Monthly Archives: May 2012

Chicken or the egg?

Which came first, supply or demand? At first blush this question appears to be of the intractable “chicken and egg” variety, however upon closer inspection we find the correct answer: Supply. How so? Surely no one will supply something if there is no demand. In order to solve this riddle we must first understand what is meant by “demand.” In the vernacular it means mere want or desire, however in economic parlance the meaning has a subtle and important difference. Demand is both the desire AND the means to fulfill that desire. In other words, it’s not enough just to want something; you must have something to offer in exchange.

No one can demand something until AFTER they themselves have produced something.

 

Why are demand and desire not economically equivalent? Consider the following: how relevant are people with no money at an auction? If we define demand as mere desire then as human desires are unbounded so too must be demand. Since we know there is not universal infinite demand for every good (i.e. infinite prices), we then know that demand and desire cannot be equivalent for economic purposes. However, desire does play a role. It is the spark that determines what should be produced. Entrepreneurs gauge market desires in order to determine the things that are a safe bet to produce while accounting for people’s ability to pay for such new goods (e.g. high desire/low affordability: people desire flying cars, but few could afford them, low desire/high affordability: nobody desires mud pies even though they could be affordably made, and high desire/high affordability: smartphones are desirable and since they could be affordably produced, they were).

So, if I want what Joe has, I have to two choices: (a) I can take it from Joe by force (the warrior path) or (b) I can produce something Joe wants and trade with him (the market path). In order for me to “demand” something I must first produce (supply) something. No one can demand something until AFTER they themselves have produced something. If Joe and Greg exist alone in the universe we can demand things all we want, but none of those demands will be met until we first produce something. Therefore supply must come first.

So if supply comes first, then where does job creation start, from those that spend money (demanders) or those that save it (suppliers)? Popular opinion and a Keynesian worldview err in the belief that demand drives job creation, but that is mere superstition. Logic clearly demonstrates it is savings that are the source of new jobs. It might seem intuitive that spending would create new jobs, after all, that money eventually goes to pay workers, right? True, but applauding the result of production (demand) while ignoring the source of such demand (supply) is a disingenuous attempt to ignore reality: that jobs are produced from saved funds. Policies that ignore reality and promote spending at the expense of saving can do nothing but harm job growth.

To understand why savings are critical to new jobs we must spiral all the way back to a business’s inception. What was the source of funds to pay those first workers before anything they had produced was sold? It came from the invested capital of the owners of the business, i.e. their savings (profit from prior ventures). To make this point a bit clearer imagine the following: all businesses decide to disburse all profit as bonuses to their employees, so all business net income is $0. Should be great for the economy right, all that extra cash floating around? Not really, the increased demand cannot be met because businesses have no unused funds (i.e. saved profit) from which to hire any new employees or purchase equipment. If they hired any now it would have to be on the condition that they could not be paid until the things they produced actually sold. Of course they can lower the pay of the other workers, but that’s my point, the funds withheld to lower the pay represents what was previously characterized as profit/savings: only profit/savings can create new jobs. Every attempt to redistribute it or tax it only undermines the job creation process.

So this begs the question, since companies have a lot of saved funds and profit why isn’t there more job creation going on now? The answer to that question will have to wait until next week…

Legalize potato marriage now!

President Obama’s recent “outing” by Joe Biden on the same sex marriage issue along with North Carolina’s Amendment 1 which bans all non heterosexual marriages has bubbled this divisive issue back to the top of the lava lamp that is our political landscape. It does not matter what the President nor the voters of North Carolina think. Laws based on the mercurial moods of the public are a recipe for tyranny, i.e. the Rule of Men rather than the Rule of Natural Law. Natural law is the immovable bedrock that supports a stable framework that PROTECTS our natural rights, not abridges them.

 

Not so recently marriage licenses were used as a mechanism to prevent whites from marrying non-whites.

