Bridge the Gap?

Photo by Ragnar Vorel on Unsplash

September 6, 2020

by Steve Stofka

What issues are your priorities this election? For more than thirty years Pew Research has surveyed people about their priorities. For the first time in 2019 a majority of 765 respondents answered that there is a “great deal” of difference in where each party stands, up from 25% in 1987 (Pew Research, 2020). I’ve included the full list at the end.

In January 2019, soon after the midterm elections Pew surveyed 1500 adults (Jones, 2020). I don’t know why the abortion/free choice debate is not on the issue list since that single issue may decide some voters. I’m particularly interested in the large gaps in those priorities among those who lean Democrat or Republican. I’ll start with gaps of 25%. For instance, terrorism is a concern for 80% of Republicans but only 55% of Democrats. Other Republican priorities are Immigration, the Military and Crime.

As you can see, these are fear issues. Should a person in a town of 2000 be more concerned about terrorism than a resident of NYC? Of course not, but it is what it is. People vote out of fear and hope, but fear probably wins the wrestling match, especially among Republican voters who are not hopey, changey voters, as former VP candidate Sarah Palin noted (Gonyea, 2010).

The issue of crime illustrates the conflicting complexities of these issues. It is a 60% priority for Republicans, who are in suburban and rural areas where there is less crime, and a 40% priority for Democrats, who are in dense urban areas where there is a higher incidence of crime. Because crime is much lower than in past decades, this issue has slipped as a priority for Democrats (FBI, n.d.).  

Two of the highest Democrat priorites – Cimate Change and the Environment – have a huge gap of 50% with Republican voters. Democrat politicians have not been able to make these two fear issues personal for Republicans. If they could, they would draw more voters to their side on this issue. 25% gaps exist on issues of the Poor and Needy, Health Care, Education and Race Relations. Rural Republican voters are more likely to be poor and needy, but this is not a fear issue for them (USDA, n.d.).

What strategy would a politician or political consultant advise? Run toward the base? If so, one would emphasize these issues where there are large gaps between the two primary factions in this country. The President has largely adopted this strategy. Republican voters are more inclined to fall in line and the President is relying on this party loyalty even if they don’t like him personally.

Some issues where there is a smaller gap between factions are the economy, the budget deficit, jobs, global trade, drug addiction, transportation, Social Security and Medicare.

A politician reaching out to voters on the fence in this election would focus on these issues. Joe Biden hits the jobs theme, the budget deficit, and protecting Social Security and Medicare to appeal to voters who have had their fill of the President’s divisiveness.

In the coming two months, candidates may adjust their strategies. In the 2016 election, Hillary Clinton may not have addressed these shared concerns as well and it cost her the election.  Governing comes after winning an election. In politics, winning is packaging the concerns and identities of voters into an appealing, if not attractive, box that will get them to come out and vote.

What are your priorities this election season? Are you a multi-issue voter, a single issue voter, a party voter regardless of the issues? Here’s the Pew survey list of 18 issues: terrorism, immigration, military, crime, climate change, environment, poor and needy, race relations, health care, education, economy, Social Security, Medicare, jobs, drug addiction, transportation, global trade, and the budget deficit.

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Notes:

FBI. (n.d.). Crime rates in the United States, 2008 – 2018. Retrieved September 05, 2020, from https://crime-data-explorer.fr.cloud.gov/explorer/national/united-states/crime

Gonyea, D. (2010, February 07). ‘How’s That Hopey, Changey Stuff?’ Palin Asks. Retrieved September 05, 2020, from https://www.npr.org/templates/story/story.php?storyId=123462728

Jones, B. (2020, August 26). Republicans and Democrats have grown further apart on what the nation’s top priorities should be. Retrieved September 05, 2020, from https://www.pewresearch.org/fact-tank/2019/02/05/republicans-and-democrats-have-grown-further-apart-on-what-the-nations-top-priorities-should-be/

Pew Research Center. (2020, August 21). Public’s 2019 Priorities: Economy, Health Care, Education and Security All Near Top of List. Retrieved September 05, 2020, from https://www.pewresearch.org/politics/2019/01/24/publics-2019-priorities-economy-health-care-education-and-security-all-near-top-of-list/

U.S.D.A. (n.d.). Rural Poverty & Well-Being. Retrieved September 05, 2020, from https://www.ers.usda.gov/topics/rural-economy-population/rural-poverty-well-being/

Could Trump Be Right On Trade?

May 6, 2018

by Steve Stofka

On Tuesday morning I had an epiphany. Some background first. I disagree with Donald Trump about many things. One of them is his fundamental tenet of international trade: it creates winners and losers. This violates an established principle of economics: comparative advantage. Trade between countries benefits the people of both countries, or a win-win. That is Principle #5 in Greg Mankiw’s Principles of Economics taught in many colleges and universities. From the textbook (6th Ed): “Trade allows countries to specialize in what they do best and to enjoy a greater variety of goods and services.”

