Competition is Good

It’s been a while since I wrote about Economic Understanding – that there is no magic money tree. Here is a short refresher.

A few often misunderstood economic concepts are that one person getting richer does not mean others must be getting poorer and that competition in markets usually benefits everyone.

Many politicians try to convince us that rich people got that way by taking money from us. They must be dishonest and greedy. They are not playing by the rules or paying their fair share (whatever that is). When they give examples of those rich, fat cats, they never seem to mention rich people we admire. They omit the professional athletes, TV and movie stars, studio heads, software executives and others who make their millions by bringing us the entertainment we crave. Those people get rich, and they don’t do it by stealing. They earn their money honestly; fans spend freely on tickets and apparel. The majority of other rich people also did it honestly, and if they took advantage of loopholes, that’s what the politicians should be focused on rather than stirring up envy. (Most of those politicians are also very well off.)

In a free society, where people make their own choices about how to spend their money, that money flows to those with the best ideas, best products or best services as determined by some combination of quality and price. Consumers get what they want at a price they are willing to pay, and the providers make a profit. 

This fair exchange, happy buyer and happy seller, keeps the economy growing. As one seller sees a rival doing more business due to a better product or better price, he is motivated to improve quality and/or make the operation more efficient to be able to lower the price. We get better things for less.

Examples are easy to find. In 1975 a good (tube) TV with a 26-inch screen could easily cost in the $450 range. Here is a 65”, Ultra HD, Smart LED TV with good reviews for about the same price. That is a direct comparison without considering that $450 in 1975 would be over $2,200 in today’s dollars. 

 Air conditioning in cars began as a luxury item, but today about 99% of new cars sold have it. And those smart phones owned by many, even some of those considered poor, were unavailable twenty years ago at any price! Anyone claiming that poor and middle class families are not better off today would have to ignore history and economic reality. Examples are so easy to find.

The progress we see all around us, and mostly take for granted, was driven not by government programs, but by the free exchange happening everyday across the nation as consumers made choices based on quality and price. Those free choices forced the competition and innovation that led to generally increased prosperity. Certainly that prosperity is not evenly divided, but that’s not the fault of people we willingly gave our money to.

The idea of competition can be scary, but it only means everyone has to work harder to keep improving price and quality. Where would your favorite sports team be without competition – playing inter-squad scrimmages all year? What fun is that?

One market where competition seems impractical is public utilities. Years ago cable companies were treated like utilities because towns and cities didn't want more than one entity digging up yards and streets to lay cable. Today in my neighborhood outside a small Midwest city, I have a choice of traditional cable, fiber optic cable, satellite dish and soon Internet and TV delivered by my electric utility. Four companies compete and prices are now coming down! 

When the government alone provides goods and services, there is no competition. There is scarce pressure to be more responsive, more customer-oriented, more efficient, with better quality at a lower price. Prices go up at rates greater than that of inflation with minor if any improvements in the product, e.g., public colleges and universities. The post office and the DMV have for years been held up as examples of poor service. If we want their services, or are forced to use them, we don’t have a choice. We take what we get, pay what they demand; and improvements are slow.

Competition should not be scary. Competition is good.

IOU

When I heard that average household debt in the US was over $90,000, I went on line to find out some of the details.  I found that the $90,000 number was the amount owed spread out over all households.  Considering that about 30% are debt-free, that means only the households that are in debt owe an average of over $130,000, an even more surprising number.

This personal debt includes student loans, mortgages, credit cards and auto loans.  Now averages are tricky and summing averages does not necessarily represent reality, but such a large debt while we hear constant reports of stagnant income for the middle class is still a matter for concern.

While I was looking for the details, I ran across this article about a similar problem in Australia.  Their “household debt has skyrocketed to 185 per cent of disposable income and continues to soar.”  They blame the problem on a combination of “ill-considered public policies and lifestyle and investment choices of individual households.”  Driving these personal spending and investment choices are artificially low interest rates and other government policies and programs that discourage savings and encourage borrowing.

The article predicts that in less than five years the household debt bubble will burst leading to widespread economic hardship for those who have incurred unsustainable levels of personal debt.  As a remedy to avoid the crisis, they recommend that the Australian central bank, analogous to the Fed in the US, raise interest rates to discourage borrowing.  This will cause some short-term pain, but will avoid a likely major economic upheaval if behaviors don’t change.

This story of Australia and the urgency with which it was written made me curious about the corresponding number for the US.  I found an estimate of the household annual disposable income for the US of $41,355.  If this is, in fact, the same calculation, the average household debt in the US is not 185 per cent of disposable income – it’s almost 220 per cent!

Should we be as panicked as the Australians?  I’m not sure.  But it seems to be at least a wake-up call about personal borrowing and spending.  Overspending is a discipline issue and the consequences, whatever they are, will catch up sooner or later.

