Welcome American Drycleaner Readers.

Thanks to those of you who have made the google trip to my blog. As you can see I like both economics and drycleaning. I try to put both in simple terms, but if you would like something rephrased or restated, please post a comment.

As drycleaners, we’ll likely never know first hand what it feels like to be outsourced; the best we can do is understand what happens and why. A recent example in a business close to our own can be found in the US hanger market.

Although the very mention of outsourcing causes anxiety to American employees, the purpose of this column is to use economics as a tool to analyze our industry, our lives and our citizenship. Unfortunately, this often means examining issues that may cause discomfort.

I reused the Adam Smith quote above as a reminder that each of us must act in his own self-interest if capitalism is to flourish. This self-serving behavior is the necessary element that made Smith’s concept of “the invisible hand” work for society. Mentioned once in hundreds of pages, the concept says that if every person does what is best for him or her, our entire society will be able to improve its condition in concert.

This belief- along with certain inalienable rights- creates the freedoms and the wealth that made this country great. The freedom to act in our own self-interest does not, however stop at the individual level; it must extend to firms that exist to maximize profits.

Throughout history, nations have found it advantageous to outsource production of goods and services to other nations for financial reasons. The United States outsources and has been outsourced to, thanks to the comparative advantage (an edge in the marketplace) it holds in many industries.

The law of demand tells us that consumers will always choose the lowest priced goods (if equal). When they do so, they have more income to spend on that good, as well as others. Thus, a firms “job” is to provide customers with goods at the lowers possible price.

One aspect of prices that is useful to remember is they cannot and should not be expressed as monetary exclusively. Monetary expressions of price lead to confusion as to what a “cost” is. All cost are ultimately opportunity costs- the loss of doing the next best thing, in favor of the good, service or activity that was chosen.

Failing to recognize opportunity costs leaves us talking with grandpa about how bread cost only a penny when he was young, rather than realizing that we are surely better off now. A better question to ask in determining cost would be “How long did you work to pay for that?” Recently, I saw a family ledger book from 1887 that mentions a $15 dollar coat; lets ponder 15 dollars value in 1887 for a while.

MODEL SOCIETY
Economists often simplify life down to a “mode” to test their theories. To illustrate comparative advantage, I’m going to borrow from Todd Bucholts’ book, New Ideas from Dead Economists.

The place is Gillian’s Island, but the cast is reduced to the Skipper and Gilligan only. To further simplify, let’s have them produce only two “goods”- fish dinners and shelters. It shouldn’t surprise you that the Skipper is better than Gilligan at production of both of these goods. What with Gilligan constantly hooking himself on things and hammering his own thumb, it is all he can do to keep working. Let’s examine what might happen if they compared notes to make their “society” work more smoothly.

The Skipper can catch a fish dinner in 10 hours and make a hut in 20; it takes Gilligan 15 and 40 hours, respectively. Some people would tell the skipper to move away from Gilligan, because of the differences in efficiency. In a year, the Skipper may work 2,000 hours and order Gilligan to work 3,600. If they split their time 50/50 between the two activities, the Skipper would “earn” 100 fish dinners and 50 huts; Gilligans efforts thru his longer hours would give him 120 fish dinners and 40 huts. The Island now has a GDP of 220 fish dinners and 90 huts.

After much thought and reflection, (perhaps an econ book washed up), they decide to specialize guided by opportunity cost, how much is sacrificed for production. They decide that the Skipper will spend all his time making huts, earning 100 huts. Gilligan will concentrate on fishing, earning 240 dinners. The result of the specialization is additional 10 huts and 20 fish dinners- without adding any more labor. The castaways are now wealthier without working harder.

HANGERS- ON
Today we can see these principles in action among the nations wire hanger manufacturers. Just as we have seen in other steel related businesses, flat productivity in America combined with explosive economic growth and investment in China created an opportunity. Also worth noting is that the Chinese Yuan is pegged to the dollars at an artificially low exchange rate, giving Chinese goods an advantage in its exports to the US.

In 1997, China exported 28.8 million wire hangers to the U.S. Each consecutive year saw tremendous growth, and during the first nine months of 2002, 405 million hangers had already been imported. Hanger prices dropped as a result, and the incentive (and cash) necessary for domestic manufacturers to make machinery improvements was gone. Three US hanger firms Cleaner Hangers Co. (CHC), United Wire Hangers and M&B Hanger Co. -had seen enough, and joined forces to seek legal protection.

Since Congress moved to normalize trade relations with China in 2000, the countries World Trade Organization (WTO) accession package offered a provision that gave US companies hope. The three firms sought protection from the International Trade Commission (ITC), with a filing that only needed to demonstrate the importers material harm.

