Stocks vs. flows... $1 trillion Apple edition

It had to happen. Apple's market capitalisation passed US$1 trillion last Thursday, so of course that invites comparisons with other big numbers. Consider the following two sentences, from this Washington Post article:

If Apple sold itself for $1 trillion in cash, the money would be enough to buy all the goods and services produced in Indonesia — population 261 million — in 2017.

Apple is bigger than the economies of about 174 countries, including Turkey, the Netherlands, Saudi Arabia and Switzerland.

The first sentence is kind-of all right. You could use $1 trillion to buy all of the goods and services produced in Indonesia in 2017 (but why would you want to?). The second sentence is an example of one of my pet peeves. Apple is NOT bigger than the economies of about 174 countries. It's not even bigger than the example of Indonesia from the article. And it's easy to see why. If investors are rational, Apple's market capitalisation represents the discounted value of all future cash flows for Apple. So, you would be effectively selling off all of the future cash flows of Apple for all time, in order to get just one year's worth of Indonesia's GDP. Clearly, Apple is worth a lot less than the economy of Indonesia.

The problem (as I've mentioned many times before, such as here and here and here) is comparing stocks with flows. The size of an economy (as measured by GDP) is a flow of resources for a single year. Apple's market capitalisation is a stock (a measure of its total value), not a flow for a single year. The appropriate stock for a country is the discounted value of all future GDP, not one year's worth of GDP. If you want to compare Apple with the size of an economy, you would need to compare Apple's market capitalisation with a much bigger number for each country.

Who would want to be a landowner in South Africa right now?

From news.com.au last week:

South Africa’s ruling party says it will push ahead with plans to amend the country’s constitution to allow for the expropriation of land without compensation.

President Cyril Ramaphosa announced the decision on Tuesday following a two-day meeting of the African National Congress, which had earlier signalled its intention to redistribute land under the current laws.

The South African parliament in February voted in favour of a motion, brought by the radical Marxist Economic Freedom Fighters and supported by the ANC, to send the matter to parliament’s Constitutional Review Committee.

“It has become patently clear that our people want the constitution to be more explicit about expropriation of land without compensation, as demonstrated in public hearings,” Mr Ramaphosa said in a video message addressing “fellow South Africans, comrades, friends”.

“The ANC [has] reaffirmed its position that a comprehensive land reform program that enables equitable access to land will unlock economic growth by bringing more land in South Africa to full use and enable the productive participation of millions more South Africans in the economy.”

From the perspective of my ECONS102 class, this is great timing given that we are about to do a topic that includes property rights this coming week. Efficient (welfare-maximising) property rights have four features:

1. Universality – all resources are privately, publicly, or communally owned and all entitlements are completely specified;
2. Exclusivity – all benefits and costs accrued as a result of owning and using the resources should accrue to the owner whether directly or indirectly;
3. Transferability – all property rights should be transferable from one owner to another in a voluntary exchange; and
4. Enforceability – property rights should be secure from involuntary seizure or encroachment by others.

Obviously, if the government is about to legislate for expropriation of land without compensation, then the 'enforceability' feature is going to be absent. What does this do to the value of land? The article tells us:

Speaking to the ABC’s Foreign Correspondent on Tuesday night, cattle farmer Jo-an Engelbrecht — whose elderly parents were tortured and killed in their home on Mother’s Day — said even if he wanted to sell his farm and leave, it was now “worth zero”.

“We had several auctions in the last two or three weeks cancelled because there was no people interested in buying the land,” he said. “Why would you buy a farm to know the government’s going to take it?”

To see why land values might fall to zero, consider the land market in the diagram below (note that it is a rental market for land, as I discussed last week). Before land expropriation was likely, demand is D0 and the land rent is R0. When land expropriation becomes likely, fewer people want to have land, either because they worry that they land they have paid for will be expropriated, or because they think "why pay for land, when I can just wait and some might be redistributed to me?" Either way, the demand for land falls to D1. Notice that there is no equilibrium in this land market now, because demand and supply never meet (or if there was an equilibrium, the equilibrium price would be negative!).

To see why the lack of enforceability reduces economic welfare in the land market (i.e. why this market is inefficient), consider the areas of consumer and producer surplus. Before land expropriation was likely, the consumer (tenant) surplus is the area ABR0, producer (landlord) surplus is the area R0BCO, and total welfare is ABCO. When land expropriation becomes likely, all of these areas (consumer and producer surplus, and total welfare) fall to zero, because there is no land trading at all! Of course, if demand didn't fall so far that there was no trading, there would still be reductions in consumer surplus, producer surplus, and total welfare.

