This week the CEOs of the “Big Three” US auto makers boarded their private jets in Detroit and touched down in Washington to beg and plead in front of Congress for a “low-interest bridge loan” from the US government to help them avoid bankruptcy. They are asking Congress for $25 billion of taxpayer money to give them the chance to re-structure and re-equip themselves for the future.

Below are eight arguments based on basic economic principles for why a bailout of the United States automobile industry is a bad idea and is bound to fail:

1. Incentives matter: A bailout of the US auto industry ignores the basic economic principle that incentives matter. Individuals and firms respond to incentives, pursuing behavior that is likely to bring them the greatest rewards. In the face of falling demand for their product and ever-increasing competition from more efficient foreign producers, providing a $25 billion bailout creates a disincentive to drastically reduce costs and increase competitiveness, and an incentive to continue using tired old techniques and providing the same old models for which demand has declined among Americans for over a decade.
2. Comparative advantage: The basic economic principle of comparative advantage states that in an era of free trade and globalization, countries should produce the types of goods for which they have the lowest opportunity cost. Since the average American car of a particular class costs the Big Three $2000 more in wages and benefits for workers than its Japanese counterpart, it makes sense that Japan (and other lower-cost countries) produce more cars, and the Big Three produce less.
3. Efficient allocation of resources: The United Auto Workers Union has a member ship of over 400,000 workers. Since the 1970s the union has lost over 1 million workers. Clearly the US auto industry has been in decline for decades, a fact that should be taken as a sign: resources employed in America’s car industry are inefficient and represent a over-allocation of resources. A drastic down-sizing of the auto industry, while resulting in (In macroeconomics): The period of time over which wages and prices are relatively inflexible. A fall in aggregate demand will lead to unemployment and recession in the short-run. Due to the inability of the nation's producers to reduce wages paid to worker, they must lay workers off to reduce costs as demand falls.');" onmouseout="tooltip.hide();">short-run hardships for the hundreds of thousands whose jobs will be lost, will in the long run strengthen the US economy as labor and other resources will be freed up to be employed in sectors in which the US has comparative advantage.
4. Economic Darwinism or “the survival of the most efficient”: America has stood for free trade in the world since helping found GATT in 1948 and later the WTO. The gains from embracing free trade are shared among all stakeholders in the economy. Consumers enjoy lower prices (thus higher real income), firms enjoy access to cheaper inputs and larger markets for their products, and governments enjoy the increased tax revenues from rising incomes driven by export-led economic growth. To bail out an uncompetitive, inefficient, and long-declining industry is to spit in the eye of free trade and denies America any moral suasion it may hold in the future over potential trading nations in our attempt to open their markets to our nation’s products. To protect our own dying industry now will send a clear message to our trading partners. “America does NOT stand for free trade”. If we believe in free trade and the allocative power of markets, then we must let the dinosaurs of American industry meet the fate the natural selection of the marketplace has determined for it.
5. The benefits enjoyed by the few represent costs born by the many: A bailout by the US government of the auto industry will protect a few hundred thousand jobs for a few years at the most but spells a reduction in the disposable incomes and spending power of millions for years to come. The US does not have $25 billion laying around to give the Big Three, which means the money must be borrowed. Increased government borrowing raises interest rates now (further tightening the credit markets) and will result in increased taxes down the road. All government debt must eventually be paid off, and in the immediate future interest on this debt must be paid directly from tax revenue. A $25 billion bailout is the same as a subsidy, meaning it redistributes income and welfare from consumers to producers. Millions are asked to sacrifice for the continued survival of a few hundred thousand in an industry that has failed to evolve in a global auto market that has seen increased competition and efficiency from foreign firms for decades.
6. Moral hazard: Bailing out the Big Three today represent a classic case of moral hazard. When American industries fail to take steps to increase their efficiency and remain competitive in the face of increased global competition, they find themselves not surprisingly on the brink of collapse. To reward these firms by taking money out of Americans’ pockets and handing it to them to do as they will, we send the wrong message and create the wrong incentives in the American economy. The message is: “Don’t worry, the market doesn’t choose the winners and losers in the economy, the government does, and certain industries are too big to fail”.
7. Market failure, or Firm Failure?: The fate of the auto industry is in the hands of the US government. But so is the fate of the free market. My fear now is that the pendulum will swing too far to the left in America’s state of panic over the ill-fated downfall of the financial markets, rooted in the irrational exuberance and over-leveraging of big financial institutions. The failure of the financial markets, however, is an entirely different story from that of a dinosaur industry like automobiles. The Big Three have had decades to reform themselves, lower their costs, improve their products, and remain competitive. THEY have failed, NOT the market. Government intervention is necessary in instances of market failure, but NOT IN CASES OF FIRMS’ FAILURE TO COMPETE IN A WELL FUNCTIONING MARKET like the global auto industry.
8. Inflexible labor markets: I saw the president of the UAW on the news today giving 101 reasons why the government should approve a bailout deal for the Big Three. In fact, the unions that supposedly represent American Auto Workers are a big part of the problem the industry is facing. For decades the UAW has fought against wage and benefit cuts for auto workers, lobbying instead for higher tariffs and other barriers aimed at keeping foreign cars out of the country. This anti-competitive behavior is a major reason the Big Three cannot compete with European and Asian car makers today. Wage inflexibility leads to higher unemployment. Unions keep wages from going down, leaving the Big Three with one of two choices: Drastically downsize your workforce and employ fewer high paid auto workers, or beg the government for a multi-billion dollar subsidy to that the unions can be placated and you can survive for a couple more years until you’re in the same situation all over again. The unions helped cause the problem, now they should pay the price by experiencing the downsizing their demands inevitably foretold.

