"Parity" Prices

0:00This is Jeffrey Tucker again. I'm here with yet another economist to talk about our new edition of Economics in One Lesson. We're covering two more chapters. The economist in question is Peter Klein. Welcome, Peter. Thank you, Jeff. It's great to be here. And the two chapters you're talking about, well, the first one begins with the title Parity Prices. Right. Parity Prices. I haven't heard this term in modern journalism anymore. What's up with this? Right. This is a term that, I guess it's a little bit archaic, you still see it in the technical economics literature, what they call purchasing power parity. Parity just meaning equality or sameness.

0:47So the concern that Hazlitt was dealing with in the 1940s is the worry that certain groups, Farmers, for example, would lose purchasing power if the prices of the goods and services that they produce, commodities, for example, did not maintain their parity from year to year. So as a general, the concern Hans-Luz is dealing with is the fear that prices will fall and that therefore sellers of those commodities will be harmed and that will have negative effects on other sectors of the economy and so on. So it's basically a plea to keep prices up. Well, it turns out to not do that much of a consideration anymore, partly because of inflation, right? Exactly, exactly. We don't worry too much about falling prices. Where we do see prices falling in industries like telecommunications, computers, of course we think it's a great thing.

1:35I mean, think of what a personal computer cost in 1980 or 1985 compared to what you got, $2,000, $2,500, $3,000 or something that doesn't have the computing power of the cheapest cell phone today Today, and you can get a PC for $500 today that's, of course, vastly greater than anything you could have gotten in 1980, Hazlett actually uses a numerical example like that with automobiles and shows how the real cost of producing automobiles has fallen and how we would think it was a horrible thing if we had to pay in today's dollars the equivalent of what we paid for a Model T Ford to get that kind of quality because we simply wouldn't pay for that quality Today. So in general, you know, price is falling is a good thing. It means there's an increase in productivity. So that I understand the argument. The argument concerning purchasing power is slightly different from the point that it's bad for the industry for prices to fall, because it is difficult to do business

2:37under falling price conditions, right? So talk first about this purchasing power point. What does it mean? Right. What he has in mind is the idea that that particular group in society, let's say that I am in the plumbing business and let's say that for some reason the demand for plumbing services falls and the market price of plumbing services goes down. I as a plumber have a hard time making ends meet. In general, you know, you might say, well, that's a sad thing, Peter. We're sorry for you. Maybe you should consider another line of work, but I as a plumber and my plumber friends I go to the state, I go to the American people, and I say, pity the plight of the poor plumbers. Wow, that takes a lot of alliteration. If we don't have plumbers, then society can't get by without plumbing, and we're a vital part of the American system, and so on.

3:30Your spending habits, or just the critical link in the... Our existence, and also our spending. In other words, if the plumbers go out of business, then they won't be spending money on the goods and services the plumbers buy, and there will be some sort of ripple effect throughout the whole economy. So essentially, it ends up being a kind of protectionist argument. It's interesting that even though this term, where we see the term parity as in purchasing power parity, where that appears today, it's more in the international trade and macro economics literature. I mean, this is in a series of chapters in which Hazlitt is talking about different kinds as a protectionism, special interest group politics, and he has in particular groups like agricultural producers in mind, that the call for agricultural producers to use government policy to keep prices from falling is just another form of special privilege for one particular group, a politically connected group.

4:21You know, I'm going to say that when you're presenting the argument, it's not inherently implausible, right? Sure. Yeah. Sure. It's absolutely true that, you know, when plumbers or farmers, let's say, are economically successful and doing well, they have money to spend on other goods and services, and there are certainly positive effects throughout the economy. But remember, there's a difference between the overall condition of the economy and the condition of one particular sector. And if we use government policy to keep prices artificially high for farmers, well, that means higher prices that consumers pay for food, less money that those consumers have to Spend on Goods and Services, and so on. It's really just, it all goes back to the basic lesson of the book, The Broken Window Fallacy. The argument that if we don't protect the farmers, the economy will collapse, is no different from the argument that what's good for one particular piece of the economy is necessarily good for all of it. It's the

5:17broken window all over again. It's also interesting, isn't it, that so much of this, I don't know if you would call it Keynesian macroeconomic theorizing or whatever it is behind there, especially Keynesian I It was good out of the experience of the Great Depression when it was widely believed that the falling prices were causing it. Yes, that's absolutely right. It makes sense in a sort of common sense intuitive way. If I'm a business person and I can't get a high price for the products that I sell, well clearly that's bad for me. I'm in poor economic shape if I can't get a high price for the things that I want to exchange on the market. And it doesn't follow from that that it's not the fact that prices are falling for my goods and services that is the cause of some sort of general economic problems, right?