Here’s Professor Trump on trade with the Japanese during their boom years in the late 1980s: “First [the Japanese] take all our money with their consumer goods, then they put it back in buying all of Manhattan. So either way, we lose.” (1990 Playboy interview quoted in National Review).

As I put my dishes in the dishwasher, a memory from a 1989 Christmas party in Los Angeles flashed through my mind. I was visiting from Colorado, doing more listening than talking. At the party were several people in real estate, construction and software development.

One guy complained that the Japanese were buying up chunks of California and there should be a law limiting their ownership. The comment began a spirited discussion and I sensed the resentment in the group. I asked if the Japanese owned that much California real estate. They were able to name landmark office buildings and vineyards.

As was my habit, I made a note to find out how much California real estate the Japanese did own. The Japanese had bought a few headline grabbing commercial properties, but they owned less than 1/10th of 1% of California real estate. The number of Japanese investors who bought homes did affect ordinary Californians, however. The percentage of homes bought was small but helped drive up prices, and fueled resentment of the Japanese.

The principle of comparative advantage is modeled on trade in goods. Real estate is different. That’s the point that I missed at the Christmas Party almost thirty years ago. Real estate is an investment whose present value is based on an estimate of future cash flows. A common refrain is “location, location, location.” Unlike an investment in a plant or machinery, real estate often consists of two types of asset: 1) a building, which has a limited, depreciable life; and 2) la location that has an unlimited, and appreciable, life. The first part is like a bond. The second part is like a stock. Real estate is a hybrid product of both asset types.

Let’s go to the first part of Trump’s statement: “First [the Japanese] take all our money with their consumer goods.” Let’s follow the money with an example. A company called Taro has a factory in Japan (not financed with U.S. dollars) that makes computers which it sells to U.S. consumers. Because Taro is making so many of these computers, people and peripheral businesses move near the factory.  This drives up the value of the factory’s real estate in Japan.

Taro’s capital is better deployed at making computers, so it sells the factory and land to a private equity firm, from which it leases back the factory. Taro then invests the U.S. dollars it has accumulated from computer sales, plus part of the proceeds from the sale of its real estate in Japan, to buy an office building on 5th Ave in Manhattan, that I’ll call Fifth.

To buy Fifth, Taro must outbid another buyer for the property, a U.S. investor I’ll call Bulldog. The higher price that Taro pays implies that the future cash flows from Fifth will be more than Bulldog’s estimate. If those future cash flows are mis-estimated by Taro, then Taro has introduced a form of bad money into the economic system of New York real estate. Gresham’s law states that bad money tends to drive good money out of circulation. We’ll see that the principle applies here.

There are two parts to Taro’s equity in Fifth. The first is the profits in U.S. dollars from selling computers to U.S. customers, a re-bundling of U.S. dollars. The second part is the profits from the real estate frenzy in Japan. What fueled the lofty sales price in Japan? Rosy estimates of future economic activity, robust cash flows, and a limited supply of property in desirable areas of Japan. Taro has transferred that frenzy, and risk, from a property in Japan to a property in the U.S.

Banks and other credit institutions, both U.S. and foreign, fund the rest of the sale. Because Taro has more equity to put into the property than Bulldog, the ratio of financed principle to Taro’s equity may be nearly the same as Bulldog’s proposal (the numbers are at the end below).  The rosy estimates that drove the Japanese valuation now influence, or infect, the wider international finance community as well.

Because the U.S. is not in a boom, Bulldog may not have access to the same funds and credit that Taro does.  This puts Bulldog at a disadvantage. Bulldog does not buy the building. No big deal, right? He’ll just buy another property with a more reasonable evaluation. But, wait. At any one time, only a fixed amount of credit money is available at a particular interest rate. The money that a bank lent to Taro for its acquisition is no longer available to Bulldog at the same interest rate for his buy of another property. Taro’s purchase, fueled by speculation in Japan and agressive estimates of cash flow in New York, will cost Bulldog money.

Economic models of comparative advantage tend to ignore the financing aspect for two reasons. Money is regarded as neutral in economic models, and the machinations of international finance are difficult to model.  The competition for credit is global and fierce, fought by vast private and public pools of capital and policy.  Those who buy and sell premium real estate in markets like New York City are regularly reminded of the fact.  They put their textbooks down and come out fighting.

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The numbers:  For every $100 in price that Bulldog offers, Taro offers $110. To finance Bulldog’s offer, he can put up $20 for every $100, or 20%. Taro can put in $27.50 for every $110 of its offer. In Bulldog’s case, $80 is financed. In Taro’s offer, $82.50 is financed. Taro has a leverage of 4-1 ($110 / $27.50), compared to Bulldog’s leverage of 5–1 ($100 / $20). Taro’s leverage looks safer. Its future cash flow estimates are 10% higher, but the finance ratio on the deal is only 3.1% higher ($82.50 / $80). If Taro’s cash flow projections are 5% too high, a lender calculates that Taro can still make payments.

