By Ajay Shah, on October 18th, 2011
A lot is being written about inflation in India today. I thought it’s worth writing about the fascinating insights into inflation that come from focusing on the distinction between tradeables and non-tradeables.
What is a tradeable
A tradeable is a product which can be transported across the world at relatively low cost. As an example, steel is tradeable while cement or paint are mostly non-tradeable barring special short-hop opportunities like Gujarat-Karachi or Amritsar-Lahore or Calcutta-Chittagong or Trivandrum-Colombo.
Steel is a nice tradeable that one can think clearly about. There are no barriers to the movement of steel worldwide. Hence, there is only a world price of steel. The quoting convention used worldwide is to express the price of steel in USD. The price of steel in India is thus the world price of steel multiplied by the INR/USD exchange rate, plus a markup for freight (The cif/fob ratio).
If there is a customs duty of (say) 10%, then the price of steel in India is 1.1 times the world price of steel expressed in rupees. For the rest, nothing changes when a customs duty is introduced. Gram for gram, every fluctuation in the INR/USD or the world price of steel shows up in the domestic price of steel.
Non-tradeables are things like cement (which are hard to transport) or haircuts (which are impossible to transport).
Measurement
Before we can analyse and control inflation, we must measure it well. Inflation is defined as the rise in the price of the average household consumption basket. The CPI is the best measure of inflation in India.
Everything in the CPI basket can be classified into the two categories: tradeable vs. non-tradeable. As a thumb rule, WPI non-food non-fuel is a rough measure of tradeables inflation. Fluctuations in food and services prices, which make the CPI diverge away from WPI non-food non-fuel, are a measure of non-tradeables.
Year-on-year inflation reflects an averaging over 12 months. If you want to get a faster sense of what is going on, you need to look at point-on-point seasonally adjusted changes. These yield early warnings of inflation, which are 5.5 months ahead on average. Such data is updated every Monday by us. The shift from y-o-y inflation, to p-o-p SA inflation, is a free lunch in measurement and monitoring.
The WPI is a useful database of many price time-series in India. But the overall WPI is useless in thinking about inflation in India: there is no household in India which consumes the WPI basket.
The use of WPI inflation, and the exclusive use of y-o-y inflation, are litmus tests of professional competence in the Indian landscape.
The function of the central bank
The job of RBI is to deliver low and stable inflation: to deliver y-o-y CPI inflation of between 4 to 5 per cent.
They have failed in this task. From February 2006 onwards, in every single month, y-o-y CPI inflation has exceeded 5 per cent. This is an important time for introspection at RBI and outside it. What have we done wrong, in the structuring of RBI, which has got us into this mess?
It is useful to think of this as a principal-agent problem. The people of India are the principal. RBI is the agent. The principal hires the agent and gives him resources. In return, the agent has to be held accountable. Delivering low and stable inflation is the accountability mechanism. It is a quantitative monitorable measure of the performance of the central bank. That we have sustained failure on this function, from February 2006 onwards, suggests that we should be modifying the nature of the contract between the principal (the people of India) and the agent (RBI).
How RBI can influence the price of tradeables
RBI has absolutely no say on the world price of steel. In that sense, the prices of tradeables are beyond the control of RBI.
When RBI raises the interest rate, more capital comes into India, which tends to give an INR appreciation, thus making tradeables cheaper. Thus, an RBI rate hike does impact upon the domestic price of tradeables.
It is also worth pointing out that the central banks of most major countries are high quality inflation targeters. They deliver on their mandate of delivering low and stable inflation. As a consequence, inflation in the global tradeables basket tends to be low and stable. Tradeables prices are a helpful source of price stability, most of the time.
(That a large part of the CPI basket is tradeable, and seemingly beyond the control of the central bank, is no excuse. There are dozens of high quality central banks visible in the world, with very large shares of the CPI basket in tradeables, who are delivering on inflation targets. We in India should not accept excuses).
How RBI can influence the price of non-tradeables
Non-tradeables reflect aggregate demand and aggregate supply in India. RBI can influence these by raising or lowering the short-term interest rate. When interest rates are made slightly higher, household consumption and investment demand are slightly lowered.
