Category Archives: Austrian economics

The Value Myth

Are teachers underpaid? How much is a teacher worth? To answer this we must first define “value”. Although it is a common myth, there is no such thing as intrinsic value. Gold has no more intrinsic value than a lump of mud. The act of digging a hole has no more intrinsic value than teaching. By “intrinsic” I mean objectively measurable. Value is an entirely subjective human construct (just as “beauty” is.) It cannot be measured like density or boiling point. However, subjectivity does not imply lack of consensus. In broad strokes we rank things quite similarly (i.e. we prefer gold over mud). But at the finer scales our value rankings are different and can shift over time. These differences are in fact a necessary condition for commerce. Generally speaking, one values things they want more highly than things they already have. For example, if I buy your wristwatch for $10 then I value the wristwatch more than the $10. Likewise, you value the $10 more than the wristwatch. The value of the wristwatch is not $10, it is either more than $10 or less than $10 depending on who you ask. If that seems counterintuitive, consider this: would you sell your $10 bill for my $10 bill? No, because you gain nothing in the exchange. Then why sell a wristwatch for $10 if you gain nothing in the exchange? Both parties realize a gain in an exchange due to their different value rankings (within the context of that trade).

Both parties realize a gain in an exchange due to their different value rankings

So how does understanding subjective value relate to determining if teachers are underpaid? In a free (non-coercively influenced) market, every completed trade is “fair” in the sense both parties subjectively gained. In a free market being “underpaid” simply means there was a willing buyer that you failed to find that valued what you sold more than the party you sold it to. Subsidized public schooling is at best a semi-free market. It has actually driven wages higher, not lower, than they would be in a free market. We know this because if teachers were underpaid then private schools would poach the best teachers with elevated pay. In fact the reverse is true. Private school teachers make on average 25% less than public school teachers. And yet some would like to widen the disparity even more. For example at the “Save our Schools” rally in 2011 (see video at 3 min.) a woman implied we should spend $72 trillion/year on education (I guess the public schools indeed failed her in that she lacked the math skills to realize that spending $1 billion/child would come to that sum).

So how do we align the fact that most if not all of us value teaching above say professional football and yet teachers make far less? The cumulative effect of our individual value rankings when filtered through supply and demand across an economy can result in apparent societal ranking of value at odds with the ranking of value of the individuals making up that society. Teachers don’t make less than football players because “society” values them less. They make less because of math. A small number divided by a very small number is bigger than a large number divided by a very large number. (e.g. what each pays in property taxes or tuition far exceeds what one might spend on watching professional sports yet teachers make less because in part they vastly outnumber (about 4,000 to 1) professional football players).

If you really think teachers are underpaid you are certainly free to start a private school and pay them exactly what you feel is appropriate. That’s the advantage of a free market vs government; nobody’s approval is needed for you to immediately take advantage of the mistakes of others in the market

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…

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.

 


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.

Bubbles…

The higher education bubble will soon burst. Like the popped housing bubble, higher education prices are being distorted by massive government subsidization. Subsidization causes prices to increase at a rate dramatically above what they would have otherwise increased absent subsidization. It is true that bubbles can occur “naturally”, but these are called “crazes” or “manias.” The most well known example is the “Tulip mania” in Holland in 1636-37. It is the first recorded example of a speculative bubble, but it lasted only 6 months. These “natural” bubbles are limited in scope and size by the limited savings of those involved. Government bubbles are different. The earliest government influenced bubbles were the bank “panics” of the 19th century. They were the result of legalized embezzlement otherwise known as fractional reserve lending (it was thought that a Central Bank (The Fed) would solve these panics but it only made them worse (e.g. the Great Depression and every recession since then)). Government bubbles grow quicker and longer than natural bubbles. Government bubbles can grow over decades because they have no built in monetary constraints. Governments are free to tax, borrow and print as much money as they desire.

Government has no feedback mechanism to limit the bubble because they “have no skin in the game”, that is, it’s not their money.