The US government should allow the free market to function and let the dinosaurs go extinct. Cars will still be made in America, they’ll just be made by the better, more efficient firms that emerge from bankruptcy when this is all over, as well as the numerous foreign firms already making cars in the US. Survival of the most efficient, that’s what markets are all about. Allowing the market to work will strengthen the US auto industry far more than a “short-term low-interest bridge loan” ever will, it will free up labor and capital resources to be employed by industries the country is better at, and make sure household income is NOT reallocated to inefficient firms to be squandered on the manufacture of a product for which demand has steadily declined for the last decade plus.

This post is in response to my colleague and fellow WW blogger Steve Latter’s recent post titled “Private market compesation: AIG CEO vs. Kobe Bryant”. It’s always enlightening to read Steve’s excellent posts, which really put things in perspective. With regards to CEO pay, it is a bit ironic that while Americans are all worked up about the high pay of its top executives, no one’s up in arms about the exorbitant salaries received by America’s professional athletes!

However, I wonder if Steve’s claim that limiting professional athletes’ pay would send the country’s top basketball players packing for leagues in other countries is true. A while back I blogged an article that asked the question of whether Lebron James would be offered a contract from a European club. James claimed that in order for him to even consider playing in Europe, he would require an offer of at least $50 million per year, more than double what he makes playing for Cleveland.

ESPN.com – Source: LeBron would consider European offer of $50M a year or more

…the Cleveland Cavaliers’ strongest competition for LeBron James’ long-term services could be the deep-pocketed new kid on the block — Europe.

A person close to James said Tuesday that the Cavaliers’ superstar would strongly consider playing overseas if he was offered a salary of “around $50 million a year.”

James’ current contract expires after the 2010-2011 season, but he can opt out after the 2009-2010 season, and while several NBA teams are working to create salary cap space for his impending free agency, none could offer a contract beginning at even $20 million a year.

So, would Kobe be on the next plane to Lithuania if the US government (or the NBA) limited his pay to $5 million? I doubt it. That brings us to the more urgent question: Would America’s top business executives begin shipping their families and all their belongings off to Jakarta or Dhaka, Delhi or Singapore, London or Paris, if the US government attempted to limit the compensation packages of its executives? Maybe, but there are many reasons to work and live in the United States beyond the salaries offered by firms for their top executives. And upon a little research, it turns out that European executives’ pay packages have in fact been under regulation by governments for quite some time, and as a result, the incentive for American executives to jump ship for European firms should US executive compensation come under regulation may not be as strong as Steve implies.