A critical feature of non-tradeables inflation is expectations. If people expect 10% inflation, they tend to wire high price rises into their negotiation of wage and other contracts. This generates inflationary momentum. Particularly in a place like India, where the institutional structure of monetary policy is primitive, economic agents have little confidence in the ability of policy makers to rein in inflation. As a consequence, inflation is highly persistent. Once high inflation sets in, economic agents expect high inflation to continue. There is a great deal of momentum in inflation.
For years now, some economists have argued that inflation will subside by itself. It will not. Inflation does not mean-revert to the target zone of 4 to 5 per cent by itself. We are now in a trap of high inflationary expectations. This structure of expectations will need to be broken. This can happen in two ways. RBI needs to turn a new coat, and convince people that it now cares about inflation without any other conflicts of interest. And, rate hikes have to take place.
There are two paths to inflation control: changing the structure of expectations and reducing aggregate demand. The former is almost a free lunch. It only requires institutional change. The latter is hard work; it inflicts pain.
What about supply factors?
Some argue that supply bottlenecks in India – such as hideous rules about mandis – are the cause of inflation.
The trouble with this explanation is that the supply bottlenecks have always existed. They have existed in high inflation times and in low inflation times. It is, thus, not possible to claim that supply bottlenecks have caused the inflation crisis which began in February 2006.
Can rate hikes deliver inflation control?
When C. Rangarajan was RBI governor, there was an inflation crisis, and rate hikes did deliver on inflation control. The phase of price stability ushered in then lasted all the way till February 2006. This shows us that even in India, it can be done.
We have to remember that in his time, the monetary policy transmission was much weaker than what we see today. With a bigger wall of capital controls, domestic rate hikes did not deliver inflation control by impacting on the INR (through higher capital inflows). With a smaller and weaker Bond-Currency-Derivatives Nexus, the monetary policy transmission from the short rate into aggregate demand was inferior, then. Yet, he got it done.
Conversely, with a very primitive financial system and monetary policy transmission, the central bank of Zimbabwe delivered a nice hyperinflation. We can quibble about the potency of the monetary policy transmission, but we should not doubt the ultimate domination of monetary policy in shaping inflation. In the long run, little else matters in shaping inflation.
Part of the story of the 1990s lies in clarity of purpose at RBI and policy credibility. Rangarajan’s period had good quality speeches, which did not dilute the message on inflation control as the dharma of the central bank. In contrast, in recent times, RBI has repeatedly written low quality speeches. To an expert reader, they have conveyed the lack of knowledge on monetary economics at RBI. To the non-expert reader, they have waffled on the subject of taking responsibility, and have encouraged the average economic agent to think that high inflation is here to stay.  
By Simon Grey, on August 11th, 2011
What caused the 1992 L.A. riot? While this question has no definitive answer, the evidence presented in this paper does suggest that South Central L.A. had some characteristics that made it more likely than other cities to explode into a large scale riot. Our empirical results suggest that the ethnic diversity of South Central L.A., the high unemployment rates of young black men in that area, and the sheer size of Los Angeles all help explain the 1992 riot. [Emphasis added. HT: Chuck.]
One of the effects of free trade has been to increase unemployment in manufacturing industries. Jobs in these industries are generally low-skill, and the proper domain of younger males, at least given the labor market value of young males (hint: it’s really low since young males tend to lack intellectual capital, i.e. skills). So, since there are fewer jobs available to young men as a result of free trade, and since young men without jobs are more prone to rioting, it would appear that free trade has a probable role in setting the stage for future riots.
Of course, it is entirely possible to avoid this possibility. The government can either impose wage parity tariffs on all imports, which would have the effect of ensuring that any imported product would have the cost of minimum wage labor factored in, or the government can stop making illegal for young males to compete with foreign labor and production on price, which means eliminating minimum wage laws. It is absolutely ludicrous for the government to have policies that hamstring domestic labor and favor foreign labor. Something has to give eventually, and let’s hope it doesn’t take a large number of unemployed males rioting in the streets to convince the government to set a pro-domestic labor policy.*
* While I’m on the subject, I’d just like to note just how completely horrible it is that the government’s current economic policy is in the worst possible interest of the citizens it claims to represent. Free trade only benefits domestic consumers because it enables them to buy goods at lower prices than they normally would. Of course, the general price of goods wouldn’t otherwise be high in the first place if the stupid government hadn’t set policies that drove up the price of goods in the first place. Between inflation, minimum wage, asinine “corporate” taxation, and incredibly cumbersome regulation, the government has managed to concoct a perfect storm of skyrocketing prices.
