Category Archives: Austrian economics

Shortages the Spawn of Short-Circuited Prices

Although the recent drought experienced by much of northern Georgia a few a years ago pales in comparison to the ongoing drought in California, the response by each region’s government is equally misguided. The shortsightedness of the standard “solution” to a drought tends to scale with its severity. While we only suffered through time restrictions on outdoor watering, California has upped the ante to rather invasive levels in their pursuit of the “common good.” They are now all too happy to step into dear citizen’s shower and issue fines for lingering too long.

Droughts are a product of nature. Water shortages are a product of man; or, more precisely, a product of government. If a shortage is occurring in any market, it is guaranteed some form of price control (private or public) is in play. It is one simple lesson from Economics 101 that so many consistently fail to grasp: demand curves slope downward. Stated differently, prices (naturally) go up as supply decreases (all other things equal). But when part of that equation is artificially constrained (prices) the effects of the decreased supply are magnified, not ameliorated. When prices rise there is a two-fold socially beneficial effect: it (a) provides a rationing/conservation incentive (people only purchase that which they absolutely need) and (b) it sends a signal to everyone that a tidy profit can be had by supplying the market with that good. High prices are the market’s method of eliciting an economic immune response. As swarms of people respond to the wailing klaxons of above average profit, supply swells until prices begin to fall. It is this natural up/down demand/supply equilibrium that lets a market know where to devote more or fewer resources.

High prices are the market’s method of eliciting an economic immune response. As swarms of people respond to the wailing klaxons of above average profit, supply swells until prices begin to fall. It is this natural up/down demand/supply equilibrium that lets a market know where to devote more or fewer resources.

But governments don’t like the price system. It is they, not the market, who should be in control. Of course they have their image to protect and the last thing they want is to be accused of being an evil “price gouger.” So instead of allowing the price system to modulate usage, they instead impose egalitarian restrictions so that all may suffer “equally” the effects of their economic ignorance. In other words, they choose the hard way rather than the easy. They deploy sticks (restrictions, fines, penalties) that require resources to enforce compliance, rather than employing carrots (demand based pricing), that require zero resources to ensure compliance.

If prices are allowed to rise, then people will switch from being wasteful to having an incentive to use as little as possible and to seek out new water savings and new efficiencies, to boldly use less than any man before. For those concerned about how the poor would fare under rising water prices, it is entirely reasonable to expect that a base tier of minimum human requirement could exist alongside progressively rising prices for greater usage. There is little daylight between this and the progressive income tax system where the poor pay virtually nothing and the wealthy pay the most. Except with this system one’s “tax” (water bill) would be within their control. If one voluntarily uses less, they will pay less. The outcome of raising prices will be either (a) similar usage with a windfall income or (b) much reduced usage with similar income. If the former is the result, then one can continue to raise prices until (b) is achieved if that is the goal, or one can use the extra income to invest in systems that will increase the supply.

At least in California one of the reasons they are hesitant to raise prices is the crony-capitalist nature commonly found among governments. The largest user of water in the state is agricultural (83%) . The powers that be are afraid that higher water prices could disrupt the state’s economy by pricing California agricultural products out of the market. So once again the marriage between big government and big business ensures private profits at public expense (restrictions and fines). Wait, I thought government was supposed to protect the little guy? Well, while you ponder that little fantasy I’ll leave you with an apropos Milton Friedman quote – “If you put the federal government in charge of the Sahara Desert, in 5 years there’d be a shortage of sand.”

Medicaid Expansion: Compassion or Trojan Horse?

Georgia is one of 19 states currently not expanding Medicaid under the auspices of Obamacare. This, contends proponents of expansion, is leading to needless deaths and poor health outcomes for many poorer Georgia residents due to the ongoing closure of rural Georgia hospitals. As with any political issue reduced to sound bites, this is a gross over simplification. Although it is true that monies received under a Medicaid expansion would indirectly alleviate some of the financial burden faced by these hospitals, it would not solve the problem nor would it address the proximate cause of these hospital’s failures.

This nationwide network of rural hospitals was established in the 1940s by the federal government. For the most part they were quite successful with few closures, that is, until the first year of Obamacare regulations came on line – 2010. Obamacare then began to smother these community hospitals with shortsighted regulations that do nothing to limit costs. These regulations included penalties for patient re-admittance if done too soon after initial release, mandates to establish electronic medical records, as well as cuts in Medicare reimbursements to hospitals.  While one hand of Obamacare beats these hospitals with a stick (regulation), the other hand offers a Band-Aid (Medicaid expansion); truly a case of governmental cognitive dissonance.

Medicaid expansion is but one part of the Obamacare-Trojan horse that will slowly stamp out the last vestige of market health care. The “Medicaid Hole” was deliberately inserted into Obamacare. This “hole” leaves some people with no coverage unless the states go along with the Federal definition of Medicaid eligibility (the states can set their own standards now). This is the second Gruber-esque ploy within Obamacare directed at enticing “voluntary” state compliance. It follows the standard Mafia extortion-pattern of an “offer you can’t refuse” by threatening harm to a third party. The first instance of this was the state exchanges: “set up state exchanges or else your citizens won’t qualify for federal subsidies.” Now it is “expand Medicaid or your citizens will suffer for lack of health care.” The individual is but a pawn in their game. If that were not so then why didn’t they simply create federal exchanges and grant everyone subsidies?