To understand the marriage issue we must first gain some perspective. The historical purpose of a state granted marriage license was to cause the applicants to plead to the state for permission to marry in order that they prove that there was nothing about the marriage the state might find objectionable. In other words you had to ask for permission from your master (the state) to partake in a natural right (right of association and speech). State prohibitions on marriage fluctuate with public perceptions of what constitutes a “valid” marriage. Not so recently marriage licenses were used as a mechanism to prevent whites from marrying non-whites. Today we view that as an absurd restriction, but the public did not view it that way a mere 50 years ago. If the majority is always right then does that mean the “rightness” of an action depends upon mass opinion? Surely such moral relativism has no place in a modern constitutional republic.

For those that suggest the Bible establishes inerrant moral edicts and therefore the ban on same sex marriage is valid, please recall that the Bible too was often used not only as justification against interracial marriage but as a justification for slavery as well. My point is not to disparage the Bible but rather to point out that whether it is the Bible or the US Constitution, humans will always find a way to interpret a complex document to fit their desired viewpoint. How do we know we aren’t doing that right now? Some are sure they aren’t doing so now, but people 50 years ago were sure they weren’t doing it then either. But even were we to agree the Bible is clear on this issue, do we truly want to live in a theocratic state where laws are based upon current religious viewpoints? As I have covered previously, morality that is imposed by law does not make one righteous. God gave us free will, our laws should not take away that which God granted (for victimless “crimes”).

Some have argued that if there are no restrictions on marriage this will lead to crazy scenarios with people marrying their cat or a potato. Please. Anybody crazy enough to marry their cat is already crazy… you can’t outlaw crazy, they’ll just find some other crazy thing to do. But even if they did marry their cat, so what? How does that in any way affect your marriage? Do you suddenly stop loving your spouse? Are matrimonial vows nullified? Others argue that children are best raised in a two parent male-female household. I’m not sure by what metric one objectively measures the outcome of child rearing but current evidence shows no deleterious effects. Besides, if we assume that two parent male-female households are best and “best” is the basis by which to outlaw that which is not “best”, then I suppose we must make single parent households illegal as well?

At the end of the day what I propose likely would make neither side of this debate happy, so that by itself should suggest it is the best course of action. In short, return marriage to the private realm. The state (government) has no place in regulating or licensing marriage (contractual associations). The right of association/contract implies we may associate with whomever we choose and in whatever manner we choose as well as giving public notice of such associations. Likewise, no individual or group (churches, health insurers, employers, etc.) can be required to formally recognize such associations. They can if they want to, but there should be no legally mandated consequences to not doing so. That’s what freedom is, freedom to do as you desire as long as it does not infringe on anyone else’s freedoms.

 

Prosperity through tools

What is wealth, or rather, what is the point of wealth? Wealth is the promise of the ability to obtain our wants and desires with minimal effort. In general those that produce much with little effort are wealthier than those that produce little with great effort. And how does one go about producing much with little effort? With tools. Tools make the difficult easy and the impossible possible. Tools are the reason we don’t spend most of our lives simply trying to obtain our next meal. Tools are the reason we have at the beginning of the 21st century a higher standard of living than we did at the beginning of the 20th century or any period prior to that. Increasing wages and increasing standard of living are a direct result of improvements in the efficiency of our tools. Wages did not rise because of unions or the minimum wage, they rose because our tools became more productive.

To those that believe unions or government can force higher wages absent improvements in productivity, please consider this scenario: A bakery employees two people and they make by hand 20 loaves in 12 hours. They are paid $1/hour, or $24 for the pair per day in wages. The bakery sells the loaves for $2 each so it can make up to $40/day, or a net $16 in profit. Now suppose the two employees join a union that demands they be paid $1.50/hour and the bakery has no choice but to agree. Wage costs have now gone to $36/day and to maintain the 40% margin it must now charge $3/loaf. There are three possible outcomes: (1) the public can no longer afford to buy the loaves and the bakery goes out of business (involuntary closure), (2) the bakery tries to operate with a lower margin but quickly finds there are more profitable ventures than baking and since all other bakeries have the same new cost structure all bakeries close (voluntary closure) and an entire industry ceases to exist in the market or (3) the customers accept a higher cost…which then compels them to join unions to demand higher wages from their employers, who in turn raise their prices until all prices spiral upward until a new equilibrium is reached of higher wages AND higher prices.* So ask yourself, what was the point? Either businesses are driven to close their doors (leading to unemployment) or the end result is entirely neutral (wages go up 3 fold and costs go up 3 fold).

