Software Circular Mar, 2004 #5

California Expert Software

Truth is Everything

BORING FIVE

My discussion of economics, continued ...

Experimental Approach

I don't want to throw out the baby with the bathwater.

Statistics

Having railed against (neo-)classical economics at length, I need to prevent a false conclusion.

There is nothing wrong with collecting economic statistics. It is the interpretation of those statistics that can be misleading or wrong.

Statistics are just that, statistics. They are collections of numbers, based on some form of counting. The counting may involve more or less complicated formulas. So far as it goes, there is nothing inherently wrong or harmful in it.

The trouble with statistics is not counting something, or doing some sort of calculation based on the counting. The trouble is what the "results" are supposed to mean. While, in theory, there are just means, medians, standard deviations, etc, in practice people use statistics to prove something. "Median income," for example, is supposed to have great significance for our society or government policy. On the other hand, politicians often cite averages, not medians.

Statistics "in themselves" don't support any particular theory, although a theory may predict what a certain statistic should be, or what a statistical function should "look like." Do we expect household expenses to fall on some sort of bell curve (normal distribution), or should the distribution be skewed? Now, if a theory makes statistical predictions, then it can be falsified (or at least questioned) if those predictions are not confirmed by experiment. On the other hand, the theory is never really verified by statistical findings, unless those findings are "statistical truths" (mathematical theorems). Because "statistical" usually means something was sampled, the statistic always has some probability of error involved in its collection. Theories that depend on statistics are therefore at best probable or likely, never certainly true or false.

Nonetheless, theories that suggest statistical tests are useful. The tests themselves, however derived, may be usefully interpreted in many theories. Governmental and private agencies collect huge amounts of information every day, and reduce those measurements to token results in published reports. Even if many of those reports are not useful, the fact that they are not useful is important. We need to separate the utility of the statistic from the theory which suggests it. This implies a statistic does not prove or disprove a theory, even if it was implied by the theory.

The things that go wrong with statistics are manifold. In polls, there is always a dispute about the wording of the question. Then, there is the matter of selecting those polled (data points). Is the sample representative, and in what respect? How are the data best represented, or is the entire sampling just a collection of data? How do we correlate various samples? To what extent do correlations verify samplings? How do we verify statistical findings?

I am reminded of a notorious controversy between Nature (a very respected scientific journal) and a certain French Dr Jacques Benveniste¹, whose work was rejected for publication. The good doctor "proved" that water derived from living things had properties different from acellular water. This notion is at the bottom of homeopathy and certain other practices of "alternative medicine." It supports the doctrine of vitalism, which was popular on the Continent a century ago.

In order for water to have the distinctive properties claimed, the transforming property needs to be transmitted at "infinite dilution." Dr Benveniste's experiments seemed to suggest that was so. After months of cross-channel arguments, London-based Nature proposed, and the doctor agreed, to set up appropriate repetitions of the critical experiments. After more months and months of analysis and quarrels, it appeared the results could only be repeated by one woman post-doc in Dr Benveniste's lab. Everything depended on her work and involvement, for reasons that were suspected, but never discovered.

The controversy was never resolved. Nature published Dr Benveniste's claims and a lengthy rebuttal. From a "standard" scientific point of view, the work could not be verified by anyone, only by the singular worker. Subsequently, very eventually, the French government agreed with Nature, and refused further grants to that research lab.

All of this is to remind the reader, once again, that nothing in my work is meant to suggest the collection of statistics is wrongheaded or useless. Such work is not to be confused with validating any particular theory. Of course, theories which suggest useful statistics may also be useful theories, but that is not the same thing as a theory being true.

Like most others involved in financial markets, I follow studies of the labor, stock and bond markets, GDP and productivity changes, consumer attitudes and much more. All of those reports are used by the Federal Reserve Bank (The Fed) in determining its policy. The Fed's Open Market Committee (FOMC) decides interest rate policy; that is, a collection of people make a decision about handling money having considered certain statistical findings. In making that decision, the members hold different views of the economy and economics. Thus, it cannot be said that a particular economic theory determined the decision, only that some people made a judgement.

How the economy works is still a matter of fierce debate. The matter is not settled, and cannot be settled by statistical studies and reports. Since there is no proven economic theory, but many useful economic ideas, I can only encourage the studies to proceed and vigorous debate to continue.

Economic Value

In making sustainability a key concept in my economic theory, I may have raised another old chestnut: how do we determine economic value?