6:10I mean, the falling prices are a result of, in this case, falling demand for the services of plumbers or the commodities produced by farmers or the services of economics professors or whatever it might be. So there's a confusion of cause and effect. You know it's interesting too how what's behind this macroeconomic theorizing is contrary to the interest of consumers, because as consumers you always want to pay a lower price. Absolutely. That's right. And we're all producers and consumers in a sense. And it's just like any other, you know, a tariff to protect the steel industry, for example. If you look only at the steel industry, it looks like, wow, higher prices for steel, higher profits, they can pay their workers more, and so on and so forth. Many people made that mistake. Exactly, and you forget about the fact that all the users of steel are paying higher prices and that those effects essentially, it's not just that they cancel each other out and are neutral, but the effects of the protectionist policy are actually harmful in terms of distorting the allocation of resources throughout the economy, directing resources artificially toward one particular sector and away from others, which is not according to the wishes of consumers as they spend.

7:18The argument that Wal-Mart shouldn't come to a city, come to a community, because look what happens, you know, the local merchants, okay, so it's a version of the same kind of argument, they'll have to lower the prices, then we'll be able to make a profit, and they'll have to go out of business, then Wal-Mart takes over. You can remember Hazlitt's one lesson that you have to see the whole story, the whole part and the whole system and not just one part. And of course if we look at a mom and pop business that cannot compete with a more efficient, more effective, more productive Walmart, of course it's sad for that mom and pop industry. But if we stop the analysis there, we've lost the most important part, namely that everybody else is actually much better off with the presence of a store like Walmart. Right. Evidently so, right? Or else they wouldn't go. and Walmart would go out of business.

8:04It's interesting that you mention Walmart because the next chapter in the book is titled Saving the X Industry. So the themes tie together. Exactly, same theme where he gives lots of examples of industries, steel automobiles, whatever it is, that claim to have a special standing in the economy. They're particularly important for economic prosperity. If this industry were to fall, well, then the dominoes will collapse. Shoes, what would be real without shoes? and of course it's very cleverly named Saving the X Industry because you can fill in the blank any way you like. Today of course it's the banking industry and the home mortgage industry and oh my goodness if we let Freddie Mac and Fannie Mae collapse, well then something else will collapse and then the whole financial system will go under. If we don't do something to stop foreclosures, all these people who lose their homes due to foreclosure, their The economic condition will lead to these spillover effects to sort of the rest of the economy and so on.

9:04It was the same thing after 9-11. Remember the airline industry and the insurance industry. We won't be able to visit our families across over on the west coast. Same thing. And the point is, you know, every argument like that ultimately boils down to some kind of special pleading why the state should favor my industry as opposed to other industries at the expense of other industries in the economy. The reason I had a seg to that from Walmart is because I was thinking about this argument. People who say we need to protect homeowners, we need to protect banks, we need to protect particular investment firms that bet heavily on these mortgage-backed securities and made the wrong bet. Walmart is a great example of a company that to the mass of consumers that it serves is of course heroic.

9:52to most intellectuals, professors, journalists and so on, is a sort of symptom of the evil of capitalism driving up a little guy and so on. But I think, suppose Wal-Mart were to be in financial hardship, suppose Wal-Mart were to declare bankruptcy or be on the verge of collapse, do you think the same members of the intelligentsia would be crying for the government to prop up Wal-Mart, to save Wal-Mart? Because it really is true. Think of all these small rural communities that are served by Wal-Mart and little else. Walmart would have disappeared right away. Masses of people would be much worse off, but I bet you wouldn't see the cause for Walmart because Walmart is so politically... Oh yeah, it could be. Of course, there are extra economic arguments typically brought into these kind of saving the X industry stories with steel or automobiles. Oh, people might make a national defense argument. We don't have a healthy U.S. steel In the case of agriculture, people say, well, agriculture is special somehow, it's part of the fabric of American society, the Jeffersonian ideal, we need to have, this sector has to be strong, it's important to have a strong agricultural sector, even if it's not purely for economic reasons, but just for sort of moral, spiritual, economic reasons, and so forth.