Executive pay in Europe | Pay attention | The Economist

How excessive is bosses’ pay in Europe? It has certainly risen sharply in the past ten years, as European firms have had to compete globally for talent. Foreign bosses now run seven of the firms in France’s CAC 40 index and five of Germany’s DAX 30. American-style bonuses and long-term incentive plans are now the norm.

European firms now benchmark pay against international peer groups in their own industries, rather than against domestic rivals, according to Piia Pilv, a pay expert at Mercer, a consultancy. But they still pay a fraction of the sums trousered each year by American executives. According to Hay Group, a management consultancy, the median European executive earns just 40% as much as his equivalent in America (see chart).

Most importantly, European companies appear to be more determined than American ones to link pay to performance. “Firms in Europe have tended to put more stringent conditions on long-term incentive awards than in America,” says Richard Bednarek, global director of executive remuneration for Hay Group. In America grants of shares are often not tied to performance, whereas European firms generally attach performance criteria to any grant of shares, typically depending on a comparison with a peer group. Such schemes often do not pay out at all, says Mr Bednarek. Dan Vasella, boss of Novartis, a Swiss pharmaceutical giant, and a favourite target of pay activists, earned SFr17m ($14m) in 2007, down 33% from 2006, because he missed his targets.

Clearly, the incentive to head to Europe as a result of increased scrutiny of executive compensation in the US is not as great as it would be if there did not already exist a threefold gap between US and European executive pay.

The liberal in me wonders if there is such a thing as “unfair” CEO compensation. The free market advocate in me points to other markets governments have attempted to control prices in, and the clear inefficiency that such regulation creates. Governments limiting executive pay, in theory, should have a similar effects to rent controls, or price ceilings in other markets. The quality and quantity of apartments available under rent controls declines, and price ceilings on other goods often result in demand". Occurs when the price is below the equilibrium level, for example, when a government imposes a price ceiling in a market.');" onmouseout="tooltip.hide();">shortages, meaning there’s not enough to go around among consumers… the quantity demanded exceeds the quantity supplied.

In the case of CEO pay in America, limiting compensation should, in theory, result in a shortage of highly qualified executives willing to head up American firms. But let’s be honest, even if the government placed highly stringent limits on the compensation of the country’s executives, the average executive in America would still likely be earning more than his counterpart in Europe. And since the average American CEO earns something on the order of 250 times what the average worker in his firm gets paid, increased regulation of CEO pay only help narrow this enormous gap slightly, but the incentive to make it to the top will still be strong among American workers.

Conclusions? It’s a tough issue. I want to have faith in the free market, in the price mechanism, in the efficacy of laissez faire economics. But the moral hazard of “golden parachutes” is a real concern. Should an American CEO be rewarded if he fails in his job? Steve makes the case that this “insurance” policy is necessary to attract the best and brightest to the firms willing to pay them most. Then again, something about the way the free market has created such a huge gap between executive pay and the pay of the average worker, and the threefold gap between America’s CEOs and Europes makes me think, “forget the free market, we need to get this insanity under control.”

Economists see financial bailout as necessary – Yahoo! News

Economists in the US are calling this week’s bailout of numerous US companies a necessary step in ensuring that no permanent harm is caused to the financial system and that we do not head into a deep recession.

The Treasury Department under the leadership of Henry Paulson is currently asking congress to move quickly on a bill that would provide $700 billion to the Department to buy up much of the bad debt that many financial institutions have incurred over the past years. Where’s this money going to come from? Since it doesnt look like the Bush Administration will be pushing for increased taxes anythime soon, Congress will have to borrow the money. 

Though most economists are agreeing that this is a necessary step in ensuring the integrity of the economy, I believe that it is important to look at how this additional debt may effect our government and economy in the future. So lets start with some numbers. The following statisitics are taken from the above article.

The deficit for this budget year, which ends on Sept. 30, is expected to rise to $407 billion, a figure that is more than double the $161.5 billion imbalance for 2007, reflecting what the economic slowdown and this year’s $168 billion economic stimulus program are already doing to the government’s books.

