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The Knowledge Problem March 28, 2014 copies of this presentation can be found at www.antonydavies.org www.antonydavies.org 1

The Players and the Goals In this experiment, each of you is a member of a community. You have skills with which your produce either 12 units of Red or 12 units of Blue stuff. www.antonydavies.org 2

The Players and the Goals You eat both Red and Blue stuff to gain happiness. The more you eat, the happier you are. www.antonydavies.org 3

Blue Chips The Players and the Goals Suppose you have 5 Red chips and 4 Blue chips. Your happiness is 123. Red Chips 0 1 2 3 4 5 6 7 8 9 10 0 0 0 0 0 0 0 0 0 0 0 0 1 0 10 16 22 26 31 35 39 43 47 50 2 0 20 32 43 53 62 70 78 86 93 100 3 0 30 49 65 79 93 105 117 129 140 150 4 0 40 65 86 106 123 140 156 171 186 200 5 0 50 81 108 132 154 175 195 214 233 251 6 0 60 97 129 158 185 210 234 257 279 301 7 0 70 114 151 185 216 245 273 300 326 351 8 0 80 130 173 211 247 280 312 343 372 401 9 0 90 146 194 238 278 315 351 386 419 451 10 0 100 162 216 264 309 351 390 429 466 501 www.antonydavies.org 4

Controlled Economy A benevolent dictator will take the stuff that the people produce and distribute it among the people. The dictator s goal is to maximize the sum of the people s happinesses. www.antonydavies.org 5

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Chaos Chaos Free to act Free market Free to act provided you don t harm others All of the stuff you produced is at the front of the room. Come and take what you want. www.antonydavies.org 7

Free Market Free to act but you may not violate others property rights. Each person starts with either 12 Blue stuff or 12 Red stuff. You may trade with other people in an attempt to maximize your happiness. www.antonydavies.org 8

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Results www.antonydavies.org 10

Total Happiness (by economic system) 36000 34000 32000 30000 28000 26000 24000 22000 20000 Command Economy Chaos Free Economy www.antonydavies.org 11

Total Happiness (by economic system) 36000 34000 32000 30000 28000 26000 24000 22000 20000 Command Economy Chaos Free Economy Ideal www.antonydavies.org 12

Gini Inequality Index 0.000 Ukraine Mexico 1.000 0.264 U.S. 0.450 0.483 Haiti 0.592 www.antonydavies.org 13

Command Economy Gini Inequality Index: 0.177 1800 1600 1400 1200 1000 800 600 400 200 0 People Arranged in Order of Happiness (Command Economy) www.antonydavies.org 14

Chaos Gini Inequality Index: 0.428 2500 2000 1500 1000 500 0 People Arranged in Order of Happiness (Chaos) www.antonydavies.org 15

Free Economy Gini Inequality Index: 0.168 2500 2000 1500 1000 500 0 People Arranged in Order of Happiness (Free Economy) www.antonydavies.org 16

Conclusion The knowledge problem prevents the benevolent dictator from achieving the best outcome. www.antonydavies.org 17

Conclusion The knowledge problem prevents the benevolent dictator from achieving the best outcome. Corollary Government does have a role to play in protecting property rights. www.antonydavies.org 18

Is the experiment a fair representation of the real world? www.antonydavies.org 19

Experiment versus Real World Information Experiment: The dictator didn t know what made people happy. Real World: The dictator won t know what makes people happy. Changing Information Experiment: People s preferences were constant. Real World: People s preferences are constantly changing. www.antonydavies.org 20

Experiment versus Real World Decisions Experiment: The dictator had to make under 60 decisions in ten minutes 6 per minute. Real World: A dictator would have to make 300 m. x (maybe ten?) = 3 billion decisions daily 2 million per minute. Quantifiability Experiment: The preference data was quantifiable. Real World: Most preferences aren t easily quantifiable. www.antonydavies.org 21

Experiment versus Real World Motivation Experiment: The dictator was altruistic. Real World: Good luck with that. Conclusion It should be easier for the dictator to satisfy people s wants in the experiment than in the real world. www.antonydavies.org 22

Assumptions About Economic Freedom Command Market Assumptions: Left to themselves, people will consolidate power, stifle competition, exploit each other, and confiscate wealth. Free Market Assumptions: Left to themselves, people will disseminate power, promote competition, cooperate with each other, and create wealth. www.antonydavies.org 23