Free Trade

March 20, 2016

This week’s blog will be about free trade.  Donald Trump first made it one of two signature Presidential campaign issues, then Bernie Sanders joined the chorus and now Hillary Clinton has made it part of her campaign speech. Have trade agreements with other countries put Americans at a disadvantage?

Most economists will not even entertain the idea.  The benefits of free trade are ultimately based on the benefits of specialization, the idea that everyone benefits when the most efficient producers supply a good or service.  Each producer achieves a comparative advantage (CA) in that specialization.   First formalized by economist David Ricardo in the 19th century, CA has long been a bedrock of micro-economic theory and introductory economics textbooks.

Greg Mankiw’s Prinicples of Economics cites the example of a rancher and farmer, who both benefit when they specialize.  The rancher concentrates on raising beef, the farmer raises potatoes and they produce more beef and potatoes at a lower cost than if the rancher and farmer did both. (Chapter 3)

A key concept to understanding CA is another bedrock economic principle:  opportunity cost, or what someone has to give up (the cost) to get some good or service (opportunity).  Each person, each country wants to minimize the cost to take advantage of the opportunity.

The same principle can be extended to international trade.  If a Mexican company can produce a good at a more efficient cost than an American company, then Americans will benefit if they buy the good from Mexico and sell something to Mexico which an American company can produce at a cheaper cost.  The ill effects in a particular part of the country are balanced by the good effects in another part of the country or economy, and lower prices benefit all Americans.

When countries impose tariffs on imports, those goods become more expensive for consumers. Economists talk about the “deadweight loss” from tariffs. Here is a graph of the negative effects of tariffs and more discussion on the topic.

The matter would seem settled then, as economist Paul Krugman noted in a 1987 paper : “the underlying commonality among conventional trade models is such that until a few years ago international trade theory was one of the most unified fields in economics.”

As early as the 1960s, economists questioned some aspects of conventional trade models, leading to the development of new models. Krugman notes, “The new view of international trade holds that trade is to an important degree driven by economies of scale rather than comparative advantage, and that international markets are typically imperfectly competitive.” [my emphasis]

Economies of scale. What’s that? This idea, also called increasing return, is when a producer gets a greater growth in outputs than the growth in inputs.  Increasing returns become a force separate from comparative advantage that leads to a “geographical concentration of production of each good,” or regional oligopolies.  We see this phenomenon in southeast Asia, Indonesia and Australia, where a complex web of materials and components production dominates the global electronics market.

“The view that free trade is the best of all possible policies is part of the general case for laissez-faire in a market economy, and rests on the proposition that markets are efficient. If increasing returns and imperfect competition are necessary parts of the explanation of international trade, however, we are living in a second-best world where government intervention can in principle improve on market outcomes.” [my emphasis]  The new idea in trade models is that strategic trade policy by a government “can tilt the terms of oligopolistic competition to shift excess returns from foreign to domestic firms.”  On the campaign stump, Trump makes the same case, although a bit less elegantly; that the U.S. government should make trade deals that shift the benefits of trade back to American workers and producers.  Is Trump channeling Paul Krugman?

Not quite.  Krugman notes three sometimes vociferous criticisms of government intervention. 1) The difficulty in measuring, understanding and modeling imperfect markets makes it impossible to formulate just the right policy.  2) If the government is going to intervene, companies will devote some resources to compete for favors from government, a process called “rent-seeking.” 3) Markets will make adjustments to offset intervention.  Other governments will initiate policies to counter the effects of a government’s intervention.

Krugman concludes “This is not the old argument that free trade is optimal because markets are efficient. Instead, it is a sadder but wiser argument for free trade as a rule of thumb in a world whose politics are as imperfect as its markets.”  This is the argument that Adam Smith made for laissez-faire capitalism, finding it undesireable but better than the alternatives.  Smith spent considerable effort in his book The Wealth of Nations to recount the degree of political corruption that distorted economies and society, that poisoned the human character.

That Krugman disregards those cautions when he favors government intervention within domestic markets confirms the fact that economists are human.

Economist Ian Fletcher presents far more arguments against free trade than Krugman. I would add an additional consideration.  When economists compute the costs of free trade policies, they use a model which does not include the economic benefits provided to workers displaced by free trade policies.  The costs are presumed to be offset by higher taxes from those areas of the country which benefit from free trade.  Admittably, these costs and additional tax revenues attributable to free trade policies are difficult to measure.  However, I do think that the effort should be made.  I suspect that the benefits paid to dislocated workers and the total negative effect, the multiplier, of the lost economic activity have not been fully accounted for and that free trade is much more costly than conventional models portray.

Even if we can measure and agree on the facts, we can not agree on what those facts mean.  Whatever the facts, we prefer our familiar and favorite idea.  They not only reassure us but are also well integrated into our values, and our philosophical sense of life.