Rick Young, Coffee Czar

Rick Young up at Berkeley is proposing politically correct coffee that should bring us closer to solving the problems of this world. He wants to make it mandatory to sell only organic, fair-trade or shade-grown coffee. However, what we have right now is working just fine, and if it wasn't, what he proposes wouldn’t work, and in fact, would have just the opposite effect.

Young uses the argument that we must pay for the externalities that are caused by overzealous coffee farmers. It doesn’t make any sense, because what he’s proposing to do, subsidize them by giving them money, actually would cause them to become even more zealous than they are (if they were ever zealous in the first place). A normal market mechanism prevents this excess through lowered prices, so that farmers, vigorously doing cost-benefit calculations in their heads, say “ah screw it! I’m gonna grow cocaine. It pays more.” or "ah rayos! mejor cresco cocaina. Paga mejor." The article states, that the market price of coffee is currently at record lows, and from that, we can infer that the supply of coffee will soon decrease. A better measure, if Young really wants to help the environment, would be to tax the coffee, and directly use the money, keeping it independent of the coffee supply, instead of worrying about whether giving that money to farmers causes them to grow even more coffee. It also doesn’t matter whether you tax the consumers or producers, because the shifts in consumer demand or producer supply from either tax would lead to the same result.

But I suspect Young wouldn’t want to tax the farmers.

The thing that Young doesn't realize is that mandatory subsidization to a producer for his product traditionally results in an overproduction of that product along with a corresponding decrease in demand for that product. It’s in any first year economics textbook. In this case, the subsidy would be in the form of the extra dollar (or so) per pound paid to the growers of coffee. One example of such a subsidy is the inflated price for oil that countries pay to OPEC. The natural incentive of a cartel member, the coffee farmer, and the oil rich country, is to take advantage of those inflated prices by overproducing; but the resulting excess would naturally bring prices down, contrary to the cartel's wishes. In order to prevent this, OPEC has to give production quotas to each of its member nations, which I suspect the International Fair Trade Coffee Register would have to do. However, even artifically high oil prices fluctuate depending on conditions – they’re not fixed – and what happens as a result is that, if oil prices decrease, member nations MUST produce more oil in order to take in the same amount of money. This lowers prices more. Needless to say, OPEC is not as effective as it used to be (or cartels in general).

The only justification for Young’s argument is that the extra dollar isn’t actually a subsidy – that it is a fair market price for organically grown coffee. Well, that can make sense. You have a market for normal coffee and a market for organic coffee. Stick a tax on the normal coffee, and watch those farmers instantly convert to organic coffee growers or people to organic coffee drinkers. And they still have a choice as to whether they’re willing or not to pay the extra expense. It’s better than offering them organic coffee or no coffee.

However, that’s examine his justification a little bit more:

“People should pay a price for their coffee that reflects the larger costs, like polluting water and cutting trees,” Mr Young says. “Prices now are artificially low because they don't take into account all the externalities.”

This would make sense if the water the farmers were polluting and the trees they were cutting down were say, government property that was set aside for unregulated usage. A competitive market CAN lead to excess resource exploitation IF the land were public. For example, over-fishing can occur as fishermen try to beat others in catching the most fish to sell, or over logging, or a million other things. But to reiterate, the solution to this would be a tax, instead of a subsidy, and the implementer of this tax should be the government. Not some little guy in Berkeley or another country’s government.

The story suddenly changes when the land becomes private property. The rational farmer, doing his cost-benefit calculations, takes into account the benefit of the trees, as well as the costs of cutting tem down. If the costs outweigh the benefits, he’s either not going to cut them down, or if he does, he’s sure as heck going to make someone else pay for it; he’s going to pass the costs down right to the consumer. If this were the case for coffee, the externalities are already priced in, and we’re already paying for them.

Of Markets and morality...

TED KOPPEL "...as you describe it, it [the market] is, of course, a game in which there are real consequences. When you bet and you win, that's good for you, it's bad for those against whom you have bet. There are always losers in this kind of a game."

GEORGE SOROS "No. See, it's not a zero - sum game. It's very important to realize..."

TED KOPPEL "Well, it's not zero - sum in terms of investors. But, for example, when you bet against the British pound, that was not good for the British economy."

GEORGE SOROS "Well, it happened to be quite good for the British economy. It was not, let's say, good for the British treasury because they were on the other side of the trade...It's not - your gain is not necessarily somebody else's loss."

Later discussing Malaysia:

TED KOPPEL "Because - I mean put it in easily understandable terms. I mean if you could have profited by destroying Malaysia's currency, would you have shrunk from that?"

GEORGE SOROS "Not necessarily because that would have been an unintended consequence of my action. And it's not my job as a participant to calculate the consequences. This is what a market is. That's the nature of a market. So I'm a participant in the market."
Copyright © ABC News ."

This interview is a little old, but still worthy of discussion. Background: the price of the British pound was being maintained using buying operations from the Bank of England, even as speculators, most notably George Soros, sold it. The Bank of England eventually gave up, the price broke badly, and Soros cleaned up four billion dollars. Obviously, if he hadn’t made so much money, he wouldn’t have ended up arguing with Koppel about the morality of his actions -- but what’s done is done -- and provides fodder for this little analytical foray!