My answer to this is relatively and approximately. At bottom, I believe value is in the eye of the beholder; the price is the price. This implies there may be as many standards of value as there are estimators of price. I have no way of resolving disparate opinions about what determines value.

That said, it is also clear that certain theories of value do apply in limited circumstances. For example, the labor theory of value may explain the price of things that involve large amounts of human labor and few resources, such as works of art. The intrinsic theory of value may explain some aspects of the gold market, because there are still a lot of people who believe gold (or silver, marijuana, sea shells, wampum ...) has some inherent, natural worth. I think it is acceptable to introduce one or more theories of value in explaining economic transactions. In doing so, one is merely "explicating" the valuation one made in that case. Putting forward a "theory of value" is to make public what started as an entirely private, subjective activity.

Since in my subjectivist view, everything is relative, I do not have a problem with conflicting statements about value. It just means someone says this, and someone else says that. I don't know who is right or wrong or neither, even if I have my own, different opinions about whatever is at stake. I will act on my opinions, regardless of what others say. Of course, if someone makes a case that strikes me as particularly worthy (by whatever idiosyncratic evaluation I perform), maybe I will act otherwise on account of it. I can change my opinion without penalty, because my opinion is whatever it is.

I note here that the most basic assumption of political democracy lies in what I just stated. Each person has an opinion based on whatever criteria; there is no final, "higher" truth or value. In a world of many opinions, the only way to be fair is take a vote under agreed rules. Regardless of what the vote decides, the value of what is decided remains indeterminate. Thus, no matter who gets elected Prime Minister, usually Tories are still Tories after the election, and the same may be said of Laborites, Liberals, Progressives, Communists, Nazis, etc. What has been decided is only who will hold a public office, or what things will be done, for a time; nothing more, nothing less. This will work only if the participants are tolerant; tolerance is a fundamental democratic value.

What has economic value is socially dependent. While most animals find or build a home, structures like bee hives are of little use to loners. Most humans seem to prefer living in connected villages, not giant central facilities (such as bee hives). There are city slickers and country bumpkins [I'm a bumpkin] who often haven't much use for those living the other way. Most people are "in between," preferring suburbia. I have no idea why we are like that; we are what we are. Social preferences have a history and evolve. That history can be studied, but does not change or even predict preferences. So the best we can do, most of the time, is just measure; which brings us back to the black art of statistics.

The vote is just one of many statistical measures we can apply in measuring value. The main thing is not to make any particular assumptions about why something is of value, but only measure the comparative. We can determine the value of one thing compared to another. We do this all the time, everyday. Even chimps do it. So, the question of value comes down to a problem of preferences.

At least, that's what I think.

Loving Care

Our ancestors did not think much about economic theories. They were confronted with the more immediate problems of basic survival. Obviously, they did well enough to produce us, the ones here today. That very success has engendered a huge threat to our future: it is possible to be too successful.

Our methods of appropriating resources have outstripped any natural defense. We take what we want, when we want it, and how we want it. In the First World, "Man against Nature" was last an appropriate description of affairs over a century ago. Even though many people live at much lower standards in the Third World, most of those people are no longer in the state of nature. In Africa, Southeast Asia, parts of South America and other outlying areas, the struggle to exist, man vs. nature, continues, but the outcome is not in doubt. Man wins.

There is very little on planet Earth which cannot be controlled by humans, excepting a few natural conditions and gigantic catastrophes. This turns many classical assumptions and outlooks inside out. The problem is not human survival, but the survival of "nature." The problem is not what I would do if I had the time, but what will I do with the time I've got. It is easy not to think about stepping on some ant-like creature, but now we must think about things like that.

We learned our lessons in Nature's survival school too well. We are overqualified for any job on this planet, so we have to worry about inadvertently destroying the competition. It's the reason Superman appears to us as Clark Kent. If Superman did not love Lois Lane, what significance could she possibly have? It is the same with us and Gaia.

Exchange

Economists have always given special significance to the medium of exchange. It seems reasonable to assume accounting records were invented to support memory. When a man's possessions got beyond 10 or 20 things, some external reckoning was probably needed to remember it all and to assign some value to them. After that, it was an easy step to think of the reckoning as one's possessions; hence, the conversion of possessions into a medium of exchange. Tokens, coinage, and money were invented in the Middle East and China in ancient times. They seem magical, because 'a fistful of dollars' can change a life.

