Sun, 21 Mar 2004

Gross Domestic Product

The Gross Domestic Product (and its friend the Gross National Product), is often criticized because it does not measure the wealth produced by non-market transactions. For example, if we do favors for each other, that does not contribute to the GDP, but if we pay each other, it does. Or take stay-at-home mothers who keep house and home together, or who do volunteer work outside the home. What they do is much like paid work, but because it involves no pay, it's not part of the GDP.

People use these examples to criticize economists for using a poor representation of the wealth of a society.

Problem!

Economists aren't using the GDP to represent the wealth of a society!

Only non-economists think the GDP represents the wealth of a society. They're constantly misled by news reporters who report changes in the GDP as if that number means anything to a working stiff. It doesn't. It measures trade, not value. Its only use is in comparing the size of one country's trading against the size of another country's trading.

I'd really, really like to see non-economists completely forget about the GDP. Or, if they simply cannot forget it, at least stop paying any attention to it. It's only meaningful to economists. Everyone else should ignore it.

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Sat, 13 Mar 2004

Free Software

Ng asks "I'm a little disturbed by this: If people give the fruits of their labour away and inform others that they value the time and effort involved very lowly, are they not undermining their economic future somehow?"

It's advertising, but only in roughly so. Most advertising is not functional. It gets presented to people as a public bad, by way of overcoming the transaction costs involved in making a public good available. Everywhere you see advertising, it's associated with some other thing which you value, e.g. advertising and publicly presented information goods are very often associated.

That said, it's not at all advertising, because it is in itself the public good. Nor does it serve to advertise itself, because the user already has the item of value. It serves to advertise ancillary things, e.g. services offered by the distributor of the software, or the reputation of the author.

One of the difficulties of purchasing a service is that by the time you have it in your hands, you've already incurred an obligation to pay for it. Much more than products, services are valued based on their reputation. You may know that many insurance companies are based in Hartford, Connecticut. This is because during some disaster centuries ago, the only insurance company which was able to pay out in full was from Hartford. The name became associated in the public eye with sound fiscal sense.

That's why the price of identical services can vary wildly. Only after the service has been performed can you be sure that it's identical. One vendor might do the same work in less time, or poorer work in less time. Another vendor might take longer, be harder to schedule, and charge more, and still produce a service whose value to you exceeds what anyone else can do by a sufficient amount to make it worthwhile. For example, when we had our kitchen cabinets done by a local Amish craftsman, we had to get on his list a year in advance. When he came to measure the cabinets, he told us what cabinets we wanted where. The cabinets were at least a week late. On the other hand, the cabinets were made from solid oak. And when the 12' x 12' J-shaped counter came in, it fit right into the space allotted for it with no more than 1/8th inch error.

Another way an author of free software can monetize the public benefit he has created is by enhancing his reputation. This reputation will make him more valuable to employers. Every book on getting a job tells you to polish your resume. Tell me: if you were hiring a programmer, you would hire one with a polished resume or one with polished software? It's very risky to hire someone, because you might find yourself having to fire him early in the relationship. A portfolio of popular open source software reduces the risk of hiring a programmer. From the programmer's perspective, it means that he can take a greater share of the value produced by his corporate efforts. A programmer of lesser reputation would have a portion of his effort spent to cover the risk that his work may not be up to snuff.

So why is most software proprietary, you might ask? I believe that it is because of an intellectual error made back in the late 70's. Proprietary software is a monopoly, and invariably commands monopoly prices. Monopoly prices are bad for society, and are only tolerated because no alternative is thought to exist. Somehow, during the time I was in college, some number of people became convinced that software was a scarce resource, and would only be produced by being subsidized by granting government monopolies (copyrights first, and later patents).

It's becoming obvious to more and more people that software is not scarce. The scarce good is people's time, and that is what commands the big bucks. Of course, people's time needs no monopoly (aka intellectual property protection) since people are free to withhold their efforts until they are paid.

The days of software as a product are numbered. Software has become more of a service than a product and will in time switch to being fully a service. At that point, all software will be open source software.

Posted [23:33] [Filed in: economics] [permalink] [Google for the title] [digg this]
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You're On Welfare

Stephen Turnbull writes, in part, on the Free Software Business mailing list, "If you have a job because somebody else is prohibited from offering the product at a lower cost, you're not on salary, you're on welfare."

