What is the Bullshit Economy?

What is the Bullshit Economy? 1

Yves here. Jared Holst thought it was important to clarify the term “bullshit economy.”

However, we’d like to add a key point: Jared relies upon the foundational chart of economics, the cute X of the downward sloping demand line and the upward sloping supply line that magically intersect and define a price.

We explained long form in ECONNED that this ain’t always so:

Consider the most basic image in economics: a chart with a downward sloping demand
curve and the upward sloping supply curve, the same sort found in Krugman’s diagram. Deidre McCloskey points out that the statistical attempts to prove the relationship have had mixed results. That is actually not surprising, since one can think of lower prices leading to more purchases (the obvious example of sales) but also higher prices leading to more demand. Price can be seen as a proxy for quality. A price that looks suspiciously low can produce a “something must be wrong with it” reaction. For instance, some luxury goods dealers, such as jewelers, have sometimes been able to move inventory that was not selling by increasing prices. Elevated prices may also elicit purchases when the customer expects them to rise even further. Recall that some people who bought houses near the peak felt they had to do so then or risk being priced out of the market. Some airline companies locked in the high oil prices of early 2008 fearing further price rises.

The theoretical proof is also more limited than the simplified picture suggests. Demand curves are generally downward sloping, but in particular cases or regions, per the examples above, they may not be. Yet how often do you see a caveat added to models that use a simple declining line to represent the demand functions? Not only is it absent from popular presentations, it is seldom found in policy papers or in blogs written by and for economists.

McCloskey argues that economists actually rely on introspection, thought experiments, case examples, and “the lore of the marketplace,” to support the supply/demand model.

Similarly, a prediction of a simple supply-demand model is that if you increase minimum wages, you will increase unemployment. It’s the same picture we saw for the oil market, with different labels. In this case, the “excess inventory” would be people not able to find work.

One curious element of some of the responses was that they charged Card and Krueger with violating immutable laws of economics. For instance, Reed Garfield, the senior economist of the Joint Economic Committee, wrote:

The results of the study were extraordinary. Card and Krueger seemed to have discovered a refutation of the law of demand. Economists were stunned. Because of these extraordinary results, they debated the results. Many economists argued that the differences . . . were more than simply differences of minimum wage rates. Other economists argued that the study design was flawed.

Notice the assertion of the existence of “the law of demand,” by which Garfield means “demand curves slope downwardly,” when in fact no such “law” exists. And there are reasons the Card-Krueger findings could be plausible, the biggest being that the sort of places that hire low-wage labor may not be able to get by with fewer workers and still function.

Yet some empirical work by David Card, an economics professor at the University of California, Berkeley, and Alan Krueger, a professor of economics at Princeton, disputed the idea that increasing minimum wages lowers the number of jobs for the lowest-paid workers. Needless to say, the studies got a great deal of attention, with the reactions often breaking along ideological lines.

And there are cases where economists acknowledge that the demand line is not downward sloping, such as when demand is inelastic:

Mind you, I’m not disputing Jared’s argument below, since the simple X picture is often accurate. It’s just every time I see that classic demand/supply chart, I feel I have to clear my throat.

Jared’s commentary about bonnet-owners and the rancid ecosystem that develops to exploit them is reminiscent of another passage in ECONNED:

It is easy to be overwhelmed by the vast panorama of financial instruments and strategies that have grown up (and blown up), in recent years. But the complexity of these transactions and securities is all part of a relentless trend: toward greater and greater leverage, and greater opacity.

The dirty secret of the credit crisis is that the relentless pursuit of “innovation” meant there was virtually no equity, no cushion for losses anywhere behind the massive creation of risky debt. Arcane, illiquid securities were rated superduper AAA and, with their true risks misunderstood and masked, required only minuscule reserves. Their illiquidity and complexity also meant their accounting value could be finessed. The same instruments, their intricacies overlooked, would soon become raw material for more leverage as they became accepted as collateral for further borrowing, whether via commercial paper or repos.

But even then, the bankers still needed real assets, real borrowers. Investment bankers screamed at mortgage lenders to find them more product, and still, it was not enough.

But credit default swaps solved this problem. Once a CDS on low-grade subprime was sufficiently liquid, synthetic borrowers could stand in the place of subprime borrowers, paying when the borrowers paid and winning a reward when real borrowers could pay no longer. The buyers of CDS were synthetic borrowers that made synthetic CDOs possible. With CDS, supply was no longer bound by earthly constraints on the number of subprime borrowers, but could ascend skyward, as long as there were short sellers willing to be synthetic borrowers and insurers who, tempted by fees, would volunteer to be synthetic lenders, standing atop their own edifice of risks, oblivious to its precariousness.

Institution after institution was bled dry. Yet economists and central bankers applauded the wondrous innovations, seeing increased liquidity and more efficient loan intermedation, ignoring the unhealthy condition of the industry.

The firms that had been silently drained of capital and tied together in shadowy counterparty links teetered, fell, and looked certain to perish. There was one last capital reserve to tap, U.S. taxpayers, to revive the financial system and make the innovators whole. Widespread anger turned into sullen resignation as the public realized its opposition to the looting was futile.

The authorities now claim they will find ways to solve the problems of opacity, leverage, and moral hazard.

But opacity, leverage, and moral hazard are not accidental byproducts of otherwise salutary innovations; they are the direct intent of the innovations. No one at the major capital markets firms was celebrated for creating markets to connect borrowers and savers transparently and with low risk. After all, efficient markets produce minimal profits. They were instead rewarded for making sure no one, the regulators, the press, the community at large, could see and understand what they were doing.