For thousands of years, people have been seduced by money. Almost everyone believes possession of money can get whatever is wanted: houses, cars, clothes, travel, health, companions, even love. We all know it doesn't buy eternal life, but few people think about that until it is nearly the end. Money, however possessed, has been a goal in itself.

But, cost and worth are not settled by the medium of exchange. It makes no difference whether values are set by barter, by reference or by token. Whether I am willing to work some time to obtain a slice of toast, or pay some money for the toast, or assign credits and debits for that toast matters little. There is something I offer in exchange, and there is the toast.

When there is unusual and extreme deflation or inflation, that is almost certainly a sign of things gone wrong. It doesn't matter what is the medium of exchange; destabilization can occur in any economy. The same situation can occur if trade is done in coconuts. Sticking to the gold standard or fixing the money supply won't solve the problem: Weimar Germany or the 1970s United States proved that.

I think an inflationary or deflationary episode is the result of a serious breakdown in social relations, not just a financial or monetary problem. The Great Depression was an American phenomenon. There were recessions or little depressions in other places at the same time, but only the United States was afflicted deeply from the 1929 crash until World War II. My mother, and many others, said The Depression was depressing. Americans went through some sort of crisis which was more than a matter of money. Maybe the Great Crash was a last straw, but, as many historians and economists have pointed out, The Great Depression need not have been the enduring catastrophe it was.

The onset of World War II ended the Great Depression. I think it was because Americans once again had a national purpose, were socially cohesive, and were willing to work for something more than mere survival. The War was accompanied by inflation, ration stamps, socialized everything and government control. After the war, all of that went away, but there was still regular inflation. Through it all, from the Great Depression until Ronald Reagan's election in 1980, the well being of the average American increased.

Since 1980, America has been on a conservative "kick," culminating in the 1990s Boom and the 2000s bust. The average American has been slowly going downhill. Business is becoming more and more profitable, and the rich are getting richer, all adjusted for inflation. Right now, in 2004, monetary inflation is very low.

In the last decade, like many other denizens of the First World, I moved away from barter and cash. I use credit to buy and sell almost everything. My financial life is almost entirely paperless, completely electronic. I might spend $10 of physical money in a month or so. My worth is a pattern of electrons on a chip somewhere. It is not held in anyone's hands.

Does any of this correlate with the value of gold, or money? Maybe. Does the value of money or gold cause inflation, deflation or other conditions, or cure them? Probably not; or, at least, I think not.

Based on that, I think gold bugs and monetarists are just silly or utterly suspicious, maybe even paranoid. Those folks live in fear of being cheated. They demand some assurance of value, when no assurance can ever be given. There is very little difference between the old habit of biting a coin and insisting upon "hard" money.

It find it curious that the same folks who fear being cheated, go about crowing when they manage to cheat some poor sucker out of a fortune. Feelings of inadequacy and paranoia are often compensated by strutting behavior and demonstrations of superiority. Someone who knows what he wants, and where he is going, should not have to go to either extreme. A trade made is a trade done; that's that, next.

People believe ideas like monetarism and the gold standard because they are entranced by numerology. It is all about counting: numbers are magic. But, mathematically, it doesn't matter how you count your riches, because there is a 1:1 correspondence between every denumerable set and the set of natural numbers. Rubles, Rupees, Yen, Euro, Dollar, or Dingbat: it's all the same. It buys the same stuff, it sells the same stuff.

People play games with money to gain advantage, that's all. There's no real reason to have a floating exchange rate, or a fixed exchange rate. All that really matters about money is that its units are convenient for the transactions people do, and that there is enough of it around to make transactions convenient. Electronic exchanges are nearly the perfect monetary medium, because there is nothing to prevent monetary expansion and contraction as required, in any number of decimal places.

Eventually, I believe, we will all use EARTH credit and debit. That eliminates most paper, coin, exchange rates and other finagling. People will be allocated credits and debits (loans) in new ways that have to do with their place in society, and social well-being. When that day arrives, and I do not think it will be long in coming, all the silliness about monetarism, gold nuggets and such fads will be exposed as historical curiosities.

Fields of Grain

How, then, are we to determine the value of something? What is the cost of a sustainable economy? What is its benefit?

The benefit of a sustainable economy is just that: it can continue for a long time without serious risk. If we are motivated to have a sustainable economy, it is for our private reasons. I think that is what we ought to do, but not everyone may agree. Lots of people believe in 'apres moi, le déluge.' For this discussion, however, it is assumed a worthwhile enterprise, so the only remaining question is its cost.

