A Cell Phone Will Save the US Economy

It appears it is after all not Scott Sumner who 'saved the US economy' by urging the helicopter pilot to create even more money ex nihilo than hitherto. What will save us instead is Apple, or rather, its latest product, the iPhone 5. Who needs Bernanke when this wondrous device stands ready to pull the economy up by its bootstraps?

A story has made the rounds lately – propagated by 'economist' (we should use the term loosely…) Michael Feroli at JP Morgan, that sales of the iPhone „could potentially add from one-quarter to one-half of a percentage point to the growth rate of U.S. gross domestic product in the final quarter of the year”.

If were to assume that he is correct, then this would mainly tell us is how useless a statistic GDP actually is. However, there are some reasons to doubt the results delivered by his abacus. According to a Bloomberg article:

 

Here’s Feroli’s math: Assume sales of previous-generation iPhones continue “at a solid pace,” while the new model from Apple (AAPL) sells about 8 million units in the last three months of 2012. Assume the average selling price for the new models is about $600. (True, people who get the new phone as part of a calling plan pay less than the sticker price, but the sale gets reported to the government for what it would have cost on a stand-alone basis.)


Out of that $600, about $200 is the imported cost, leaving $400 as the value captured in the U.S. Multiply $400 times 8 million and you get a pop of $3.2 billion, which is enough to boost the annualized growth rate of the economy by one-third of a percentage point. Feroli, the bank’s chief U.S. economist, expects the U.S. economy to grow at an annual rate of about 2 percent in the fourth quarter, and says the iPhone will “limit the downside risk” to that projection.“


 


Now, before we continue, a few words about the iPhone 5. It is undoubtedly a marvel of engineering (as a friend and card-carrying Apple fan told us, the aluminum unibody alone is a stunning achievement of modern-day milling methods). However, many observers seemed to agree that apart from a sleeker design combined with lower weight and a somewhat bigger screen than the predecessor model, it offers only incremental improvements.


Its new map application is generally regarded as a letdown compared to the previous Google map app. All in all, the phone allegedly lacks, as one journalist at Reuters put it, a 'wow' factor.  Mind, we are not trying to put the new iPhone down – we merely want to make the point that its release has not exactly made the iPhone 4 (or previous models) completely outdated or unusable.


 


 

The iPhone 5 – will its release add to economic growth?

(Image via Apple.com)

 


 

Another somewhat more famous economist has chimed in on the topic, the man who has forever destroyed what was left of the nimbus attached to the Nobel Prize for Economics by somehow winning it, namely Paul Krugman.

Not surprisingly, Krugman used Feroli's line of argument regarding the iPhone  to fashion a screed designed to convince readers of his column that more government spending is called for. We kid you not.

 

Broken Windows, Carts and Horses….

Krugman's article on the topic in the NYT is entitled „The iPhone Stimulus“. Below are a few excerpts:


So is the new phone as insanely great as Apple says? Hey, I’ll leave stuff like that to David Pogue. What I’m interested in, instead, are suggestions that the unveiling of the iPhone 5 might provide a significant boost to the U.S. economy, adding measurably to economic growth over the next quarter or two.


Do you find this plausible? If so, I have news for you: you are, whether you know it or not, a Keynesian — and you have implicitly accepted the case that the government should spend more, not less, in a depressed economy.“


 


Wow. So if that is what it really means, then some readers may already decide on the spot that Feroli's theory has just been disproved. Seemingly unwittingly, Krugman is shooting his whole intellectual house of cards down in this first paragraph. However, you will be surprised just how deluded this political hack actually is. Bear with us.

 

„The crucial thing to understand here is that these likely short-run benefits from the new phone have almost nothing to do with how good it is — with how much it improves the quality of buyers’ lives or their productivity. Such effects will kick in only over the longer run. Instead, the reason JPMorgan believes that the iPhone 5 will boost the economy right away is simply that it will induce people to spend more.


And to believe that more spending will provide an economic boost, you have to believe — as you should — that demand, not supply, is what’s holding the economy back. We don’t have high unemployment because Americans don’t want to work, and we don’t have high unemployment because workers lack the right skills. Instead, willing and able workers can’t find jobs because employers can’t sell enough to justify hiring them. And the solution is to find some way to increase overall spending so that the nation can get back to work.“

 


The short version of the above paragraph is: we can consume ourselves to prosperity. And if you accept that premise, then you must of course  accept what comes next. After bemoaning the reluctance of businesses and consumers to engage in an orgy of mindless spending (except of course when there's a new i-gadget released), Krugman reminds us of  his solution: the government must jump into the breach.