The Bush administration is estimating that the deficit for the budget year that begins Oct. 1, which will cover the new president’s first year in office, will hit $482 billion, a record in dollar terms.

And that forecast doesn’t include the $200 billion the administration committed to spending two weeks ago when it took over the nation’s two biggest mortgage companies, Fannie Mae and Freddie Mac.

And it doesn’t have any of the $700 billion the administration is seeking to soak up the bad mortgage-backed securities that have been at the heart of the severe credit crisis the country has been struggling with since August 2007.

The legislation the administration is now seeking to authorize the financial system bailout, according to a draft obtained by The Associated Press, would boost that debt limit to $11.3 trillion, up another $700 billion.

It is the rapidly rising debt that is cause for concern. The government is already spending more than $400 billion a year just to pay interest on the national debt. The higher that debt goes, the higher the government’s borrowing costs and the less it has to spend on other programs.

Discussion Questions:

1. What impact does the knoweldge that the government will bailout struggling financial firms have on investors willingness to take risks?
2. Should the government intervene in these finacial markets or leave the “invisble hand” to its own devices?
3. What are the opportunity costs associated with this decision?
4. What are some short term and long term implications of this bailout?

The summer before last, I spent three weeks exploring the mountains, beaches, volcanoes and temples of the Indonesian island of Bali. While crossing Bali’s central mountain range, I stopped at a produce market where local fruits, vegetables, coffee and nuts were brought in from the surrounding hills to be sold. As I strolled the market snapping pictures, I caught out of the corner of my eye a flash of a familiar shade of red. Upon closer inspection, I was surprised to find a “Blue Chelan” apple from Washington state (my home state!).

I could not help but be shocked to see a fresh red apple grown on another continent in another hemisphere on the Eastern slopes of the Cascade mountain range of Washington state for sale in a farmer’s market in a remote village 60 km from the nearest port. It got me thinking about globalization, trade, specialization and comparative advantage. So I pose these questions to you, my Econ students:

Discussion Questions:

1. How did a ripe apple grown 9,000 miles away in the United States end up fresh and shiny in a market 1500 meters up in the mountains of Bali? I mean, literally, HOW did it get there?
2. Why would Indonesia import apples from so far away when surely it could grow apples domestically and avoid the hassle of transoceanic transport?
3. Where did Indonesians get the dollars to buy US grown apples?
4. How does trade between Indonesia and the US affect consumers? Producers? Is trade between these distant countries good or bad? Discuss.

Switzerland “could become a feudal state” claims an economist. – swissinfo

One Zurich economist thinks so:

In Switzerland 71 per cent of the wealth is concentrated in the hands of just ten per cent of the population – a figure that economist Hans Kissling finds alarming.

Kissling tells swissinfo that the gap between the rich and everyone else is growing and that this could threaten traditional Swiss democracy and the economy. He makes a call for an inheritance tax for the wealthy.

Statistics show that the 300 richest people have become 40 per cent wealthier in the past eight years, whereas most of the population has a lower income than at the beginning of the 1990s

Kissling has nothing against wealth, he just thinks that if someone did not earn their wealth but inherited it instead, they should have to share a bit with the rest of society.

I call for a tax on very high inheritances, from SFr1 million ($900.000) upwards, and only on the excess value of that. I certainly don’t want people to think that they can’t pass on their family home to the next generation.

I’m only interested in trying to stop any creeping feudalisation, to avoid having huge clans like in South America, which threaten the economy and the political world

He’s most concerned that if the gap between rich and middle class continues to widen and the middle class of Switzerland don’t start benefiting from the country’s growing wealth, there could be a dangerous backlash against the free market system.

…the richest one tenth of a percent in Zurich – there are no full Swiss statistics – had 677 times more wealth than an average citizen in 1991. By 2003, 12 years later, the richest one tenth of a percent had 1,027 times more wealth. So the gap has really grown.