That's not the end of the story though. The South African government has its reasons for land expropriation and redistribution. South Africa has one of the highest levels of inequality in the world (it's so bad, it even has a dedicated Wikipedia page). Reducing inequality is a worthy goal, and with a bit of luck, this might go some way towards addressing that. So long as they don't follow the example of Zimbabwe, where according to this New York Times story from 2002:

...the government's chaotic and violent seizure of white-owned farms has come at a price. The economy is collapsing. The land program, coupled with severe drought, has left half the population in need of emergency food. And so far, Mr. Mugabe has failed to transform the agricultural sector into a viable system that can feed the nation and drive the economy.

Vast stretches of previously productive farmland are no longer in use because about half of the aspiring black commercial farmers have failed to take up their allotted farms since August, when most white farmers were told to leave.

The government, which seized the farms without compensation, still lacks title to most of the land. Many prospective black farmers are reluctant to occupy farms without title deeds because it is nearly impossible to get loans without them.

Meanwhile, thousands of impoverished, resettled farmers are struggling to survive without seed, fertilizer, irrigation and plowing assistance, basic services that the government has promised.

If South Africa wants to address its inequality problem, land expropriation by itself will not be enough.

Behavioural economics is a work in progress

Behavioural economics is one of the 'in things' in economics, and has been for the last several years (and evidenced by last year's Nobel Prize award for Richard Thaler, following the earlier prize for Daniel Kahneman back in 2002). However, a good article last month by Koen Smets takes issue with behavioural economics, not because he prefers models of rational decision-makers, but because behavioural economics is still just a collection of cool stories of things that get in the way of rational decision making (that's my paraphrase of Smets). He begins with:

Compared to just a few years ago, the term behavioral economics has gained tremendous currency. To say it is on everyone’s lips would be only a minor exaggeration. For the scientists and practitioners in the field, this emergence from relative obscurity should, at first glance at least, be a source of happiness.

One reason for this growing interest is the way behavioral economics has been presented and interpreted. Behavioral economics is, it seems, the field that confronts us with our deeply irrational selves. We are bamboozled by biases, fooled by fallacies, entrapped by errors, hoodwinked by heuristics, deluded by illusions...

This is all very exciting, of course, and as a result we are knee-deep in articles and infographics that gleefully point out how flawed we really are. But is that really all there is to behavioral economics?...

To a worrying extent, biases have become the defining feature of behavioral economics.

This focus on biases is unhelpful in several ways. It fails to acknowledge that biases are broad tendencies, rather than fixed traits, and it oversimplifies the complexity of human behavior into an incoherent list of flaws. This leads to misguided applications of behavioral science that have little or no effect, or which can backfire spectacularly. We need to appreciate better the role biases play on the wider behavioral-economics stage.

If you are interested in behavioural economics, I encourage you to read the whole article. It's clear that Smets' view is that behavioural economics has come a long way in describing the various decision-making quirks where we deviate from rational decision-making, but that it still fails to fully explain why those quirks appear in some circumstances and not others. But despite how that sounds, Smets isn't entirely negative towards behavioural economics. Here's the end of his conclusion:

Behavioral economics will be a work in progress for a long time to come. But with the right sculptors, there is hope yet for a masterpiece.

[HT: Marginal Revolution]

Rents are best for assessing the state of the housing market

In my ECONS102 class, we cover the market for land, but we cover it as a rental market rather than a market for the sale and purchase of land. This often raises a few eyebrows from students, who may expect us to be thinking about land using a seller-buyer perspective rather than a landlord-tenant perspective. In an article in The Conversation on Monday, Rachel Ong (Curtin University) does a great job of explaining why looking at housing markets from a rental perspective is actually a better approach:

If property prices are rising, it is commonly assumed we must be facing a shortage of supply relative to demand. So if we’re ever going to reduce housing affordability problems, we’re simply going to have to build our way out of it. After all, as anyone who’s sat in an introductory economics class would tell you, basic economics is sufficient to at least suggest that if prices are rising in the long term, then supply must be lagging behind demand.

It’s true the housing market is largely subject to the forces of supply and demand. The deficiency of this argument lies, not so much in any perceived cracks in the supply-demand framework taught in Economics 101, but in the fact that the appropriate “price” indicator is not property prices. It’s rent...

The problem with relying on rising property prices as a “price” signal of a supply shortage is that the dwelling an owner-occupier buys is both a consumption and an investment good. It offers a place to live as well as an asset in which the owner invests a substantial part of their wealth. Hence, property prices are at best a murky indicator of the balance of supply and demand for housing as a home to live in and an asset to own.

It is well established in the housing economics literature that the “price” signal for the adequacy of supply relative to demand for housing services is rent. Rent reflects the cost of consuming housing or, to put it another way, the cost of living in a home. So if housing supply is lagging behind demand for housing as a place to live in, we should expect to see rents rise.

So, there you have it. When we're trying to understand what's happening to housing we should be looking more closely at what is happening to rents, and less closely at what is happening to house prices.