The second part of this Trojan horse is that Obamacare sets a substantial tax on “Cadillac” health care plans. The threshold for a Cadillac plan is the ONLY financial figure in Obamacare that is NOT indexed to inflation (let that sink in for a minute). Once a state expands Medicaid they must follow the federal eligibility requirements. The end game is a masterful pincer action; Medicaid eligibility will be eased upward by the feds while the Cadillac cap will in effect be eased downward (as a result of healthcare inflation). “Affordable” plans will disappear and thus people will have no choice but to jump over to Medicaid. End result: single payer healthcare (Medicaid) without a shot being fired.

Now before anyone argues that we need single payer to fix this “free market” mess remember that we have never had a free market based health care system in this country – there has always, at some level, been government intrusion into the market.* These intrusions distorted natural incentives and created unintended consequences. The “solution” to these unintended consequences then is always more government intrusions. Wash, rinse, and repeat.

To find a real solution to government interventions we must “undo” – not “do”. If proponents of Medicaid expansion in Georgia are serious about helping the poor and uninsured then they should propose the total repeal of all “Certificate of Need” laws (O.C.G.A. 31-6) in this state that require both state approval and the approval of any potential competitors for not only any new health care facility, but even the expansion of an existing one. CON laws have nothing to do with maintaining a certain standard of care. They are entirely a crony-capitalist measure, like taxi medallions, meant to limit competition among providers of a particular service. These laws do nothing but scare off potential investors and add years onto the process of opening a new hospital. The best thing to help the uninsured would be low prices brought about through competition. Subsidies to the uninsured in a CON environment are nothing but an indirect subsidy to high cost providers.

 

*Sky high income tax rates during World War II fostered the creation of tax free health insurance through ones employer. That, coupled with the creation of Medicare in the 1960s soon led to rapidly increasing health costs in the 1970s which Congress tried to stem with the HMO Act of 1973  and this country’s first dalliance with “managed-care” – that is the insertion of a third party between the doctor and patient who would pay for all care but also inject their opinion on the necessity of care. As costs continued to spiral upwards (due to the artificial disconnect between the customer (the patient) and the vendor (the doctor), Congress introduced layer upon layer of additional regulations trying to keep costs down. That was about as successful as throwing more blankets on a leaking waterbed to stop the leak. Like whack-a-mole, as soon as they plugged one hole a new one appeared, normally as a direct, unintended consequence of the “fix” for the last hole. And that story is how we now got to Obamacare – the latest fix in a long line of fixes.

 

The Unseen (Septic)

What does a septic tank have to teach us about economics? This rather mundane bit of technology is at the center of depressingly familiar story figuratively brewing in my backyard. It’s not my septic tank that is the issue, but rather one literally just down the street from me in the small town of Bishop, GA. Bishop residents Blyth and Diana Biggs purchased the “Fambrough House” on the main thoroughfare (Hwy 441) with the intention of residing there and turning it into the first ever restaurant in Bishop. They were on target to open in August 2014 when they hit a snag, well, more of a massive pothole, on the road of entrepreneurship. It seems the Oconee County Health Department is going to require them to rip out their current septic system and install a commercial grade unit to the tune of a mere $75,000. Why? Well, ‘cause regulations say so. And we all know that regulations are infallible because the mantra “one size fits all” has never ever resulted in unintended consequences. Suffice it to say, when I saw their post about this last year on Facebook, all I had to read was “We’ve run into a bit of a problem…” and I instantly knew what the source of their problem was – the state. Nothing will throw cold water faster on the dreams of an entrepreneur than a byzantine labyrinth of irrational regulations.

So, to return to the original question, what does a septic tank teach us about economics? In this case it reminds us of the central lesson of Frédéric Bastiat’s Broken Window Fallacy – unseen effects must also be brought to account when analyzing economic outcomes. In this case, a restaurant that never opens would be an “unseen” effect of a gross misapplication of this particular regulation.

Regulations are an economic good. They provide a benefit, but like all economic goods they have a cost. However, when economic goods are forcibly imposed their cost no longer bears any relationship to the true demand (and hence price) for them. For example, some people like aquariums, but not everyone does. If the government made a law that required all households to have an aquarium, this would naturally shift the demand pattern from partial to universal. From this universal demand we would then witness an elevated price (Econ 101: as demand increases so does price). In the same way an artificially increased demand for regulation drives up the costs for those regulations. The price of these imposed regulations operates in a vacuum, uninfluenced by any other considerations that might compel one to balance their costs with other equally important considerations. For example, if the owners were not compelled by the threat of violence to keep their doors shut they would then be able to freely weigh the costs of opening with a potentially undersized septic vs. the costs of a delayed opening. All things being equal, absent state imposition of these regulations, we would find that demand, and hence price, for septic installation would be lower. This leads to the rather ironic outcome that in the absence of state mandated regulations many places like the Bishop House would actually be more likely to make these such changes owing to their lower costs).

But, if the Bishop House is unable to open due to this artificially imposed barrier, then we will all be the poorer for it, for what is wealth if not the betterment of our lives by the voluntary actions of fellow human beings? Every person barred from adding his own unique contribution to society by artificial barriers (the economic interventionism of regulations, licensing and employment law) erected by the state makes all of society that much poorer.

P.S. If you would like to learn more about The Bishop House or help them please see http://www.gofundme.com/fo1klc

Pool your own resources

It seems everyone wants a pool. But nobody wants to pay for it, because after all pools are really expensive – both to build and maintain. When I moved into my current neighborhood we were “promised” it would have a pool by the real estate agent and the builder. Our HOA dues were inflated owing to the necessity of maintaining this incipient pool. It was not to be. A mixture of the housing bust and and builder antics sealed the fate of the “free” pool. Now that our neighborhood is about 95% occupied there is increasing pressure for “we the neighbors” to build one ourselves via a self-assessed HOA dues increase. When we moved in my children were at the prime “pool” age, however they are nearly grown (college already?!?) and so we have little interest in footing the bill for something we would almost never use. But, we moved in here voluntarily, fully aware that pool expenses would be part of the deal so I have no ethical basis for complaint, merely a pragmatic one. If I don’t like it, I can, as they say, move.