Let us take, for example, determining the cost of growing a field of wheat. How this would be evaluated depends entirely on the local culture, and the era in which the work is done.

Accidental Crops

At the beginning of "civilization," 10,000 years ago, people gathered wheat and rice. They did not grow those plants until someone discovered that plants grow from seeds. At that time, the cost of growing wheat - or any of the staple crops - would have been evaluated as "opportunity cost" plus "labor cost." The proto-farmer had to set aside time from hunting and gathering to acquire seed, and then more time to prepare the ground, manage the plot and, finally, harvest the crop. Most of the effort was opportunity cost: the time taken from meeting basic needs in order to plant crops. Labor costs would amount to the extra food and supplies needed to do farming instead of hunting and gathering; i.e., a surplus arising from hunting and gathering would be required to support farming.

The proto-farmer had to be very productive in hunting and gathering efforts in order to have time to manage a crop. It must have been that high productivity which created the means of paying the opportunity and labor costs. When wheat farming was invented in or near Iraq, the crop must have been easy to grow and not likely to fail. Otherwise, the payoff for domestic growth would have been too low, which is to say the investment required would have been too high. The risk of growing a crop was its failure, possibly resulting in famine. After all, the hunter-gatherers were probably very poor and very near starvation in their subsistence economy. The initial cost of growing wheat must have been very high, but worth the trouble for reasons other than the nutrition provided. (Maybe it was a tasty luxury food.)

In that early situation, it doesn't make sense to evaluate the cost of growing wheat in terms of currency or barter (except for retrospective comparisons). It is likely the only exchanges occurring were within the family unit, whether extended or nuclear. Initially, the cost of growing may have been reduced by assigning otherwise unproductive people (children, the aged) to that project. The cost of wheat could be measured in terms of the food, housing and other supplies required by those tending the crop. It could also be measured by the time required to provide those resources, and the time taken away from hunting-gathering. Thus, the cost might have been a goose or a deer or a (handmade) tool for a bushel of wheat. (I think archaeologists eventually might find some way to estimate that cost more accurately.)

Ancient Farms

Later on, once farming was established, the cost of wheat must have come down, and would have been measured differently. Growing wheat requires an organized life style most of each year. The growers would need food, clothing and shelter for at least 6-8 months. They would need tools to prepare the ground, and possibly methods to provide water on a schedule. They would need some knowledge of the seasonal calendar, in order to decide when to prepare, when to plant and when to harvest. They would also need some basic botanical knowledge in order to manage plant life cycles.

The price of wheat in this stage is not determined by opportunity cost, but by a combination of labor and resource inputs, and the surplus required to support ancillary services. There had to be a surplus - savings - to pay for the food, clothing, shelter, tools and seed required in perennial farming. In addition, probably there were payments to support the agricultural experts (such as they were) who had the knowledge about growing crops, and the temporary help needed to bring in a large harvest on time.

5,000 - 7,000 years ago, the price of wheat was probably determined by barter. The farmer traded his wheat for any other goods he needed, but most of what was needed was homemade. To survive, the ancient farmer had to be shrewd businessman, warrior, laborer and lucky. The ancients were entirely at the mercy of a changing climate, the fertility of the soil (which they did not understand), sun, rain and water at the right times, & c. The lucky ones probably eventually dominated everyone else. The price charged by the successful determined the cost of growing wheat, as, clearly, the unsuccessful did not (or could not) devote enough resources to the enterprise. It is likely most farmers were worse off than their hunter-gather ancestors, but had no way to know it.

In that description, I have in mind what I've read about the American Frontier and the Gold Rushes during the 19th Century. While the experience of the White Man on the Great Plains was certainly not a repetition of ancient travails, it does give us some idea of what it took to survive. Life expectancy was not high; in fact, it was much lower than in the settled, Eastern cities.

Modern Farms

Eventually, the farmers' "support" people became the priests, warlords, accountants and others who lived on the backs of the peasantry. The system of farming was turned upside down, ending the independent family farm. The English Yeoman and the American family farm were really throwbacks to a very ancient time, made possible by unique circumstances. Everywhere else, by modern times, peasants had been enslaved or enserfed for the benefit of elite classes.

