Category Archives: Economic Fallacies

Be thankful for…Capitalism

In May 1607 the first American settlers from England arrived in North America and established a colony at Jamestown, Virginia. It was a veritable Eden: rich, fertile soil, abundant fish, game (deer and turkey),fruits, and nuts. By November 1607, 66 of the 104 colonists were dead (due mostly to starvation). In 1609 the Virginia Company attempted to “reboot” the colony with another 500 settlers. Within 6 months 440 of them were dead, again due to starvation.* How was this possible? How could so many perish among such abundant natural resources? Were they unprepared? How could the same things happen two years apart? The answer lies in the words of an eyewitness, who stated that the famine was the result of a “want of providence, industry and government, and not the barenenesse and defect of the Countrie, as is generally supposed.” Translated into modern English: it was the result of a lack of work ethic, effort and self-discipline and not due to any problem with the environment.But how is this possible? Surely the Virginia Company (the entity contracted by the British aristocracy to establish the colony) would not recruit a bunch of lazy slobs to run their very costly endeavor in the New World? No, the fault did not lie with the settlers per se but rather with the Virginia Company itself. The settlers were (willing) indentured servants. They agreed that if the Virginia Company would pay their way to the New World (a not inconsiderable sum at that time) then they would labor for the benefit of the Virginia Company for the next 7 years. The fatal error the company made was in heeding the words of Plato (who advocated collective ownership of land). They decided that all land and production therefrom would be held in common, the colonists would take from that stock what they needed and the remainder would be for the company. The company feared that if each colonist owned his land he would farm just enough for himself.

The failure of this collective ownership arrangement was a result of human nature,which leads to the “free rider” problem. Humans are inherently lazy. When given a choice between more work and less work to accomplish the same goal we will choose less work (why use a hammer if you can use an air-nailer?) In a communal system it is easy to hide indolence behind the work of others. For example, if 10 men produce 100 bushels of corn per month (total of 1000 bushels) and from that they are allotted 1% of the total output for themselves each month (10 bushels), then if one man slacks off and only produces 50 bushels then what he gets back is not cut in half, rather it is only cut by 5% as he gets 1% of 950 bushels or 9.5 bushels. Once everyone realizes they can “free ride” on the work of the more industrious (as some might increase output in a noble but futile effort to make up for the slackers) total output will decline. Or stated differently, if something is Everyone’s responsibility, then Nobody will do it.

How was the starvation problem finally solved? In 1611 Sir Thomas Dale was sent to serve as the “high marshal” of the colony. He recognized the problem and instituted a system in which each man was given 3 acres of land that he would own and farm.* All that was asked in return for ownership of the acreage was a lump sum tax for the colony of 2.5 barrels of corn (note, it was not a percentage of his output but rather a lump sum headtax!) The colony immediately began to flourish. Now rather than an incentive to decrease output and slack, each man had an incentive to produce as much as possible because he could keep the excess. He could now use the excess to trade with the Indians for furs and other goods. Trade also had the side benefit of helping to maintain peaceful relations with the Indians (why risk life and limb in warfare to get something when you can just trade for it).

This conversion from a communal property system with rampant starvation to a private property (capitalist) system with abundance was not a fluke. The same thing happened again at Plymouth, Massachusetts in 1620. After three years of starvation and death the governor of the colony, William Bradford, finally realized the problem and ordered that they “should set corn every man for his own particular, and in that regard trust to themselves…”* In other words, private plots of land were established for each family to farm themselves.
Why does this notion of communal property keep appearing throughout history? Why does it intuitively seem like it should just “work”?Perhaps because we are already familiar with the one and only place it can work: the family. A family is the ideal setting for a communal system because it is (a) small and (b) members are bound to each other by love. There is no incentive to free ride because (a) you’ll be caught and (b) you’ll harm those you love. The fatal error is in assuming that what works in a small group can work in a large group. This can never be due to an alteration of the incentive structure as the group size and character changes. No one will ever love their neighbor to the same degree as they love their own family.

* “How Capitalism Saved America”,DiLorenzo, Thomas J., 2004, Chapter 3.

FOLLOW UP: I received two Letters to the editor in the Morgan County Citizen, here and here, and my response is below:

In response to Bill Scholly (Dec 7, 14): Bill, would that I could opine on your version of events, but alas I cannot, as you have provided no citation source. Is the reader simply to believe your version is infallible and therefore requires no substantiation? I provided only one source (DiLorenzo) due to length limits on editorial articles. There are several other sources that I have added to my blog version of the article that substantiate the version I presented. However I find it curious that rather than question the specifics of the events, you instead chose to attempt to discredit the source by way of name-calling (“delusional”) and innuendo (the “hang with” comment). But I’m afraid you have us all at a disadvantage. Without knowing your source it is impossible for anyone to question you. How convenient.

