October 8, 2009

Apples and Oranges: A Parable of Distorsiolandia

Quico says: OK, time for a thought experiment/parable.

Welcome to Distorsiolandia, a land of simple rural folk where everyone works in agriculture. Distorsiolandia's economy is so simple, in fact, that the country has no money. It's not really necessary, because Distorsiolanos produce only two goods: apples and oranges. It's a tropical place, mind you, so there are a lot more oranges around than apples.

In fact, there are three times as many oranges as apples in Distorsiolandia. So its GDP looks something like:

Remember, we said there's no money in Distorsiolandia, but there is trade. As people barter apples for oranges, they soon settle on the terms of trade between them: one apple is worth three oranges.

In other words, the price of an apple is three oranges, and the price of an orange is one-third of an apple. Not having discovered money, Distorsiolanos have to quote the price of each product in terms of the other.

And those price, of course, match the relative scarcity between them.

One day, a radical revolutionary people's government comes to power in our fictional little country on the back of a radical redistributive discourse.

The revolutionaries rail against the way a parasitic elite has hoarded all the oranges, making them far too expensive for regular people to afford. So they decree that, from now on, the price of an orange will be controlled: for an orange, you can charge no more than one-quarter of an apple.

Which means that, instead of three oranges, an apple will buy you four.

People love oranges, so this decree makes the government very popular indeed. Lots of people who were happy to hold apples - back when an apple would only buy three oranges - now come forward to trade those apples for four oranges a pop.

But notice what the decree doesn't do: it doesn't change the underlying distribution of apples and oranges in the economy. You still have just three oranges around for every apple.

The relative scarcity of the two products hasn't changed: apples are still 3 times more scarce than oranges.

That means that, at the new price, the total stock of apples in the economy can buy more than the total stock of oranges. If everybody who has an apple tries to trade it for four oranges, you soon realize there are too many apples around chasing too few oranges. Soon enough, every orange has been sold off, but you still have people holding apples, wanting oranges, and finding nowhere to buy them.

What you end up with, in other words, is Orange Scarcity. At the government set price, there are simply too many apples chasing around too few oranges.

Now, notice what's happening here. There are oranges around. And there are apples around. There are people with apples who want oranges. And there are people with oranges who want apples. The only thing that's keeping the two apart is the government set price. Orange holders just sit there, holding their oranges, because they realize that, at that price, selling an orange only makes you poorer.

The revolutionary people's socialist government sees this and is outraged!

"Hoarding!" it cries, "speculators!"

Soon, the government is sending off soldiers with Kalashnikovs to round up people who are holding oranges and refusing to sell them for the controlled price. It makes them do a perp walk, holds them up to public contempt, blaming them in front of the cameras for the fact that people can't find any oranges in the shops! It never for one moment occurs to them that, at the price they've set, there simply aren't enough oranges to satisfy all the apple-holders in the system!

What happens next is also clear enough. If sellers aren't allowed to hold oranges and buyers can't find anyone to sell to them at 0.25 apples, soon enough somebody will decide to sell oranges on the down-low, for 0.33 apples a piece.

Of course, you're not allowed to do this openly, so you have to sneak around. A black market for oranges crops up. Soon, the government cracks down, threatening permuta orange sellers with jail and - here's the precious part - actually blaming them for the rise in the price of oranges!

So the government faces down the distortions created by one policy intervention - fixing the price of oranges - with another intervention: jailing black-market orange-mongers. But that second intervention itself creates a distortion. By making orange-selling riskier, it ensures black-market oranges will sell at an even more inflated price, since orange-mongers will now demand a risk-premium for participating in this dangerous illegal activity. So instead of 0.33 apples, they may demand 0.4, or even half an apple for an orange. By now, orange-buyers are out of options: they're bound to pony up.

And how will the government face up to the distortions created by the policy it implemented to confront the distortions created by the previous policy it had implemented?

You guessed it! By implementing yet another policy that brings with it yet another distortion!

Will they take over the Orange processing and distribution system? Will they threaten orange farmers with jails if they don't plant enough oranges? Who can tell? The sky is the limit!

Welcome to Distorsiolandia, where the solution to the problems created by one distortion is always...another distortion!

Lost in the thicket of laws and regulations that this kind of thinking generates is a simple insight: no bureaucratic dictate can change the fact that if there are three oranges out there for every apple and you force people to hand-over four oranges for an apple, oranges are gonna run out as sure as night follows day.

What's scary is that that thought, simple as it is, will cause a chavista's head to implode. When these people say they're against capitalism, what they really mean is that they're against arithmetic.

[Hat-tip for the "distorsiolandia" thing: AA, which, come to think of it, I'm not even sure if she reads the blog...]