The three ITC commissioners unanimously agreed with the American hanger companies filing, and recommended to Pres. George W. Bush that he impose a 25% tax on the value of Chinese hanger imports- some 95% of all hanger imports. Laidlaw stood against the tariffs at the time, since it had seen the trend develop early on and had signed an agreement with one of the new Chinese companies.

The result of the ITC challenge was not what the three American companies would have wished. Bush went against the Commissions recommendations saying that the tariffs adverse effects would be greater than the relief that it provided. Since then, the largest of the three Cleaner Hanger Company filed for bankruptcy and liquidated its assets.

The import trend has continued in the years since, industry insiders estimate that Chinese hanger imports are up to 800 million per year (2005). What percentage of that number is coming from the state-of-the-art Shanghai Wells factory we don’t know, but in 2003, the company expected to export 500 million hangers to the U.S.

If the 25% ad valom tax suggested by the ITC commissioners had been adopted in 2002, the anticipated tax revenues for that year would have been approximately $3.4 million. What does this mean to the consumer? At 2005 import levels, drycleaners are saving $4 to $6.5 million per year.

Capital and human resources alike, (CHC had to lay off 600 workers), have been redistributed to more profitable enterprises. While I still believe that every consumer and every firm must act in their own interest for the invisible hand of capitalism to work, I am reminded of an expression I like to use “The marketplace works out problems well….but sometimes people get hurt”. Often, we study an issue only to find it much more complex than politicians might lead us to believe; I think this is such a case.

On Asymmetrical Information

I speak of asymmetrical information so often, I have shortened the expression to asymmetry. I recognize that asymmetry could refer our DNA programming concerning beauty, or chiral molecules, or many other miscellaneous uses for the word in science. Rather, when I use it, I will exclusively mean asymmetrical information.

My new, (cousin-in-law?), Reese was recently espousing a hot opinion about Clint Eastwoods' movie "Flags of Our Fathers". He insinuated that by telling the truth about the events of those days, we not only disrespect the soldiers, and their offspring; but harm future prospects of soldier recruitment. It was his contention that soldier recruitment was necessary to uphold our military strength and war-making ability.

This sounds as if Reese believes that asymmetrical information helps keep up the supply of soldiers. If this is true, it must be that some utility (for the potential soldier) is lost by more complete understanding of what goes on in warfare and the wartime public relations "machine". Certainly, certain occupations are effected by public relations and media exposure. Perhaps the "Doug Flute" effect is worth mentioning here. The Doug Flute effect is the rise in public interest that the victorious teams University achieves from significant sports victories.

From the "price theory" perspective, I am reminded of some of the research I've done on the development of the US oil industry. It began with whale oil, progressed thu coal oil and settled (currently) on oil derived from drilling deep into the earth. Between each transition, a price spike caused the the next energy source to become newly viable.

If the "cost" of war is based upon keeping the price down for one of the major "inputs" (namely soldiers); perhaps this is not such a bad result. Reese's opinion can be backed up with facts dating from Vietnam until present day. Today's casualty reports pale compared with conflicts in the past, but our public seems to have no stomach for the losses. Some have interpreted this lack of public will as a national character flaw; but I think that through media involvement (starting in Nam), the previous condition of asymmetrical information has steadily been dissolving.
Previously only the military and its soldiers knew the "true" costs of warfare. No nations citizenry will support warfare without compelling reasons for its existence.

The bright side may be that future trends may lean away from war as a viable solution to problems. So ultimately both Reese and I could be right, only the final results are in question.

Should a purchase order be considered M1?

On the drive in from Southlake my daughter and I discussed how obtuse taking Macro-Economics in school is. The lines of unimportant data that must be memorized in order to make an acceptable grade can be mind-numbing. Instead of memorizing the definition and exact amount of M-1, one should ponder the uses and ramifications of currency, the multiplier effect etc. We discussed the question of a p.o. from a fortune 500 company. Would a rational businessman buy equipment and hire personnel based on a purchase order from IBM? If the answer is yes, what does this say about the relative importance of M1?

Bono solving poverty.

Did anyone see Bono last night? He was preaching to an appreciative audience about the end of extreme poverty. He obviously has read Jeffrey Sachs books, in fact he and Sachs are close friends. I have not seen the incentives that the Sachs-Bono plan promotes. If economics is about "people respond to incentives, the rest is commentary", as most economists agree with the quote by Steven Landsburg; where is the Bono incentive? The truth is the Sachs-Bono plan is about shifting wealth transfers. No incentive. No real result.

Tom

Biblical Economic Principles, although adding stability, stifled incentives and hindered occupational freedom.