That option, moving, however, does not exist moving up one territorial notch to the county level. Every county in the US pretty much operates the same way. I recently read that a swimming pool has been the number one recreational request in my county (Oconee) for many years. I find this fascinating on several levels. For one it flies in the face of the oft given justifications for government, that is, courts, cops, roads and schools. Surely government must provide these absolutely essential functions, no? Well, no, but for the sake of argument I’ll concede the point right now. However, I find it laughable that recreational amenities now too fall into the category of “essential state functions. Really? That brings me to my second wry observation: Oconee County already has a private provider of pools and gymnasiums (another common request). So, it’s not that people want access to a pool per se, (clearly there is already “access” locally), it’s that they want someone else to foot the lion share of the bill. Getting the county to provide these things means that when you utilize them a disproportionate burden of the cost is shifted to (a) all those with a higher property value than yours and (b) all those that use it less than you do. Subsidization, pure and simple. Not very conservative for a supposedly conservative county?

There is a common misconception that we need a county government to provide these sorts of things because governments can lower the cost for everyone because they don’t extract any evil profit. But think about what that means for a minute. Profit is the increase in subjective value realized when one takes a pile of resources and alters them into a more pleasing arrangement (think raw ingredients —> apple pie). If there is a decrease in satisfaction (think Ferrari melted down to make pie plates) that would be a loss. So when one argues that if a private business were providing access to a park or a pool it would be “too expensive” but that government can “make it affordable” what you’re really saying is that highly valued resources (private pool) should be rearranged into something that is of lower value (public pool). Because that is exactly what happens when money is taken from a property tax payer A to offset the cost of pool access for property tax payer B. Payer A’s funds were diverted from whatever he would have spent them on (high value to him) to something of lower value, that is, something he never would have spent them on, a pool. To argue this is “ok” is to argue that theft is justified in order to provide essential human rights like park and pool access. As they say, first world problems.

So to all those in the county that want a pool I would offer this bit of advice: put your money where your mouth is and join the private pool already here so that it can grow and expand in relation to the demand for its services, or, if you believe you can do a better job then come together voluntarily and risk your own capital (not mine) by building one yourself. I would offer similar advice to the pool proponents in my neighborhood. “Pool” your resources, buy a lot, build the pool and run it for profit. Only with a profit/loss test can anyone know if that would be a wise redirection of capital. There is no better method of plumbing the depth of a man’s belief than to ask him to risk his own capital.

Substitute Band Leader

President Obama unwittingly invoked dramatic irony during his recent state of the union address. For those unfamiliar with this less common definition of irony I provide herewith a definition: “dramatic irony: a literary technique by which the full significance of a character’s words or actions are clear to the audience or reader although unknown to the character.”

He opens his speech with, “Tonight, after a breakthrough year for America, our economy is growing and creating jobs at the fastest pace since 1999.” For now we’ll ignore the dissembling in that remark (faster growth has actually occurred 4 times since 1999 – in 2010, 2006, 2004 and 2000). Later in the speech he then remarks that, “we’re the only advanced country on Earth that doesn’t guarantee paid sick leave or paid maternity leave to our workers.” Again, not entirely accurate – Canada and Japan also do not.

However, the point of irony here is that while he praises the capacity for the American economy to foster vigorous job growth he is entirely oblivious to the fact that the rate of productive job creation (that is, not busy-work jobs) scales with the level of freedom of the individual to pursue their own ends, unmolested by meddling third parties. And being so oblivious he then calls for yet another layer of regulation that is guaranteed to retard the very job growth he praises.

More individual freedom translates into more opportunity, but less freedom, by way of a mountain of inscrutable regulations, increases the net cost of hiring. Given a fixed source of funds, one has no choice but to buy less of something if its cost goes up. The President seems to be under the impression that wages are derived from a bottomless pot of money kept at company headquarters, the disbursement from which is artificially limited by Monty Burns-style corporate bosses. Companies, unlike the government, can’t steal or print their money; they have to actually earn it by giving the consumer something they want.

Just as with his perplexing proposal to zero out the tuition of community colleges he is once again answering a question no one is asking. He claims 43 million workers have no access to sick leave. Since he doesn’t cite his source it’s unclear if that number would be reduced if we included workers that are permitted to substitute vacation time when sick. Nevertheless, this certainly sounds like a lot of people. Let’s parse it out. Using data drawn from the government’s own Bureau of Labor Statistics (bls.gov) we find total employment for 2013 averaged around 143 million. We also find that 75% of full-time workers and 23% of part time workers had access to paid sick leave. That’s about 93 million with such access. If we are to be impressed with the President’s figures, we should be doubly so impressed with this one. However the weedy details are not nearly as interesting as the game he is playing. He is imitating quite well his political predecessors who also sought to take credit for something the market had already brought about. He would like nothing more than to step in front of the ongoing parade and pretend it was following him all along.

Market forces have independently, and in the absence of government coercion, expanded access to an economic good that employees demanded: paid sick leave. In 1950, 46% of full-time workers had access to paid sick leave. In 1970, 51% did. By 1992 that number had risen to 58% and then by 2012 to 75%. A similar narrative can be found for other “we only have this because of government” myths, such as the 5 day, 40 hour work week, ending of child labor, or worker safety.  All improved over many decades long before politicians got involved and passed “laws” that simply memorialized what was already common practice.

