I try to do a little more than just link to other people's writings, but this is one of the best articles I've read in a while:
Upwardly Mobile Africa: Boomtown Slum
And the correspondent undoubtedly knows a lot more on the subject than I do. The article tells the story of a day in Kibera, the largest shanty town slum in Africa. It is part of Nairobi, the capitol of Kenya. Around 1 million people live informally (i.e. as squatters), without a sign of the government, in one square mile.
The point of the article is that this is not a pit of humanity festering in poverty. It is a very poor place, but has a very entrepreneurial and growing economy. Signs of growth can be found all over, and new residents come from the country side to seek a better life. Many in Kibera have incomes above the poverty threshold (of $1.25 a day), many residents are counted among the middle class according to the World Banks threshold of $10 a day.
Before anyone gets too libertarian about it, the government can make these people better off. Their richer neighbors in Nairobi pay less for water and electricity because they don't rely on informal businesses to tap into the grid. But what can a cash-strapped government do? Formalizing the shanty town and giving property ownership to the residents would immediately boost their wealth and give the countless entrepreneurs access to capital.
A random thought hit me today. It’s about Ayn Rand, but don’t let that stop you from reading this. Ayn Rand argued that true morality was to not care about anyone’s interest but your own. Everyone pursuing self-interest would end up maximizing their own benefit. And if everyone’s benefit is maximized, society is best off. This logic comes from the First Fundamental Theorem of Welfare Economics, which holds that “competitive equilibrium is Pareto Efficient”. Competitive equilibrium means markets are perfectly competitive (no one firm has market power), and all in equilibrium (supply equals demand, no shortages or surpluses). Pareto Efficient means that no one person can be made better off without making someone else worse off.
There you have it, one paragraph. So if you were considering reading Atlas Shrugged, don’t worry about it. But there are a few essential requirements for the First Fundamental Theorem to work; and they can't possibly exist in the real world:
1. All markets are in equilibrium – The economist Leon Walras proved that if all but one market is in equilibrium (say, theoretically, 9 out of 10) the remaining unstudied market must also be in equilibrium. The flip side is that if any one market isn’t in equilibrium, other markets must also be in disequilibrium. Which sounds more likely?
2. No externalities/market failures/public goods – This condition can’t possibly be true in the real world. Think of pollution, without government regulation a coal power plant suffers no cost for pollution, but the wider public does. This means from the point of view of society, the power plant over-produces because its monetary cost of production is less than the true cost of production. This externality breaks the no surpluses condition of equilibrium. There are clearly market failures, asymmetry of information being a classic example. There are clearly public goods, such as education.
3. No interdependent utility – This is the condition Rand was so in to[1]. It means no one’s utility, or personal well-being, depends on anyone else’s. Parents don’t care about kids, friends don’t care about friends, etc. It clearly isn't the case.
So it’s impossible for the First Fundamental Theorem to exist in the real world, though it is a very useful model for studying economics theoretically. And it’s a shame people can’t distinguish between a thought experiment and legitimate policy. Pareto’s theories were eagerly adopted by supporters of planned economies because they can show that optimal efficiency can never be brought about by purely unregulated markets (which will not be perfectly competitive)[2].
The reason I bring this up is the last condition, no interdependent utility. Rand argued that an individual’s utility shouldn't be influenced by other individuals. She spent a lot of time on it, wrote rambling monologues on it, yelled “compromiser!” at Friedrich Hayek the only time they met. She cared that he wasn’t as much an ideologue as she was[3]. She cared about spreading her ideas, and convincing people to believe them. You could say that part of her utility depended on what other people thought and did. This of course violates the 3rd condition for the theory she espoused to be true. It simply can never exist; humans just don’t act that way.
This week the Federal Reserve has taken further unconventional action to attempt to stimulate the economy. In September the Fed announced it would buy bonds and other securities with newly created money to increase the money supply (more details here). With not much sign of things getting better yet, the Fed has expanded its asset purchasing (as in money creation) from $40 billion to $85 billion per month.
But that is only half the story. In September the Fed said it would continue making new money until unemployment falls back to "normal" levels, but only if inflation stays low. The limitations and thresholds were somewhat vague, which dulls the effect of the policy. However, this time, the Fed explicitly stated that it will continue creating money until unemployment goes below 7%, and keep interest rates near 0% until it goes below 6.5%. And even when it does they will not stop immediately, but rather gradually wind down the program. This is conditional on inflation staying near or below 2.5% in the short run[1]. The benefit of this policy is that the Fed is now committed in a clear manner to its stimulus. And as conditions change economic actors will know at what point the Fed policy will change.
I previously spoke of how large a change outlining policy in this manner is for the Fed. This is the first time ever the Fed has set an unemployment rate target[1]. Past efforts have involved set dollar amounts and calendar deadlines. Now the policy is still clear and predictable, but flexible and limited only by the accomplishment of its goals (you can find information on how monetary stimulus helps the economy here and here). I am a huge supporter of the Feds recent policy changes. While its no magic bullet and the magnitude of the effect is a matter of debate, it speaks well of our monetary institution that the Fed has been so able to adapt and act to economic conditions.
My only present concern is the focus on keeping inflation near or below 2.5%[2]. I've posted about why inflation is not a threat in this weak economy here and here. We would not be hurt by inflation in the 3 - 4 % range, inflation has been that high numerous times in the past two decades. Keeping inflation relatively low will dull the stimulative effect because the Fed can only reduce inflation by slowing down the economy. The low inflation ceiling could lead people to expect that stimulus will be withdrawn too early. Metaphorically, the Fed is giving the economy more gas while still keeping a foot slightly on the breaks.
Middling is a good way to put it. 146,000 jobs were added in November, which is pretty close to average. In the face of the uncertainty of the fiscal cliff, depending what effect that uncertainty has, average could be better than it seems. According to the BLS, hurricane Sandy had little effect on employment.
But the situation looks a bit worse once one looks deeper. The labor force participation rate declined, off-setting October's increase. This, and the added jobs, has brought the unemployment rate down to 7.7%. The data for the months of September and October were revised down by a combined 49,000 jobs, the first downward revision since April. The revision brings the monthly average job growth so far this year to 151,000, compared to 2011's 153,000.