OTHER REFERENCES

Tom Bethell, TheNoblest Triumph: Property and Prosperity Through (New York: St.Martins’ Press, 1998).

Warren M. Billings, ed., “George Percy’s Accountof the Voyage to Virginia and the Colony’s First Days,” in The Old Dominion in the Seventeenth Century: A Documentary History of Virginia,1606-1689 (Chapel Hill: University of North Carolina Press, 1975), 22-26.
Philip A Bruce, Economic History of Virginia in the Seventeenth Century (New York:Macmillan, 1907).
Gary M. Walton and Hugh Rockoff, History of the American Economy, 9thed. (New York: Dryden Press, 1998), 30.
Mathew Page Andrews, Virginia, The Old Dominion, vol 1 (Richmond, VA: Dietz Press,1949), 59.
William Bradford, Of Plymouth Plantation, 1620-1647, with an introduction by SamuelEliot Morison (New York: Knopf, 2002), 116.
Samule Eliot Morison, The Story of the “Old Colony” of New Plymouth (New York: Knopf,1960).
Larry Scweikart, The Entrepreneurial Adventure: A History of Business in the UnitedStates (New York: Harcourt Brace, 2000), 37.
Jeremy Atack and Peter Passell, A New Economic View of American History,2nd ed. (New York: Norton, 1994), 50

Economic Slavery

I have a proposal. Since we as a society permit children to inherit the accumulated wealth of their parents (unless you are “too” wealthy, then we take half of it!) then isn’t it reasonable that children should also inherit the liabilities as well as the assets of their parents? Currently if assets exceed liabilities then there is a positive inheritance. If liabilities exceed assets then there is nothing to inherit and the creditors and thus society end up paying (by passing those losses onto everyone else). Surely the children should be the ones to carry the burden of those liabilities since they must have benefited to some degree while under their parents’ guardianship. After all the parents made a life long investment in their children, so it’s only fair that that investment pay off. It would not have to be overly burdensome; it could be paid back over decades. And if those children happen to pass on then they would simply pass those debts onto their children, and so on until eventually all debts are repaid.

Anybody think this is a reasonable and sound idea? I’m hoping not. I’m hoping everyone views it as completely unreasonable, unfair and immoral. For a child to be born into this world saddled with the obligation of repaying debt that they had no part in incurring is the a most insidious kind of indentured servitude.

So if we all (I hope) agree this is unreasonable, then why is it considered reasonable when a group of individuals (society) through their proxy (government) borrows and thus incurs liabilities that are then simply passed on to their collective progeny in perpetuity? We frequently hear about how terrible it is that we are passing onto our children our debts of today. Well, we’ve been doing this for a long time, and as one of those children from 40 years ago, I have to say I really don’t appreciate being asked to pay higher taxes now to pay off the debts incurred by our government during the Nixon – Reagan administrations. As a child I had no vote, I could not give consent either legally or mentally, and yet I and everyone else my age are now asked to pony up a whole lot more in taxes. The left pontificates that that is the “responsible” thing to do. Hogwash. I have no moral obligation in repaying debts that I did not even have a voice in. The “responsible” thing to do is to simply cut spending in non-critical areas. Surely EVERYTHING government does can’t be critical.

If something is morally wrong at the individual level then simple logic dictates that it is still wrong when a group of individuals does the same thing. Right now we have a nearly $15 trillion IOU that will have to be repaid at some point, but not by those that enjoyed the benefits of those debts, but rather by those that will have to greatly sacrifice their present benefits (lower standard of living) in order to repay that debt. That is simply another form of slavery: economic slavery. It must be abolished.

Stimulus: Bread and Circuses, Part II

Government bread (stimulus) attempts to misdirect the citizenry into believing “something” is being done. Tragically, the bread is hollow. Inherent self-interest problems with government spending ensure that such spending is less efficient in terms of goods received per unit of money. In other words if government spends $1 they get 10 apples. If I spend the dollar I’ll get 15 apples. But there is another inherent problem with government stimulus – sustainability.