 

Why not have the government step in and spend more, say on education and infrastructure, to help the economy through its rough patch? Don’t say that the government can’t add to total spending, or that government spending can’t create jobs. If you believe that the iPhone 5 can give the economy a lift, you’ve already conceded both that the total amount of spending in the economy isn’t a fixed number and that more spending is what we need. And there’s no reason this spending has to be private.“

 

Yes, why not, indeed? We'll explain that in just a moment, but let us first point out what the fundamental error in this whole iPhone/GDP story is.

It is actually a variation on the 'broken window fallacy' – it completely ignores a basic economic concept that we would normally expect every economist to be aware of, namely opportunity cost. We mentioned above that the predecessor of the iPhone 5 remains perfectly serviceable in order to underscore this crucial point.

By buying the iPhone 5, the buyers will no longer be able to buy something else. Every buyer of the new iPhone has a personal scale of valuation that ranks the items he wants to spend his funds on. Obviously, for all those who actually go out to buy the new iPhone, some goods or services that are ranked lower on their value scale will end up not being bought.

Would people cease to buy smart-phones if there were no new iPhone? Of course not – but it is a good bet that at least some users of the predecessor model would not yet junk it. It is highly questionable given the incremental improvement the iPhone 5 represents that they are really gaining much more than the satisfaction that comes from owning what is held to be the latest and greatest gadget (but we are not arguing with that – they want it, and that means they feel it is useful to them). It seems likely though that absent the new iPhone, they would spend the funds on something else instead – so the argument that “total spending” in the economy  will increase is standing on a very flimsy foundation.

Let us assume though that instead of spending the funds on consumption, they were to decide to save instead. Would that be 'bad'? According to Keynesians like Krugman, the answer is yes.

However, we would not even have this discussion if no-one had first produced the iPhone. How do things get produced? To make production possible, one must invest in capital goods. And savings are what funds these investments – they are the sine qua non.

Note here that it is not money created from thin air by Ben Bernanke that can fund production. What funds production is the pool of real funding.  Unless at least some people refrain from consuming their entire economic output, no new additions to the economy's capital structure will be possible. In fact, there must be savings to merely maintain the existing production structure (for a brief overview of capital theory, interested readers might want to check out our previous essay on the production structure that summarizes the essential points).

In other words, when Krugman insists that more spending and consumption will bring the economy back on track, he is putting the cart before the horse. Increased consumption is an effect of economic growth, not the cause of it.

What about his suggestions regarding government spending? Is there not something to be said for 'infrastructure' or 'education' spending'?  Are these not worthy causes?

The problem with this line of argument is that the government is the one organization that is the least able to decide what types of spending are economically sensible. Since the government has no profit motive – it ultimately obtains all its funding by means of coercion – it has no way to engage in proper economic calculation (although the people it hires to implement the spending can up to a point make inferences by observing the private sector).

In other words, once again the main problem is opportunity cost. Say for instance that government decides to finance the building of a bridge. How can it possibly know if the resources expended on building the bridge would not have satisfied more urgent consumer wants if they had been employed differently? The answer is, it cannot possibly know that. Without a profit motive and without economic calculation enabling it to compare input costs to expected income, there simply is no way to know.

This is also the reason why socialism is literally impossible: a socialist community has no market for the means of production, and hence lacks the very basis of economic calculation, as calculation without money prices is obviously not possible. Chaos is the inevitable result, or as Ludwig von Mises pointed out (in 'Calculation in the Socialist Commonwealth'):

 

“Without economic calculation there can be no economy. Hence, in a socialist state wherein the pursuit of economic calculation is impossible, there can be—in our sense of the term–no economy whatsoever. In trivial and secondary matters rational conduct might still be possible, but in general it would be impossible to speak of rational production any more.”

 

Of course we are luckily not living in a command economy. Ours is still a market economy, if a severely hampered one. And yet, the basic problem of being unable to calculate confronts every government agency, regardless of the fact that the problem is even more acute in full-blown command economy.

Therefore, Krugman is wrong when he asserts that “there's no reason this spending has to be private”. There is a very good reason: government spending is extremely likely to waste scarce capital and liable to induce intra-temporal discoordination in the production structure – in other words, its spending will create a configuration of the economy's capital structure that is not in accordance with consumer wants.