The middle classes, unlike the lower classes, have not benefited from any concessions, such as health insurance or childcare allowances. Here they have to use up all their assets before they receive any support. The lower classes have help from the beginning. This is why the middle classes are threatened

Discussion Questions:

1. Why does a growing gap between rich and middle class threaten social stability in Switzerland?
2. What would advocates of socialism propose in order to avoid future struggles between the rich and the middle class?
3. What kind of tax system would help re-distribute the wealth of Switzerland and narrow the enormous gap that exists here?

Capitalism and democracy: friends or foes? | Free exchange | Economist.com

How Capitalism Is Killing Democracy – Foreign Policy (abstract only)

“Why is FREEDOM so important in a market economy? If people in society are not free, can a market economy truly succeed?”.

Friday’s class discussion focused on the different answers to the basic economic questions offered by centrally planned versus market economies. 

The question I left them to ponder over the weekend had to do with an apparent paradox visible in China today: that of a free market economy seemingly thriving in a society where political and social freedoms are severely limited by the communist dictatorship. It has long been claimed that free markets will be followed closely by political freedom, and vis versa. The two are thought to go hand in hand. According to the Economist.com’s blog, Free Exchange:

The late Milton Friedman emphasized that economic freedom promotes political freedom and is also necessary for the sustainability of political freedom over time. His underlying logic is that competitive capitalism separates economic power from political power. One could point to Chile, Taiwan and South Korea as examples where Friedman’s logic seems to hold.

So if, as Friedman said, free markets lend themselves to free societies, then how has China’s thriving market economy not resulted in a freer society, even after 30 years of economic liberalization? Robert Reich, writing in the Foreign Policy Journal examines the issue in some depth:

Conventional wisdom holds that where either capitalism or democracy flourishes, the other must soon follow. Yet today, their fortunes are beginning to diverge. Capitalism, long sold as the yin to democracy’s yang, is thriving, while democracy is struggling to keep up. China, poised to become the world’s third largest capitalist nation this year after the United States and Japan, has embraced market freedom, but not political freedom. Many economically successful nations ”from Russia to Mexico” are democracies in name only. They are encumbered by the same problems that have hobbled American democracy in recent years, allowing corporations and elites buoyed by runaway economic success to undermine the government’s capacity to respond to citizens’ concerns.

Of course, democracy means much more than the process of free and fair elections. It is a system for accomplishing what can only be achieved by citizens joining together to further the common good. But though free markets have brought unprecedented prosperity to many, they have been accompanied by widening inequalities of income and wealth, heightened job insecurity, and environmental hazards such as global-warming.

What can explain the recent divergence of capitalism and democracy in countries like China, Russia and Mexico? The Free Exchange blog explains:

The cause of this divergence, Mr Reich contends, is that companies seeking an advantage over global competitors have invested increasing amounts of money in government lobbying, public relations and bribery. This process of corporations’ writing their own rules has weakened the ability of average citizens to have their voices heard through the democratic process.

So it appears that as capitalism and free markets have flourished, freedom of the individual has been trumped by freedom of the corporation to lobby and thus influence government into creating favorable environments for investment and growth, often times at the expense of society’s health and the best interests of the public as a whole. We will learn a term for this kind of activity in AP and IB Economics: rent-seeking behavior.

As firms grown larger and industrial and commercial power becomes concentrated in powerful multi-national corporations, the priorities of governments seem to be shifting away from individual freedoms and civil rights and towards the interests of the corporate world, whose money and influence run deep through the veins of the world’s governments.

So perhaps I was wrong. Maybe Milton Friedman was wrong too. Perhaps the 21st Century has bred a new relationship where free market capitalism is wed not to democracy, but to a new kind of corporatocracy, a term used by Noam Chomsky, in which governments bow not to the will of the people they govern, rather to the pressures from corporate entities. Freedom and justice for all (firms, that is). Gives you something to think about, huh

Discussion Questions:

1. Do free markets lead to free societies?
2. Is political freedom a prerequisite for a successful market economy?
3. Has “corporatocracy” surpassed democracy as the dominant influence in the rich, developed countries of the world?
4. In what ways could economic strength come at the expense of individual freedom?

Powered by ScribeFire.