Government projects are always short term in nature (e.g. roads, bridges, etc) and when the project is done, that’s it. Those workers are out of work again… until we need some more bridges. Are we supposed to build bridges forever to keep the economy moving? Government spending is akin to a circus coming to town. Money is drawn into a community temporarily, and for awhile everything is great for local merchants. But clearly the circus is a bubble, it can’t stay in town forever. So it is a foolish business that expands based on the sales receipts generated while the circus is in town. When the circus leaves such a business collapses. It pleads for support from the government – the only thing they can do is bring the circus back. As long as the circus is there all is good. But clearly the circus is an unsustainable event, it was never meant to sustain an economy forever.

When people ask for government stimulus they are asking for “circuses” to maintain the status quo. Stimulus is supposed to spark some new more permanent venture, but exactly how can it do that? It simply reinflates the old bubble industries at their unsustainable bubble levels. Those industries can only be sustainable at their new post-bubble levels. Stimulus prevents this equilibrium from being achieved. Sustainable economic growth comes from industries responding to the direct desires of CONSUMERS. If consumers want it then a market will grow and that’s where the jobs will be. Consumer demand will not disappear overnight as can government spending. Consumer desires can change over time but it takes years for these changes to occur which is sufficient time for an economy to absorb the slowly shifting moods of consumer demands.

So this begs the question of why we had such a rapid change in the economy recently. If you’re astute you will have a good idea why. That’s right, it was a government-stimulated bubble inflated by loose fiscal and monetary policy and then popped by a reversal of that policy. It is these policies combined with the moral hazard of “too big to fail” that encouraged the RISKY behavior that is blamed for the crash. We must look beyond the risky behavior itself and ask what encouraged that behavior if we’re serious about preventing such things in the future. The solution is not to add more 20-20 hindsight regulation that attempts to prevent risky behavior but rather to remove the root cause that encouraged said behavior, namely the “too big to fail” policies of our crony-capitalist-big-government state. These polices are the manifestation of what government busybodies thought was the “right” thing (“home ownership for all!”) but sadly unintended consequences always come home to roost in a tragic mess. Treat the disease, not the symptoms.

Stimulus: Bread and Circuses, Part I

The “cuts” in the recent budget deal have renewed mutterings of the “dangers” of decreasing government spending in a down economy. Somehow this “government spending as the path to prosperity” myth will just not die. The idea is that when government spends money it magically reaps greater economic benefits than when private parties spend money. Not only is this wrong, it is completely backwards! We’ve spent trillions in stimulus and it hasn’t “fixed” the down economy. No consideration is given as to why that might be, it is simply assumed that (a) we didn’t spend enough or that (b) it would have been worse absent stimulus. Argument A simply dumps us in an infinite loop from which there is no escape, akin to an old computer program like

10 RUN STIMULUS

20 IF STIMULUS FAILS, GOTO 10

Argument B is a sign of intellectual laziness as it relieves the arguer of a duty to supply any data to support their claim – just speculate on what might have been and call it a day.

Well, I’ll call that bluff. Using logic we can rationally discern a reasonable outcome of a lack of government spending.  Let’s address the “multiplier effect” part of this myth first. In short no such effect exists. This “effect” is simply the relabeling of a normal function in the economy and claiming it is an inherently unique attribute of government spending. It has a more common name – trade.  If I buy something then that enables the person I spent the money with to go buy something, and that person to do the same and so on. This happens everyday – if government rather than individuals spend the money it doesn’t magically transform the process into something else. When government stimulates by purchasing, the theoretically BEST possible outcome is no better than if the government did nothing.

All government spending by definition must come from the citizens. So in other words we are simply moving money from the left pocket to the right pocket of society. Citizen A had $1 and can spend it on X OR now government has taken the $1 of Citizen A and given it to Citizen B to spend it on Y. Citizen A does not have his $1 anymore so does nothing. Citizen B has the $1 and spends it. As Frédéric Bastiat explained, the “seen” benefit is what Citizen B bought; the “unseen” harm is what Citizen A did not buy. All we have done is shift the preference of goods that are being purchased in the economy. No net economic change has occurred.

But this assumes 100% efficient spending. Government has no inherent self-interest to efficiently spend money it distributes ($1000 hammer anyone?). Although the same AMOUNT of money is spent the goods and services received in return will always be fewer than had it been spent by someone with a vested interest in maximizing what they get for their money (i.e. the original owner). This net decrease in goods received per unit of “government” money spent lowers the overall standard of living and productivity of the economy over time.  This obfuscation of the citizenry by government “bread” (i.e. handing out things that appear to be beneficial and good to some) is a vain attempt to do “something”. Next week we’ll continue with the “Circus” part of the stimulus equation.