Here is how better tools make everyone wealthier. The bakery purchases a new fangled gadget that allows the two employees to make 200 loaves a day. It can now afford to charge only 28¢/loaf while still doubling profit. The employees continue making $12/day but because they are so much more productive the bakery offers them the option of only working 8 hours for the same $12 ($1.50/hour). Because bread costs have gone down everyone in society has more disposable income. The employees are working fewer hours and earning more per hour and the bakery is earning more as well. Everyone wins (society, employees and employer) and no coercion from the state was necessary. Now repeat that in multiple other industries over many years and what you see is an increasing standard of living and wealth. Everyone’s condition is improved over what it otherwise would have been. Some believe that it is mere “high paying” jobs that make society wealthy, but unproductive high wage jobs can do nothing to raise society’s standard of living. I will close with a quote  (attribution varies but the sentiment is valid nevertheless) that crystallizes this sentiment: “While touring China, a businessman came upon a team of nearly 100 workers building an earthen dam with shovels. The businessman commented to a local official that, with an earth-moving machine, a single worker could create the dam in an afternoon. The official’s curious response was, “Yes, but think of all the unemployment that would create.” “Oh,” said the businessman, “I thought you were building a dam. If it’s jobs you want to create, then take away their shovels and give them spoons!”

* For my Austrian economics friends I am glossing over the “supply of money” point so as not to overly detract from my main argument, but for those uninitiated in the core logic of Austrian economics here are more details on the various paths Scenario 3 can take: Of course with point (3) all prices can only rise if the government prints more dollars… in a hard money economy where the supply of money remains constant some prices would go up and others must necessarily go down thus potentially driving those businesses to close shop and their employees to become unemployed. To simplify the supply of money argument imagine the following: You have $10 and there are 4 vendors each selling their wares for $2.50. You are able to buy from all 4. But if they all demanded $5 for their wares then you would only be able to buy from two of them… you would choose the ones you find most valuable and the other two would simply not receive the sale. Repeating that multiple times means those businesses must close as they have no sales. But some could stay open if for example two raise their price to $4, then the other two could obtain sales if they dropped their price to $1 ($4x 2 + $1 x 2 = $10). If they can stay in business on $1 they will survive but if not then they will go out of business. A real world example wherein prices were driven up but vendors were not permitted to drop their prices was with minimum wage laws, these include such services such as milkmen, full-service gas, door men, they simply cease to exist because no one is willing to pay an amount for that service that will cover the government mandated minimum wage that must be incurred to provide that service. Now although these out of work employees would increase the labor supply and drive labor costs down somewhat (to the extent there was still non-union labor in existence, if all were unionized then they would simply remain unemployed and would have to start their own businesses to fend for themselves in a new “underground” union-free economy). To the extent there was not 100% union coverage of the workforce non-union wages would be driven down, i.e. the gains of the union are offset by the losses of everyone else. But even with this net 0 in wages for society there would still be a net loss to society in that the goods and services supplied by those businesses that closed are removed from society and thus it is a net loss to society… the value they formerly produced simply no longer exists.

 


Moral Hazard at the local level

A few weeks ago it was reported in the Morgan County Citizen that the Morgan County Board of Commissioners agreed to fund a $15,000 study in order to determine the economic viability of creating a regional “food hub” in Morgan County. It would seem government backed subsidies of private businesses is not just a federal or state issue but a local one as well. In an of itself there is nothing wrong with the idea of the food hub, the problem is why is any government in any way assisting in funding a possible private enterprise? If the backers of this idea feel it may be a good idea then they need to invest their own funds for this study. If the study finds it is viable and this new enterprise comes into existence will they refund the county the $15,000 fee? Perhaps, but if it indicates it is not viable will they still refund the fee? I’m guessing not, otherwise what would be the point in having the county pay for it, why don’t they just pay for it to begin with? This is a case of “heads I win, tails you lose.”