More badness If the command market assumptions were correct, then we would expect to see patterns in the data like this More freedom Freedom www.antonydavies.org 24

Less goodness and this. More freedom Freedom www.antonydavies.org 25

Economic Freedom of North America Economic Freedom of the World Size of government Government consumption Transfers and subsidies Social Security payments Takings and discriminatory taxes Tax revenue Top marginal income tax rate and threshold Other tax revenues Labor market freedom Minimum wage Public sector employment Union density www.antonydavies.org 26

For each year, divide the states into two groups 25 least free 25 most free www.antonydavies.org 27

Economic Freedom of North America States Always Among the 25 Least Free States: 1985 2009 www.antonydavies.org 28

Economic Freedom of North America States Always Among the 25 Most Free States: 1985 2009 www.antonydavies.org 29

Economic Freedom of North America States That Switched Groups At Least Once: 1985 2009 Average state switched groups 3 times. www.antonydavies.org 30

Employment www.antonydavies.org 31

Economic Freedom of North America (all levels of government) Data Source: Census Bureau, Statistical Abstract of the United States; Ashby, Bueno, and McMahon, Economic Freedom of North America 2011, Fraser Institute www.antonydavies.org 32

Economic Freedom of North America (all levels of government) Less free: 5.8% More free: 5.2% The difference in unemployment rates = 1 million jobs. Data Source: Census Bureau, Statistical Abstract of the United States; Ashby, Bueno, and McMahon, Economic Freedom of North America 2011, Fraser Institute www.antonydavies.org 35

Income and Growth www.antonydavies.org 36

Economic Freedom of North America (all levels of government) Data source: U.S. Census Bureau, Historical Income Tables: Households, Table H-8; Ashby, Bueno, and McMahon, Economic Freedom of North America 2011, Fraser Institute www.antonydavies.org 37

Economic Freedom of North America (all levels of government) Less free: $35,300 More free: $38,000 Median household income averaged $4,000 more in the most free states. Data source: U.S. Census Bureau, Historical Income Tables: Households, Table H-8; Ashby, Bueno, and McMahon, Economic Freedom of North America 2011, Fraser Institute www.antonydavies.org 40

Poverty www.antonydavies.org 41

Economic Freedom of North America (all levels of government) Less free: 13.6% More free: 11.9% The difference in poverty rates = 5 million people living in poverty. Data source: Bureau of Economic Analysis, GDP and Personal Income Regional Data; Ashby, Bueno, and McMahon, Economic Freedom of North America 2011, Fraser Institute www.antonydavies.org 42

Do these results hold across countries?? www.antonydavies.org 43

Child Labor www.antonydavies.org 44

Economic Freedom of the World (75 reporting countries, 2000-2009) Less free: 28% More free: 13% Data source: Childinfo.org, Economic Freedom of the World, Fraser Institute www.antonydavies.org 45

Economic Freedom of the World (75 reporting countries, 2000-2009) Less free: 28% More free: 13% Data source: Childinfo.org, Economic Freedom of the World, Fraser Institute www.antonydavies.org 46

Economic Freedom of the World Big country effect? www.antonydavies.org 47

Economic Freedom of the World (45 below median income countries, 2000-2009) Less free: 36% More free: 17% Data source: Childinfo.org, Economic Freedom of the World, Fraser Institute www.antonydavies.org 48

Economic Freedom of the World (26 poorest quartile countries, 2000-2009) Less free: 41% More free: 27% Data source: Childinfo.org, Economic Freedom of the World, Fraser Institute www.antonydavies.org 49

Environment www.antonydavies.org 50

Economic Freedom of the World (85 countries, 2007) Less free: 85 More free: 30 Data source: World Health Organization, Economic Freedom of the World, Fraser Institute www.antonydavies.org 51

CO 2 Metric Tons per $1000 GDP Economic Freedom of the World (118 countries, 2000) Less free: 2.5 More free: 0.5 Data source: World Resource Institute (World Bank), Economic Freedom of the World, Fraser Institute www.antonydavies.org 52

Economic Freedom of the World (136 countries, 1990-2005) Less free: 7% More free: +7% Data source: Mongabay.com, Economic Freedom of the World, Fraser Institute www.antonydavies.org 53

Economic Freedom of the World Big country effect? www.antonydavies.org 54

Economic Freedom of the World (29 poorest quartile countries, 1990-2005) Less free: 13% More free: 7% Data source: Mongabay.com, Economic Freedom of the World, Fraser Institute www.antonydavies.org 55