Sweden, Sweden, Sweden…

Recently my wife and I became embroiled in a “Facebook” debate with some of her liberal friends. I won’t bore you with the details as you can probably guess where they stood and where we stood! We were disappointed to learn, however, that when arguing with (some) liberals (many responded to the thread) if they can’t offer a counter argument they simply resort to (a) name calling or (b) answering questions with non-sequiturs or (c) invoking “Sweden”. Well, I probably can’t convince them to dispense with a & b, but at least I can poke some big holes in the Sweden myth.

The Swedish “social utopia” myth is basically a conflation of two independent phenomena (high growth and high taxes) and confusing that conflation as causation rather than correlation. High taxes (the cart) do not push the horse (high growth), rather the converse. In other words: a leaking boat takes time to sink, the length of time depends on the size of the boat and the leak, but eventually, if nothing is done, that boat will sink. Sweden did well in the beginning because it was a big boat with a small leak.

Sweden built up a strong capital base starting in the 1860s after several free-market reforms transformed it into an industrial powerhouse. It also has been aided by the fact that they stayed out of both World Wars and thus avoided the catastrophic destruction of their economy that the rest of Europe endured. In 1932 the “Social Democrats” came to power and began implementing new “social” programs. These programs did not kick in fully until about 1950 at which point they had one of the highest per-capita income growth rates in the world. From 1932 to 1976 government spending grew from 10% of GDP to over 50%. Then the economy began to strain under the enormous tax burden. For about the next 20 years the government thrashed around trying to figure how to solve the stagnating economy. Eventually lowered tax rates and a number of free market reforms were implemented which resulted in an economic rebound in the last 10 years. Another myth is the low unemployment figures, but as they say there are lies, damn lies and statistics. In this case Sweden’s unemployment figures are manipulated by classifying people as “employed” who are on long-term sick leave, paid not to work or people pushed into early retirement. The real rate is closer to 25% without all the statistical sleight of hand.

The Sweden myth is the classic Bastiat example of “the seen and unseen” effects of an economic policy. We “see” the wonderful utopia of universal “free” goodies for all, but we don’t see the “unseen”: the consumption and destruction of previously saved capital (1860-1950) not being replaced at an equal rate. This net consumption breeds a society of dependency. The Swedes are slowly squandering their inheritance, as are we (ours, not theirs!). But being human (“kick the can down the road”) we most likely won’t figure this out until we are at the brink of destruction. Hopefully it won’t come to that.

Productivity kills Jobs?

Recently Congressman Jesse Jackson Jr. (D-IL) remarked that Apple’s iPad was “probably responsible for eliminating thousands of American jobs.” Further, he tried to link it to the recent bankruptcy of Borders Books as well, quipping that “Why do you need to go to Borders anymore? …just buy an iPad and download your book…”

Wow.

Such an expression of sheer ignorance of basic economics is astounding. And from a sitting U.S. Congressman no less makes it all that much more sad and appalling. But I guess I shouldn’t be too hard on Jesse. This fallacy has been with us for a long time. Every time some new tool that enhances productivity (and thus lowers costs) is introduced it is decried as terrible because it will put so many out of work. The benefits (lower prices) are ignored. But after awhile the controversy dies down and we’re all much happier to be paying less for our robot built cars, our sewing machine made clothes and our machine harvested food.

So why does this myth persist? Well quite simply because it is true – people do of course lose their jobs – in the short term. However it is disingenuous to evaluate productivity gains over a narrow time frame and summarily conclude the outcome as negative because a few will lose jobs.  That’s like planting seeds and a day later noting that nothing has yet sprouted therefore the seeds must be worthless. Productivity gains take time to take root and spread their fruit of lower prices throughout the economy. As people spend less money on the newly cheaper goods they now have more money to spend on other goods. The increase in demand for these “other goods” drives job creation. Of course it does take time for people to retrain or to move to where the new jobs are, it doesn’t happen overnight. That’s why we have Unemployment Insurance. In the “big picture” there are no job losses, in fact there will be net job gains if the productivity enhancements are sufficiently large.

But some inevitably want to prevent the process from ever starting because of short term fears, thus they use the power of government to act as a break to these productivity gains. Government will either subsidize the outmoded industry or attempt to penalize the new entrant through punitive taxes or burdensome regulations. This only happens of course if the “harmed” industry has a sufficiently well funded lobbyist group. This explains why sugar is more than twice as much in the US than in all other countries (due to the trifecta of tariffs, quotas and subsidies) whereas typewriters have practically gone the way of the Dodo. Government meddling in the market simply makes the process take even longer (we’ve been waiting since 1812 in the case of sugar!) by eliminating most if not all of the cost savings achieved and thus the net additional jobs that could have been created.