The only thing that obfuscates this fact is the presence of foreign trade, which the government welcomes because it helps keep consumers from knowing the true cost of government interference. Of course, this charade can’t be kept up forever because foreign labor will eventually become more productive, leading to increased demand, leading further to increased prices (wages). As this happens, the buying power of foreign labor will increase, relatively speaking, and drive up the price of goods on a broad, international level, meaning that Americans will eventually pay more for goods anyway. By the time this happens, though, the American economy will have been so hamstrung as to become permanently crippled.
And that’s why I hate the American government and the politicians and bureaucrats that run it. They are fools, every last one of them. They, and I mean this literally, deserve to rot in the bowels of hell for all eternity for the fraud, deceit, and destruction that they have practiced against the American people.
By Simon Grey, on April 12th, 2011
Later this year, the Obama administration and Congress will seek bipartisan votes to pass free trade agreements with South Korea, Colombia and Panama. With 87% of global economic growth over the next 5 years taking place outside of the United States, trade supporters believe these agreements will create jobs and prosperity by helping American companies tap into fast-growing export markets.
Opponents disagree. They argue that “NAFTA-style” trade agreements hurt rather than help the U.S. economy — and polls show that much of the public agrees.
But is this conventional wisdom correct? Or do trade deals work? As Washington gears up for hard-edged debates about trade, it’s worth exploring some common misconceptions about free trade agreements.
This line of argumentation reminds me of Milton Friedman’s attempt at defending central banks. Friedman took the approach that the free market was the bees’ knees at everything, except money. Likewise, trade proponents take the approach that the market is good, but then somehow manages to conclude that we need the government to step in and a) create an artificial legal entity (the corporation) and b) enter into trade treaties with foreign nations.
Somehow, all this government interference is defended in the name of the free market, and those who don’t accept this new gospel are branded as ignorant or worse. There is good reason to be wary of governmental interference, seeing as how virtually all interference is destructive, inefficient, or counterproductive.
If trade proponents are truly concerned about free trade, they would first oppose the massive tax and regulatory burdens placed on domestic production and trade. Then maybe their message of increased foreign trade would seem more sincere.
By Trace Mayer, on July 7th, 2010
Trace: Welcome back to the RunToGold Podcast, I have a special guest with us today, Thomas Woods. He is a senior fellow at the Ludwig von Mises Institute, a bastion for Austrian economics, he holds a degree from Harvard in history and a Ph.D. from Columbia, and he has a new book out called Nullification: How to Resist Federal Tyranny in the 21st Century. 
Welcome, Tom.
Tom: Thanks very much, Trace.
Trace: When I was in law school, we never talked about the 10th amendment. When I was studying for the bar, they said if there was an answer that mentioned the 10th amendment, it was wrong. Can you give us a little bit of an overview on what nullification is and how the States can apply this?
Tom: Yes. Well, it is linked to the idea of the 10th amendment and it’s so funny how the legal establishment hates and tries to downplay, or smear, the 10th amendment when in fact the principle of the 10th amendment, that the states retain all powers not delegated to the federal government, was told to people as having been implicit in the Constitution as drafted. In other words, before there even was a 10th amendment in the Constitution, supporters of the Constitution told people that, in effect, it was already implied in the Constitution. This is the very principle that law schools try to pretend doesn’t exist or is just stupid. Supporters of the document itself said this principle is already implicitly contained in it, so nullification just follows from this.