The growth of such benefits is akin to the steady growth of stock dividends. Both increase at a steady pace because the growth in human ingenuity (leading to greater productivity) is an incremental process. We didn’t go from the steam engine to the integrated circuit overnight. Productivity enhancements accruing from incremental improvements in mechanical capital take time. As a society and an economy becomes more productive it becomes more able to afford things it could not afford in the past, like paid sick leave, paid vacations, or paid maternity leave. In 100 years our economy may be so productive it is literally only necessary to work 1 day a week. So if government is the true source of all that is good and fair in the world, why don’t they pass a law now capping work to 1 day a week? Because even they know that will fail. It is much more expedient to find something the market has already nearly achieved and swoop in at the last minute in order to take full credit. Perhaps their next act will be to pass a law mandating the sun rise each day. Isn’t law just grand?

Halloween Economics

Every Halloween children engage in the single largest simultaneous generation of mutual profit and yet not a single dollar changes hands. As the lights go out on the front porches the opening trade bell chimes for the time honored post-Trick-or-Treat ritual known as “the trade”. Twizzlers, Snickers, M&M’s, lollipops all change hands multiple times. The absolute quantity of candy changing hands is static, only ownership changes. Yet when all trades are complete everyone is happier than when they started out. How then can this apparent zero-sum game produce a positive output not just for some participants, but for all participants? The answer is quite simple: all value is subjective.

The Halloween candy market mirrors the real world in microcosmic fashion. Each participant starts out with a random distribution of candy; some may have more and some less, but all have something. In the same way each of us is born into this world with differing abilities that carry with them advantages and disadvantages (i.e. some are born into candy rich or candy poor neighborhoods to extend the metaphor). This process may be “unfair” but all have something to offer each other. But, what all have in equal proportion is the human propensity for general dissatisfaction with whatever they do have and therefore each has a desire to improve his or her condition. So, people have X but they want Y, and in order to achieve Y they will use X to get as much of Y as they can. Of course trade is usually never that simple. Sometimes to get X you must trade Y for T and T for R and R for U and then U for X. But the point is that with each completed trade both participants have a profit; that is, both place a higher value on the item(s) obtained post-trade then the items they had pre-trade. Profit is merely our subjective assessment of having gained an increase in satisfaction when we consider our post and pre-trade mindsets. Were there not an anticipated increase in satisfaction then naturally we would not have engaged in such a trade. Of course it is not impossible to deliberately trade away something we hold in high esteem for something we hold in much lower esteem, but it would be foolish. But do not misinterpret that as meaning that a “sacrifice” is foolish. In fact if done willingly it is not possible to “sacrifice” something. The one “sacrificing” does receive something of greater value in the exchange; the satisfaction of benefitting the one for whom they willingly “sacrifice”.

Because all value is subjective it makes it difficult (if not impossible) for a third party to judge the outcome of a trade. To use the candy example, if a parent who detests Tootsie Rolls witnesses their child trade away all of their Hershey Kisses for Tootsie Rolls, then that parent will indignantly conclude their child has been “ripped off” and may attempt to intervene. But since their child loves Tootsie Rolls and the other kid loves Hershey Kisses then both kids are now much happier because of their swap. Both children have profited from the trade but the parent believes one child has gained and the other has lost. This demonstrates the utter futility of believe a third party can “regulate” economic trade by substituting their own subjective opinion for the equally subjective opinion of the market participants. For example, imagine what would happen if a parent decreed a minimum wage of sorts. House rules say jawbreakers must trade for at least two Hershey Kisses. But, jawbreakers are so universally disliked that the market rate is actually 10 jawbreakers for one Hershey’s kiss. What do you imagine would happen to the kids with lots of jawbreakers? That’s right, no one would trade with them because no one would be willing to meet the decreed price minimum. This market intervention and subsequent distortion causes decreased profit not only for the kids with jawbreakers but for all other participants that now are barred from trading with them. Intervention robs all of the maximum satisfaction that could have been achieved.

Fortunately the state has yet to get involved in exerting control over this chaotic and unregulated candy free market. Each Halloween we are witness to the simple beauty of the natural equilibrium of increasing satisfaction achieved by those able to freely engage in uncoerced and unregulated trade.

Minimum Wage: Be careful what you wish for, you might just get it

Last Friday a group known as “Fast Food Forward” (tightly affiliated with the SEIU union) led a series of demonstrations in over 100 US cities at fast food restaurants where they called for a near doubling of the federal minimum wage to $15/hour. In further news there were a number of similar demonstrations in which short people demanded to be declared as tall, the overweight demanded to be declared as thin, and the un-athletic to be declared as athletic. Oh, wait, that last bit didn’t actually happen. Sure would have seemed silly if such events had taken place wouldn’t it? Well, if you can see why a “raise the federal minimum height” rally would be silly you’re on the first step to understanding why calls to increase the minimum wage are equally absurd.