Peace www.antonydavies.org 56

Global Peace Index (inverse scale) Economic Freedom of the World (133 countries, 2009) Data source: Institute for Economics and Peace, Economic Freedom of the World, Fraser Institute www.antonydavies.org 57

Global Peace Index (inverse scale) Economic Freedom of the World (133 countries, 2009) Countries that are more free are also more peaceful. Data source: Institute for Economics and Peace, Economic Freedom of the World, Fraser Institute www.antonydavies.org 58

Poverty, and Inequality www.antonydavies.org 59

Economic Freedom of the World (79 countries, 2000-2010) Less free: 59% More free: 17% Data source: World Bank, Economic Freedom of the World, Fraser Institute www.antonydavies.org 60

Economic Freedom of the World Big country effect? www.antonydavies.org 61

Economic Freedom of the World (25 poorest quartile countries, 2000-2010) Less free: 81% More free: 64% Data source: World Bank, Economic Freedom of the World, Fraser Institute www.antonydavies.org 62

Poverty figures only measure the lower extreme. What about income inequality? www.antonydavies.org 63

Per-Capita Income Can Hide Inequality Average = $40,000 Average = $40,000 www.antonydavies.org 64

No one ever died from income inequality. www.antonydavies.org 65

Economic Freedom of the World (123 countries, 1995-2009) www.antonydavies.org 66

Economic Freedom of the World (123 countries, 1995-2009) Less free: 43 More free: 35 Data source: CIA World Factbook, Economic Freedom of the World, Fraser Institute www.antonydavies.org 67

Economic Freedom of North America That inequality thing happens in the U.S. also! www.antonydavies.org 68

Economic Freedom of North America (all levels of government) Data source: Census Bureau, American Community Survey, B19083; Ashby, Bueno, and McMahon, Economic Freedom of North America 2011, Fraser Institute www.antonydavies.org 69

Correlation Causation Data don t show that economic freedom causes goodness. www.antonydavies.org 70

No Correlation No Causation Data do show that economic freedom doesn t cause badness. www.antonydavies.org 71

Conclusions Across states, across countries, and across time, societies with more economic freedom have Less unemployment More income Less poverty Less income inequality Better environmental outcomes www.antonydavies.org 72

The Knowledge Problem March 28, 2014 copies of this presentation can be found at www.antonydavies.org www.antonydavies.org 73

But Free people will act selfishly! www.antonydavies.org 74

More freedom greater ability to act selfishly, greater ability to harm each other, greater ability to harm the environment. More freedom greater ability to act altruistically, greater ability to help each other, greater ability to protect the environment. www.antonydavies.org 75

Appropriate role for government is in preventing people from harming each other. More freedom greater ability to act selfishly, greater ability to harm each other, greater ability to harm the environment. More freedom greater ability to act altruistically, greater ability to help each other, greater ability to protect the environment. www.antonydavies.org 76

We have to do something! The rich are getting richer while the poor get poorer! www.antonydavies.org 77

U.S. Households According to Income 30% 25% 20% 15% 10% 5% 0% Under $15,000 $15,000 - $25,000 $25,000 - $35,000 $35,000 - $50,000 $50,000 - $75,000 $75,000 - $100,000 Over $100,000 Incomes are in 2009 dollars. 1970 1980 1990 2000 2009 Data source: Statistical Abstract of the United States, U.S. Bureau of the Census, 1995-2012. www.antonydavies.org 78

Problems with Inequality Measures Assumes that the pie is fixed. Assumes that the population is stagnant. www.antonydavies.org 83

Fraction of Total Income Received by Each Fifth 50% 45% 40% 46.6% 49.7% 35% 30% 25% 20% 15% 10% 5% In 2000, the poorest Americans earned 3.8% of all income. 3.8% In 2007, the poorest Americans earned 3.4% of all income. 3.4% 0% Poorest Lowest Quintile Highest Richest Quintile 2000 2007 Data source: Statistical Abstract of the United States, U.S. Bureau of the Census, 2010, Table 678. www.antonydavies.org 84