Thomas Jefferson It comes from Thomas Jefferson, and then in turn through others since then. Jefferson said that if the federal government tries to exercise a power that is not one of the delegated powers, tries to exercise a power that would be unconstitutional, then the states should not enforce it within their borders. That is to say they should nullify it. And Jefferson himself is deriving this idea from the Virginia ratifying convention of 1788. 1788 Virginians were very skeptical of the constitution, a lot of them were. Virginia was probably the most important state at that time, and so many of our great states men came from Virginia. I mean obviously James Madison, Thomas Jefferson, Patrick Henry, George Mason, the list goes on and on, so it’s very important to get Virginia in. And then there were skeptics, Patrick Henry among them, who said this constitution is going to yield you a government that will be impossible to control. It will grow beyond our ability to imagine, it’s got a phrase in there that can become loopholes for ambitious politicians. And Patrick Henry was told “don’t worry”, and this was the supporters of the Constitution talking, “don’t worry, the federal government will have only the powers expressly delegated to it, and if the federal government should attempt to exercise any additional powers, don’t worry. Virginia will be exonerated from those additional powers.” So in effect there is the germ of nullification right there, in the state ratifying convention.
Now this is not talked about, the stuff I’ve just said… I mean you, if you picked up in American history textbook you’d be more likely to read that I, Tom Woods, am the King of England then you would to read any of that history.
Trace: That goes right along with our principal of judicial review, which is outside the scope of this interview, is that there are certain things that the establishment out of Washington definitely doesn’t want to talk about, and nullification is one of those.
How can nullification, and this principle, help a state become an attractive place for capital, both human and economic? A place where people want to go and do business there, because you know we’ve got these huge unfunded liabilities that are hanging out there like a Damocles sword on the economy, we’ve paralyzed the entrepreneur, and they are withdrawing from engaging in the economy, providing value, because we’ve got all these regulations, just pages and pages that come out in the Federal Register. How can the states use nullification to create an attractive business climate for people?
Tom: That’s a good question. Let me start by saying that when you’re in an economic crisis, such as the one we continue to be in, I think people become willing to entertain ideas that they would otherwise reject, that people are willing to put a lot of possibilities on the table, they become skeptical of experts, they become more willing to listen to heterodoxy. So certainly we saw that in the sudden meteoric rise in the interest in the Austrian school, mostly due to Ron Paul, but also simply because in an economic crisis the experts don’t seem to know what on God’s green earth caused it, and yet these Austrians seem to have been calling it for quite some time, and they have an explanatory basis for accounting for it. Suddenly people became interested in that. Well, likewise of nullification. I think people five years ago would say “well, that’s some crazy idea”. Well, first of all it’s not a crazy idea. I think my hope in my book Nullification is to show how non-crazy it is, how based it is in American history, and the Constitution, common sense, morality, everything you can name, demands that you have the power of nullification.
But I think now… could you imagine, let’s say even right now but let’s say how about in four or five years from now, let’s say that economy is still stagnating, no sign of recovery. Or maybe it’s worse, it has dipped down substantially, and I mean that is certainly quite possible. Let’s suppose that you had a few charismatic governors from influential states who said “All right look the federal government obviously is not interested in economic recovery, and they have proven that in their policies, and so okay maybe they want to bring the country down and destroy it and ruin the economy, but I’m the governor, I’m responsible for the people in this particular states. And in this state we are going to try to carve out some type of livable existence here. We are going to try to carve out the most attractive business climate that we possibly can. So, beginning tomorrow, I am hereby appointing the following commission to go through state budget line by line, I want you to identify every single line in which we are spending money on some unconstitutional federal mandate that we know and they know perfectly well are unconstitutional, and from now on we are just not doing it anymore. The money does not exist, there is no more government fairy who’s going to produce money out of thin air, the game is over. And we are just not doing it.” Now there would be tremendous popular support particularly in certain states…
Trace:… like Texas.
Tom:… where the Governor would have the guts to do that. Yeah, like in Texas. Unfortunately the problem with Texas is that anybody who manages to get elected as governor of Texas, always has ambitions to become president, and that usually clouds his judgment. He always feels like “I’d better be restrained, I better not do anything that’s not in the John McCain/Mitch McConnell play book. You know I must stay Mr. Moderate”. So unfortunately, maybe they wouldn’t do that. On the other hand, maybe there would be some governors who would realize that there’s popular support for this. Chris Christie is getting a lot of support in New Jersey for just saying we’re slashing and burning, because this is absolutely necessary. Well add the slashing and burning, combine that with… oh and by the way we are sticking our middle finger in the face of the Feds who are imposing unlawful requirements on us, and they are contributing to our rotten economy.