A wage is nothing more than a point system used by each of us and applied to all of us that allows us to rate how valuable we find each other’s labor. This value assessment is however tempered by the immutable law of marginal utility: the more there is of something, the less we value any one unit. Water is the most valuable material on the planet (as our day to day survival depends on it) but it sells at a mere 0.7¢ a gallon (from the tap) because of its abundance. Likewise, in any given profession, the more people capable of doing a job, the lower the wage for that job. The wage is lower, you see, not because the buyer (employer) is deciding what it shall be, rather it is the result of the numerous sellers (employees) bidding prices down in order to make the sale. If your wage is lower than you’d like, don’t blame your employer, blame your peers and yourself. You can blame your peers for being willing to work for less than you. You can blame yourself for not improving your skills or productivity so that you can distinguish yourself from your less productive brethren and thereby demand a higher price for your services. To blame your employer for paying you minimum wage when you would prefer to have double that wage is as silly as the shop owner blaming his customers for not buying his wares and opting instead to purchase from his competitor who charges half as much.

If workers latch onto sympathetic politicians (interested in buying votes) who pass laws that raises their wage then the employer is still free to explore all options that might get the job done for a lower price. Minimum wage law does not require employers to buy the product (labor), only that if they do buy the product they must pay at least the floor price. Thus enters the specter of automation: a machine that is economically unviable when competing with low wage rates will suddenly make more economic sense at much higher mandated wage rates. Those looking for a minimum wage increase are going to price themselves right out of the market. The truth of this statement is already evident today in the growing trend of automated self-checkout systems becoming commonplace. In a few years we may find the concept of a human cashier as alien as a full service gas station (and if you don’t know what “full service” at a gas station means, then all I can say is: point made.)

Whenever there is a call to raise the wages of this or that class of worker (whether it be fast food workers, teachers, or police or what have you) there is a major insight that is always lacking by those making the call. They believe that if they get what they desire they will be the ones to enjoy the higher wages. But they are mistaken. It is the more highly skilled and more productive worker that will replace them. The less productive or skilled worker can’t compete with the highly skilled worker if the mandated wage is set at the productivity level of the more skilled worker. Would you buy a Kia or a Mercedes if the minimum car price were mandated to be $70,000? Bonus question: what do you think would then happen to the Kia car company?

Eliminate, Don’t Raise, the Minimum Wage

Argumentum ad populum

Of the various flavors of government interventionism in our lives, the minimum wage is perhaps the most welcomed. It appeals not only to our innate sense of “fairness” but also to our self-interest. It’s allure may erroneously lead us to the conclusion that because “it is popular” ergo “it is right”. Arguments for the minimum wage that are predicated on such popularity succumb to the logical fallacy known as argumentum ad populum (appeal to popularity). Mere popularity does not translate into legitimacy. The truth of this statement should be apparent to any citizen of a country that at one time exhibited popular support for prohibitions on biracial marriage and women’s voting, Jim Crow laws, and of course, slavery itself.

Even if we accept the assumption that an essential function of government is to make all human interactions “fair” and thereby enhance the outcomes of those interactions, it is still prudent to examine the principals and methods employed towards those ends to see if they are in fact achieving those goals.

 

A Priori Principals

Prior to examining the empirical evidence resulting from employing these methods we should first examine the principals behind them in order to determine if what we are trying to achieve is even theoretically possible. Although some principals must be verified by empirical evidence to confirm their validity, there are some that are immune to such testing. For example, the geometric axiom that the ratio of a circle’s circumference to its diameter equals “pi” is a priori true (meaning the truth of the statement does not depend on experience or examination). Measuring one circle or a million circles to test that principal cannot alter its universal validity. Likewise, there are economic principals that are also a priori true. One of these is that given two parties, the total wealth of both parties cannot be increased by transferring wealth between parties (this economic reality is a corollary to the Law of Conservation of Mass). To the extent one party gains, the other party loses, and the net remains zero. It is immaterial whether one believes this process is right or wrong, the simple fact is this process cannot increase total wealth. Owing to the subjective nature of value it is impossible to say that $1 in the hands of Person A has more value to him than it would in the hands of Person B. People’s value scales are different and can not be added or subtracted any more than one can add dollars and pesos.

 

Empiricism tested – The seen and the unseen

So, given the truth of this a priori economic principal, how is it that so many empirical studies show no deleterious effects or even positive effects of redistributive policies (e.g. minimum wage increases, redistributive taxation, fiat money inflation, etc)? Has an a priori principal been disproven? Not at all. Such programs appear to work for the same reason we are fooled by magic: misdirection. Economic misdirection illustrates the principal described by 19th century economist Fréderic Bastiat, namely that of the “seen and the unseen.” Magic appears to work because we “see” the surface illusion, but we do not see the action behind the surface, the gears, as it were, that are driving the illusion. Similarly, empirical studies of the effects of the minimum wage observe only the positive benefits while turning a blind eye to the unseen harms. As Henry Hazlitt wrote in “Economics in One Lesson”1.

 

“the art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups”

 

Studies that show no effect from such redistributive policies such as a minimum wage are guilty of violating Hazlitt’s axiom: they examine the consequences only for one group, or only the immediate effects.

The more astute proponents of minimum wage laws often grab the metaphorical bull by the horns and address its most obvious conceptual flaw, namely that a $1,000/hour minimum wage would be unequivocally detrimental. However, the argument quickly turns to dismissing this fear by demonstrating that empirically no such job loss occurs when minimum wages are slowly raised. This is akin to saying that although fire can boil water, a small fire small won’t heat it up.  The support for this assertion is the oft-cited 1994 study of Card & Krueger2 showing a positive correlation between an increased minimum wage and employment in New Jersey. Many others have thoroughly debunked3,4 this study and it is not my intent to engage in a “weedy” deconstruction here, but suffice it to say even the original authors eventually retracted their claims.5

The problem with such “studies” that purport to demonstrate a neutral or positive effect from a rising minimum wage is that there necessarily must be a positive bias even from the most careful and fair-minded researcher. Why is that? The “seen and unseen” effect. It is quite easy to count individuals whose pay went up. What is more challenging, if not impossible, is to count the people that would have been hired but were not. This has the effect of masking increased unemployment: if the unemployment rate remains the same but would have dropped absent a minimum wage increase then this is a net increase in unemployment even though the absolute rate did not change. Likewise, offsetting reductions in non-monetary compensation will not show up in a monetarily focused analysis. Additionally, unemployment may also slowly rise without any direct job loss. How can this be? New positions will become constrained due to either stretched payroll budgets or a shift toward automation, which at a lower wage was not economically viable but is so at higher wages. Someone new to the employment market that cannot find work is seeking work and is thus counted as unemployed even though they have never been “fired”.

