwest Africa. The ivory was obtained from the tusks of African elephants, hunted to near extinction because private ownership of elephants was mistakenly forbidden. (In the late 20th century, those African nations that experimented with allowing private ownership of elephants saw dramatic increases in elephant populations and successful control of poaching.) Ivory was greatly prized for a myriad of uses and elephants were extant only in Africa and India. Thus, elephant tusks also attained a high value relative to their substantial bulk.

Overall, this represented an incredibly meager showing for one of the world’s largest continents and populations. At the most, it produced prosperity for small African regions for limited historical periods. The slave trade was outlawed in the 19th century and this edict was policed by the British navy. The ivory trade was a self-limiting business, plagued by its illegal status and the short-sightedness of officialdom. Gold mining is limited by the stinginess of nature and the expense of extracting gold from the ground.

Alternative Explanations for Africa’s Lagging Economic Development

Africa has long been the poster child for the failures of economic development in the Less Developed Countries, or what was formerly called the Third World. Most of the blame for this failure was placed on the fact that, for comparatively short historical time periods, many African nations were colonies of European countries.

On general direction, this seems an odd position to take. The theory of colonial immizeration – if it can be called that – apparently assumes that colonizers gained by withdrawing resources from colonies in some way analogous to that in which, let’s say, an embezzler gains by withdrawing funds from a successful company. But that misconceives not only the basic nature of trade between nations but also the stylized relationship between colonizer and colonized.

There is a theory that colonizers gained by imposing unfavorable terms of trade on their colonies and by substituting less efficient trade relationships for those that colonies would otherwise have developed with the rest of the world. But even if we subscribe to this, it does not imply that colonizers wanted to prevent or retard economic development in their colonies. Presumably, just the opposite was true, since development would enable the colonies to produce more and better goods for the colonizer to acquire via biased trade. And in fact, colonizers expended vast sums of time and money on attempts to promote development in the African colonies. If they failed, their failures seem small in comparison to the spectacular failures achieved by Western economists and development agencies like the World Bank and the International Monetary Fund after World War II.

Another oft-cited villain in African non-development is authoritarian political institutions. Doubtless, the fact that Africans exchanged colonial masters for home-grown despots in case after case is not only ironic but tragic, in view of the appalling human toll taken by famine, executions and all-around misery. But the question here is: Is despotism per se responsible for the lack of economic development in Africa? There is a very well-established relationship between political freedom and economic freedom, but the causality seems to run mostly in one direction – from economics to politics, not vice-versa. It seems reasonable to think that more democratic institutions would lead to fewer executions and political imprisonments and less repression in Africa. But Western nations have proven that democracy is fully compatible with economic serfdom and penury.

One of the most objectionable theories of African economic development is racial. It ascribes Africa’s development failures to the genetic inferiority of a predominantly black population. Since this theory offends current sensibilities, it seldom receives serious discussion. A dispassionate examination would cite, among other objections, the economic and intellectual success that the same genetic strains have achieved elsewhere in the world. Indeed, one of the most compelling counterarguments was played out in southern Africa itself, where the successful competition of poor black workers forced dominant white minorities to impose apartheid in order to protect white incomes. The same scenario was played out in the American South under the Jim Crow laws. If blacks are inferior in some economically meaningful sense, why do whites so often need the law to enforce economic protection against black competition?

That last example should click on the light of realization in our minds. Africa seems to be an object lesson in how badly a free market is needed. The African continent is home to less than 10% of the world’s population but over one-third of its languages. This cultural indicator reeks of economic and cultural isolation. In an America blessed with plentiful natural resources, navigable rivers, hospitable climate and a century’s worth of relatively benign colonial stewardship, some sort of economic development was virtually inevitable. Our experience with free markets was a huge bonus that made us the world’s leading economic power. Scandinavia, with its added advantages including complete cultural homogeneity, needed free markets even less. But nothing less than free markets would have sufficed to bring economic development to the Dark Continent.

Free markets do not work miracles; they merely permit the best to be made from available opportunities at any particular point in time. They also provide the widest scope for innovation and technological advancement over time. When nature has dealt you an inferior hand of cards, you can only make the optimal draw, then play those cards for all they are worth. Freedom and free markets are that optimal strategy for economic development.

Today, there are stirrings of economic development in Africa, as there are in longtime development laggards like China and India. The Economist has reported on the ability of individual African fishermen to use cellphones to check the market prices of their daily catch. At long last, technology is beginning to improve the bad hand that Africans have been dealt. Technology has been working its wonders for a couple centuries in the West. Now free markets are bringing them to the poorest of the poor in the heart of Africa.

DRI-326 for week of 3-31-13: The Kansas City Star Meets Flexible Baseball-Ticket Pricing

An Access Advertising EconBrief:

The Kansas City Star Meets Flexible Baseball-Ticket Pricing

Economics is the formal logic of human choice. Newspapers report human affairs. Reporting the news affords endless scope for economics as a tool of explanation and analysis. Yet newspapers are notorious for their ignorance and mishandling of economics. Why?

One possible answer is deliberate misrepresentation and concealment of facts by the papers for ideological reasons. Another is simple error. The latter hearkens to the old maxim, “Never ascribe to venality that which can be explained by mere stupidity.”

Whatever the cause, examples of this phenomenon abound. A recent front page of the Kansas City Star offers fresh evidence of it. The subject is the pricing of baseball tickets by the Kansas City Royals.

Major-League Baseball Meets “Dynamic Pricing”

“Get Set for Big Swings,” shouted the front-page headline of the Star on Sunday, March 31, 2013. An overhead explained: “Royals Ticket Prices: Like airfares and hotel rates, they will fluctuate.” The subhead continued with: “Dynamic pricing, a fixture in the travel industry and growing more common in the entertainment world, has come to Kauffman Stadium. Below are prices for the same outfield seat to see the Royals in their first week at home – as of now.” The graphic chart showed a $54 price for the sold-out home opener on April 8, followed by prices ranging from $23 to $31 to the identical seat for subsequent games that week.

The article underneath, written by veteran staffer Mike Hendricks, contrasts the age-old procedure of fixed seasonal pricing for Kansas City Royals’ baseball games with its successor. So-called “dynamic pricing” is familiar to contemporary shoppers for airline and hotel reservations. Prices can fluctuate from day to day instead of from one season to another. Moreover, these daily fluctuations are not uni-directional; they will move up and down. That is something new for baseball fans – for decades, the only changes in official ticket prices have been upward ratchets from one season to the next.

Economists will immediately recognize that the term “dynamic pricing” is a misnomer – probably owing to (bad) advertising psychology. The precise descriptive term is “flexible pricing.” It implies the actual state of affairs, in which prices are responsive to changes in consumer demand. Failure to recognize and report this misnomer is the first of many depredations committed by the author of this piece.

The headline – “Get Set for Big Swings” – embodies a longtime Kansas City Star tradition: promising revelations that the accompanying article does not deliver. This constitutes lying to the reader. It is reasonable to suppose that Star readers resent being lied to and that this has contributed to the precipitous declines in the paper’s circulation and consequent ad revenue. The only “big swing” in price cited in the article occurs between opening day and succeeding games. One of the safest predictions about any Royals season is that the opening-day game will sell out and that attendance will immediately plummet thereafter. Given flexible pricing, it is therefore axiomatic that opening day will command a high price and that the price will thereupon fall. Maybe there will be “big swings” later in the season, maybe not. But the author doesn’t say that and offers no evidence that it will happen.

By any reasonable standard of journalism, this article is off to a miserable start.

Flexible Pricing of Baseball Tickets

The author’s vagueness on future price fluctuations is not surprising because his grasp of the basis for pricing is demonstrably shaky. Although the phrase “supply and demand” appears once in the article, its underlying logic is left to the reader’s imagination.