I’d love to sit back and watch the fireworks.
Trace: …and especially if you get a state that’s got enough critical mass, I mean Texas or Florida or who knows maybe even California, because it’s such a mess out there budgetarily…
Tom: Yeah exactly, look obviously we have to do this, we do not have the money. Or I wonder if even conversely it might be the case that if we had a couple small uninfluential states do it the federal government might figure it’s not even worth bothering them. Who cares if North Dakota isn’t forcing’ No Child Left Behind’, we’ll live with it. But it would be a precedent for the future .
Trace: …and we have seen what they have done with their state banks. North Dakota, or another small state, like a New Hampshire could…
Tom: …and I should point out with regard to the economy we are hearing about cap and trade back on the table again. There are already several states drafting cap and trade nullification, let’s say I would assume North Dakota would have to be on board there. I mean theirs is a completely energy-dominated economy, I mean that’s what they do. They would be ruined, they would be completely ruined by that stuff. So if they can get away with that, or just the prospect of annoying the federal government and reminding people that it is possible to say no to these guys, well you know I can’t guarantee that this is going to work, I can guarantee you that staying on the path we are on, just voting for some stooge every four years, that that certainly is not going to work.
Trace: Sometimes it’s just in a mere flexing of your rights that you are able to exert a lot of political pain. I know whenever ideal as law enforcement officers in it’s “no officer I don’t consent to any searches,” or “officer, am I free to leave?” Just to exert the constitutional rights instead of rolling over like some dead possum and letting him pilfer through all my belongings when I know that they’re not going to find anything, so I don’t want to be wasting taxpayer money in that way, so likewise I think they’re going to see a little bit more, especially as the money continues getting tight, between states competing for the capital, getting people to move there, because you know the young people they’re coming out of school now with 19.6% unemployment, and what happens when immigration starts happening in the opposite way, when people are like, oh man there are plenty of jobs over in Hong Kong. And so the best and the brightest start leaving America as opposed to coming into it. We see Texas already catering to the young people, trying to bring the job climate in favor and create jobs for the young people, do you think we might see some of the states working in this manner to attract that capital?
Tom: Yes absolutely. Certainly just taking everything it in their own power, you know their own state sales, property taxes and things like that, certainly they can do all that. And then you can couple that with attempts to stand up to the Feds. Even the best-known case of nullification in American history is when South Carolina nullified the tariffs in the 1830s and what wound up happening is that the federal government reached a compromise with them and said “All right, about if we lower the tariffs over the next 10 years?” Well all of our historians are big nationalists, and they hate nullification. All of our historians say “well that just goes to show that nullification is a failure and it doesn’t work”. Are you kidding me!? That’s exactly how it’s supposed to work. Where both sides say look I’m not going to do what you want in you’re not going to do what I want so now let’s make some type of agreement. That’s exactly how it’s supposed to work.
Trace: And that’s to show that, you know we’ve got the political framework at least somewhat there that we can work our way out, you know we could come to grips with the problem we’ve got and we could solve it, and still have our institutions and be able to provide a climate where we can still have a nice standard of living, we don’t have to go back into the stone age, or become an Argentina.
Tom: Yes, exactly right. And yet that is exactly where we are heading, if we don’t begin thinking in a different way.
Trace: This has been a fascinating interview, Mr. Woods. Thank you and we are out of time so everybody you have been listening to the RunToGold.com podcast thanks. That was wonderful interview with Tom Woods, very powerful. And I recommend you look at www.TomWoods.com, that way you can learn more about his work and get a copy of Nullification.
By Rok Spruk, on December 16th, 2009
On Sunday, December 13th, Paul A. Samuelson has died at the age of 94 (link).