OK. I said it. This has been on my mind since I discovered the Jubilee principle a couple of years ago. But it doesn't stop at the debt forgiveness and freeing of slaves every fifty years. Jubilee also features the return of land to its original owners. Thus legally land cannot be sold, only its harvests purchased for a set period of time. There are many other principles included in a proper examination of Biblical economics, but we'll just consider Jubilee. If one needed funding and was close to the 50 year celebration, you would have been limited to the sale of X < years to jubilee of crop revenue. Keep in mind that in an agrarian society, (which all societies were not that long ago), land control was occupational control. If Grandpa was a grain farmer, your options to have a fine vineyard were limited.

The Philosophy of Economics.

Economics is not only an social science, but a philosophy as well. One could see every sacrifice experienced in life, as a loss of utility (or happiness). Something like the cliche of :"you mother gave up her singing career to raise you". I am not speaking of a stoic view of eternally deferred satisfaction, but something entirely different.

If economics is used to understand the exchange of career for child rearing, (or any other such exchange), such a choice is to be celebrated. A ever higher value was placed on the traded "good". If little was traded, the assumed value of what was received would be less as well.

In the movie: "True Colors" 1991,James Spaders' character is told toward something along these lines toward the end of the show. A Federal prosecutor tells (Spader), that when justice doesn't cost anything....He (Spader) could not claim it.

Cheap corn calories.
Although I have not finished the Pollan book yet, I am sure that corn-based calories are too inexpensive for our own good. If we are judged as a society by how inexpensive food can be, well then we have arrived. If conversely, we are judged by the outcomes of our cheep calories; we have been exposed as failures. We must do a better job of eating without gaining fat, our children deserve better from their role models.

What do Greshams law, Akerlof's lemons and Easterly's heterogeneous people have in common?
The expectations (demand) of consumers of currency, Yugos, and human capital, respectively effect not only the short term specific markets; but more importantly the long term equilibrium for the goods in question. Eventually, the expectations will determine the future viability of the good.

The Cost of being a successful Christian are often misunderstood. In economics all costs are considered to be opportunity costs. An opportunity cost is best defined as the next best thing. For example the next best thing you might do rather than read this blog, is the true cost of reading this blog. Thus the opportunity cost of Christianity is not Islam or Hinduism, because that is not the next best thing the majority of Christians might choose. The opportunity cost of Christianity is more likely to be: the judging of others, or bass fishing, or sexual promiscuity, gossip, greed , or any number of things potentially given up to become a successful Godly person.

Jesus knew that scarcity helps define and determain our priorities.
Jesus seemed to prefer the poor over the rich, perhaps it is because the poor needed him more. After all, the rich of his time had an even greater share of the total wealth than we see here (in the USA) today. But, I have decided that it is the fact that the poor understand scarcity better than the wealthy. The poor understand opportunity cost (the next best thing given up to get something), and this understanding helps them determain what is important to them. Jesus must have felt that for this reason, the poor would be either more responsive or at least decide quicker, questions about their own spirituality.

Velocity can be as important as money supply in determining economic activity and the aggregate multiplier. If citizens feel constrained to hold their monies it matters less what the state of the money supply is. I also ponder the role of inflation in adding employment to the economy. I don't mean to belittle Okuns law, but the reason it works is the asymmetrical information. The asymmetry involved in finding extra money in your, or your business's bank account. If you knew it was inflation, rather than your business acumen, you wouldn't spend or hire. I guess that is why Okun can't be exploited.

Michael Pollan called the #2 corn created by the nations farmers a biomass. It seems that farm policy created by Earl Butz (secretary of agriculture under Nixon), encourages a glut in the more generic version of corn often used by the industrial food complex. This glut becomes the fodder for the brightest food chemists industry has to offer. The result....foods our Grandma would not recognize. Pollan says if Grandma wouldn't recognize it, we shouldn't eat it.

From the economist point of view. The government takes the view that externalities, (things that have either positive or negative effect that goes beyond the price paid for them), must be either taxed or subsidized. If corn is subsidized (ostensibly because it is somehow undervalued), more corn will be produced than consumers really want. As David Friedman's delightful Intermediate Micro-Economic Text reminds us, through a potato metaphor (ironically enough), consumer welfare is ultimately worse off because of the subsidy altered equilibrium. Pollan would tell us that the #2 corn glut has an opportunity cost of less processed foods.

Net result......Consumers Nutrition suffers.

Tom

Today I am fascinated with a book I am currently reading and its implications on America's nutritional history. I am reading Michael Pollan's "The Omnivore's Dilemma", which speaks of food chains, the history of corn and our disenfranchisement from a sense of authority concerning the feeding our own bodies. This is not a conspiracy, but a result of the post war industrial infrastructure and a search for agricultural efficiency.

I'll let you know as I finish the book.

Tom