 

Empiricism supports prediction of youth unemployment

If we believe that those who will be most negatively impacted by a minimum wage should be those with the least amount of experience and skills then that that would lead us to predict higher unemployment among such a class of individual as compared to those with more experience and skills. To test this prediction we can then examine unemployment data for those aged 16-24 (less experience) as compared to those 25 and above (more experience). Indeed, if we look at the data6 from the Bureau of Labor Statistics (www.bls.gov) we find that the unemployment rate (June 2013) among 16-19 year olds is 24% and among 20-24 year olds is 14%. These values far exceed the unemployment rate (6%) of those workers with sufficient experience and skills to make them largely immune to minimum wage pay scales, namely 25-54 year olds. But it gets worse. Even when there are jobs to compete for, the young are at an experience disadvantage. Again the empirical evidence bears this out since were this not the case youth unemployment should slowly decline following minimum wage increases as the two groups equally compete for the same jobs. However we do not see this, youth unemployment is consistently higher across decades.7 The reasons for this are born out by the following analysis: At a given wage X (minimum wage) it is difficult for inexperienced worker A to compete with experienced worker B. However, Worker A could be competitive at wage X–Y. Think of it this way. If the government mandated a minimum haircut price of $200 per haircut whom would you hire for the task? The person who had been cutting hair for years or the person who had never done so? If you have to spend a $200 you might as well get the best you can get. However absent such a mandated wage you might be willing to try the neophyte for $5. You get a cheap, albeit imperfect haircut; the neophyte gains experience and improves his skillset.

 

Deleterious effects of youth unemployment

Although the redistributive effects of a minimum wage may be economically neutral in terms of wealth transfer between parties, it is definitely not neutral in terms of its non-economic effects, namely the prevention of free people doing as they please (i.e. gaining experience and contributing to society through work). People whose productive value is less than the minimum wage are de facto unemployable. They are denied the opportunity to gain experience and skills. Their exclusion from the job market is a net loss to society.

Minimum wage laws are a misguided attempt to help “the poor” by presuming all workers are similarly situated, i.e. that the vast majority of hourly employees earn minimum wage and that they are uniformly composed of heads of households. In fact the opposite is true. Only 2.1% of hourly employees earn minimum wage and of that 2.1% over half (55%) are 16-24 years old.8

If the intent were to help the poor, it would be better from a strict economic standpoint to simply eliminate the minimum wage and concomitantly expand social support for that tiny 1.2% of workers at the bottom if needed. The vast increase in youth employment resulting from a minimum wage repeal would expand the productivity of the economy thereby resulting in lower prices for goods and services, which would help “the poor” by giving them a stronger dollar.

 

There’s no free lunch – the many pay to support the few

If the wealth transfer effects of the minimum wage are economically neutral (in terms of strict monetary transfers) then who is gaining and who is losing? Obviously the people who get raises gain the most. Who loses? Everyone else. We lose in terms of higher prices resulting from cost increases being passed on. We also lose due to higher costs resulting from the withholding of labor of the unemployed, which reduces productivity relative to what it would have been. How much will prices go up? It depends. Do not be fooled by citations of a single study that demonstrates prices would not go up or if they did it would only be nominal. The truth is if you got twelve different studies you’d get twelve different answers. There are a multitude of variables because every company and industry is different. Some of those variables include: percentage of labor cost in the goods, percentage of workforce that will be affected, presence or absence of unionization, and elasticity of demand for the goods (i.e. will consumers pay more or not). Even if the effect is small, it still exists. Justifications based on the size of the cost are no different than justifying a new tax because it is proclaimed to be “nominal.” Whether the reason 100 million people pay an extra $1 so that 1 million people may be given $100 is the result of a tax or a law, the outcome is the same: redistributionary theft of the many to the few. It is wrong when corporations benefit from such practices and it is wrong when an individual benefits. Morality does not turn on the numbers engaging in the act. Just because the effect may be small at the individual level does not mean we just found our free lunch.

Even when costs are not passed on (due to inelastic demand) the owners of the company are “paying” in the form of decreased profits. Some may be inclined to argue that the workers “deserve” it more than the owners, however what one may not argue is that there has been a net benefit to the economy. It is often argued that if workers have more money they will spend it, all the while ignoring the fact that if the original owner of that money still had it they would have spent it as well. If one wishes to argue that some are more deserving, then simply be honest about that assertion and own up to the fact that one is advocating theft in order to rectify perceived social injustice. Do not attempt to shroud your motives behind a façade of economic utilitarianism (i.e. theft is ok because the economy benefits). These firms with inelastic demand for their product that are made to endure multiple bouts of minimum wage hikes will eventually go out of business as profit margins are squeezed down to 0%. Or if they are fortunate they will be in a position to automate most processes (think self-checkout lines). Automation or bankruptcy increases unemployment. Surely this is incontrovertible harm to those workers (the newly unemployed) that must be suffered in order that some workers at other firms may enjoy a small increase in pay.