He was on the economic giants of the 20th century. His ideas reshaped the economic science and revolutionized the mode of economic thinking around the world. With the mathematical rigour and analytical mastermind, his groundbreaking approach to economic analysis transfored the economic science into a dynamic problem-solving tool. In this short essay, I will present my reflections on the life and contributions of Paul A. Samuelson to the economic science.
I first came across Paul Samuelson in the year before I entered the university. In the first year of the undergraduate class, Samuelson and Nordhaus’s Economics was the assigned reading for the Introductory Macroeconomics. I read the textbook back and forth and I liked it; not because of its simplicity in introducing the analytical framework of economics but rather because of the clarity, intuition and incentives to undertake a rigorous pursuit of analytical economics at the theoretical and empirical level. In addition, Samuelson penetrated the application of linear programming to economic problem-solving.
Together with Milton Friedman, Paul A. Samuelson is the economic giant of the 20th century. Hardly any economist could take the same place in the scope of influence as an economic thinker. He conducted the Neoclassical synthesis. As an interested reader can verify in his Nobel prize lecture (link), Samuelson’s synthesis combined a Keynesian macroeconomics with a rigorous Marshallian microeconomics. In microeconomics, Samuelson extended the Marshallian analysis of partial equilibrium with strong mathematical articulation of demand and supply curves, cost curves and deadweight loss. On the abstract level, together with Abram Bergson, he constructed social welfare functions based on three marginal conditions and extracted from earlier work of Kaldor-Hicks-Scitovsky analysis (link). In macroeconomics, Samuelson further affirmed the dominance of Keynesian macroeconomics with a strong emphasis on the role of fiscal policy in stimulating full-employment output. In addition, he invented the term multiplier and the acceleration, the former relating to the effect of change in exogenous macro variables on endogenous variable (notably, output) and the latter referring to the partial adjustment of aggregate investment to the capital stock. Samuelson-Hansen multiplier-accelerator principles spurred the theoretical foundations of Keynesian economic policy. He also popularized Overlapping Generations Model which later became the corner stone of innovations in the modeling of aging population. In macroeconomics, Samuelson also proposed the so-called “Samuelson-Mishi condition” for the efficient provision of public goods. When the condition is satisfied, it implies that further substitution of private goods provision for public goods will result in a diminishing social utility.
Assuming Pareto efficiency, Samuelson-Mishi condition satisfied the criteria for Lindahl equlibrium. The equilibrium states that when individuals are willing to pay for the provision of public goods according to marginal benefits, it will be Pareto efficient. However, such condition is not compatible with the incentive mechanism since it requires the complete knowledge of individual demand functions for particular public good which could result in the asymmetric distribution of benefits in response to relevation-principled taxation.
As a student of international economics, I came across the influential theoretical work of Paul Samuelson. Modern international economics is a combination of mathematical economics, advanced microeconomics, game theory and international finance. One of the most interesting and penetrating areas of international economics are theorems in international trade. Under particular assumptions theorem postulate axiomatic explanations based on previous statements. Back in 1941, he proposed Stolper-Samuelson theorem together with Wolfgang Stolper. The theorem quickly became a source of academic debate. In its simplest form, the theorem states the following: assuming constant returns to scale and perfect competition, a rise in the relative price of good will lead to higher return on the factor which is used more intensively in the production of the good and to the fall in the return to the other factor. Stolper and Samuelson wrote:
“Second only in political appeal to the argument that tariffs increase employment is the popular notion that the standard of living of the American worker must be protected against the ruinous competition of cheap foreign labor… In other words, whatever will happen to wages in wage good (labor intensive) industry will happen to labor as a whole. And this answer is independent of whether the wage good will be exported or imported.”
The theorem showed that the international trade between two countries could lead to the opposition of international trade since the relative price of labor-abundant good in the high-wage country will be higher than the world price of that good, reflecting the relative abundance of capital or human capital. The theorem quickly became the main theoretical weapon of opponents to free trade. Even today, Stolper-Samuelson is the best explanation of why labor unions in high-wage countries oppose free trade agreements and further economic integration with low-wage countries.