The importance of consumer demand to pricing is never mentioned, let alone explained. In this case, the supply of tickets is fixed – limited by the seating capacity of Kauffman Stadium. Thus, the economic logic of baseball ticket pricing comes straight out of the textbook diagram marked “Very Short Run,” in which the supply curve is a vertical line and price is completely determined by its intersection with the downward-sloping demand curve. In the very short run, economists teach, price is “demand-determined.”

Thus, price changes are caused by changes in demand. These are given very short shrift indeed by the author. His marquee explanation for the Royals’ new pricing strategy is that “the hotel and airline industries have used variable pricing strategies for years as a way to encourage customers to make their reservations early.” It is true that hotels and airlines do have one thing in common with baseball teams; namely, a fixed capacity (seating or lodging) that offers the constant incentive to keep capacity utilization as high as possible.

Hotels and airlines, though, commonly suffer the peak-load problem. Their capacity is insufficient to handle demand at its very highest point(s), but too great to utilize efficiently much – perhaps most – of the time. Since the late 1980s, the Royals have suffered from inadequate capacity about one day each season – opening day. In recent years, they have had a hard time giving away tickets to late-season games – and that is not hyperbole. In any case, baseball teams simply do not suffer the kind of scheduling problems endemic to the airline and hotel industries. Business travelers or vacationers on strict timetables are key components of airline and hotel demand, but much less important to baseball teams. Even allowing for the Royals’ atypical status as a regional franchise, buying weeks or months in advance usually provides little value to fans and little convenience to the team.

Why Now? The Timing of the Shift to Flexible Pricing

Mel Brooks’ famous protagonist Maxwell Smart on the classic TV series Get Smart once responded to a villain’s derisive defense “You’re not going to try to convict me on that flimsy evidence, are you?” with the rejoinder “No, I’ve got some more flimsy evidence.” Similarly, the author buttresses his non-explanation of Royals’ ticket pricing with more flimsy evidence. “Of all professional sports, major-league baseball teams have the greatest challenge in selling tickets, given the number of seats [and] games played,” gravely declares a “market analyst” employed by a ticket reseller.

But when baseball was truly America’s national pastime, its long season and big edge in games played was not viewed as a disadvantage. On the contrary, it was cited as a+ leading factor in the economic advantage enjoyed by baseball. Pro football, basketball and hockey were second- and third-string sports, miles behind baseball in income and prestige. Owners envied baseball its long season, which provided a tremendous opportunity to generate revenue. Baseball’s only rival as a leisure-time activity was the movies, which were probably the true national pastime.

No, the long baseball season is only a drawback when the team is a poor attraction. 1985 marked the Royals’ last post-season playoff appearance – they won the World Series by overcoming 3-1 deficits in both post-season playoffs – and they have threatened to return only in 1989, 1994 and 2003. They are the deadbeats of major-league baseball. Their 27-year absence from the playoffs is by far the longest of any team in North American professional sports.

Of course, this begs the question of why the Royals have chosen to introduce flexible pricing now, at this particular point in their history. As it turns out, it is not pure happenstance. Flexible pricing is one of various types of pricing alternatives to single pricing. The common feature behind all these is motivation – the seller’s desire to increase total revenue and profit by charging multiple prices rather than just one.

That motivation stems from more than merely the desire to profit from multipart pricing. Conditions have to be right in order for the alternative scheme to work. The different prices must be designed to gain from differing characteristics of different buyers or different conditions existing among the same buyers at different times. Either way, the firm must have the ability not only to identify the differences but to act upon them. When it does that, it is engaging in price discrimination.

Baseball teams already strive to segment different groups of buyers and charge them different prices to watch the same baseball game. That is the purpose behind different seat categories such as general admission, reserve seats, box seats, field level, upper level, stadium boxes and luxury suites. Each seat category is geared to a different category of buyer and priced accordingly. The general admission tickets are geared toward low-income fans and students. Outfield general admission is the farthest away from the action and is also geared toward the low-income fans who might otherwise not attend games if not for the affordability of a low price. Luxury suites are reserved for corporate clients and millionaires who can afford to plunk down five figures to reserve a season ticket in relative luxury. Box and reserve seats are targeted toward upper-middle-class fans that want a good seat and can afford to pay a price slightly above general admission.

This system has long been in effect in baseball and other sports. It is familiar throughout the entertainment industry. The Star article cites the symphony – an art form whose legendary disdain for solvency seemingly places it above the vulgar domain of commerce and profit. Yet the time-honored seating divisions separating dress circle, orchestra, ground floor, loge or mezzanine and balcony represent the same price-discrimination segmentation of demand practiced by sporting events.

Flexible pricing takes the idea of differential demand in a different direction. Rather than focusing on demand differences among consumers at the same point in time, it considers fluctuations in demand that affect all categories of buyers – but at different points in time. For example, instead of targeting different groups of buyers, segmented by income, it targets different games that support a higher price. These are late-season games when pennant races and individual honors such as batting championships and pitching titles are at stake. These games should command premium prices, as long as the team can stand up under pressure. For over two decades, the Royals did not play such games because they were never in contention that late in the season. Consequently, there was little purpose in setting up flexible pricing because the team would not benefit that much from flexibility. There was little additional pricing strategy the Royals could use to enhance their revenue; all they could do was get what little they could from the standard price-discrimination techniques. The introduction of inter-league play did briefly inject some novelty into the schedule, particularly by adding an interstate rivalry with the St. Louis Cardinals, the Royals’ 1985 World Series opponent. This allowed the team to give flexible pricing a tryout last year in Cardinals’ games.

But prior to the 2013 season, the Royals beefed up their pitching staff. They acquired ace starter James Shields and starter/reliever Wade Davis from the Toronto Blue Jays and starter Ervin Santana in another trade. This transformed the league’s worst pitching staff into a potentially serviceable one while retaining their current offensive strength, spearheaded by all-star Billy Butler and Alex Gordon. Shields is currently pictured on Sports Illustrated’s cover, highlighting the magazine’s baseball pre-season issue. For the first time in years, the team seems able to contend for a playoff berth.

At lastthere is a prospect that late-season games may be competitively meaningful. Opening day may not be the only sellout game on the schedule this year. Thus, an effort to milk more box-office revenue from those games makes sense, since there is more potential revenue to seek.

In theory, flexible pricing benefits teams whenever there are substantial fluctuations in demand from game to game. Various factors other than competitive performance might influence the amplitude of demand over the course of a season. Weather is the most obvious; Kansas City is subject to cool Springs, hot Summers and brisk Falls. A spate of unseasonably bad weather might give the team a chance to head off bad attendance by offering offsetting discounts to fans. Games for which announced starting pitchers are marquee players will generate stronger demand.

But these subsidiary factors will become more important when core demand for tickets is strong. The improvement in the Royals’ competitive position was clearly the driving factor in the team’s change in pricing policy.

Baseball, Politics and the Star

One would suppose that an above-the-fold, front-page article would command the full attention and premium resources of a metropolitan newspaper. Yet none of the real considerations found their way into the Star‘s story on the Royals’ ticket-pricing change. Aside from simple incompetence, how can we explain this?

The Star is a left-wing newspaper. That encompasses more than merely a capsule summary of its editorial stance. Ideology infects every aspect of the newspaper’s operations, from coverage to reporting to editorials to op-eds to advertising. It permeates not only the editorial page but the front page as well. It infiltrates the sports pages, the entertainment section and even the comics. It also affects how the paper treats the Royals.