Is international trade really as good for a nation’s standard of living as economists say? And, what the heck is comparative advantage anyway? And what about the foreign currency market and those confusing supply & demand curves? Yes, the quest to understand the economic benefits of international trade is enough to make any citizen or first-year economic student vomit, tremble, get a headache, or at least curse.

Having been an AP Economics’ teacher for 8 years now, I must candidly admit that it took me a few years of study and research to try to reduce international trade to pure simplicity and understanding. Let me give it a shot below. I love simplicity.

The average “Joe Citizen” in almost any country in the world is suspicious of trade, and rightfully so, since he reads or observes factories being closed, jobs lost, and the feeling that somehow his country is going down the toilet as his own home fills up with foreign-made products. Unfortunately, what Joe Citizen does not understand is that the money his own nation is spending for those foreign products (imports) is spent right back into the pockets of his own country, increasing employment and income.

Let’s take a single, real-world, international trade example being careful to accurately explain the whole economic story:

Let’s say that the United States (we’ll say Wal-Mart) decides to buy several shirts costing $400 from a Chinese shirt manufacturer, in lieu of buying those same shirts from a shirt manufacturer in Elon, North Carolina (USA). As a US AP Economics’ teacher I am one of about only 47 Americans in Fairfax County Virginia, which not coincidentally ties to the number of AP Students I taught this year, that quickly understand that the decision to purchase the shirts from China, in lieu of the US manufacturer in North Carolina, is actually BETTER for America and will make my home country better off in the long run! What? Mr. Latter, are you Benedict Arnold, the American traitor, reincarnated?

Let me explain how the US benefits (and China too!) in simple terms ignoring foreign currency transactions, which will just confuse the discussion and cause the student to lose sight of what is really happening:

The first key point is that when Wal-Mart buys the shirts from China for $400 it can only pay China with US dollars. Why? Because Wal-Mart has only US dollars! It has no Chinese currency (Yuan). It literally drains its bank account of US dollars that are transferred/paid to China!

The second key point is that when China receives that same $400 US dollars for the shirts, China cannot, unfortunately, spend any of the $400 in its own economy since only the Yuan is accepted as a medium of exchange in China! China is now forced to either throw the currency away (not advised!), or immediately spend the money back to the USA (advised!).

In summary, China has actually traded a product (shirts!) for paper (US dollars!), and those US dollars cannot be spent in China. For China to receive any value at all for the shirts it sent to America, China must now spend the $400 back into the US economy for, say, a global positioning system (GPS) from FleetMatics out of Waverly, Massachusetts (USA). Cutting through to simplicity, in essence, it’s almost as if Wal-Mart (USA) just paid FleetMatics (USA) $400 directly for the shirts!

Yes, the “punch line” is that all home-currency spending by the domestic nation on foreign products (imports), in turn, are spent right back to the domestic nation increasing the domestic nation’s employment, income, and standard of living. (Note; this is shown in a nation’s balance of payments schedule which always nets to zero, but, yuk, who cares about that right now with summer coming!)

And, yes, let’s not forget that Elon, North Carolina shirt maker that did not get the original $400 from Wal-Mart in our above example! Our nation loves competition (ready for the Olympics?) and I am excited to see if that North Carolina shirt manufacturer can “raise their game” (increase productivity), and hopefully get the next shirt contract from Wal-Mart or some other firm! If not, well, that North Carolina firm may just have to close down.

If you are still reading this post at this point, you may be thinking the following if you have a little economics’ background: “But the US has a growing trade deficit with China, so China may not immediately buy that GPS system from FleetMatics for $400”. And, you are correct, but that is also not a problem for either the United States or China. What China is really doing right now is deciding to temporarily save or invest a minority percentage of their US dollars received back into America in lieu of buying US products. Said another way, China is not buying as many GPS’ as the US is buying shirts and, of course, we call that phenomenon the US trade deficit which immediately seems to speak “problem”. But it is really no problem at all! China is still spending their “saved” US dollars back into the US economy, but in different ways. China is saving and investing some of those US dollars directly into the United States economy by building plants in America, buying US stock to fund American companies’ expansions, and temporarily saving some of their dollars, for future US purchases, by buying US bonds to help the US government pay for the war in Iraq, the war against terrorism, and several other US government initiatives necessitating borrowing. Eventually, China will sell these US bonds and buy that GPS system or build more plants to employ more Americans!