To understand why prices go up in a government induced bubble we must first understand how normal economic transactions occur. Actor 1 (Buyer) wishes to obtain a good or service from Actor 2 (Seller). What Seller can charge is constrained by the willingness of Buyer to pay (max price). Likewise, how much Buyer can purchase is constrained by the willingness of Seller to sell (min price). A pricing equilibrium is maintained through the efforts of both parties to maximize their self-interest. However, when government gets involved (Actor 3) they insert themselves in the middle of the transaction. Actor 3 now pays Seller for what Buyer wants (typically by stealing from Actor 4). The shackles of price restraint are severed and thus Seller is free to perpetually escalate pricing because (a) Buyer doesn’t care about price because Buyer isn’t paying and (b) Actor 3 doesn’t care about price because it’s not their money. Likewise nothing inhibits Buyer from limiting their consumption because (a) price increases don’t affect Buyer and (b) Actor 3 doesn’t care because it’s not their money. In a free market an increased demand by Buyer upon Seller would drive prices up, however that would attract new providers who, through competition, would drive prices down. However with the presence of Actor 3 this feedback is disrupted. Increased prices do attract more providers however not for purposes of competition. They are joining everyone else at the government trough of largesse.

Government has removed the price barrier to education by providing grants and guaranteed loans. Students don’t worry about price because someone else is paying for it right now, and the schools have no constraint on limiting price increases because they know the government will subsidize whatever tuition is charged. College education costs have gone up at nearly 5 times the rate of inflation. To put that in perspective, health care costs have gone up “only” about 3 times the rate of inflation.

To underscore the point that costs are driven by government subsidization – cosmetic surgery, which is not subsidized nor paid for by insurance – has actually gone DOWN relative to inflation.

Education costs are doubling about every 10 years. In 2011-12 the average cost of tuition and fees for in state four-year college was $8,244/year. Private college tuition and fees average $28,500/year. Based on present trends I predict the education bubble will burst around 2025-2030. So clip and save this article so that you may impress your friends with your ability to predict the future… it will happen, just as the tech stock and housing bubbles burst, so too will the education and healthcare bubbles burst. Apparently the old aphorism is true, “Those that fail to learn from history are doomed to repeat it.”

Money doesn’t matter

Can one make too much money? Are the poor getting poorer? Will the rich amass so much wealth that it will leave none for the rest of us? No. Unfortunately affirmative responses are all too common and simply betray an ignorance of basic economics.

The mantra “the poor are getting poorer…” is a statistical sleight of hand reinforced by the notion that the economy is like a pie. The slice that the bottom 20% held in 2007 was indeed 0.3% smaller than it was in 1947. But the pie has nearly tripled in size and thus nominal (inflation adjusted) income has more than doubled. In terms of standard of living the poor are even better off. We include in the definition of “poor” even those suffering from a mere dearth of the latest goods. But such a metric is misleading. In terms of creature comforts the “poor” are better off today vs just 50 years ago (e.g. ubiquitous home air-conditioning, inexpensive TV’s, game systems, iPods, smartphones, etc). Compared to even the wealthy of a hundred or two hundred years ago the poor are living like kings – indoor plumbing, refrigeration, plentiful food, washing machines, cars, telephones, and the list goes on. Measured on an absolute rather than relative scale the “poor” in most countries are better off today than in any time in history.

Now, to the first and last point – aren’t some taking “too much” of even this bigger pie? If a few get “all” the money won’t that make everyone else “poor”? To answer this, let’s assume the most extreme case: one wealthy person amasses 99% of all the money in the economy. Surely this is a terribly “unfair” scenario that must be prevented, right? Wrong. Why? How can anything get done with so little money? Easily (in a non-government manipulated economy). In this scenario money would be in HIGH DEMAND. Demand is proportional to price, thus “money” would have a HIGH PRICE. Price is the cost of one good in terms of another good. A unit of money will cost more goods than it used to. So if $1 cost a dozen eggs then now it will cost more eggs, lets say 120. So we go from $1/12 = 8¢/egg to $1/120 = 0.8¢. What has happened? Because dollars are in high DEMAND the PRICE of dollars in terms of other goods has gone UP, whereas the price of other goods in terms of dollars has gone DOWN. This is monetary price deflation and contrary to what the Fed might have you believe it is a good and natural thing. The rest of the people in the economy can go about their business producing and exchanging as they were before simply using pennies in place of dollars. It is production of goods & services that produces wealth, not money. The amount of money in an economy does not matter and has no effect on the productivity of that economy. As long as people continue producing, they can never be “poor” no matter how much the “rich” have.