The wider issue here is this is a miniature version of why we had the recent housing bubble, and that issue is known as “moral hazard.” Moral hazard is when someone else takes on the responsibility for any bad decisions you might make. This tends to increase the number of bad decisions. For example if I told you to go into a casino and gamble as much as you wanted and that if you lost I would reimburse all your losses, how much constraint would you feel about gambling as much as you could vs if it was your own money and it would not be reimbursed? No constraint at all. This is a similar situation. If a group of private investors have an idea for a new venture but they are unsure of the viability of it, why not get the government to pay for the background information? If it is a winner they will start the business, and if a loser than none of them are out any money, only the government (the people) are.

Now I am not accusing anyone of any malfeasance or sinister motives here, my point is that our system is set up in a way where this is simply the normal mode of operation, so why not take advantage of it? But when you codify moral hazard into your governmental system you will only increase the odds for a lot of waste. The counter argument here may be that “this will lead to jobs possibly.” Yes, maybe it will, and maybe it won’t, but why should the people (the government) gamble their money on ideas that may or may not pan out. If the investors think it is a good idea then they need to spend their money and put their money on the table. Diffuse costs and concentrated benefits inevitably lead to problems of economic distortions and cronyism.

A reply to objections raised against Educational Responsibility

My “Education” editorial prompted a rational and cogent response from David Land in the Morgan County Citizen. This is one of the reasons I began writing this column, to engage those with differing views in polite discourse free of the usual “Left-Right” rhetoric. Thank you David. I would like to respond to the issues raised.

should anything benefiting the individual be subsidized by the state?

First point: Education is a public good because it tends to benefit society; therefore society should subsidize it. Anything that benefits the individual can benefit society (because society is composed of individuals). This begs the question: should anything benefiting the individual be subsidized by the state? For example, automobiles permit a broader range of employment options and access to goods, so one could argue businesses should subsidize (through taxes) automobile purchases, as that would ultimately benefit those businesses that will have access to more employees and customers. But we don’t do that. Why? Because the free market responded to the demand for this valuable good, thus transforming the car from a luxury available exclusively to the wealthy into a luxury available to every sector of society.  The point is that while a K-12 education is now extremely costly (+$100,000) this would not be the case had there been a free market in education all along, the cost would be closer to an affordable $30,000 over 13 years and thus the argument over “who should pay for it” would vanish. Companies need educated workers, but workers need an education to get jobs. It’s a two way street in which two parties engage in a mutually beneficial exchange (labor <–> money) and there is no a priori reason to assert that party A must provide resources to party B in order that party B may meet the requirements of said exchange and thereby benefit both parties. If you want to buy my house should I be forced to lend you money because said purchase ultimately benefits me?

If shifting costs from an employee to their employer tends to drive wages down, why is it hard to accept that shifting costs from an employer back to the employee would not drive wages up?

Second point: In a free market business owners would never pass on the tax savings derived from elimination of subsidized public education. I do understand the basis for this objection: normally if a business has a good year or receives a tax cut there is no incentive to simply divide the surplus among all employees. However the situation I was describing is unique because it is a specific trade of funds, namely, the tax being cut is used for a known (earmarked as it were) cost of living for the majority of employees. So the incentives are different from that of a “normal” tax cut. If we understand the incentives then we can understand why most would raise wages and/or lower prices. Let us suppose we could wave a magic wand and eliminate all property tax and most state income tax overnight. Employees would now find themselves in the position of having to pay for their children’s education directly. Those formerly subsidized employees would jointly demand higher wages to approximate their net increase in costs. The incentive to comply for the employer is two fold: 1) maintenance of employee morale through a raise that employers can easily afford (for example, we could easily afford this as we pay over $60k/year into the school system) and 2) lack of rehiring options if a trained employee quits over wages…most potential replacements would be demanding the same higher wage. But let us assume for the sake of argument that no employers would give raises. What would be the result? Because most (99%+) employees with children would value their children more than anything else in their lives they would pay for their education first, thus decreasing their demand for discretionary goods and services. The decline in that demand would result in lowered revenue for those businesses, who would then in turn lower their prices (which they could afford to do out of the tax savings) in an attempt to attract back customers…this would thus make goods and services more affordable for everyone. Even if nominal wages ($) are static, real wages (purchasing power) increase as prices decline (price deflation). Because education costs could drop by as much as 2/3rds the overall effect is a net gain to the aggregate productive capacity of the economy. If you’re still skeptical, ask yourself this: Imagine the reverse, imagine that the government instituted a new “food tax” that supported a program that provided all food for all citizens, would we not expect wages to decline over time (e.g. if you spend $12,000/year less on food it makes it easier to accept a lower wage)? So if shifting costs from an employee to their employer tends to drive wages down, why is it hard to accept that shifting costs from an employer back to the employee would not drive wages up?

