Friday, July 27, 2012

The Economic Spider Web

Earlier (July 9, 2012) I addressed the problem of juries without economic understanding assuming that no one is really hurt when big corporations or someone else’s insurance pays for a legal verdict.  This mindset often causes corporations to minimize costs by paying a settlement rather than the added expense of a court battle where the odds are stacked so heavily against them.  The point I made was that whether it’s paid after a long trial or as a result of one of those out-of-court settlements, the money does not come from some secret stash or magic money tree.  It comes indirectly from you and me.

The sight of this wonderful spider web while on one of my weekly nature walks reminded me to expand on this topic.  When the fly or bug hits a spider web, the spider hiding in the corner feels the vibration and quickly locates its prey.  The signal is sent through the web and gets back to the spider.  For the spider, this is good news.

On the other hand, when a corporation or government or anyone else we do business with spends more money, the effect is the same, but it’s bad news for us.  Most companies are in business to make a profit.  When expenses increase, profit decreases.  To offset this they either reduce other expenses or increase their prices.  If an action affects a whole industry, it’s very easy for everyone to raise prices.  (Look at how different brands of gasoline go up and down at the same time when they all face an OPEC action or bad weather near the refineries.)  We end up paying more for these cost increases whether the reason is higher utility rates, shoplifting, legal actions, higher taxes, or anything else.  We are all connected, like the web example and the cost comes back to us.

Take cigarettes as an example.  States sued the tobacco companies.  The cost of those legal settlements was merely passed on to smokers in the form of higher cigarette prices  Since all companies were affected,  no one was afraid to raise prices.  The effect of the suit was equivalent to raising cigarette taxes, but raising taxes would have been perceived as "punishing" the wrong people.  Ironically, after the settlement, tobacco companies' stock price and profits continued to rise.  As it turned out, the Attorneys General looked like heros, the tobacco companies prospered and smokers paid the price.

A more recent example comes as a survivor of the Aurora, Colorado shooting is preparing to sue the theater.  Who do you think will ultimately pay for that?  Everyone who plans to see a movie at any theater in the future will be affected by higher prices to cover the additional liability costs.

It is the same story with government spending.  Decisions made in Washington or your state capitol or town hall indirectly affect your wallet.  Local or state politicians, who proudly declare that a new bridge won't cost you anything because it's federally funded, would like us to forget that our federal taxes pay for that bridge and for every other similarly funded project in America. It is our money.  When governments force utilities to buy a certain percentage of their power from higher-cost "green" sources, we end up paying through higher electric bills.  When governments subsidize a product or go deeper into debt, the subsidy or the interest on the new debt is paid for with our money.

It's important to remember that these things don’t happen in a vacuum.  Just as the vibrations of the web reach the spider, the vibrations caused by added costs or higher taxes set up economic vibrations that eventually find their way to our wallets.  To believe in some magic money tree or other isolated source of insurance, government or corporate funds is to delude ourselves.  Many politicians and lawyers would be very happy if we continued to delude ourselves in this way.

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