 

No one earns minimum wage for life

Even those who start out making minimum wage do not continue to make minimum wage their whole life. They gain experience and skills and move up the pay scale in a company or they may move onto other employers who have a vested interest in acquiring such skilled labor. Just because you’re stuck at McDonalds making minimum wage does not mean you will be working there at minimum wage your entire life. You will at some point decide you want to make more and you will seek out a new job at a higher wage. And you will be able to do so precisely because of the skills and experience you acquired at your prior lower wage job. Low wage jobs serve a function in an economy. They should not be outlawed. They provide the opportunity for the inexperienced and unskilled to acquire both. They also offer those not looking for a career or who are not supporting themselves the means to engage in remunerative short-term work. Low wage jobs exist in those industries where job duties do not require any particular skill set and where consumers are sensitive to the price of goods in that industry. For example, McDonalds could pay all their employees $50,000 a year however the market for $50 Big Macs would necessarily be much smaller than it is today. At some point it is not the employer that sets the wage but rather it is the consumer. If the consumer will not spend more than X on a product then the wages to make such a product must necessarily be some fraction of the cumulative sales of X.

 

How did we get here? The subsidization of poverty.

Why are we even having this discussion? Do we really need the government to tell people to not work for less than they can survive on? Surely if people were working below a true “living wage” they would be dying in droves. Why is that not the case? Why are the streets not littered with the corpses of minimum wage workers? The key to this question is to understand that workers earn two wages: one from their employer and one from the state. Such workers are provided with the full panoply of government assistance. For example, someone making the current full time minimum wage earns $15,000/year, however they are also eligible for additional government benefits that bring their total remuneration to approximately $35,000/year if they are childless, or up to $52,000 year if they have children.9 In fact, earning more does not get one out of this situation as government assistance drops off slowly or precipitously depending on how much income has increased. These decreases in benefits actually incentivize the worker to not make more lest their higher income disqualify them for various aid programs. These benefits include the earned income tax credit, refundable tax credits, food stamps, housing, energy, and childcare assistance. These safety net systems, although started with the best of intentions, have resulted in the perverse incentive of encouraging the very thing we are trying to eliminate. Both the employer and the employee are aware of these safety nets, so each is willing to offer less and accept less given the assurance that society will pick up the tab. In other words, absent such subsidization, taxes supporting these programs would necessarily fall and wages would necessarily rise. Not out of generosity of an employer but as a result of the fact that absent any assistance no one could live on $15,000 a year, therefore no one would accept that wage any more than they would accept $100 a year. The young who make up about 20% of the labor pool8 would quickly fill in all the low wage job demands and once that pool was consumed employers who wanted more employees would have no choice but to pay the higher market wage.

 

Summary

Minimum wage laws should be understood for what they are: an unwarranted interference by Tom, Dick and Harry into the private trade negotiation of Dave and Fred. At its core, labor is just like any other good. The laborer would like to acquire money and is willing to sell his labor. Likewise the employer has money and would like to acquire labor. The two parties come together in order to reach a mutually agreed upon price. If that price is lower than you would like don’t blame the employer, blame competition. There are too many others willing to do the job for that price. Do stores blame their customers or the competition if they lose a sale? Blaming your employer for too low a wage is as silly as a store blaming its customers for not buying from them.

Minimum wage laws are simply price fixing by another name. They allow the public to intervene in employee/employer negotiation and tell the employer “It is illegal to pay less than X for this labor” and likewise tell the laborer “It is illegal for you to sell your labor for less than X”. When it comes to handling your own affairs, your neighbors do not know better than you. We should all be free to make such decisions for ourselves without outside interference.

Regardless of our current pay, everyone always wants more. There are two routes though to obtain more. There is the unethical route of using force (government) to extract what we want. This method is appealing in that it requires little effort, in the same way that picking up a gun and robbing someone requires little exertion. Theft is the time-honored tradition of obtaining goods with less effort than would have been expended in their honest production. But as with any theft, it is a zero sum game, there is always a winner and there is always a loser. The pie stays the same size because the thief has added nothing to it; pieces have merely been shuffled.

However, there is another method to achieve higher wages. Improve yourself so that you have a basis for negotiating. Differentiating yourself from the competition means you have less competition. You are capital that owns itself. You have it in your power to enhance the value of that capital. Wages correlate directly to the value society places on the tasks we perform. If we acquire those skills that society values more highly then we will necessarily produce greater value for society and this in turn will be reflected in the higher wage we are able to demand. These gains are not a zero sum game. The pie gets bigger because your enhanced productivity adds to the pie. Your employer pays you more not out of generosity but because you are able to give him more than you used to.

We each hold in ourselves the ability to improve our circumstances in a way that benefits us as well as society. Self-improvement through education and/or work experience is the answer to the question: how do I earn more? Elimination of the minimum wage is a necessary, although not sufficient, condition for improving the economic value of the inexperienced or unskilled.

A version of this article also appeared as a Mises Daily on January 16, 2014.