Wouldn’t we expect automobile ownership (that is, any luxury item) to be lower in Haiti?

Third point: Haiti as a real world example where a mostly private education system has failed. This is an interesting example, however it is an apples to oranges comparison that only underscores the expected market penetration of a luxury item in an impoverished country.  Education, while desirable and beneficial, is not essential to life and so it is economically classified as a luxury good. So are automobiles. If we were comparing automobile ownership between the US and Haiti wouldn’t we expect automobile ownership (that is, any luxury item) to be lower in Haiti? In fact they are: 12 vs. 808 per 1000 people. So if one luxury good has a low market penetration in a poor country wouldn’t we expect all other luxury goods to as well, including education? Using an impoverished country such as Haiti as an example of how the free market cannot provide education to all citizens is as fallacious as arguing that the private market in Haiti has been a failure in making automobiles available to all citizens and thus the only answer is a publicly subsidized automobile ownership program.

Fourth point: Children of the poor would suffer due to lack of educational opportunity. Poor children would not experience a lack of educational opportunities as schools would offer needs based scholarships (as private schools do today) and charitable organizations focused on education would quickly sprout up (funded by those who honorably believe it is their obligation). But let us assume again a worst-case scenario and that those in poverty could not go to school. Will they just lay down in the street and die? Of course not. If there is a demand, the market will respond. Perhaps home schooling co-ops might form. Perhaps businesses would charter trade-focused schools. One example of how the market can quickly and effectively provide a superior education to those in the low income spectrum was the destruction of the public school system in New Orleans by Hurricane Katrina. Charter schools were quickly legalized and the market responded with schools that have by every measure outperformed the old system (see video at 30:00 mark). The point is that the creative brain power of millions of people will find solutions to even the most challenging issues.

I could just as easily argue that public education was the cause of those countries’ poor GDP as I could argue that private education was the cause in Haiti.

Fifth point: Education drives productivity and since private education would result in fewer people being educated this would result in lowered US productivity. Again, private education would not result in fewer people being educated, but even if we assume for the sake of argument it is true it would not change the productivity of the US. Enhanced educational opportunities are not what drove the tremendous growth in the US, but rather are a result of it. It’s like saying “look at that wealthy guy with the fancy car… if I buy a fancy car then I can become wealthy too!” If we accept this assertion then we would expect in every country where there is public education we would find a GDP comparable to the US. But that is not what we see. There are numerous countries that have public education and a GDP near that of Haiti’s . Why would education be a determinant in GDP outcome in Haiti but not in these other countries? I could just as easily argue that public education was the cause of those countries’ poor GDP as I could argue that private education was the cause in Haiti. In point of fact, Cuba ranks above the US in the United Nations Education Index, so that alone should dispel any notion of education driving economic prosperity.

Sixth point: Uneducated masses being unable to secure jobs would turn to crime. The correlation between crime and education is real, but the assumed causal relationship is backwards: lack of education doesn’t make criminals, rather most of those with criminal proclivities are afflicted with a pre-existing condition: contempt for education (by either themselves, their families or culturally). Every criminal in our jails went through our public school system. Clearly a lack of educational opportunity played no roll in their current status.

If we had a non-monopolized private system of K-12 education then education would be one of those “luxuries” that all could enjoy, just as things that were once considered luxuries only for the wealthy are now commonplace (e.g. cars, cell-phones, ball point pens, air travel, air conditioning, etc). That’s what a free market does over time, it becomes more efficient at producing those goods and services in high demand until they become affordable for all. Affordability eliminates subsidization.