22 Nov 2017

How to Beam Factories to Mars

Economics, Krugman 6 Comments

I give some practical instruction in this piece. An excerpt:

Now suppose that the Martians finally get their wifi routers working, and they are shocked to discover intelligent life on the nearby blue planet. After figuring out how to communicate and consummate financial transactions, an amazing thing happens: Massive amounts of financial capital from human investors start pouring into the Martian economy. The human investors are amazed at the real interest rates of 100% available on the red planet, and rearrange their portfolios accordingly. This pushes down the market rate of interest on Mars, and pulls up the market rate of interest on Earth, until the Martian interest rate — due account being made for the riskiness of the investments — is comparable to the yield on terrestrial assets.

Yet to answer Krugman, we need to be more specific about how this process occurs physically. Well, in the extreme example I’ve constructed, we can imagine that the huge Earth economy swamps the Martian economy. So what happens in the first year is that all trade goes one-way. Specifically, anything that can be imported from Earth is imported from Earth. This includes database and cloud hosting, CPA services, math tutoring, and website design. Any work that can be done by Earthlings and then beamed to Mars, will be performed.

Yet as Krugman says, this may only account for, at most, 2% of the Martian economy. Even so, consider the impact. The Martian workers who used to maintain databases and perform CPA services, will now be freed up to do other jobs. Indeed, Martian workers and industries will be reshuffled so that they now devote 2% more of their economic output to the production of machines, tools, and other equipment.

6 Responses to “How to Beam Factories to Mars”

  1. Transformer says:

    Great thought experiment !

    I think I see how this works.

    In barter terms:

    – I am an Earthling investor who sees the great returns on Mars. I barter some of my Earthly wealth for goods that are tradable with Mars (say Databases services).

    – I then barter these database services for a Martian factory and a year later I trade the goods produced there and get my 100% rate of return ( physical in Martian goods).

    – I trade these Martian goods for interstellar tradable goods, that I convert (If I choose to) to consumer goods here on earth.

    – The competitive process over time will (in theory) equalizes rates of return for both Earthly and Martian capital via the magic of relative price changes.

    I’m still a bit worried that Krugman may be right and that if the potential for trade is very small that the effect of trade on local interest rate may also be small – but I am still thinking about that.

    • Transformer says:

      If the volume of tradable goods is small then the rates of return on capital could also be equalized by exchange rates between the currencies on the planets changing through time (once they had moved beyond barter obviously).

      • Bob Murphy says:

        Yes Transformer this is all great stuff. I’m glad you appreciated the coolness of the scenario; I think a bunch of readers (understandably) thought my purpose was to beat up on Krugman, when in fact my purpose was merely to explore this cool possibility.

        Krugman in this post thought it was the currency exchange rate that would slow up the equalization of the (physical) return to capital (goods). I don’t disagree, but I think you can push it deeper and realize that it’s the different (spot, real) prices of the capital goods that is the issue.

        So, the way I’m thinking of it, I abstract away from the currency by assuming both the Earthlings and the Martians have adopted their consumption basket as the numeraire.

        I am actually working on a formal model right now (for a peer reviewed journal) to give an example of this kind of outcome, which is partly why I wrote up the casual version for Mises.org. The idea is that right when the shock occurs (i.e. when trade opens up between the two regions), the rates of return on financial capital immediately equalize. The way it happens is that the price of capital goods (measured in units of consumption good) in the region with high time preference / low capital stock shoots up, because the interest rate to them has fallen. In contrast, the price of capital goods in the capitalistic region drops, because to them the interest rate has skyrocketed. (Remember that the spot price of a capital good equals the present discounted value of its future marginal products, measured in terms of consumption goods.) So that’s why during the adjustment period, producers find it profitable to make more capital goods in the poorer region, but producers don’t make more in the richer region.

        However this is all still tentative in my mind, which is why I was agnostic in the Mises.org article about how quickly the rates of return would equalize. But I’m just putting it out there for you, that it’s possible they “instantaneously” adjust and that the mechanism is changes in the market price of machines and other capital goods.

        • Transformer says:

          I can see that if Earthly investors saw much better returns on Martian investments then they would try and bid the prices up so that the returns equalized.

          But take an extreme case where the only tradable good is one that only one person likes on each planet , and to such a small extent that in equilibrium they would only consume one unit each.

          I can see that Earth investors would bid the price of this good up (in terms of Earth-only goods) to the point where it can buy a share in Martian capital that returns the same (risk-adjusted) return as the rest of Earthly capital. But I cannot see this single good making much of a dent in Martian interest rates.

          If one then assume more and more goods become tradable then as the share of tradable goods as a % of total output increases it will start to lower Martian rates (and increase Earth rates) until eventually they are equal. But it it far from clear to me where this point will be and precisely what happens to relative price levels and exchange rates before that point is reached.

          • Transformer says:

            I was thinking about this in a different way:

            Assume he ultimate aim of Earthlings buying capital on Mass is to generate a flow of consumer goods back from Mars to Earth.

            Say Earthlings end up owning all the capital on Mars and returns on capital have equalized at 5%. As long as their is enough volume of tradable goods to accommodate this flow of returns on capital in the form of consumer goods back to Earth (5% of Martian GDP) we get a stable equilibrium with rates of return the same on both planets.

            If not then Earth investments in Mars will stop when the flow of goods coming back has reached its optimal point. This will be above the point where exchange rates have equalized in nominal terms and differing rates of price changes between the planets will have to do the rest of the equalizing. . I think I see how this works. Assume that Earthlings can buy shares in Martian stock which gives nominal returns of 10% compared to Earth stock that returns only 5%. Martian assets prices will be bid up in Earth currency but not Martian currency until the rates of return are all equilbriated with Martian assets inflating at 5% a year in Earth-money terms.

            • Transformer says:

              “This will be above the point where exchange rates…” should be “This will be above the point where rates OF RETURN…”

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