Further, I would say that if your job depends on subsidies or tariffs, you're not working for a living, you're begging for one.

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Fri, 12 Mar 2004

Bad Economist, No Donut

Eli Noam embarrasses himself with an egregiously wrong-headed analysis of Market failure in the media sector. One thing that you must, must know, is that any economist who talks about "market failure" needs to put his feet on his shoulders and push. Markets do not fail any more than gravity fails. What would you think of a physicist who talked about "gravity failure"? Probably not much. You should think as little of an economist who talks about market failure.

Now, you can certainly claim that a broken egg is due to gravity failure. That's not science, however. That's a misdirection; applying fault to something which is clearly not culpable. In terms of fault, the person who dropped the egg is much more likely to be guilty. Furthermore, it's assigned a negative quality, when in fact the egg may be broken because it was dropped into a mixing bowl.

The real kicker, however, can be seen by reading farther down in Noam's article. You can see that his prescription for "market failure" is government interference. That points to the cause of his claims that markets have failed. Once markets have failed, no sensible person could possibly object to government picking up the pieces, could they? Well, I think I'm sensible, and I object!

Now, I would be the last person to claim that markets always produce good results. Some problems are hard for markets to solve simply because they are hard problems. Pointing to a problem which is hard for markets to solve doesn't automatically mean that solution-by-government will be better. It may turn out to be that government interference will produce a better result (pareto optimal) than peaceful cooperation. I allow that as a possibility at the same time that I doubt it will ever happen, once all costs are accounted for.

Posted [21:37] [Filed in: economics] [permalink] [Google for the title] [digg this]
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Freedom of Trade

I'm very skeptical of the idea that taxation can solve free rider problems and transaction cost problems and create positive externalities. Controlling taxation has free rider and transaction cost problems and creates negative externalities. In essence, rule by majority turns into rule by special interest minorities, and since everyone is a special interest, everyone ends up trying to lord it over everyone else. Sure, you can saddle up the horse and it's a lot faster than walking, but by the same token it doesn't pay much attention to how you yank on the reins.

I wouldn't be the first person to propose this theory. The Anti-Federalists wrote it all down over two hundred years ago. They predicted what we have now. It's hard to argue against a theory that produced a correct prediction.

Here's the analogy I make: Three hundred and fifty years ago, everybody thought that a country had to have a single religion. Politics and religion were thought to be inseparable. These days, politics and economics are thought to be inseparable. The idea of politicians not interfering in the economy is unthinkable. Most people seem unable to think of such a thing. And yet ... I believe that some day in the future, people will consider it a basic human right to have freedom of trade, just as we do for freedom of speech, press, assembly, and yes, religion.

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Gregory Mankiw, III

A reader relates the following story. I don't argue from anecdotal evidence because you can always find an opposing anecdote. Still, it's always nice to hear that the theory can work in practice, because if the theory never works, the theory is definitely wrong.

I was a project manager with [computer hardware company] in 1989 and quit my job to pursuit a career in Financial Services. My salary was roughly around 52K at the time I quit. I made on my own for a while then through a series of mistakes; I ran into trouble so I had to close my shop and try to come back my old career in late 2000. Talking about 11 years in dormant and I almost forgot everything from electronic, computers and programming which I was damn good before. No one would hired me because I was either too "obsolete" or whatever the excuse they could give me. I figured perhaps in my resume I could put down a minimum hourly wage so everyone knows that they can get me cheap to give me a try. I put down exactly $12/hr which is equivalent hourly wage of a "dumb" technician doing nothing but following the order of the engineer. There is no way an honest employer could not want to take a look at me and I got quite a few offers even in late 2000, jobs are hard to get after the dot.com bubble. I took the offer of a company is closest to my home, 7 miles one way, in road. Not bad for California work environment when people spend minimum hour one way to work. Within one month, they raised my salary about 4 times big time, put me back doing things which I was and am still good at it. There's your living proof of "unemployment is another word for inability to find a job for a wage of their choosing".