Now one last thing. Promise! Let’s get back to why trade is really so economically advantageous to any nation that pursues it. And by advantageous, I mean how it increases our incomes and standards of living. In one word, the answer is “productivity”. If we go back to the original example of the US buying shirts from China and China taking the US dollars to buy the GPS, we remember that the shirt manufacturer from North Carolina was “left out in the cold” because Wal-Mart did not buy the shirts from them. We can logically conclude that perhaps some Chinese manufacturer of GPS systems was “left out in the cold” because some Chinese business elected to buy from FleetMatics in the USA, and not the Chinese GPS manufacturer. Wow, I love global competition! What a great way to incent businesses in both the USA and China to compete against each other and increase their productivity and conserve our nations’ scarce resources, increase our choice, and lower our costs!

Discussion Questions:

1. Which basic economic principles underly the emergence of international trade as a global economic force.
2. Who are the winners and losers of trade between the US and China as explained above?
3. Why do you think free trade is such a controversial topic among certain groups of Americans an other Western nations’ people?

One of the many reasons that I find the study of economics so fascinating is that what so often appears to be a negative situation to the average citizen is actually a positive one. In other words: “down is often up” and “black is often white”. One of my favorite examples of this “180 degree moment”, and why I love to teach AP Macroeconomics, relates to the study of unemployment.

UN chief warns world must urgently increase food production – Yahoo! News

So you don’t say things that make you sound stupid to people who have studied economics, i.e. AP Econ students. Here’s UN chief Ban Ki Moon speaking at a UN conference in Ghana this week:

“One thing is certain, the world has consumed more (food) than it has produced” over the last three years, he said.

Ban blamed a host of causes for the soaring cost of food, including rising oil prices, the fall of the U.S. dollar and natural disasters.

He said he would put together a special task force to help deal with the problem and called on the international community to help…

“We need a real world and not the world of economic theories,” Ban said. “I will work on this right now with a sense of urgency.”

You know who says things like that? People who don’t understand the basic economic theories. Sadly, the theory Mr. Moon is missing here is one of our science’s most basic and simple to understand: that of supply and demand.

First of all, I’d just like to point out the absurdity of his first statement, that “the world has consumed more than it has produced.” Mr. Moon, I’d like to ask you this: If our world has not produced all the food we’ve consumed, then whose world DID produce it? Can’t we just call up the world where all the extra food we’ve consumed was grown and ask them to send us more?

Next, regarding Mr. Moon’s “task force” that he plans to form to deal with the problem, my question is this: What can a handful of bureaucrats accomplish around a table in New York that the market can’t do on its own? Rising food prices send signals to farmers who grow food; a signal that sends a very clear message: “GROW MORE FOOD!”

I’m sorry, but Mr. Moon and his “task force” can spend all the time and money they want brainstorming ways to get farmers to grow more food, but in the mean time the invisible hand of the market, guided by price signals sent from consumers to producers, will work its magic to allocate more resources towards food production and away from alternative uses of grain crops such as ethanol production, eventually shifting the supply curve of food out, stabilizing food prices.

Mr. Moon’s intentions are honorable, but his means of achieving his goal are misguided in an era of the market mechanism, which underpins most of the world’s agricultural economies today.

Live from Shanghai – OnPoint with Tom Ashbrook

The 21st century has been called “China’s Century”. With the Olympics in Beijing in a couple of months, the torch relay touring the worlds’ major cities has been met with fierce anti-China protests as angry activists have accused China of countless offenses from human rights violations to oppression of democracy movements to environmental destruction. Although it may be “China’s Century”, it sometimes seems that the rest of the world is not too happy about China’s emergence as a global superpower.