11:20and other virtual inspirational reasons. In fact, you do see that policy much more explicit in Europe, for example, where, you know, agriculture, having beautiful little, you know, communities, it's like rural France, it's like Disneyland, right, so the people who live in Paris and the big cities want to have the beautiful countryside to escape to, and they want to see a guy with a plow or a pitchfork, you know, the yeoman farmer in his little cottage, because it's part of the scenery. It looks pretty. And it's a purely economic story. It's sort of a political and social story as well. And it's why they keep out these big, big stores, big discount stores. Absolutely. It would ruin the landscape. Meanwhile, unemployment is very high. I've actually heard about a case where, a place in Europe where there are popular biking routes and where some local governments have put up fake cows and horses up on the hillside When the bikers are going by, they look off and they see this pastoral scene with the horses and the cows and so on, but they're actually just made of cardboard and they're off in the distance on the mountaintop to make it look more romantic.

12:29A virginian local industry, the manufacture of cardboard cows? You might think they would wonder at some point why the cows never move. Can I ask you something about the whole question of falling prices and doing business under falling prices? You mentioned the computer industry earlier. What are the kinds of challenges that an industry faces under these conditions? Well, it's extremely difficult because you not only have prices falling, but just the fact that prices are so uncertain. It's much easier to run, to be in business as an undertaker, where demand and supply conditions are relatively stable in a rapidly changing industry like IT, where there's all sorts of technological innovations coming down the road.

13:14On the other hand, we have to keep in mind, when we talk about falling prices in the computer business, for example, it's not just the price of the PCs that Dell or Apple or HP or Lenovo sell to consumers, but also the prices of the intermediate products that go into the computer are falling as well. I'm sure the final manufacturers are paying less for the products. Absolutely. It would be bad for Dell if output prices were falling but input prices remained the same. Then Dell would be in an increased, there would be a squeeze. But of course the prices of memory and hard drives and the LCD screens, all of the components, those prices are falling too. But you have to be very careful about inventory then, don't you? Oh, absolutely. What are the factors? It's just an extreme attachment to the whole question. You have to just have very good short-term forecasts.

14:02No, no. I think that's exactly right. Because if the manufacturer were to stock up on a bunch of components, when the component prices are high and not use them until the price of the computers has fallen, it would be a difficult thing. But that's why we see in industries like that a move towards the sort of just-in-time manufacturing model And of course, Jeff, remember there are other things that businesses can do. They can try to reduce price variability through long-term contracts with suppliers and with customers. So, you know, companies like, computer companies like Dell, for example, you know, most of their business is not simply sales to computers, but sales to large companies, government agencies, universities, and so on. And they often have long-term, long-term, long-term, long-term, long-term, long-term, long-term, long-term, from contracts with those clients where some prices can be specified ahead of time.

14:57So of course, doing business in a highly volatile sector of the economy is challenging, but there are many opportunities there as well. It leads to increases in efficiency, doesn't it? Oh, sure. I mean, we as consumers, we just sit and enjoy the ride, right? Ultimately, it doesn't matter to me a lot whether it's Dell or Lenovo or HP or whoever manufactures the computer. I mean, my goodness, look at all the goodies I get to consume. They're competing with each other, dog-eat-dog, in a highly competitive world in which their margins are getting smaller and smaller, but hey, it's great for the consumer. And it must be good for them, ultimately, I mean, they could easily leave the industry, right? There's nothing forcing anybody to be a computer manufacturer. Exactly, that's exactly right. And the same is true in other industries. Agriculture? Sure. It would survive under the following prices. I mean, an additional problem with the argument for propping up Industry X is that it sort

15:45sort of locks us into the way the economy is at the point that that legislation comes into place where we may wish things to be completely different. It's an obvious example that I use in class all the time is imagine that when the automobile first came around, if we had special protection for horseshoe manufacturers, blacksmiths, people who scooped up after the animals in the roads and so on, sure it would be good Good for people who are employed in that sector, but how would you like to be riding a horse and driving a horse-drawn buggy today as opposed to the automobile? The point is with the computer business, again, think how rapidly things change. Who knows what kind of computing devices the market will give us in 20 years, 10 years, even five years, if we were to try to keep things the way they are right now to have some short-term stability, we might lose out in a huge way in the long term.