Sports teams have grown accustomed to public subsidies. These take various forms. Most commonly, they include stadia built and maintained at taxpayer expense – including periodic repairs, refurbishment and reconstruction. That does not mean there are not quid pro quo, though. It is tacitly understood that the team and its employees are to back the multifarious public projects launched by the local political establishment with endorsements and campaign cash.

The newspaper, as the establishment’s informal public-relations and promotion agency, treats the Royals with due deference. The team is viewed as a kind of quasi-public utility – an economic and psychological necessity that is not so much too big to fail as too important to fail. The newspaper sees the team’s economic interactions as gifted with remarkable generative powers – multiplier effects and such – that are really beyond the reach of any mortal business firm. But the Royals have a tacit left-wing seal of approval, which means that they are assumed to be above such vulgar considerations as profit. That is why the economic rationale for flexible and multipart pricing never reaches the tender ears of Star readers.

To the Star, the Royals are not so much a sports franchise as a political franchise and ideological asset. No information potentially damaging or embarrassing to that franchise – no matter how newsworthy – will pass unfiltered through the Star to the general public.

How has the new pricing regime been received by fans? “So far there hasn’t been much of an outcry here or anywhere else.” (21 of the 30 major-league baseball teams have now adopted some form of flexible pricing, the article discloses.) Why not? Again, the article’s author’s lips are sealed on this matter. But the answer is clear. The rise of ticket brokers and a legal secondary market for tickets, cultivated by firms like Stub Hub, has prepared the ground for flexible pricing. In other words, the free market is way ahead of Royals’ management. The author, a faithful Star minion, holds no brief for freedom or free markets and saw no reason to enlighten readers on this point.

The Economics of Flexible Ticket Pricing

The point of the Star‘s story is obscure. The headline promises “big swings” in ticket prices, but the article doesn’t provide any, nor does it suggest any real basis for them. It seems clear that something pretty new and different has come to baseball ticket pricing in particular and to professional sports in general, but the author either doesn’t know what it is or doesn’t want to reveal it. At this point, it is necessary for economic logic to take the tiller of the story in order to bring us to a coherent destination.

Will flexible pricing produce higher or lower prices than the old seasonally fixed pricing method? The short answer is: Both. But that’s not a satisfactory answer. The precise answer is that price will be closely attuned to demand on a game-by-game basis, rather than a yearly basis. (We should bear in mind that there are as many separate “demands” as there are ticket categories – that was true under the old system and remains so under flexible pricing.) From a fundamental economic perspective, that is a good thing.

The article is woefully ambiguous on this point. It first informs us (correctly) that “the prices…will fluctuate day to day, and across all sections based on supply and demand.” (This is the article’s only reference to supply and demand.) It then continues by revealing that “fewer than half the seats in your average ballpark are occupied by fans who have bought season tickets,” thereby setting a “challenge for baseball clubs…to attract casual fans who want to see a game or two during the year.” And “free bobbleheads and ‘buck nights’ only go so far in building attendance numbers.” So far, so good – flexible pricing’s raison d’être is improving ballpark-capacity utilization.

Sure enough, a company called Qcue, headed by entrepreneur Barry Kahn, sold the San Francisco Giants on the concept of flexible pricing on a trial basis in 2009. It yielded a 20% increase in sales of the seats in sections picked for the trial. Today, the company works with two-thirds of major-league clubs and has achieved revenue increases of between 5% and 30%. “That’s ticket-revenue dollars, not an increase in the number of tickets sold. However, that tends to go up, too. Dynamic pricing doesn’t necessarily make it more affordable to attend a ball game than before, but it can.”

This burbling incoherence is typical Star analysis. If attendance is increasing across the board and the only thing that’s changed is prices charged, then the prices must be falling on net balance. That’s the Law of Demand at work. The questions are: What makes them fall? When do they fall? Do they ever rise? When is the best time to buy? And – the $64,000 question – is flexible pricing a good thing overall for baseball fans and for the rest of us?

The article implies that midweek games will carry a lower price tag. It is certainly true that, all other things equal, the demand is greater on weekends when kids and working parents are less encumbered by obligation. But that is a comparatively minor factor in segmenting demand.

High-demand games are special occasions – opening day, marquee players or teams appearing – and pennant-race games. A computer algorithm will alert team officials to opportunities for price increases, which will be implemented electively. It is these games in which Royals’ sales director Steve Shiffman’s advice to “buy early, save money” makes sense. Not only will buying early get the best price, it will also avert the possibility of a shutout; e.g., failure to “score” a ticket at all due to unavailability.

The rest of the time, buying early benefits the team, not the fan. A baseball ticket, like a stock option airline seat or radio advertising time, is a wasting asset whose value expires when the game’s first pitch is thrown. (More precisely, it plummets dramatically, expiring completely at about the fourth or fifth inning.) As game time nears, the holder will likely accept successively lower prices rather than see it expire unused. This is particularly true of sports teams, who have a vested interested in filling seats to increase the incomes of concessionaires. The rise of ticket brokers has complicated pricing for team management, who are extremely reluctant to stimulate price wars lowering seat prices too much. Thus, the Royals advertise the season-ticket-holder’s discounted single-game price as their rock-bottom price. But from the fan’s standpoint, there is no point in transacting before this price is offered and no reason to rush once it is in place – for garden-variety, low-demand games.

Thus, the brave new world of flexible baseball-ticket pricing does demand that fans distinguish between high-demand and low-demand games, in order to get the best price. But this should not tax the capabilities of any experienced fan or intelligent non-fan. As a practical matter, it will not severely disadvantage even the most incapable consumer until and unless the Royals become contenders.

Is flexible pricing economically efficient? Flexible pricing brings the number of tickets fans wish to purchase in each seat category closet to equality with the number available, using price as the coordinating mechanism. This is another way of saying that the amount of alternative consumption fans are willing to sacrifice to get a ticket (their demand for it) is closer to the amount they have to sacrifice (determined by the ticket price). Equality between those two things constitutes the famous economic condition called “equality at the margin.” It is one good way of defining economic efficiency. Thus, the verdict on flexible pricing and economic efficiency is favorable.

This is good for everybody because we all have a stake in using what we have to make each other as well off as possible. It’s good for taxpayers because baseball is publicly subsidized, but the presence of subsidies doesn’t make the case stronger. In fact, the subsidies themselves are inefficient and should be ended – that would make things even better. (Sports meet none of the textbook criteria for subsidy and none of the claims to economic exceptionalism advanced in their behalf.)

If prices sometimes go down but sometimes go up, how can we claim that fans, per se, are better off? Prices go up when people value a ticket than they value the alternative consumption that the ticket’s price embodies. Flexible pricing enables us to sort out the cases when this is true from the cases when it isn’t true. In the old days, we needed illegal ticket scalpers to do that. Now ticket brokers can do it, but not as well as when the team gets involved in the process, too.

If the Royals benefit from flexible pricing, doesn’t this mean that fans must lose? Both entities can’t benefit at the same time, can they? The left-wing, socialist concept of exchange as a power relation implies that trade is a zero-sum game in which the gains of one party are the losses of the other. Mutually beneficial voluntary exchange benefits both parties to the exchange, and when the gains from trade are increased the gain can be divided to benefit both traders. This needn’t be true in every transition from inefficient to efficient conditions, but there is no reason to doubt its occurrence here.

Perhaps the most concrete way to drive home the importance of this principle is by stressing the fact that the benefits of sports teams are heavily location-dependent. If the Royals move away from Kansas City and operate elsewhere, most of the benefits created by the team will flow to sports fans in that new location. Allowing the Royals to maximize the benefits they earn from the value the team itself actually creates will maximize the chances that the Royals continue to operate in Kansas City. The current system strives to keep the team in town by giving them subsidies extracted from non-fans based on phony economic value not really created. Baseball fans deserve to get the value they want and are willing to pay for – not value extorted from unwilling third parties who gain nothing from the team’s presence.