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Gregory Mankiw, II

TM Lutas comments again, saying that I just don't get it:

There are two reasons to create a trade imbalance which impoverishes your people and enriches your partner. One is because you need to put an enormous number of people to work in order to avoid bad political outcomes and the second is to create such a preponderance on debt held by you that you can crash your partner's economy at will and extract a never ending stream of concessions to avoid that fate.

He's conflating two different topics. If you're trying to explain and elucidate, as opposed to convince, you shouldn't do this. Topic #1 is "What do you do when a foreign trader is willing to sell you things for a price substantially below their value to you?" Topic #2 is "What do you do when a foreign trader sells and sells and never buys from you?" I'll address them separately, as they deserve to be treated.

Selling below value

In a certain sense, everyone does this. In a free market, nobody sells something for less than they think it's worth. How does trade, then, occur? Simple: because people value things differently. Anybody who sells something for money values the money more than the thing. Anybody who buys something for money values the thing more than the money.

When can this be a problem? In a free market, it can't. The trouble is when governments interfere with markets, by, for example, fixing exchange rates, by fixing interest rates too low, by allowing slave labor, or by capping wages. In each of these, the government is destroying information about who wants what, and how badly. Another term for that is censorship. (As a side note, I wonder why leftists decry government censorship but allow government interference in markets?)

The trouble with this censorship is that it can lead country A's customers to buy products from country B even though country A can "really" produce the products more cheaply. Some might argue that it's inherently unfair for one country's citizens to be set against another country's citizens. They're right, it is inherently unfair, but the unfairness is created by country B's government against its citizens. They're producing something which is "really" cheaper for country A to produce. Country B's citizens should be left free to produce some other product which they can "really" produce more cheaply.

I put "really" in quotes above because you can't really separate out the actions of a government from the economy of the country. Any government is going to use its power to extract income from the citizens of the country. This inherently distorts the economy. A good government will make sure that it only does things which are good for its citizens in both the long and short terms. I must point out here that a country which elects new caretakers every few years is going to have a hard time maximizing its long-term welfare. In part, the incumbent factor, and bureaucrazy and "Washington insiders" that so many people decry function to mitigate this factor.

From outside a country, it's hard to tell on a market basis if coal is cheap in the country because they have so much of it, or because it's being mined by slave labor. In other words, a free marketplace is going to treat the product as it appears in the marketplace. If a government acts against the interests of its citizens by causing them to produce less than they might, then that is the government that those citizens deserve. This is one of the impacts of economic ignorance that I'm trying to communicate to you, gentle reader

Regardless of the cause of the low price from country B, the producers in country A are going to be priced out of the market. Regardless of the cause, the producers in country A are going to go out of business. While one might regret that the citizens of country B are harmed, and in being harmed, are creating an externality that harms country A, the exact cause is really besides the point. Conditions are such that country B can produce the product cheaper than country A.

TM Lutas's implication that "country A ought to do something" about country B is wrong. All that country A can do is say "thanks for the products" and move on.

Selling and never buying

International trade seems hard to understand, at least judging from the number of people that are confused about it. Bring it back down to the level of the household, and it's much easier to understand. What happens when you buy something? You have to pay money for it. When you sell something? You get money for it. International trade works the same way. When someone in the US buys something from another country, they pay dollars. When someone in the US sells something to another country, they get dollars.

The key complicating factor here is that, in another country, dollars are nothing more than collectible monochrome presidential portraits (and of US presidents, to boot). Dollars are a very widely accepted currency all over the world, but you have to want to buy something. Some countries sell a lot to the US, in particular Japan and China. These two countries have not been buying products from the USA (or products from other countries who have already bought from the USA and who now need more dollars). Instead, they have been accumulating dollars and buying Treasury Notes.

The point to which TM Lutas was referring is that you have a small number of entities which control those Treasury Notes. They can choose to destroy some of their accumulated wealth by selling those Treasury Notes in large quantities. This has a negative effect on them, but also a negative effect on the USA as well. The USA government is getting its spending money (on the margin) by selling Treasury Notes. If the price it gets for them drops, it has to sell more to get the same amount of money.