Last week, NPR’s Tom Ashbrook, journalist and host of the OnPoint radio program, visited Shanghai and featured daily stories about China in the world today. Below is an excerpt from the first of these stories, which caught my attention because it shared a minor fact that I had never heard before but which I find extremely interesting. Ashbrook’s guest, David Lampton, is a leading scholar on China’s re-emergence as a global superpower. Listen to what he says here:

China's Challenge - OnPoint with Tom Ashbrook [ 0:01 ] Play Now | Play in Popup | Download

“Re-claim their share of global GDP?” you might be asking? Here’s the thing… for much of the last 2,000 years, China was THE leading superpower in the world. In fact, up to the 1430′s, China had the largest navy in the world, had established tributary relations with dozens of kingdoms from Southeast Asia to India to Africa, had established and secured trade routes stretching overland to Europe and by sea as far away as East Africa, and some even think Chinese explorers had made it to North America seventy years before Columbus! While Europeans were dying of the plague by the millions and struggling under absolute poverty in a feudal society where the idea of national unity was still a century off, China had grown to be the largest empire the world had ever seen, first under the Yuan Dynasty and then the Ming.

As professor Lambert says, China’s GDP, or its total output of goods and services, accounted for ONE THIRD of the world’s output during much of the common era. This fact shocked me, but made sense once I thought about it. China truly was the greatest example of a global superpower the world had known by the 15th Century. Much of its wealth and power was a result of its efforts to globalize, or to integrate itself with the economies of the foreign nations, empires and kingdoms. Trade with its neighbors, near and far, had helped enrich China, but also built among China’s leaders a rightful sense of superiority over the other peoples of the world.

It was this sense of superiority that would lead to a long period of decline in Chinese dominance of the global economy. In 1432, the Ming emperor ordered the trading vessels of Admiral Zheng He destroyed. 3,000 of the largest ships the world had ever seen were sunk to the bottom of the Yangtze river and the East China Sea. The emperor declared China as “The Middle Kingdom” and ordered that all links with the outside world be severed, as China had no need for trade with others. China, the emperor claimed, was totally “self-sufficient” and could flourish without trade with the “barbarian” outsiders.

What followed was a long period of decline in China’s superpower status. From 1432, through the fall of the Ming in 1644 throughout the subsequent Qing Dynasty, into the 20th Century which saw repeated shifts in power between KMT, the Japanese and finally the CCP, China for the most part resisted attempts by its own and by foreigners to open its doors to the world, welcome trade, and encourage globalization of China’s rapidly dwindling domestic economy. The belief that China was “self-sufficient” endured while China’s share of total economic activity in the world dwindled to nearly nothing.

In the mean time, Europeans “discovered” the New World, philosophized about the gains from trade, integrated their own markets and later the markets of the colonies in Asia, America, and Africa, and grew wealthy as a result of these global exchanges. All the while, China stuck to its path of isolationism and self-sufficiency, as its influence and power slipped ever deeper into obscurity.

This period of isolation essentially lasted until the death of Mao Zedong, who could basically be called China’s last emperor. Since 1978, China has followed a new path, one that has attempted to reverse the mistakes of past dynasties, based on the doctrine of isolation and protection of domestic markets. Since its re-emergence as a global economic superpower, China has rapidly seen its share of global GDP increase from less than 2% in the 1970′s to around 16% today; a rebound achieved only through year after year of rapid economic growth, fueled by exports to the rest of the world. Isolation, it appeared, was not the path to wealth and power. China had discovered a new path, one that has done wonders for it income and standing in today’s circles of global power.

China’s re-emergence was made possible by one simple shift in doctrine and philosophy among its leaders: the belief that trade is good. While today the country still has many obstacles to overcome, such as the environmental challenges posed by growth, achieving a more equal distribution of wealth and income, fostering the growth of a domestic market to lessen its dependence on exports, and the challenges relating to human rights and demands for democratization, it would be wrong to say that China has not benefited from economic globalization in many ways.

A little history lesson is sometimes necessary to better understand where China is coming from and where it is going on its path towards re-emerging as a superpower in the global economy. The West, in the mean time, should pause to consider the rightful place the Chinese people believe is theirs based on their long history of economic power and dominance that for hundreds of years placed China at the pinnacle of power in the world economy.