Monthly Archives: October 2006

Another Nobel for an Economist

The New York Times reports:

A Bangladeshi economist, Muhammad Yunus, and the bank he founded 30 years ago won the Nobel Peace Prize yesterday for pioneering work in giving tiny loans to millions of poor people no commercial bank would touch — destitute widows and abandoned wives, landless laborers and rickshaw drivers, sweepers and beggars.

Muhammad Yunus spoke to reporters Thursday with his wife Afrozi in Dhaka, Bangladesh.
The Nobel Committee praised Mr. Yunus, 66, and the Grameen Bank for making microcredit, as the loans are called, a practical solution to combating rural poverty in Bangladesh and inspiring similar schemes across the developing world.

Economics is not a zero sum game

Barry Ritholtz thinks economics is a zero sum game:

The economy is more of a zero sum game than most people realize. The Politics of the past decade has been more about capturing a bigger piece of the pie, rather than EXPANDING that pie.

That is a zero sum game.

Consider taxes: The dividend and capital gains tax cuts fell to a very narrow portion of the population (of which I am a prime beneficiary). The known costs of these — increased deficits, weaker dollar strength and buying power — are borne more by certain segments in the population than others. That is zero sum.

His basic premise is that in order for one side to benefit, another must lose. It is unfortunate for someone as knowledgeable as Barry Ritholtz to propagate this claim.

It may be true that, “The Politics of the past decade has been more about capturing a bigger piece of the pie, rather than EXPANDING that pie”. However, this is a political issue. Politicians often see the world as a zero sum game. In order to win an election someone else must lose and only 50 people can be Senators. Economics is different.

Despite the politicians best efforts, the economy has continued to expand. Even if this expansion has only affected one segment of the population, that one group would be better off while the other groups would be no worse off. However, Mr. Ritholtz seems to believe that the problem is that they would be worse off relative to the other group. While this certainly may create envy and give some the impression that they are worse off, in reality, they are not.

It is easy to look at income distribution and believe that economics is a zero sum game because the distributions will always sum to one hundred percent. Therefore, when one share becomes larger, at least one of the other shares must fall.

Nevertheless even if one group’s share should fall, an expansion of the pie will benefit everyone. Further, there is very clear evidence that the pie is expanding. Over the last 35 years, real GDP per capita has doubled.

Mr. Ritholtz also uses tax policy to argue that economics is a zero sum game. He contends that the rich received money through tax cuts while the government created a larger deficit. However, this is an argument about a budget, not economics.

By making this claim, Mr. Ritholtz is making inferences about the deficit. The federal budget is large and complicated (too much so, actually). However, Ritholtz implies that tax cuts caused the deficit. The tax cuts no more caused the deficit than the famous transportation bill or earmarks.

Even if we give Mr. Ritholtz the benefit of the doubt, there is still no reason to believe that this is a zero sum game. The government incurs the cost of interest when it borrows to fund the deficit. The recipients of the tax cuts do not simply stuff the extra money under a mattress, they use it to invest in stocks, real estate, mutual funds, bonds, and even businesses. Therefore, if the individuals are able to see a greater return on their investments than the government pays out in interest, this is not a zero sum game.

To put it quite simply, economics is not a zero sum game. Economics, on its most basic level, is the study of the allocation of scarce resources. Adam Smith famously explained that in order for a transaction to take place, both parties must benefit. Therefore, it is true that in order to buy a stock, someone else must sell the stock. However, this is not a zero sum game because I value the stock more than the money I paid and the seller values the money more than the stock. We are each better off. This is a basic fundamental of economic theory. It is unfortunate that someone as knowledgeable as Barry Ritholtz would propagate anything else.