Another important contribution of professor Samuelson is the so called Ballasa-Samuelson effect which states that higher growth productivity growth rate in tradable goods relative to non-tradables will lead to the real exchange rate appreciation. Balassa-Samuelson effect also went through numerous time-series regression. The effect has been tested 60 times in 98 countries. Cross-section regression studies of Ballasa-Samuelson effect were analyzed in 142 countries. In a vast majority, the empirical evidence of Ballasa-Samuelson hypothesis was supported. The main empirical findings emphasize that productivity differential between tradeable and non-tradable sector is positively correlated with differences in relative prices. The empirical evidence also supported Samuelson’s initial proposition that productivity differentials translate into higher purchasing power parity through real exchange rate appreciation.
In finance, Paul Samuelson penetrated the analytical aspects of lifetime portfolio selection. In 1972 he published The Mathematics of a Speculative Price which later became the ground of option pricing. Based on discoveries of Bachelier’s pioneering work, he laid the foundations of stohastic price movements and random forecasting matches. His pioneering work in financial theory of speculation and random walk (stohastic) movements in stock prices became the underlying theoretical foundation in the emerging financial industry. In an article entitled Probability, Utility and the Independence Axiom (Econometrica, 1952), he discussed the role of probability models in measuring the overall utility. In this sense, he relied on Keynesian defence of subjective theory of probability and argued that the subjective perception of probability does not inhibit the proper functioning of financial markets. In 1965, he published A Proof that Properly Anticipated Prices Fluctuate Randomly where he provided the foundation of the efficient market hypothesis that has been further developed by Eugene Fama and other scholars. For a detailed discussion of Paul Samuelson’s contribution to financial economics, see Merton Miller’s contribution in Britannica (link).
In addition to his theoretical and empirical work, he is the founding member of the Econometric Society and its president in 1951. In 1961, he was the president of American Economic Association. In the political sense, Paul A. Samuelson influenced the economic policy of the Kennedy Administration. In 1960, the U.S headed for the recession. President Kennedy, following Samuelson’s advice, enacted tax cuts and a balanced budget. In 1964, when Kennedy tax cuts were enacted, top marginal tax rate was reduced from 91 percent to 70 percent. The economic reasoning behind tax reductions was firmly laid in the Keynesian multiplier (1/(1+c)(1+t)). Paul Samuelson and Walter Heller (Chairman of Council of Economic Advisers during Kennedy Administration) argued that lower tax rate would stimulate consumption spending and boosted output and employment. Throughout the 1960s, the U.S economy experienced one of the longest periods of stable economic growth, favorable employment outlook and balanced federal budget. Here is how JFK, following Samuelson’s advice, supported the tax reduction (link). Also, David Greenberg’s article on Kennedy tax reduction is a worthy source of further information on that topic (link).
On Sunday, the economic titan passed away. He not only revolutionized the field of economic science but also spurred the interest for economics and popularized it in a manner that turned dismal science into a problem-solving science based on theoretical foundations and empirical verification of theoretical postulates. His approach to economic analysis combined Marshallian microeconomics and Keynesian macroeconomics which he joined together after the WW2 in a Neoclassical synthesis. Compared to other economic thinkers, he knew how to formulate theoretical postulates in a manner that stimulates the research interest for further investigation.
He will be missed and remembered as the giant of the economic thought and a titan of economic theory.
By J.D. Seagraves, on July 20th, 2008
One issue that differentiates economists from the vast majority of the general public is free trade. Economists overwhelmingly support international trade, with little or no regulation or taxation, and abhor protectionism—trade policies designed to “protect” domestic jobs. Meanwhile, upwards of 80% of American citizens believe that the U.S. government should be protectionist—or at least that’s what they say when asked. Their choices as consumers, however, tell a different story.
First it should be established what we mean by “free trade.” The term has taken a beating due to its association with non-free trade agreements and organizations such as NAFTA and the World Trade Organization. Real “free trade” is unilateral—it does not require an “agreement” between nations, only an agreement between the two parties involved in a given transaction. This laissez-faire philosophy rests upon the principle that people have property rights and they may dispose of their property as they see fit, so long as they do not infringe upon the rights of their peers. Thus, it is illegitimate for a national government to place tariffs or other taxes on imports or exports, even in retaliation for another country’s actions, because in doing so, it is only inhibiting the freedom of its citizens to buy or sell as they please. (More specifically, trade embargoes are ineffective in fighting human trafficking.)