In essence, these external borrowers have a doomsday device located in the USA. They can harm our economy by dumping large numbers of Treasury Notes. They can use this leverage to extract political favors. Here's the problem with that threat: it's a paper tiger. They can sell Treasury Notes, but they have to sell them for dollars. The very same reason why they do not sit on dollars would force them to buy something else with the proceeds of the sale of those Treasury Notes. Yes, they could cause some short-term harm, but they are subject to their own internal pressure to do something useful with those dollars. The harm they cause by dumping Treasury Notes will be made up by the benefit caused by whatever else they do with those dollars. There is nothing they can do to eliminate that pressure except to destroy the dollars. That would hurt them more than it would hurt us. We can be confident that they won't do that.

TM Lutas is worrying about a mirage of quicksand.

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Household Robots

Surely you've noticed that nobody has servants anymore. It used to be that members of the middle-class had household servants. A maid to clean, and a cook to, well, cook. Why has that job nearly died out? Well, for one, people don't want those kinds of jobs anymore. They can get other jobs that pay more (there's an economics lesson there that I'll leave for another day).

For another, we have technology which eliminates those jobs. Household robots. These robots started off pretty stupid, e.g. a robot which would stir a bowl forever at whatever rate the cook set it at. Or a robot which would peel and core an apple just by turning its crank.

What can we learn from the existance of these robots? Mostly, you're seeing the effects of capital formation. Back when everything had to be done by banging two rocks together (e.g. laundry, food processing, knife creation), you had to spend a lot of time banging those rocks. Some people found that specialized rocks did a better job. To find or create these rocks, they had to take time out of doing their job. They needed to be able to give up current consumption to create a greater efficiency. That's capital. Tools are capital.

Of course, if it's not your effort, you don't care quite so much about making it efficient. Not, that is, until the end of the month, when you have to pay for the effort. At that point you have to consider: do I continue this consumption, or do I do without for a while, save my money, and buy a machine to do this job?

Some economic illiterates will, at this point, say "But you're talking about putting that person out of a job!" No, I'm not. I'm talking about putting them out of *that* job, not every job which they might possibly perform. There are some jobs which are so tedious that nobody wants to do them, e.g. scrubbing a floor, or handling garbage. We now have floor scrubbing and vacuuming machines available at a reasonable price. There is no machine for handling garbage that I've heard of. No doubt multiple inventors have created them, but human labor is still cheaper than the necessary capital.

Specifically, iRobot has created the Roomba vacuuming robot. The key to its success, besides its cuteness and its efficacy, is its price. They have brought the price of a robotic vacuum cleaner down to the point where a lot of people value $200 less than their time spent doing all the vacuumings that a roomba can do over its lifetime.

irobot's next product should be a mini-zamboni for clearing and cleaning pond ice. It can cost 15x what the Roomba costs. Call it a Zoomboni. There's an attachment for your John Deere lawn tractor for cleaning pond ice, but what lunatic parent wants to be out there in the cold running a lawn tractor around on the ice?? But to be able to buy a robot that does it while you're sitting inside the house? Now that's worth money.

Of course, it could fall through the ice. Yes, no question. But if it's gonna, then you were gonna, and why were you so foolish as to consider going out on that ice much less sending a valuable robot out on it? But yeah, somebody will do it, so a retrieval tether is a good idea. If you had two of them, the Zoomboni could tell where it was on the ice, which is also a necessary characteristic. Probably can't use Roomba's random walk and wall-following algorithms.

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Are Lemon Laws useful?

A Canton, NY auto dealership was cited for tailing to identify one of its vehicles as a "lemon". This is another example of the principle that rules don't lead to freedom. Instead, rules lead to more rules. The state of New York has a "Lemon Law", which says that if a new car goes in the shop four times (three times for a used car) to fix the same thing, the car is a lemon. You can return it and get your money back.

Let's think about this law as economists. Is it a good law or a bad law? One's instinct is, and should be, to not interfere in the workings of the marketplace. After all, if people wanted protection from buying a lemon, they would purchase lemon insurance, or buy from a dealership with anti-lemon policy. Why is this law at all conscionable?

In fact, the law might not be conscionable. Who gains and who suffers from it? Obviously, it imposes a risk on a dealership that a car will be judged a lemon, and they'll have to take it back. While that may seem on one hand to be entirely within the control of a dealership (fix it on the first three tries), it will lead to risk-avoidance behavior. A dealership will be more likely to do a more expensive repair than otherwise. Instead of attempting to fix something, they'll replace it outright.