DRI-250 for week of 1-27-13: What Are the Lessons of Econometrics?

An Access Advertising EconBrief:

What Are the Lessons of Econometrics?

Recently, Federal Reserve official Janet Yellen earned attention with a speech in which she justified monetary easing by citing the Fed’s use of a new “macroeconometric model” of the economy. The weight of the term seemed to give it rhetorical heft, as if the combination of macroeconomics and econometrics produced a synergy that each one lacked individually. Does econometrics hold the key to the mysteries of optimal macroeconomic policy? If so, why are we only now finding that out? And, more broadly, is economics really the quantitative science it often pretends to be?

Econometrics

As practiced for roughly eight decades, econometrics combines the knowledge of three fields – economics, mathematics and statistics. Economics develops the pure logic of human choice that gives logical structure to our quantitative investigations into human behavior. Mathematics determines the form in which economic principles are expressed for purposes of statistical analysis. Statistics allows for the systematic processing and analysis of sample data organized into meaningful form using the principles of economics and mathematics.

Suppose we decide to study the market for production and consumption of corn in the U.S. Economics tells us that the principles of supply and demand govern production and consumption. It further tells us that the price of corn will gravitate toward the point at which the aggregate amount of corn that U.S. farmers wish to produce will equal the aggregate amount that U.S. consumers wish to consume and store for future use.

Mathematics advises us to portray this relationship between supply and demand by expressing both as mathematical equations. That is, both supply and demand will be expressed as mathematical functions of relevant variables. The orthodox formulation treats the price of corn as the independent variable and the quantity of corn supplied and demanded, respectively, as the dependent variable of each equation. Other variables, called parameters, are included in the equations as well, but isolated from price in their effects on quantity. Finally, our model of the corn market will stipulate that the two equations will produce an equal quantity demanded and supplied of corn.

Statistics allows us to gather data on corn without having to compile every single scrap of information on every ear of corn produced during a particular year. Instead, sample data (probably provided by government bureaus) can be consulted and carefully processed using the principles of statistical inference.

In principle, this technique can derive equations for both the supply of corn and its demand. These equations can be used either to predict future corn harvests or to explain the behavior of corn markets in the past. For over a half-century, training in econometrics has been a mandatory part of postgraduate education in economics at nearly all American universities.

Does this procedure leave you scratching your head? In particular, are you moved to wonder why mathematics and simultaneous equations should intrude into the study of economics? Or have we outlined a beautiful case of interdisciplinary cooperation in science?

Historical Evolution

As it happens, the development of econometrics was partly owing to the collision of scientific research programs that evolved concurrently in similar directions. Economics has interacted with data virtually since its inception. In the 1600s, Sir William Petty utilized highly primitive forms of quantitative analysis in England to analyze subjects like taxation and trade. Adam Smith populated The Wealth of Nations with various homely numerical examples. In the early 19th century, a French economist named Cournot used mathematics to develop pathbreaking models of monopoly and oligopoly, which anticipated more famous work done many decades later.

A Swiss economist, Leon Walras, and an Italian, Enrico Barone, applied algebraic mathematics to economics by expressing economic relationships in the form of systems of simultaneous equations. They did not attempt to fill in the parametric coefficients of their economic variables with real numbers – in fact, they explicitly denied the possibility of doing so. Their intent was purely symbolic. In effect, they were saying: “Isn’t it remarkable how the relationships in an economic system resemble those in a mathematical system of simultaneous equations? Let’s pretend that an economy of people could be described and analyzed using algebraic mathematics as a tool – and then see what happens.”

At almost the same time (the early 1870s), the British economist William Stanley Jevons developed the principles of marginalism, which have been the cornerstone of economic logic ever since. Economic value is determined at the margin – which means that both producers and consumers gauge the effects of incremental changes in action. If the benefits of the action exceed the costs, they approve the action and take it. If the reverse holds, they spurn it. Their actions produce tendencies toward marginal equality of benefits and costs, similar in principle to the quantity supplied/quantity demanded equality cited above. Jevons thought it amazing that this incremental logic seemed to correspond so closely to the logic inherent in the differential calculus. So he developed his theory of consumer demand in mathematical terms, using calculus. (It is also fascinating that the Austrian simultaneous co-discoverer of marginalism, Carl Menger, refused to employ calculus in his formulations.)

By the early 1900s, the roots of mathematics in economics had taken root. Soon a British mathematician, Ronald Fisher, would modernize the science of statistics. It was only a matter of time until mathematical economists began using statistics to put numbers into the coefficient slots in their equations, which were previously occupied with algebraic letters serving as symbolic place-holders.

In 1932, economist and businessman Alfred Cowles endowed the Cowles Commission at the University of Chicago. The purpose of the Commission was to do economic research, but the research was targeted toward mathematics and economics. The original motto of the Commission was the same as that of the Econometric Society. It was taken from the words of the great physicist Lord Kelvin: “Science is measurement.”

Seldom have three words conveyed so much meaning. The implication was that economics was, or should strive to be, a “science” in exactly the same sense as physics, biology, chemistry and the rest of the hard physical sciences. The physical sciences did science by observing empirical regularities and expressing them mathematically. They tested their theories using controlled laboratory experiments. They were brilliantly successful. The progress of mankind can be traced by following the progression of their work.

In retrospect, it was probably inevitable that social sciences like economics should take this turn – that they should come to define their success, their very meaning, by the extent and degree of their emulation of the natural sciences. The Cowles Commission was the cutting edge of econometrics for the next 20 years, after which time its major focus shifted from empirical to theoretical economics – back to mathematical models of the economy using simultaneous equations. But by that time, econometrics had gained an impregnable beachhead in economics.

The Role of Econometrics

Great hopes were held out for econometrics. Of course, it was young as sciences go, but by careful study and endless trial and error, we would gradually get better and better at creating better economic models, choosing just the right mathematical forms and using exactly the right statistical techniques. Our forecasts would slowly, but surely, improve.

After all, we had a country full of universities whose economists had nothing better to do than monkey around with econometrics. They would submit their findings for review by their peers. The review would lead to revisions. The best studies would be published in the leading economics journals. At last, at long last, we would discover the empirical regularities of economics, the rules and truths that had remained hidden from us for centuries. The entire system of university tenure and promotion would be based on this process, leading to the notorious maxim “publish or perish.” Success would be tied to the value of government research grants acquired to do this research. The brightest young minds would succeed and climb the ladder of university success. They would teach in graduate school. A virtuous cycle of success would produce more learning, better economics, better econometrics, better models, better predictions, more economic prosperity in society, better education for undergraduates and graduate students alike and a better life for all.

As it turned out, none of these hopes have been fulfilled.

Well, that’s not entirely accurate. A system was created that has ruled academic life for decades and, incredibly, shows no sign of slowing down. Young economists are taught econometrics, after a fashion. They dutifully graduate and scurry to a university where they begin the race for tenure. Like workers in a sausage factory, they churn out empirical output that is read by nobody excepting a few of their colleagues. The output then dies an unlamented death in the graveyard of academic journals. The academic system has benefitted from econometrics and continues to do so. It is difficult to imagine this system flourishing in its absence.

Meanwhile, back at the ranch of reality, the usefulness of econometrics to the rest of the world asymptotically approaches zero. Periodically, well-known economists like Edmond Malinvaud and Carl Christ review the history of econometrics and the Cowles Commission. They are laudatory. They praise the Commission’s work and the output of econometricians. But they say nothing about empirical regularities uncovered or benefits to society at large. Instead, they gauge the benefits of econometrics entirely from the volume of studies done and published in professional journals and the effort expended by generations of economists. In so doing, they violate the very standards of their profession, which dictates that the value of output is judged by its consumers, not by its producers, and that value is determined by price in a marketplace rather than by weight on a figurative scale.