Fraction of Total Income Received by Each Fifth 50% 45% 40% 46.6% 49.7% 35% 30% 25% 20% 15% The Pie Isn t Fixed 2000 RGDP = $11,216 b. x 3.8% = $425 b. 2007 RGDP = $13,206 b. x 3.4% = $450 b. 10% 5% 3.8% 3.4% 0% Poorest Lowest Quintile Highest Richest Quintile 2000 2007 Data source: Statistical Abstract of the United States, U.S. Bureau of the Census, 2010, Table 678. www.antonydavies.org 85

Average Age 70 65.7 66.8 60 50 40 30 20 In 2000, the youngest Americans were 7.1 years old. In 2010, the youngest Americans were 6.9 years old. 10 7.1 6.9 0 Youngest Lowest Quintile Highest Oldest Quintile 2000 2010 Data source: Statistical Abstract of the United States, U.S. Bureau of the Census, 2010, Tables 8, 9. www.antonydavies.org 86

Average Age 70 65.7 66.8 60 50 40 30 The Population Isn t Stagnant The young grew up and were replaced. 20 10 7.1 6.9 0 Youngest Lowest Quintile Highest Oldest Quintile 2000 2010 Data source: Statistical Abstract of the United States, U.S. Bureau of the Census, 2010, Tables 8, 9. www.antonydavies.org 87

Inequality and the Gini-Coefficient Line up people from poorest to richest. Total income = $1 million These people earn a total of $200,000 These people earn a total of $400,000 These people earn a total of $300,000 These people earn a total of $100,000 www.antonydavies.org 88

Inequality and the Gini-Coefficient Line up people from poorest to richest. Total income = $1 million These people earn 20% of all income. These people earn 40% of all income. These people earn 30% of all income. These people earn 10% of all income. www.antonydavies.org 89

Median Income Within Each Quintile (2006$) $120,000 $100,000 25% 0% $80,000 $60,000 $40,000 100% 52% 27% $20,000 $0 Bottom Quintile Second Quintile Middle Quintile Fourth Quintile Top Quintile Parents Children Source: Pew Economic Mobility Project www.antonydavies.org 91

Median Income Within Each Quintile (2006$) $120,000 $100,000 25% 0% $80,000 $60,000 $40,000 + 100% 52% 27% $20,000 $0 Bottom Quintile Second Quintile Middle Quintile Fourth Quintile Top Quintile Parents Children Source: Pew Economic Mobility Project www.antonydavies.org 92

Median Income Within Each Quintile (2006$) $120,000 $100,000 25% 0% $80,000 $60,000 $40,000 + 100% + 52% 27% $20,000 $0 Bottom Quintile Second Quintile Middle Quintile Fourth Quintile Top Quintile Parents Children Source: Pew Economic Mobility Project www.antonydavies.org 93

Median Income Within Each Quintile (2006$) $120,000 $100,000 25% 0% $80,000 $60,000 $40,000 + 100% + 52% + 27% $20,000 $0 Bottom Quintile Second Quintile Middle Quintile Fourth Quintile Top Quintile Parents Children Source: Pew Economic Mobility Project www.antonydavies.org 94

Median Income Within Each Quintile (2006$) $120,000 $100,000 + 25% + 0% $80,000 $60,000 $40,000 + 100% + 52% + 27% $20,000 $0 Bottom Quintile Second Quintile Middle Quintile Fourth Quintile Top Quintile Parents Children Source: Pew Economic Mobility Project www.antonydavies.org 95

Employment Measures Population Non-working age population Working age population Institutionalized Non-institutionalized Non-employed Labor Force Unemployed Employed Unemployment Rate = Unemployed / Labor Force www.antonydavies.org 96

Employment Measures Population Non-working age population Working age population Institutionalized Non-employed Non-institutionalized 20 100 Labor Force Unemployment Rate = 10 / 100 = 10% 90 people employed Unemployed 10 90 Employed Suppose 2 unemployed people become discouraged. www.antonydavies.org 97

Employment Measures Population Non-working age population Working age population Institutionalized Non-employed Non-institutionalized Labor Force 20 + 2 = 22 100 2 = 98 Unemployed Employed Unemployment Rate = 8 / 98 = 8.2% 10 2 = 8 90 Unemployment rate drops from 10% to 8.2%, yet the same 90 people are working. www.antonydavies.org 98

Employment Measures Reported unemployment rate Data Source: freelunch.com www.antonydavies.org 99

Employment Measures Unemployment rate after adding back discouraged workers The Year of Weirdness Reported unemployment rate Data Source: freelunch.com www.antonydavies.org 100