Apple's iPhone offering is certainly different in this regard: it obviously does conform to consumer wants. Apple's profits provide ample proof for this assertion – in fact, it is the most profitable company in the world. However, this does not mean that one  can safely ignore opportunity cost when arguing that spending on the new iPhone will add to overall economic growth.

 


 

The performance of Apple's stock price speaks for itself – click for better resolution, chart by StockCharts.

 



Krugman Discovers A 'Theory'

However, what really takes the cake is a small posting of Krugman's on the same topic that we discovered incidentally when searching for the article discussed above on Google. Apparently Krugman felt the need to address the topic of obsolescence in more detail and on this occasion lets us in on the fact that he has indeed heard about the 'broken window' before. The post is entitled “Broken Windows and the iPhone 5”.

When seeing the headline, we at first thought that Krugman would attempt to refute that the broken window fallacy appealed to him. Far from it!

 

“The key point is that the optimism about the iPhone’s effects has nothing (or at any rate not much) to do with the presumed quality of the phone, and the ways in which it might make us happier or more productive. Instead, the immediate gains would come from the way the new phone would get people to junk their old phones and replace them.


In other words, if you believe that the iPhone really might give the economy a big boost, you have — whether you realize it or not — bought into a version of the “broken windows” theory, in which destroying some capital can actually be a good thing under depression conditions.”


 


(emphasis added)


Once again, this man has actually won the Nobel Prize for Economics. Perhaps it is time for the prize committee to consider demanding its return. 


So it is the 'Broken Window Theory' now, is it? Actually, as noted above, the concept is known as the 'Broken Window Fallacy'. It was originally formulated in the form of a parable by the great French economist Frederic Bastiat, who explained that in economics, one must not only consider that which is immediately seen, but also that which is not seen.


It is a fallacy to believe that destruction can make us richer –  in fact, Krugman admonishes us to simply deny that opportunity costs exist in what he refers to as 'depression conditions'. The implication of this assertion is that fundamental economic laws magically cease to apply whenever the economy suffers a downturn.


This view is erroneous – economic laws are not dependent on economic conditions. This is akin to arguing that the laws of nature will cease to be operational on Wednesdays. Not surprisingly, Krugman is also a supporter of the view that 'war is good for the economy' – even if it is war against imaginary space aliens, or what we might call Krugman's version of  'Plan 9 From Outer Space'.


 


 

Paul Krugman: getting ready to break some glass to save the economy. In Krugman's capable hands, a fallacy becomes a 'theory'.

(Photo via the Web, source unknown)

 


 
 

 
 

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9 Responses to “The i-Krug”

  • JasonEmery:

    The ‘broken window’ theory is not as farfetched as some would have you believe. The repair of a ‘broken window’ is beneficial to the local economy, IF it pulls money off the sidelines, thus increasing the velocity of money in the local economy. However, to be successful, it must be savings that are pulled, locally manufactured ‘windows’ that are installed, and existing ‘low velocity of money’ must be one of the existing problems.

    The iPhone-5 is doomed to failure for numerous reasons. I’m guessing that a lot of the ‘money’ used to buy iPhone-5s will actually be new debt, not savings, entering the economy. To the extent that debt to GDP is already too high, by most metrics, increasing it more will be counterproductive. And as was pointed out in the article, iPhone-5 purchases will likely divert spending from other less attractive items, thus have little or no effect on velocity of money.

    Another problem is the country of origin. It is just a continuation of the export of manufacturing jobs to 3rd world countries.

    If the ‘broken window’ theory had any validity, then so to would the claim that military spending is beneficial to the economy. Spend a billion and bury it in the ground, lol. This is the real reason we’re broke. Borrow money from communists who hate freedom, to spend it on weapons systems, to explode in the general vicinity of terrorists that hate freedom, without ever actually making a dent in their overall strength, so you can rinse and repeat, lol.

    The system is far beyond so fixing, these strange theories are bound to pop up regularly. Every one wants to be the one to ‘discover’ the solution to our problems. Who knows, if you’re successful you might eve win the Nobel prize!!!

    • worldend666:

      Isn’t saying monetary conditions need to be right for the broken window to stimulate the economy akin to saying any coincidence could lead to economic benefits? Nice in theory but useless in practice :)

      • JasonEmery:

        666 said, “Isn’t saying monetary conditions need to be right for the broken window to stimulate the economy akin to saying any coincidence could lead to economic benefits?”