Is College Worth the Cost?

Here is something worth thinking about.  Young people spend five or six years getting a college education, some with the belief that it will help them do better financially in life.  Let’s look at a few numbers dealing with averages to show how this assumption can go wrong.

First we must address opportunity costs.  While attending college a student typically is not working, except possibly part time to contribute to current expenses.  Time spent at college is time lost to earning (and experience and possibly seniority).  We need an estimate of how much time that is.  A Time Magazine article from 2013 tells us:  “According to the Department of Education, fewer than 40% of students who enter college each year graduate within four years, while almost 60% of students graduate in six years.”  For a rough average, five years seems reasonable.

Next look at the relative average pay for a college graduate and a high school graduate.  The National Center for Education Statistics helps out there:  “in 2013 median earnings for young adults with a bachelor's degree were $48,500, compared with …$30,000 for those with a high school credential."  (Note: The Start Class website lists 22 colleges where the median salary of their graduates is less than what a high school graduate earns, but we’ll stick with the averages.)

The salary difference is substantial, but don’t forget the opportunity costs.  Right off the graduation stage with diploma in hand the college graduate is already 5 years of salary (@$30,000 per year = $150,000) and five years real work experience behind.  The average graduate is also almost $30,000 in debt.

Assuming out any interest on loans and the effects of inflation (to keep it simple), the graduate needs to make up about $180,000 just to get even.  With an advantage of $18,500 in salary (before taxes) it will take nearly 10 years to close the gap.

This is for the average.  Some will do better and some worse.  It takes a few more assumptions and a few simple calculations to get down to the individual case.  Additionally, college is not for everyone and some people with only a high school education can do much better than average.  The big watch out, however, is that competition for unskilled or semi-skilled jobs is fierce – not just here, but in places like Mexico and Asia where a $20 hourly wage job can be done by a replacement earning $4 or less per hour.

It is important for every high school student to consider these issues carefully and calculate the likely long-term outcome using realistic personal assumptions.  I heard of one young man who chose a private college at $40,000 per year over a public college at about $12,000 per year because the private college was smaller and he had a better chance to make an athletic team (no scholarship involved).  The five-year difference will be almost enough to buy a modest house in the part of the country where he lives – and his goal is to be a high school math teacher!  Even if he gets that teaching job, chances are he will work an additional 6 to 10 years just to make up the difference financially of this one decision.

Making Connections

Some people who are appalled at the NSA routinely reviewing phone records will sit glued to the TV as an undercover reporter tries to pin down a crooked businessman using a hidden camera.  Some people who start their day with a cup or two of coffee to wake up and end the day with a drink to calm down or have a beer on the weekends to relax are outraged at proposals to legalize marijuana or other recreational drugs.  These people are not being hypocritical.  They just don’t stop to make connections between one behavior and another.  Recognizing the similarities between seemingly unrelated behaviors, opinions or choices uncovers contradictions that often go unnoticed.

This brings us to examples of gasoline prices and student loans.

Early in June, the Midwest was surprised at having the highest gas prices in the country.  Prices jumped to $4.25 per gallon.  Local news stories featured the usual pain-at-the-pump stories.  The temporary price increase was attributed to problems at regional refineries, but not many people paid attention to this detail.  Naturally, the conspiracy theorists came out of the woodwork accusing the oil companies of price gouging.  A short time later the price had gradually dropped by more than a dollar a gallon with no mention in the media of our sudden good fortune.

During the same time period, this news appeared.  “An environmental group that helped push BP PLC to a multimillion-dollar settlement last year over air emissions at its northwestern Indiana oil refinery says the sprawling complex's revised wastewater permit falls short of what's needed to protect Lake Michigan's waters."  Do we recognize the connection between high gas prices attributed to refinery issues and the legal challenges of this environmental group making operation more difficult, risky and expensive for one of those regional refineries?  Clean air and clean water are important, but it’s so easy to forget that it’s not BP or any other corporation that ultimately pays the bill.  It’s you and me as we complain about our pain at the pump.  It’s simple economics.

Another news story getting attention is the failure of Washington to deal with student loans, allowing the interest rate to double.  Many students are struggling to get by and the additional interest will increase their burden.  To make matters worse, news broke that the federal government is making a profit on student loans.  As the story unfolded I noticed this article that tried to personalize the crisis with a real-life example.  It told of Kristy Currier, 26, of Detroit who owes $75,000 in loans.  When I expanded the photo, the caption said that she lives with her fiancé and two dogs and two cats.  One pet would be considered a luxury for someone owing $75,000, but it’s hard to feel sorry for someone who voluntarily takes on the extra costs of feeding, medical treatment and daily care of four!

When we miss the underlying connections and the contradictions they imply, it’s hard to come to a workable solution.  We bumble along and feel like victims of the system, but sometimes it’s not the system’s fault.