That is the moralistic argument. Now here’s the utilitarian one: many “economic nationalists” (i.e. protectionists) believe that the U.S. should erect literal or figurative walls around its borders and laws should force consumers to support only domestic producers. It is reasoned that this would keep jobs from being “exported” overseas or to Mexico and Latin America. Thus, these misguided souls believe wages could be kept higher, presumably at the expense of greedy corporations and their insidious profits. (Read G.L.C.’s blog for a lawyer’s take on laws against outsourcing.)
If this were true, then it would also be true that a state, such as Michigan, would benefit from restricting trade to within its own state borders. After all, keeping jobs in Michigan rather than having them shipped out of state would be an imperative of Michigan’s governor, just as keeping jobs in the U.S. would be the president’s. If the U.S. can produce everything Americans need, then couldn’t Michigan produce everything Michiganders need?
Can we take this logic further? Why not keep commerce restricted to products produced within a county? Within a city? Within a neighborhood? Within a household?
Pure Restrictionism
Imagine if you had to produce everything you consumed—the ultimate in trade restrictionism. Think of the time you’d waste sewing your own clothes, building furniture, hunting and/or farming for your own food and providing your own entertainment. Your standard of living would be extraordinarily low. Now imagine that trade opened up to include everyone in your county. Now you could focus on the one thing you did well—say, drawing comic books—and you could trade the comic books you produced for the clothes, furniture and food you needed. You would end up with a greater quantity and a higher quality of goods and services since the best seamstresses, woodworkers and hunter/farmers in the county would be working solely on the activities they did best, thereby increasing the total quantity and quality of goods and services produced in the county economy.
If trade then expanded to include everyone in your state, then perhaps the local seamstress would be put out of business as entrepreneurs combined to create more efficient methods of producing clothing. Maybe she’d have to take a job in the clothing factory for less pay than she previously received. But now the new clothing factory would be producing more clothes at a higher quality and a lower price than ever before. The seamstress’s dollar would stretch farther in the growing economy, and even though she may be nominally worse off than she was before, in real terms, her living standard would improve. Meanwhile, the demand for your comic books goes up as the state gives you a broader customer-base to which you can market your wares.
You should be able to get the idea. The greater you expand the pool of individuals working to produce the goods or services in which they have a comparative advantage—i.e. the activity that allows them to maximize their utility—the higher the standards of living for everyone in the country and the world. This principle is known as division of labor, and it is the building block of capitalist economics.
The Austrian Take
Now, it must be reiterated that although things like NAFTA and CAFTA might expand trade, and thus many economists see them as “good things,” the Austrian School of Economics does not. That’s because Austrians oppose government intervention into the economy, and trade agreements such as NAFTA and CAFTA are nothing but interventionist. They are agreements between nations that contain several thousands of pages of rules and restrictions designed to benefit special interests. Most people who oppose NAFTA, CAFTA and the WTO do so because they’re opposed to free trade. The Austrian school and its most prominent proponent, Ron Paul, do so for exactly the opposite reason.
Restrictions on trade are not only inefficient, but they’re also immoral. If you don’t want to support another country’s development, even though doing so would be to the immediate and long-term benefit of you and the rest of the world, then fine; don’t buy products produced there. It is hubristic to agitate for the passage of laws restricting your neighbor’s choice to do so. And the fact that 80% of Americans, the vast majority of whom regularly shop at the People’s Republic of Wal-Mart, say they want protectionist laws shows a great deal of American hubris.
So give free trade a chance. It is the traditional American view declared by Washington, echoed by Jefferson and then somehow drowned out amid the clamor of Lincoln’s war. But just like our traditional non-interventionist foreign policy, free trade is an American tradition worth revisiting. The two go together, in fact, as Washington proclaimed his support for “commerce with all nations, entangling alliances with none” in his farewell address. Maybe it’s time to listen to the man on the one-dollar bill who could not tell a lie. He certainly was telling the truth about free trade.
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