        Not at all. To solve a problem, you must understand the problem. That is why criticizing Krugman, is like criticizing the janitor for moving around the deck chairs on the Titanic. He’s wasting his time, but he’s not hurting anything. The asset bubbles are already too big to unwind, and have been at least since before 1995, when the fed raised rates numerous times, but were abruptly stopped by the ‘Tequila Crisis’ and the bankruptcy of Orange County CA. Hence all the can kicking.

        If you understand Mises, then you would know that this ship USA is going down, and no amount of spending, or lack thereof, can save it, at least until the dollar is declared null and void.

        • worldend666:

          I would not say Krugman is harmless. By advocating spurious government spending he is mis-directing capital. I agree with you that it’s too late to save the monetary plane, but the real physical plane is being further damaged by capital mis-allocation. Once it’s all said and done and fiat is gone, what will remain is real assets. If those assets were tended privately in the past, they will be in significantly better condition than if they were managed by disinterested parties. You can take my word for it. I live in Eastern Europe and 20 years later the legacy of communism is still obvious.

          • JasonEmery:

            world666–Not a big Krugman fan, but I don’t think he advocates nationalization of private assets. Do you understand the importance of the velocity of money? Krugman is probably looking at it closely. (see link below) Where Krugman is making his mistake is that we’re too far gone for an increase money velocity to do any good. Too much debt.

            http://www.zerohedge.com/contributed/2012-09-21/have-last-5-years-been-worse-great-depression

            • worldend666:

              I saw a very interesting chart of 50 years US data – not sure where, so I am sorry I cannot post it here, but it showed that as velocity of money changes the interest rate compensates perfectly (or vice versa as normally the Fed adjusts the interest rate). In this sense I think the velocity of money is probably irrelevant in the same way as squeezing a balloon with water in it will just result in a bulge somewhere else.

              I appreciate there might be some very short term benefit to increasing velocity of money but to what end? In the final analysis what matters is the physical plane and the coincidence of needs. Any attempt to distort it via the monetary plane will just make it harder for market participants to calculate prices correctly, and the inevitable result is someone will get a bad deal.

    • The thing is, whenever there is actual destruction, we also see a ‘boost to GDP data’ in the subsequent quarters – see e.g. Japan after the tsunami.
      But this is quite different from saying that actual wealth has been created. In reality, wealth has been destroyed, and resources that could have been used to augment it had to be employed to restore what was lost. Naturally it is good business for certain people – but it cannot possibly increase wealth for society at large. Krugman as a good Keynesian is of course a believer in Pyramid building, ditch digging and spending in preparation for imaginary alien invasions as well, but again, he ignores the scarcity of capital and opportunity costs in all these deliberations. After all, government does not possess a secret stash of resources that can be deployed at its whim – it has to take every cent it spends from the private sector (whether by taxation, borrowing or inflation).
      Again, one must very carefully differentiate here between an actual increase in economic welfare and a mere increase in GDP growth, which is a statistic I often criticize in these pages for this and other reasons.

  • worldend666:

    I hate to be a party pooper but the math is wrong:

    “Multiply $400 times 8 million and you get a pop of $3.2 billion, which is enough to boost the annualized growth rate of the economy by one-third of a percentage point.”

    US GDP is 15 trillion USD. I assume the author is basing his numbers on one quarter. Quarterly GDP would be about 3.75 trillion. 3.2 billion is less than one tenth of one percent of quarterly GDP, or what is commonly known as a rounding error.

  • I don’t think that was his first glass of wine. Krugman isn’t stupid. Krugman is lying like most of his kind.

    The iphone is really just one more Wall Street scam. It is the 2012 version of the 1998 version of Dell computer. The form of the phone business itself is going to change and that will, by itself put a kink in the smart phone business. Why not get a new phone when your contract is up. You are paying on the old one still and it is yours by that time.

    Also, I think people will begin to realize if they are going to have a life, they are going to have to get their hands off, not on these devices. Millions have become phone zombies. I go to ballgames and the 20 somethings and 30 somethings can’t watch the game, as they have their phones.

    Lastly, I would suggest we send Krugman a link to the Andrew Dickson White book, Inflation in France that you posted a few days ago. I read the whole book in a couple of hours. It sure looks familiar to what is going on today, complete with the excuses of why it hasn’t worked yet. I am putting up the link for those that missed it.

    http://mises.org/document/3041

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