Some might say "Well good enough!" to that. But remember that in a free market, eventually price == cost. Anything that increases the cost of an automobile will in time be reflected in the price of the automobile -- including risks placed on a dealership.

It imposes a cost on taxpayers -- even taxpayers who do not purchase cars. You can argue that, well, nearly everybody buys a car now and then, so it's okay to impose on the few that don't. Perhaps the few feel differently? But they're a minority and voting their desires is a guaranteed loss.

Who gains from this? That's harder to say. The person who gets their money back? In the end, they still don't have a useful car, which was what they wanted in the first place. They're still out the time it took them to deal with the malrepaired car.

People don't buy that many cars in their lifetime. There's not much opportunity in the way of repeat business, given how much people move around. And yet, dealerships can be seen to be concerned about their reputation. Someone who has gotten a lemon will surely be cautious about purchasing that brand of car from that dealership ever again. They will also undoubtedly be seen to be unhappy.

I think that, on the whole, it would be better to let the usual market process of business reputation work. A law has its compliance overhead, as the Canton dealership found to its loss. Not clear that that overhead is better than the overhead of letting the business's reputation speak for the quality of its cars.

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U.S. Airlines: From Bad to Nationalized?

Without having read the report, I can state without fear that nationalizing anything is a bad idea. First, what are the costs that airlines face?

Maybe the airlines can trim some costs, maybe not. If they go bankrupt, though, it's because people don't want to fly. They're not going to go bankrupt at the same rate. Some will go bankrupt before others, and stop operating. Other companies may be able to pick up their passengers, and avoid bankruptcy. Nationalizing the whole industry assumes that passengers want every flight to continue -- an assumption based on a price-preference of zero

Another effect that nationalization will have is to reduce the pressure for profitablility. Profitability is price - costs. An airline tries to keep its costs down, because its profits are based on the difference between price of a ticket, and the cost to fly the passenger.

Airlines can be interesting to run because every flight has a large fixed cost. The incremental cost of flying one passenger is very low -- lower now that fewer flights have food. This leads to all sorts of price discrimination as airlines try to over their fixed cost while still giving everyone a price they can afford and are willing to pay. Still, that problem goesn't go away with nationalization.

The problem with nationalization and profitability is that profitability goes out the window. Nobody expects a nationalized business to make money. You lose control over the costs. If every airline has been nationalized, then you lose competition. Without competition, you have no reasonable way to set the price of the tickets.

Nationalization is a major lose, and while airlines and their stockholders would benefit, the flying passengers would lose, and taxpayers would lose more.

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A patent is a monopoly.

Nobody is disputing the good you have done. Creating new ideas is laudable. Patenting them may not be. It is inarguable that your patent has given you a monopoly. This gives you the ability to charge monopoly prices. Monopoly pricing is a-priori a cost on society. You charge more than you otherwise would be able to, and fewer implementations of your idea will be sold.

The idea behind the patent system is that the cost is acceptable because without paying that cost, the ideas would not be created. Without the ideas, there would be no benefit, and no cost either, for that matter. So the cost is thought to be acceptable.

Is this a true idea? It's disputable. For those people who say that it is a false idea, it inevitably falls out that society is paying for something without gaining anything in return. There is another word for that: theft. But it all hinges on the idea being false. If you don't think the idea is false, and by definition American society does not, because it has not seen fit to dismantle the patent system, then you can sleep easy.

You assume that simultaneous invention and reinvention never happen. They do. If they are common rather than rare, then the patent system is theft from the public domain rather than a contribution towards it.

Theft is an intentional act intended to transfer value from one party to another without the first party's consent. The fact that society itself is an unwitting accomplice to this theft makes it no less theft. It is still theft even if the victim doesn't realize that value has been taken from them. It is still theft even if the absence of the value is never discovered.

I want to close off this discussion of patents as theft with an observation: If A owns a patent, and B acts as if the patent belongs to him, if B publicly claims that the patent belongs to him, if B seeks to stop other people from using his patent, most people would consider that theft. If A is actually the public domain, then B is equally guilty of theft.