The one thing that remains constant since earliest times is the inability of most farmers to survive and stay in business very long. Today, farming is still among the most hazardous occupations in America. Corporate agriculture succeeds, but family farms do not, probably because the lion's share of government subsidies go to corporations. Corporate agriculture also passes off a lot of the risks to life and limb to tenant farmers, farm hands and braceros. There is something about being the owner-operator of a farm that often leads to a short life and eventual bankruptcy. (Thomas Hobbes had the English yeoman-farmer in mind when he wrote, "the lives of most men are nasty, foul, brutish and short" (unlike Courtiers, aristocrats and City folk).

The cost of wheat is decided today by a very complex calculation, and valued in local currency ($, €, ¥, £, INR, RMB, etc). Growing wheat still requires the same old combination of real estate location and luck, but it also requires irrigation water, accurate weather forecasting, chemical fertilizers and pesticides, heavy machinery, precision tools, advanced biological services, specialized seeds, bank loans and other financial services, computers, commodity markets, grain elevators, railway and truck transport, processing companies, etc. All that and more are required in addition to food, clothing, housing, education, medical care, retirement planning and the other things involved in modern life.

I am fairly sure that the price of wheat today is low by historical standards. It is so because of the complex support system - the inputs - which make growing wheat a science, not an art. Modern methods take much of the luck out of the process, and even guarantee a harvest within a certain range of bushels/acre. The success of modern methods reflects the extent of our control of natural processes.

I am not a farmer, but I do know farmers can report just how much it costs to grow a bushel of wheat or corn, or a head of cattle, sheep, pig or chicken. We know this, exactly. The cost is the result of integrating many inputs, and also of feedback into the system.

Corn is turned into ethanol to fuel cars, but also into margarine, corn oil and many other things. It is very difficult to isolate the components of a modern economy, partly because they cannot stand alone. It is difficult conceive a modern farm lasting long on its own. Even the organic farmer needs a schoolhouse, a banker, and the County Agricultural Station.

Farms don't work according to the neo-classical laws of supply and demand. They are inelastic with respect to supply and demand. You aren't going to get more corn out the ground than seeds you planted. You cannot determine what the demand will be when the season is over, any more than you can determine exactly how much rain will fall and when. Further, you cannot just switch from corn and soy beans to kiwis and kumquats overnight; sometimes not at all. Some land is more suited to one kind of crop than other land.

Farmers must take advantage of what they have. They cannot hire some Madison Ave PR firm to force feed raisons, although many California agribusinesses continue to try (milk, eggs, cheese, raisons, wine). The fact is, resource-based industries just don't work according to Adam Smith's economics.

Experimental Approach

The only way the cost of wheat and iron can be determined is from a careful review of all the inputs, and assigning values to the scarcity of land, water, seed, ore and other limiting factors.

What is the cost of the irrigation water pumped up from under the San Joaquin Valley? How much would it cost to replace that water? Where would it come from, and how long would it take to develop?

What is the cost of replacing the oil we burn? What is the cost of getting rid of the carbon dioxide and other greenhouse gases? What is the cost of a destabilized climate system?

Does anyone really know the answers to these questions? Are the answers known a priori? Can they be known by some deduction from well established knowledge?

My contention is we don't know all the answers, but we should know as many as possible. To do that, we need to fund small scale research projects that determine the actual costs. There should be a valid, scientifically-based estimate of the cost of replacing San Joaquin groundwater. Such an estimate would be based on one or more methods of doing it. The estimate should indicate what happens if we do not do it. The estimate should provide ranges of expectation wherever possible. These estimates should be included in the cost of using that water; i.e., this "external" cost should be made internal.

These research projects should be incorporated into economic models, and pricing - by law, if necessary. The price of coal, oil, copper, iron and water (and many other resources) should include the resource cost, as determined by research and experiment. If the market price does not now include those components, the government should impose taxes and regulations to reflect the results of that research.

Currently, we are almost certainly using up our resources faster than anyone knows how to replace them. Sooner or later, we are going to run short of something critical, and then that's it, it will be all over. A rational economic theory will account for resource use, and suggest allocating a replacement cost. After all, businesses do this every day when they assign a service lives and depreciate the value of their properties.

Our economic ideas need not be exact, as they are in the Newtonian calculus used by professors of Eco 101. What they need to be is good enough; good enough to avoid economic disaster and even planetary catastrophes.

That is why we need to start with the idea of a sustainable economy, and do the research required to implement it. That is why governments should make laws based on sustainable processes, and not allow riches to pass into the hands of marauders.