It is considered a truism within the economics profession that no theoretical dispute was ever settled by econometrics – that is a reflection of how little trust economists place in it behind closed doors. In practice, economists put their trust in theory and choose their theories on the basis of their political leanings and emotional predilections.

We now know, as surely as we can know anything in life, that we cannot predict the future using econometrics. As Donald (now Deirdre) McCloskey once put it, you can figure this out yourself without even going to graduate school. All you have to do is figuratively ask an econometrician the “American question:” “If you’re so smart, why ain’t you rich?” Accurate predictions would yield untold riches to the predictors, so the absence of great wealth is the surest index of the poverty of econometrics.

Decades of econometric research have yielded no empirical regularities in economics. Not one. No equivalent to Einstein’s equation for energy or the Law of Falling Bodies.

It is true that economists working for private business sometimes generate predictions about individual markets using what appears to be econometrics. But this is deceptive. The best predictions are usually obtained by techniques called “data mining,” that violate the basic precepts of econometrics. The economists are not interested in doing good econometrics or statistics – just in getting a prediction with some semblance of accuracy. Throwing every scrap of data they can get their hands on into the statistical pot and cooking up a predictive result doesn’t tell you much about which variables are the most important or the degree of independent influence each has on the outcome. But the only hope for predictive success may be in assuming that the future is an approximation of the past, in which case the stew pot may cook up a palatable result.

The Great “Statistical Significance” Scandal

In the science of medicine, doctors are sworn to obey the dictum of Hippocrates: “First, do no harm.” For over twenty years, economists Deirdre McCloskey and Stephen Ziliak have preached this lesson to their colleagues in the social sciences. The use of tests of “statistical significance” as a criterion of value was rampant by the 1980s, when the two began their crusade against its misuse. For, as they pointed out, the term is misunderstood not only by the general public but even by the professionals who employ it.

When a variable is found statistically significant, this does not constitute an endorsement of its quantitative importance. It merely indicates the likelihood that the sample upon which the test was conducted was, indeed, randomly chosen according to the canons of statistical inference. That information is certainly useful. But it is not the summum bonum of econometrics. What we usually want to know is what McCloskey and Ziliak refer to as the “oomph” of a variable (or a model in its totality) – how much quantitative effect it has on the thing it affects.

The two modern-day Diogenes conducted two studies of the econometric articles published in the American Economic Review, the leading professional journal. In the 1980s, most of the authors erred in their use and interpretation of the concept of statistical significance. In the 1990s, after McCloskey and Ziliak began writing and speaking out on the problem, the ratio of mistakes increased. Among the culprits were some of the profession’s most distinguished names, including several Nobel Prize winners. When it comes to statistics and econometrics, it seems, economists literally do not know what they are doing.

According to McCloskey – who is herself a practitioner and believer in econometrics – virtually all the empirical work done in econometrics to date will have to be redone. Most of the vast storehouse of econometric work done since the 1930s is worthless.

The Difference Between the Social Sciences and the Natural Sciences

Statistics has been proven to work well in certain contexts. The classical theory of relative-frequency probability is clearly valid, for example; if it weren’t, Las Vegas would have gone out of business long ago. Those who apply statistics properly, like W. Edward Deming, have used it with tremendous success in practical applications. Deming’s legendary methods of quality control involving sampling and testing have been validated time and again across time and cultures.

When econometrics was born, a small band of critics protested its use on the grounds that the phenomena being studies in the social sciences were not amenable to statistical inference. They do not involve replicative, repetitive events that resemble coin flips or dice throws. Instead, they are unique events that involving different elements whose structures differ in innumerable ways. The number of variables involved usually differs between the physical and social sciences, being vastly larger when human beings are the phenomena under study. Moreover, the free will exerted by humans is different from unmotivated, instinctive, chemically or environmentally induced behavior found in nature. Free will can defy quantitative expression, whereas instinctive behavior may be much more tractable.

In retrospect, it now seems certain that those critics were right. Whatever the explanation, the social sciences in general and economics in particular resist the quantitative measurement techniques that took natural sciences to such heights.

The Nature of Valid Economic Prediction

We can draw certain quantitative conclusions on the basis of economic theory. The Law of Demand says that when the price of something rises, desired purchases of that thing will fall – other things equal. But it doesn’t say how much they’ll fall. And we know intuitively that, in real life, other things are never unchanged. Yet despite this severely limited quantitative content, there is no proposition in economic theory that has demonstrated more practical value.

Economists have long known that agriculture is destined to claim a smaller and smaller share of total national income as a nation gets wealthier. There is no way to predict the precise pattern of decrease, but we know that it will happen. Why? Agricultural goods are mostly either food or fiber. We realize instinctively that when our real incomes increase, we will purchase more food and more clothing – but not in proportion to the increase in income. That is, a 20% increase in real income will not motivate us to eat 20% more food – not even Diamond Jim Brady was that gluttonous. Similarly, increases in agricultural productivity will increase output and lower price over time. But a 20% decline in food prices will not call forth 20% more desired food purchases. Economists say that the demand for agricultural good is price- and income-inelastic.

These are the types of quantitative predictions economists can make with a clear conscience. They are couched in terms of “more” or “less,” not in terms of precise numerical predictions. They are what Nobel laureate F. A. Hayek called “pattern predictions.”

It is one of history’s great ironies that Hayek, an unrelenting critic of macroeconomics and foe of statistics and econometrics, nevertheless made some of the most prescient economic predictions of the 20th century. In 1929, Hayek predicted that the economic boom of the 1920s would soon end in economic contraction – which it did, with a vengeance. (Hayek’s mentor, Ludwig von Mises, went even further by refusing a prestigious appointment because he anticipated that “a great crash” was imminent.) In the 1930s, both Hayek and von Mises predicted the failure of the Soviet economy due to its lack of a functioning price system, particularly the absence of meaningful interest rates. That prediction, too, eventually bore fruit. In the 1950s, Hayek declared that Keynesian economic policies would produce accelerating inflation. Western industrial nations endured withering bouts of inflation beginning in the late 1960s and lasting for over a decade. Then Hayek broke with his fellow economists by insisting that this inflationary cycle could be broken, but only by drastically slowing the rate of monetary growth and enduring the resulting recession for as long as it lasted. Right again – and the recession was followed by two decades of prosperity that came to be known as the Great Moderation.

Ask the Fed

One of the tipoffs to the complicity of the mainstream press in the Obama administration’s policies is the fact that nobody has thought to ask Janet Yellen questions like this: “If your macroeconometric model is good enough for you to rely on it as a basic for a highly unconventional set of policies, why did it not predict the decline in Gross Domestic Product in fourth quarter 2012? Or if it did, why did the Fed keep that news a secret from the public?”

The press doesn’t ask those questions. Perhaps they are cowed by the subject of “macroeconometrics.” In fact, macroeconomics and econometrics are the two biggest failures of contemporary economics. And there are those who would substitute the word “frauds” for “failures.” Unless you take the position that combining two failures rates to produce a success, there is no reason to expect anything valuable from macroeconometrics.

DRI-380 for week of 8-26-12: Markets, Government, Law and Truth

An Access Advertising EconBrief:

Markets, Government, Law and Truth

You listen to the radio regularly. A manufacturer of health-oriented dietary supplements prefaces their infomercials with this disclaimer: “This product is not intended to diagnose, treat, prevent or cure any disease.” During each program, you note that the attributes of the products discussed and promoted are clearly intended to do one or more of the above. Is the disclaimer a lie, or are the products fraudulent?