16:41So how would you speculate what would happen to the housing industry if prices just continue to fall? What happens? Well, I mean, look, there are a couple different possibilities. I mean, if people's preferences for how they live and where they live and so on were to remain basically unchanged, there's going to be a demand for housing, right? Now, on the margins, some people who own their own homes might prefer to own condominiums or to be renters and so on, but it isn't the case that we're all going to start living Living in these massive, you know, collective apartment buildings where we live in family units of a thousand people each or something like that. So presumably there's a rough distribution of people between living in single-family homes versus apartments and so on. Probably wouldn't change that much, but, you know, there might be different entrepreneurs building the houses, different financial institutions funding the houses, and there might be different people living in the houses, sure.

17:37I mean, it's one thing that is so frustrating about the current mortgage bailout is how grossly unfair it is to people of modest means who didn't buy a house because they thought it was more financially prudent to rent, for example, and their friends of equal means who sort of recklessly purchased a house that they couldn't afford and signed an adjustable rate mortgage they didn't really understand and are now getting a subsidy check or are getting some kind of protection to bail them out, it's really unfair to the person who And the renter who's out on the housing market would probably appreciate housing prices falling a little bit more already. Jeff, you could turn the question around the other way and say to the person who advocates the subsidy, the protection of the bailout, essentially they're arguing that market forces don't work in this particular case.

18:31Space. Just as we had a horse and buggy industry at one point and now we have an automobile industry and there was a transition as technology changed, as new resources became available, as consumer preferences changed, we had a rapid, sudden dynamic shift from having one type of industry being prominent to having a new industry being prominent. Same thing with computers and aerospace and lots of other industries that we see. Well, if that's a If it's a bad thing, if we don't think the market can adequately meet people's demands and can adequately adjust for changes and for technological breakthroughs, well, I think the burden of proof ought to be on the critic to explain why the market doesn't work in that case. Why can't the free market handle housing? Why can't the free market handle food?

19:18Why can't the free market handle automobiles or clothing or computers or anything else? Instead, usually the burden is put on the defender of the market to explain why this regulation isn't needed. Well, okay, fine, that's the world we're in, that's the game we have to play, and sometimes it's fun to turn it around and put the shoe on the other foot. Isn't it interesting how we're somehow only now paying the price for this policy that began sometime after World War II? Absolutely. Isn't it remarkable? And again, I think there's an extra economic aspect to this, too. There's this sort of romantic notion of post-war, baby boom notion of the high house and the white picket fence and the 2.5 kids and the car in the garage and so on, and of course that's a wonderful thing and there's nothing wrong with having that sort of vision each of us individually having one vision or another of how we want to live but the use of government policy to promote one particular lifestyle one

20:09particular you know housing choice doesn't seem to be justified and when Hazlitt speaks about thinking about the long-term implications of policies in this case the long term is something like 60 years that's absolutely right remarkable that's right and again we have to that's another as you do well to remind us that Hazlitt, when he talks about looking at the big picture, it's, you know, the overall economy at any one point in time, and also looking at the long-run consequences. Again, think of housing. You know, sort of the legislation that's just working its way through Congress now, right? There's massive mail-out policy, people, they're not at all looking at the obvious long-run consequence of encouraging irresponsible behavior. I don't I don't know what else to call it. Anytime you have an industry like housing, airlines, automobiles, whatever it is that is perceived to be, quote, too big to fail, there's an implicit, anytime there's an implicit government guarantee to protect you and you run into hard times, well of course that's going to affect behavior, right? The economists call that moral hazard, but in layman's terms we would call it, you know, irresponsible or inappropriate behavior. Sure, of course, if I know my downside is covered, I'm going to engage in a lot more risky behavior than I would.

21:25If I had to bear the consequences of my own action, and people talking about this legislation today, most of its advocates are completely ignoring these long-run consequences of encouraging malinvestment in the future, because you know the taxpayer is always going to come and pick up the tab. Well, we've got the solution. Read the book. Absolutely. Highly recommend it to all of your viewers. Thank you for explaining all this to us. My pleasure. Great to be with you, Jeff.

21:55Thank you for watching!