References

1. Hazlitt, Henry. “Economics in One Lesson”, (1946), p.5,

2. David Card and Alan B. Krueger, “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania,” American Economic Review 84, no. 4 (1994): 792. A later book expanded on these results, see David Card and Alan B. Krueger, Myth and Measurement: The New Economics of the Minimum Wage (Princeton: Princeton University Press, 1995). (this reference cited here)

3. David Neumark and William Wascher, “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania: Comment,” American Economic Review 90, no. 5 (2000): 1390. Researchers from the Employment Policies Institute also reported finding data errors in the Card and Krueger sample. In one Wendy’s in New Jersey, for example, there were no full-time workers and thirty part-time workers in February 1992. By November 1992, the restaurant had added thirty-five full-time workers with no change in part-timers. See David R. Henderson, “The Squabble over the Minimum Wage,” Fortune, July 8, 1996, pp. 28ff. (this reference cited here)

4. Block, Walter. “The Minimum Wage Once Again”, Labor Economics from a Free Market Perspective, (2008), pp 147-154.

5. David Card and Alan B. Krueger, “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania: Reply.” American Economic Review 90, no. 5 (2000): 1419. (this reference cited here)

6 http://www.bls.gov/web/empsit/cpseea10.htm

7. http://www.americanprogress.org/issues/labor/report/2013/04/05/59428/the-high-cost-of-youth-unemployment/

8. http://www.bls.gov/cps/minwage2012tbls.htm#1

9. http://www.aei-ideas.org/2012/07/julias-mother-why-a-single-mom-is-better-off-on-welfare-than-taking-a-69000-a-year-job/

 

The Debate that Never Happened

I was recently involved in the “Debate that Never Happened” at UGA through the Phi Kappa literary society where the question “Is full employment possible under capitalism?” was the topic. Unfortunately the audio is a bit low… if you turn it all the way up and sit in a quiet room I think you can just about make out what I’m saying. I guess if I get to do something like this again I’ll be sure to shout into the microphone 😉

The Debate That Never Happened from Phi Kappa Literary Society on Vimeo.

Mo’ Money, Mo’ Problems

It has recently come to my attention (thank you George Warren) that the economist Steve Keen has proposed a solution to our economic woes: the government should give people money to pay off their debts. According to Keen it is the high level of private debt (about three times that of annual US GDP ) that is causing the economy to move so sluggishly. While enormous artificial debt creation did indeed foster the previous boom and our current bust, Keen has erred in both identifying the root cause of this debt explosion as well as an appropriate solution.

It is revealing that Keen does not ask the most pertinent question: he blames the banks for the debt explosion yet he does not address how is it possible banks could collectively lend out five times the amount of money in existence ($50 trillion in private debt vs a $10 trillion monetary base (M2))? He then decries “bad lending” – lending for purely financial market speculation, but again fails to ask why it would be in a lender’s interest to make such “gambling” loans – loans that more often than not would default (hint: moral hazard).  What is the answer to these unasked questions? Government. Government interference in the market (legal tender laws, legalization of fractional reserve lending, a central bank, implied bail outs, etc) resulted in the distorted outcomes Keen identifies. Being apparently unaware that government is the root cause of the problems he cites, he then unwittingly invokes that same entity as our savior: he proposes that “government created money” (through deficits) will solve the problem of too much bank created money (loans). But government is the sole reason banks can (legally) create money out of thin air to begin with! The legality of a central bank and fractional reserve lending makes phony debt possible. In a truly free, hard money economy (where the lending of demand deposits would constitute the actual theft that it is) credit expansion and unproductive loans to gamblers would cease to exist (because loan defaults will not be bailed out.) Only time deposits are eligible to be loaned out, thus naturally regulating the debt load in an economy.

Keen falls into the trap of blaming those capitalizing on the fruits of the government created circus (speculators, brokers) with causing the circus. That’s like blaming the existence of slavery on slave traders; slave traders capitalized on a situation made possible only by governmental enforcement of the legality of slavery. It’s the same old story: government creates an artificial scenario that some other group takes advantage of and then that group is subsequently piously vilified while the root cause is ignored.

As the intricacies of lending and finance are rather opaque I shall attempt to distill what has occurred and what Keen proposes to a simple narrative. Let us imagine three friends, Dave, Bob and Gary. Dave needs $800 to buy a house. Nobody has money to lend to Dave. Gary has a solution. Gary prints money ($1000) and gives it to Bob (because Gary doesn’t want Dave to know he is the source of the money). Bob loans the money ($800) to Dave and Bob keeps $200. Dave has his house built which provides builders with money. When the house is done Dave begins paying Bob back. All the builders are sad because Dave is not paying them anymore. Others are sad because Dave buys fewer goods because he has to repay Bob. When Bob gets money from Dave he gives it to Gary who promptly burns it (to hide what he has done). Because Gary is burning the money it is not being spent and so all the sad people ask Gary to print more money (so they won’t have to lower their prices) and to give it directly to Dave so Dave does not have to pay Bob anymore. So Gary prints more money and gives it to Dave to pay Bob, who then gives it to Gary who burns it. So what is the end result here? Dave got a free house and Bob got $200 for handling the money. Seems like everyone came out ahead here, right? Almost makes counterfeiting seem noble – I wonder why it is illegal? Oh, that’s right, because it is theft. It is theft from those not mentioned in the story. It is theft from every other person who holds and is paid in dollars as their dollars become worth less (because there are now more dollars) or worthless – take your pick!

When people propose “solutions” to our economic woes that involve government bailing out some group know that it is nothing more than calls to legally do what would otherwise land any one of us in jail were we to do so individually. It is theft. To have government take from unfavored groups and give to favored groups is theft. It was wrong to bail out the banks and it is wrong to bail out individuals. The only solution is to remove all authority government has over fiscal and monetary concerns. All unfairness in our current system is attributable to crony-capitalism fostered by big government colluding with big business. Dismantle big government and you’ll dismantle the inequity it fosters.