You often browse business-related magazines and websites. In articles devoted to job interviews, you are startled by the asymmetrical advice given to employers and job applicants. Why are employers legally ordered not to ask many questions, while applicants are encouraged to ask as many questions as they wish?

You are a student of economic regulation of business by government. You followed FDA regulation of the cigarette industry from its inception to the agency’s recent proposal for large graphic warnings to appear on cigarette packages. You are unable to discern any logical thread unifying the series of agency rules and court rulings that have followed the onset of regulation. What is FDA trying to do?

You are a believer in the value of truth. What are the impact of markets and government, respectively, on the emergence of truth?

The Market, the Government and the Law

Economics is the science of rational human choice. Economists have long faced withering criticism from other scientists (physical and social) and from the general public. The standard criticism is that people do not act rationally – therefore economics is of little practical value.

The conclusion is wrong, but the premise contains a large grain of truth. Economics has tended to assume that producers, consumers and input suppliers possess all relevant information about the present and the future. This makes rational choice easy. Even when relaxing this assumption, the theory has substituted a probabilistic theory of uncertainty that is only slightly less unrealistic. As the late, great Nobel laureate F.A. Hayek pointed out in the 1930s and 40s, economics has ignored the true nature of the economic problem by assuming what the theory should prove. Rational choice demands the evaluation of a vast amount of data. But people don’t automatically possess the information economic theory assumes they do. The data doesn’t exist in one place or even in known information repositories. How are all this data assembled, evaluated and revised over time? How are the actions of billions of people coordinated to produce a coherent outcome?

Markets provide the incentive for individuals to contribute the bits of dispersed information necessary to comprise a functioning market. No individual possesses all the relevant information. Indeed, nobody has a full and complete picture of, let alone intellectual comprehension of, reality. Instead, each of us views reality fragmentarily through our own subjective prism. But markets bring each of us closer to comprehension by refining and revising that subjective view and drawing it closer to objective truth.

Any time somebody’s knowledge is incomplete or their perception is inaccurate, somebody can make a profit by acting within the market to expose the truth. Throughout human history, societies relying on markets have enjoyed more material success than those eschewing markets because objective truth is more productive of material wealth and human happiness than falsity.

By definition, governments exist to constrain human conduct. When governments prevent people from harming each other and violating basic rights, they contribute to wealth and happiness. When governments constrain lawful markets, they hinder the distribution of information and the gradual coalescing of objective truth from subjective perception. The Rule of Law evolved because governments that operated according to its precepts fostered prosperity. They confined themselves to narrowly limited proscriptive rules allowing citizens to understand and predict the impact of the law on their lives. Governments that took the opposite tack foundered, as did the totalitarian regimes of the 20th century.

This perspective on markets and truth helps us understand the relationship between government and truth.

Dietary Supplements

Throughout recorded history, man has eaten, drunk, sniffed, poulticed, smoked and otherwise consumed the bounty of nature to yield pleasure, reduce pain and promote health. Since the dawn of science and medicine, he has extracted vitamins, minerals, proteins, fats, carbohydrates, acids, alkalis, enzymes and various other substances for the same purposes. If all human beings were carbon copies and reacted identically to stimuli, the production of health and happiness would be straightforward. The actual range of human variation makes it anything but easy to ascertain the value of available substances for human purposes.

The success of science has posed a tempting pitfall. The temptation is to assume that scientific experts know – or can easily determine – what is safe and effective for human consumption. This implies that by giving a committee of experts legal dominion over this realm, we can avoid the problems associated with free-market provision of medicines, supplements and the like. Such problems include unfavorable reactions by individuals to products as well as products that do not live up to the billing of producers or the expectations of consumers.

Unfortunately, safety and efficacy are not only hard to determine, they also vary with each individual. Really, the only practical approach is to allow individuals and their physicians to make these determinations. Doctors will employ judgment informed by years of practice and results of continuing research. Research will be directed toward areas indicated by consumer demand, much as any other investment is guided by demand. The alternative is to put the process in the hands of government, which assumes that a small number of men are wise enough to know better than the mass of people what we want, what we should want and how to produce it.

Currently, “medicines” are controlled very strictly by the Food and Drug Administration (FDA). “Dietary supplements” are not. But the disclaimer noted above is included in advertisements to fend off product liability lawsuits. Failure to include it would allow consumers to sue the producing company because the supplements did not cure a disease, prevent its onset or ameliorate its spread. The question is: Does the disclaimer serve the cause of truth or hinder it?

Even the most casual observer of health and nutrition knows that thousands of health supplements are legally available to consumers. These range from fish oil in liquid and capsule form to resveratrol extract to vitamins A, B, C, D, E and K, including the various B subsidiaries. Ongoing research continually discovers new uses for known substances and devalues old uses. Currently, for example, research now suggests that vitamin D – long considered of secondary importance and easily obtainable with very modest exposure to sunlight – is vastly more important and difficult to maintain in optimal quantities without supplementation. The high hopes once held out for vitamins C and E in curing colds and preventing heart disease have been revised downward after considerable study and experience.

But the FDA wields tight control over the language that can be used in selling and advertising all these substances. And unless FDA-approved studies have been conducted specific to the treatment, prevention and cure of disease, the disclaimer noted above must appear on packaging and in advertising.

The undeniable drawback to this requirement is that the disclaimer is a lie.

Even a child knows that the purpose of all these products is obviously to treat and prevent disease. In some cases it is to cure disease. (It is unclear what health supplements would purport to diagnose disease; presumably this word is included so as to apply to devices and test kits as well as supplements.) Instances of this are legion.

When Linus Pauling began to promote vitamin C as the discovery of the age, it wasn’t merely in order to fulfill man’s daily requirements. No, he maintained that megadoses could cure colds and prevent cancer. Aspirin’s analgesic properties have been known for thousands of years, but it wasn’t until its blood-thinning action was touted as a preventative for cardiovascular artery closure that it became a therapeutic medicine. Subsequently, its active ingredient, salicylic acid, was implicated as a potential preventive of colon cancer as well. St. John’s Wort has been a folk remedy for prostrate enlargement for decades. Cranberry juice has been “prescribed” for urinary discomfort and kidney stones since time immemorial by old wives and do-it-yourself physicians.

How do people react when they read or hear the disclaimer? They are confused. One has only to peruse comments online to confirm this. “What’s the good of your product if it doesn’t ‘diagnose, treat, prevent or cure any disease’? is a typical question. The stock answer is that, in effect, the FDA mandates this disclaimer. This does nothing to allay fears of the timid and does nothing to deter the incautious. In short, it does nothing good. In turn, this begs one more obvious question: If the disclaimer does nothing good, what’s it doing there?

The answer is that the disclaimer protects sellers from product liability. By not promising anything, sellers cannot be held responsible if the product does not deliver anything. The fact that the sellers are lying does not seem to concern anybody. Everybody knows they are lying – except of course for the confused ones, who do not know. It is easy to blame tort lawyers for the confusion. But they are merely responding to the law as written or interpreted by the government. Why does this law exist?

When producers knowingly sell products that do not deliver stated benefits to consumers, that is fraud. A time-honored duty of government is to prevent and punish fraud. Presumably the law mandating the disclaimer exists because the government thinks it is wrong for producers to sell substances that may not always deliver their full intended benefits to consumers, even when producers knowingly intend and anticipate that outcome. But the effect of the disclaimer is to deceive consumers by lying to them about the intentions of producers and the benefits of their products.

The government’s position is as follows: It is terribly wrong for producers to deceive consumers by selling them non-existent benefits. But it is not wrong for producers to lie to consumers by deceiving them into not buying actual benefits; in fact, it is mandatory for producers to do this. (This is an implicit position, not an explicit one; it follows from the law governing FDA policy and the acquiescence to the course of tort litigation.)