Cosmetically, Koppel wipes the floor with Soros. He’s able to portray Soros as a person who destroys lives and economies without a second thought, as well as simplify, beyond belief, something that should not be simplified.

What Soros does, as a money manager, is to buy undervalued assets, and sell overvalued assets. This is arbitrage in its most general form. Notice that, by definition, a successful money manager, performs arbitrage, because he buys undervalued assets before they rise in price, and sell overvalued assets before they fall, equilibrating price to value by his actions. And this is what a market is and does. Soros’ argues that he is merely a extension of the market, that the market mechanism works through hundreds of participants like him, and that there is no morality in a mechanism.

It's probably right before this thought that Koppel falls off the ride.

Again, by definition, a SUCCESSFUL money manager fundamentally has an information difference, which allows him to buy assets before they rise, or sell assets before they fall. Without an information advantage, he would be gambling, and in the long run, should perform just as well as an index would. That informational difference is where Koppel’s argument is from. A better formulation of his argument would be that Soros is ripping people off (to put it bluntly) when he conducts his trades, because he happens to know more than they do. When the British pound fell, it happened to be good for the economy (according to Soros) as their currency was returned to par– but it was bad because Soros was taking advantage of the Bank of England (according to Koppel).

However, let’s just assume Koppel’s premise. If we generalize, we realize that informational differences exist as a necessary condition of our society. The corporation is able to gain market share from a competitor because of its’ innovation. The information difference between students allows them to be ranked and curved. In short, these differences are what we use to gauge merit. The only way we can say this method is not valid is if the information were gained through unscrupulous ways, i.e, cheating, corporate espionage, or insider information. However, the type of information that Soros had, was not insider information: no one can tell you if the pound were about the be devalued.

And keep in mind that the Bank of England was not exactly informationally disadvantaged.

What’s strange though, is that people who disparage money making through this informational difference, at the same time also disparage day trading because of its gambling qualities. The two thoughts can't mutually exist.

Medical Malpractice ain't easy

"Advocates of reducing the amount insurers have to pay for medical mistakes often cite California as a model. In the 1970's, California set a ceiling of $250,000 for jury awards for pain and suffering, and malpractice insurance prices have not soared there. But Harvey Rosenfeld of the Foundation for Taxpayer and Consumer Rights in Santa Monica, Calif., says patients have suffered. Because of the cap on payouts, he said, many lawyers refuse to represent malpractice victims, making it difficult for them to pursue claims."

Hmm... let's start from the beginning... imagine that one day, John Smith (that would be you), were injured as a result of medical malpractice: a surgeon accidently left his spatula in your stomach and you experienced pain and suffering as said spatula passed out. After hiring a lawyer and submiting this case to a jury of your peers, they awarded you a monetary value, which would be paid by said surgeon's insurance carrier.

This scenario belies a very intricate equilibrium. Each entity has different incentives under the system, with the result that the payment cap becomes the linchpin that holds it together (abeit not very well). John Smith has two incentives, 1) to inflate his pain and suffering and 2) To file as many claims as he can, because he would not have to pay attorney fees unless he won. The Lawyer makes money either way; generally, he has the incentive to facilitate the lawsuit because he makes more money if he wins. The insurance company charges Mr. Surgeon an insurance premium, based on whether Mr. Surgeon has a prediliction towards leaving spatulas in patients. However, they have an incentive to overprice the premiums, because heck, they can lose an infinite amount of money. Finally, Mr. Surgeon has the incentive to not leave spatulas in John, so that he can keep his premiums down.

In an ideal world, everything would be hunky dory, but let's look at this in pseudo-mathematical terms: John, if he lost, would lose a little time (with a monetary value placed on it of course), but has the possibilty of (almost) infinite gain, if he won. Sort of like a free lottery ticket. The lawyers and the insurance companies make money either way the case goes*. They want MORE cases. And the surgeon faces the possibility of an infinite loss, in the form of insurance premiums. What he does is attempt to balance that, by changing John a heckuva lot of money for surgery, and making him sign a contract that limits that liablity. But these things, in excess, also give him incentives to leave spatulas in John (because John is only worth so much eh)

What the payment cap does is 1) Limit John's potential lottery ticket by capping it, 2) By capping it, it also gives him less of an incentive to play the lottery i.e sue, because he has to balance it with the loss he might incur. 3) It also limits the incentive of the lawyer to play the lottery, because now he has to balance his wins with his losses. 4) It keeps premiums in check, because using the payment cap and some statistics, a surgeon can calculate how much he should be paying as a premium. 5) Using these same premiums, the surgeon can decide how much he should charge John vis-a-vis how much he needs to charge John to stay in business.

But, there are negatives: Some valid cases would not be tried because they are too minor and some rewards may be too small because of the cap. Whether this is fair or not depends on your point of view. However, keep in mind that because the $250,000 cap was decided by a legislature, we can be sure that it was the proper utilitarian result of a cost-benefit calculation done by society. Yup, several million Californians have balanced the gains and losses of the cap effects.

*lawyers have different incentives, depending on whether they are paid a lump sum, or on a percentage basis, but that doesn't change this much.