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Severe Acute Respiratory Syndrome

They say that it appears that SARS has a 4% fatality rate. Doesn't sound too bad, you say? That's only four people out of a hundred. Do the math, though. A billion Indians. That's four crore corpses. 250 million Americans. That's ten million dead people. Or to put it more personally, it's one dead family per block.

The 1917 influenza pandemic. The Black Death. Now SARS. While some good people may imagine that they wish for there to be fewer people on the world, none want it to happen this way. I suspect that, once this has passed, said people may change their mind. Besides all the obvious costs of a pandemic: medical treatment and lost work, you have the deaths.

Dead people cost society incredible amounts of wealth. Imagine each person creating a million dollars worth of value in their lifetime. Not hard to imagine. Now imagine that value gone. Let's say that SARS really does kill ten million Americans. Let's assume that it kills people evenly across the board. It won't, but assuming it does gets us closer to reality rather than farther. Now make Americans poorer by five trillion dollars.

Five trillion dollars. Doesn't sound like much? It's a half a years worth of production by the entire US economy. Wiped out. Gone. Imagine if you had to work for six months accepting no pay.

Are you all imagined-out yet? Now think about what Europe was like after the Black Death. It killed 33% of all people in Europe. Their economy didn't just suffer, it collapsed. Too many holes in the economy. Too many butchers, bakers, and candlestick makers gone the grave.

Now we get into total imagination fatigue. You know, of course, about the aboriginals of North America, commonly called Indians even though they had no clue how to play cricket. We killed some of them in the Indian wars. Those numbers pale in comparison to the ones we killed with our germs. The Indians had no natural resistance. By one estimate I've seen 95% of Indians were killed. Others say 90% or 80%. Everybody agrees that at least two-thirds of Indians were killed.

I am done with you. You cannot imagine anything worse. That's good, because SARS isn't going to be that bad. It's just going to be bad.

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Wheels to Work

Wheels to Work is a program of St. Lawrence County. Under the yearlong program, the county will spend more than $300,000 in federal welfare-to-work funds to provide used cars for 50 to 70 residents who have at least one child and who meet income guidelines -- about $35,000 a year for a family of four. Participants will have to pay for routine maintenance and insurance and be free of drunken-driving convictions for 15 years.

Now, you might expect that a liberal economist would think that any government give-away or subsidy is a bad thing. It is, of course. The question, though, is which is worse: to keep someone on welfare, or to kick them off welfare and give them a car. The long-term answer clearly is the latter, if one must choose. A better long-term answer is to have not taxed away those dollars from private sources in the first place. A good economist must keep both short-term and long-term in mind, and this is a reasonable short-term solution to help wean people from the government tit. (Note: just in case you're wondering, I think corporations should also be weaned from the government tit, and they don't need to get cars to do it, either!)

Wheels to Work might be a bad thing is if it causes some people to change their activities to make themselves eligable for a car. If someone is earning $36,000 a year, and can reduce their income to $35,000 to qualify, they have just purchased a car for $1,000. Or else, if they don't qualify, they have just squandered $1,000.

This, by the way, is what economists call "rent-seeking". If government is giving away actual cash grants, then it's rational for everyone to spend nearly all the value of the grant in order to receive the grant. They have to factor in the chance of getting the grant, of course. Example: if there's a grant for $30,000, and an agency has a 50% chance of getting that money, it makes sense for them to spend up to $15,000 to get it. They won't actually go that high, because that would destroy all the expected value of the grant to them. So they'll stop at $14K, with an expected winning of $1K. $1K in free money is still free money.

The problem with rent-seeking is that people have a tendency to over-estimate their chances of winning (which is why Las Vegas is swimming in money). It's quite likely that government grants of cash are completely squandered by rent-seeking. It's even possible that, when the government gives away cash, they actually destroy all the cash plus some more in addition. How much more depends on how over-optimistic the grant-seekers are. Anything over a total of 100% of expectations results in lost money.

Yeah. It's that bad. Fortunately, governments aren't completely stupid, and so their grants are usually matching grants. In order to get $30K, you have to come up with $30K from other sources. Still, it's a bad deal, since the $30K is almost completely wasted in an effort to extract $30K from other sources.

Another way Wheels to Work might be a bad thing is if it becomes an addition to instead of a replacement of welfare.

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