An ancient principle of common law is salus populi suprema lex, meaning “the welfare of the people is the supreme law.” In other words, the overarching purpose of law is to improve the happiness and well-being of the citizenry. Does FDA policy do this? It is reasonable to suppose that FDA policy prevents some unhappiness resulting from unintentional deception of consumers by producers. It is worth noting, however, that markets themselves punish producers who promise benefits that they do not deliver. The punishment takes the form of lost customers, reduced revenues and foregone profits. The prospect of such losses acts as its own deterrent to laxity by producers in accurately describing and truthfully advertising product benefits.

Counterbalanced against the gains from the FDA policy are the losses from deceiving consumers by hiding or obscuring product benefits. Organizations like the Independent Institute and Economists Against FDA have told the story of the FDA’s ban on advertising the cardiovascular benefits of taking aspirin in response to first-heart-attack symptoms. The director of Cardiovascular Medicine of the Florida University College of Medicine estimated that as many as 10,000 lives per year could be saved if aspirin manufacturers were able to advertise these benefits. That estimate was made in 1995. As recently as 2008, the FDA was still threatening aspirin manufacturers who tried to market aspirin with labeling that claimed this benefit. And this is only one of the thousands of products with benefits that go unadvertised or that live under the cloud of the disclaimer.

Some may object to the characterization of the disclaimer as “confusing.” “Everybody knows that it doesn’t really mean what it says,” they may say. But if this is really true, then exactly what is gained by saying it- or rather, by having to say it? Let us leave aside the fact that there are clearly some people who are confused by the disclaimer. Compelling reasons exist for not insisting on a disclaimer that nobody takes seriously. When the law manifests itself in trivial, counterproductive and confusing ways, respect for the law in general declines. People begin to pick and choose which laws to obey, because they come to realize that they cannot know or hope to obey the complete body of laws. It becomes harder to law to perform its fundamental tasks. This shows up in small, seemingly random trends such as mounting disobedience of traffic and tax laws.

Job Interviews

Freedom of speech is commonly cited among the bedrock freedoms safeguarded by the U.S. Constitution and the American way of life. Thus, it is shocking to review a list of questions that employers and their representatives are legally forbidden to ask job applicants during an interview. Generally speaking, employers cannot inquire about applicants’ age, race, national origin, or status relative to marriage, disability or parentage.

Readers approaching retirement age will be stunned to discover that what once was small talk is now a crime. That includes conversational starters like “Where were you born?” and “Are you married?” The former is verboten because it might be a sneaky way of determining the applicant’s national origin, the latter because the employer might be trying to find out if the applicant’s home life might interfere with their work – an issue that they are entitled to probe only in government-approved ways. Similarly, “What is your native language?” is an obvious non-starter, as are “Do you have children?” and “Do you plan to get pregnant?”

“How old are you?” used to be one of the first questions asked of applicants whose age did not appear on their resume. Now it is taboo, prima facie evidence of the crime of ageism or age discrimination. The government is saying one of two things: Either employee productivity is assumed to remain constant with increasing age rather than falling or, alternatively, the employer has no right to get information about the employee’s productivity in advance of employment.

“Do you observe [insert name of religious observance day or days here]?” is a definite no-no, while “Are you available to work on holidays or weekends?” is permissible. This raises the potential for conflict by allowing the applicant to define a holiday. A Jew may treat Yom Kippur as a day of atonement but not a holiday, and may or may not choose to limit availability for work.

“Do you smoke or use alcohol?” is an infringement of the applicant’s rights because it “discriminates” against the use of a legal product consumed off the job and the business premises. The fact that the product has an obvious potential to affect job performance is irrelevant because the employer has only a limited right to inquire about the applicant’s productivity. Likewise, “Are you in the National Guard?” overlooks the fact that the employer has no unbounded right to inquire about the applicant’s availability/productivity. Viewed in this light, “Do you have a disability or chronic illness?” is a veritable abomination. After all, the employer can always ask if the applicant could perform particular tasks – “with reasonable accommodation,” of course, since each employer has a unilateral responsibility to create a level playing field between competing workers in the labor market.

After a suitable refractory period for recovery from the shock of seeing the burden placed on the employer, the student of job-interviews changes perspective 180 degrees and sits in the applicant’s seat. He expects to meet a comparable array of rules and prohibitions to those confronting the employer.

But there are none. Whereas the employer is verbally gagged like a juror at a murder trial, the job applicant enters a recumbent ACLU paradise of unhindered self-expression, free of legal duties, responsibilities and taboos.

As if this state of affairs weren’t incredible enough, the student who dips into characterizations of the interview process in the business press is whisked down Lewis Carroll’s fabled Rabbit Hole. Jacquelyn Smith of Forbes Magazine (7/6/2012, “Questions You Should and Shouldn’t Ask in a Job Interview”) informs us brightly that “A job interview is a two-way street. The employer asks questions to determine if the employee is an ideal fit for the job, and the smart candidate uses the interview [analogously].” She quotes “workplace expert” and author Lynn Taylor: “The fact that this is a two-way interview is often lost on many candidates, especially in this period of high unemployment when it seems like employers hold all the cards” [emphasis added].

The so-called “two-way street” of the job interview consists of clear, unimpeded driving on the applicant’s side of the road, while the employer’s side is lined with barricades, barrels and road hazards that a Joie Chitwood or Evel Knievel could hardly negotiate successfully. Not only do employers not “hold all the cards,” the federal government has marked the deck and stacked it in an effort to prevent the employer from accomplishing exactly what the magazine admits should be the objective of the interview – finding out if the applicant is an ideal fit for the job.

After all, in order to find out if the applicant is an ideal fit, the employer must be able to ask any and all questions deemed necessary. That must be true because that is what the word “ideal” means. But if there is one process in economic life that is implacably, unalterably opposed to truth, it is the job interview. With malice aforethought, the federal government has driven an Orwellian wedge between employer and applicant that has foreclosed all possibility of full informational disclosure.

The importance of this divide emerges from looking at just one of the forbidden topics listed above. We know that marital status is perhaps the key behavioral variable for the human female. The biological fact of women’s’ ability to bear children has intractable economic implications. Women are many times more likely to leave the labor force than men. These career detours mean that, in the aggregate and on average, their incomes and longevity-linked achievements will not equal those of men. But this does not mean that any individual woman might not be just as viable as any male job applicant. How can a rational employer, headhunting for a groomable CEO, distinguish between ideal and non-ideal female applicants? Clearly, marital status and/or family plan are the logical determinants. (The precise word is “discriminants,” but this word now has an unmerited pejorative cast – another Orwellian legacy of government policy.) And these are exactly the questions that the employer is forbidden from asking!

Unhampered, unhindered markets tend to promote truth. Truth enhances productivity. It also bolsters morality. In a purported effort to fight discrimination, federal-government labor-market policy harms the ostensible victims. Government regulation crushes truth to earth – and compliance officers are always on the lookout should it try to rise again.

By separating truth from hiring, government has vastly increased the costs of employment. When an input becomes more costly, other things equal, businesses use less of it. Consequently, what economists call the “natural rate of unemployment” rises – and up goes the actual rate of unemployment along with it. In Europe, governments have responded in true totalitarian fashion, much as Joshua ordered the sun to stop in the sky. They have made it incredibly difficult for businesses to fire or lay off employees. And businesses respond by not hiring employees in the first place. Unemployment rates exceeding 10% have been commonplace in Europe for decades.