Forgive this very long-winded set-up to Jared’s somewhat light-hearted illustration of the bullshit economy at work. Businessmen once sought to gain advantage by creating a competitive advantage, which in the past generally meant finding a way to serve customers better or at lower cost. “Serving them better” might mean catering to niche needs, like having a convenience store open 24 hours where the patrons accepted high prices because the store’s location and hours were worth paying for. Too often now schemes for gaining advantage rely on exploiting customer ignorance or desperation, or using legal and regulatory process to restrict their choices.

By Jared Holst,  the author at Brands Mean a Lot, a weekly commentary on the ways branding impacts our lives. Each week, he explores contradictions within the way politics, products, and pop-culture are branded for us, offering insight on what’s really being said. You can follow Jared on Twitter @jarholst. Originally published at Brands Mean a Lot

It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our necessities but of their advantages. — Adam Smith, The Wealth Of Nations.

Economics, the sort which most people study in high school and undergrad, teach us that if demand exists for a good (good, in this essay, can mean a product or service), supply will rise to meet that demand. Conversely, if demand falls, so too will supply. This function is meant to illustrate the relationship between buyers and suppliers—market equilibrium is when demand and supply equal one another, signaling that suppliers and buyers agree, sans coercion, on a price and a supply of a good.

What is the Bullshit Economy? 2

The price of a product also plays a role. If a product’s price is too high, the supply of the product will outstrip the demand, creating a surplus. Priced too low, and the demand outstrips the supply, creating a shortage.

But in foundational economics, virtually no time is spent on the creation of demand.

The origin of the demand for a particular good is central to The Bullshit Economy. In our high school and undergrad economics, we’re taught to think of market equilibrium in terms of staple goods like gasoline and plumbing and discretionary goods like PlayStations and first class airfare. People need gas because it powers combustion motors and they want first class airfare because of comped bloody marys and wide seats. Although external forces impact the demand of each—an OPEC embargo in the case of gas or a recession in the case of first class flying—most of the demand for those goods is intrinsic to the good itself. The supply and the goods themselves are generated to meet demand.

At the root of The Bullshit Economy is artificial demand. Demand that precedes supply. Market equilibrium, rather than an unfettered and unspoken agreement on terms between buyers and suppliers, becomes coercion on behalf of buyers.

What is the Bullshit Economy? 3

You possess a priceless family heirloom, an embroidered lace bonnet worn by 6 successive generations. It’s traveled from the grey skied, hardscrabble motherland, to the shores of America, all the way to your attic. Through Facebook, you happen upon a vast community of others in possession of priceless antique bonnets. The community numbers millions.

Sensing opportunity, an interloper makes their way into the community. The rapscallion invents a unique jelly that permanently stains the antique bonnets. At that years’ Antique Bonnet convention in Springfield, MO, they manage to stain millions of heirloom bonnets. Being unique, this jelly’s resistant to all existing stain removers. The only solution? A patented jelly remover, invented by the rapscallion.

Knowing they’ve got the market cornered and control the supply of jelly remover, the rapscallion charges obscenely high prices for the product. They recruit companies, who in partnership with the rapscallion, conjure financial products to help those with stained bonnets afford the jelly. Those with stained bonnets have two options, pay the price, or go without a pristine bonnet, thereby angering the ghosts of generations past and forgoing spotless headwear for future generations.

What is the Bullshit Economy? 4
Pictured: Adam Smith in a bonnet

The government gets hip to it all and rules that Rapscallion® brand jelly remover has created a monopoly for itself and must share its recipe so that other jelly remover brands may enter the market. Towards the financing products created to make jelly remover affordable, both public and political sentiment sours. New laws are written that expressly outlaw the extension of certain types of jelly remover loans and cap the rates at which the remaining, legal loans can be given.

Knowing that jelly remover is vital to antique bonnet owners, other companies produce their own removers, but prices remain high due to unspoken acknowledgement by jelly remover producers of the crucial nature of jelly remover. A jelly remover cartel forms.

Noticing loopholes in the government’s ruling, new firms step in to help bonnet owners pay for the product. Instead of calling them loans and charging interest, they brand them ‘fiscal favors’. Receiving a fiscal favor requires bonnet owners to provide their bank routing and account numbers so the new entrants may provide an initial deposit into the users’ accounts…and subsequently garnish a portion of the users’ paycheck for the next 10 years. The garnishing rate shall never be less than 45% and increases from there depending on the lunar phase of the users’ payday.

Illuminated by fluorescent tube lights, lawyers examine government regulation to stay on the right side of the law and draft consumer-side terms and conditions to be agreed upon via browser checkbox. Advertising agencies staffed with lit majors from universities like Bennington, Bard, and Yale pitch these companies on which non-binary colorway will appeal to the stained bonnet cohort. Product managers fresh out of MIT and Harvard Business School ingeniously work dark patterns into each new app so as to befuddle bonnet owners into agreeing to pay more as each month passes.

It’s a shit seed, from which sprouts a shit tree, which bears shit fruit. It stinks!

What is the Bullshit Economy? 5

Some will read this and say, “Isn’t it good that now the bonnet people can afford the cleaner for which they so desperately yearn?” Couldn’t the bonnet people just put it on a credit card, that must be better? The average credit card APR is 15.56% to 22.87%. Also, in a properly functioning economy and society, there’d be no need for these companies in the first place. The genesis of the demand is rotten.

Not every good in the bullshit economy follows this exact pattern, but many occupy a portion of the story. Uber and Lyft, for example, thrive because of loopholes in the law around what constitutes an employee versus an independent contractor. The college admissions ecosystem perpetuates because, amongst other reasons, inequality of opportunity and access.

In the coming months, I aim to expand on this by way of presenting fresh examples. In the meantime, I hope this helped narrow in on the source of the stench.

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