In the U.S., the government responds in line with the age-old joke about a husband drying dishes washed by his wife: “Am I supposed to wipe off what you don’t wash off?” The U.S. government tries to wipe off with stimulative fiscal and monetary policies what its defective labor-market policies don’t wash off when they create higher unemployment. Unfortunately, contrary to popular belief, there is no successful theory of countercyclical government stimulus policies to fight recessions and end unemployment. And the created unemployment remains.

Thus, in the labor market as well, we are currently reinforcing George Orwell’s insight that a characteristic of totalitarian states is to suppress truth by suppressing markets.

Graphic Labels on Cigarette Packaging

The case of cigarette regulation parallels that of regulation of aspirin advertising. In both cases, freedom of “commercial speech” is subordinated to some ostensible greater good, as perceived by federal-government regulators. Yet despite this surface similarity, the underlying philosophy followed by FDA differed completely in the two cases. The agency’s reasoning was ad hoc; the only consistent thread was the insistence that its will prevail.

Cigarette packages have long carries text warning consumers of health dangers associated with smoking. Proponents of regulation have viewed this as a watershed in economic regulation. In fact, smoking has carried a de facto hazardous label in the market of public opinion since at least the 19th century. Textbooks dating to the early 20th century refer in general terms to its deleterious effects on lungs, breathing and longevity. Although the armed services provided them freely to their personnel, World War II movies like Thirty Seconds Over Tokyo referred to cigarettes as “coffin nails” – a nickname that testifies as strongly as any research study to contemporary public awareness of their dangers.

The impetus to the text warnings was a link between cigarette smoking and lung cancer. The link was forged by statistical correlation; populations and ethnic groups that smoked more had higher incidence of lung cancer. The precise medical pathway between the two was uncertain, primarily because the etiology of cancer itself was uncertain. Cigarette smoke irritates the nasal membranes of non-smokers and smokers alike, though, and this contributed to its growing unpopularity. As the size and strength of government grew, its use as a means of enforcing personal prejudice became more frequent. This was generally cloaked in more altruistic garb, and a public-health rationale for discouraging smoking was a convenient means of disguising prohibition as altruism rather than bigotry.

Gradually, more and more smokers have kicked the smoking habit. This has produced a sizable decline in the total number of smokers. Curiously, this has not prevented young people from continuing to pick up the habit, though. Not surprisingly, the former development has been ascribed to the beneficial effects of cigarette warnings, scientific “discoveries” of harmful effects, no-smoking laws and the like. The latter has been ascribed to the demonic motivations of cigarette executives and the baneful effects of their advertising campaigns targeting the youth market.

The real causes are more prosaic. For over a century, people continued to smoke although generally well aware of the possibility of a lethal result. They treated cigarettes the same way they treated any other tradeoff – by evaluating the degree of benefit and the likelihood of death (e.g., the cost). Lung cancer was not a pleasant prospect, true, but most cancers are incurred late in life. When life expectancy was less than seventy years – and the final years rated to be comparatively unrewarding – many people did not value the risk of losing those years to lung cancer as sufficient to forego a substantial benefit from smoking.

But as life expectancy steadily increased and medical science continually enhanced the quality of life by triumphing over disease and pain, the smoking tradeoff became less and less favorable. The later years of life became more productive and pleasurable, hence more valuable. The potential cost of losing them loomed larger. So people stopped smoking earlier and earlier. This effect operated least upon those for whom the prospective tradeoff was most distant; namely, the youngest prospective smokers.

All this had little or nothing to do with tobacco regulation and health warnings. But the money provided to state governments by progressive more draconian taxes and penalties levied against tobacco companies provided an attractive rationale for continuing the charade of regulation. In 2009, the regulatory zealots of the Obama administration took charge and instituted an across-the-board onslaught against health and pharmaceutical companies, as well as most other businesses. This included a demand for large graphic warnings on cigarette packaging.

The federal appeals court ruling illustrated the utter lack of regulatory coherence and unity across the spectrum of government. FDA was scored by Judge Janice Rogers Brown for failing to “present any data – much less the substantial evidence – showing that enacting their proposed graphic warnings will accomplish the agency’s stated objective of reducing smoking rates.” This does not justify abrogating cigarette manufacturers’ First Amendment rights, claims Brown, because “the First Amendment requires the government not only to state a substantial interest justifying a regulation on commercial speech, but also to show that its regulation directly advances that goal.”

The first thing to be said about Judge Brown’s verdict is that it is patent hooey, since the First Amendment says no such thing. Its five lines merely forbid Congress from “abridging the freedom of the press” – period. If there is more to it than that, it is to be found somewhere other than in the Constitution. Judge Brown’s pretense of solemnly measuring one weighty interest against another according to a formula specified by the Founding Fathers is merely a pretext for substituting her judgment for theirs.

The second point worth making is the inherent contradiction involved in requiring supporting data or substantive evidence for a policy not yet implemented. What sort of data could support that policy? Historic data on graphic images on cigarette packages in some other country? Why, yes, according to a representative of Campaign for Tobacco-Free Kids. Considering that it is already illegal to sell cigarettes to kids, this seems quaint indeed. He is apparently claiming that fear of death in the far future will succeed where fear of violating the law in the present failed.

The most absurd element of the ruling, however, is the idea that obedience to the First Amendment depends on the results of statistical investigation. If the science of statistics were as reliable as chemistry, that would be questionable enough. But social-scientific statistics are about as robust as a grass shack in a hurricane. The notion that we’ll tear up the First Amendment whenever a regulatory agency comes up with some really good numbers would be hilarious if it weren’t so terrifying.

It is hardly surprising that a previous Appeals Court ruling – focusing on the entire 2009 law rather than merely its graphic-warnings component – upheld FDA’s authority in full. The only point of agreement is that ultimate federal authority is unlimited; the warring government factions disagree about who wields it and what triggers its imposition.

The End of Truth

The raison d’être for the FDA is the preservation of lives and promotion of human happiness. In the aspirin advertising/dietary supplement case, the FDA took the position that it was entirely up to industry to demonstrate the benefits of aspirin. Even after the clinical studies did this, FDA continued to rely on First Amendment legalism and insist that expansive legal precedent allowed the agency to restrict manufacturers’ First Amendment rights to advertise benefits in spite of the confirming results of studies. In other words, FDA adamantly refused to take the welfare of consumers as their ultimate criterion of action.

In the cigarette case, FDA demands the right to force tobacco manufacturers to injure themselves by defaming their own legal product, not merely with warning text but now with inflammatory graphic warnings. The FDA asserts a sovereign right to abrogate the rights of individual and corporate U.S. citizens in order to attain a lowered aggregate statistical rate of cigarette smoking. Here, FDA is so obsessed with consumer welfare that they claim to be able to achieve better consumer outcomes than consumers themselves can.

Yet U.S. labor law asserts the individual worker’s right to consume the same legal product – cigarettes – that FDA claims the right to abrogate individual rights in order to discourage. Meanwhile, producers’ rights to produce and promote their own legal products are abrogated. Producers are told they have no right to avoid employing labor made less productive by consumption of the same cigarettes that FDA is moving heaven and earth to discourage.

The composite implications of these cases are roughly as follows: Producers have no rights at all except the right to go broke. Consumers have only the right to take what the government gives them, under the theory that government knows what is good for them better than they do. Workers have the right to do anything they damn please but not the power to do the only thing they really want to do, which is find and hold a job – because government has made jobs so expensive to create that producers have no incentive to offer them.

Finally, government has the right to do anything and everything, without limit. The only issues to be settled are which branch of government exercises that unlimited power and under what competing legal theory.

In markets, the assembling of dispersed information produces a tendency toward truth, owing to the continual incentive to earn profits by correcting error. In government, the only incentive is to accumulate and preserve power. Truth is an obstacle to this process. Orwell’s vision of totalitarianism as the end of truth is unfolding before our eyes.