Category Archives: Redistributive fallacies

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/

 

Keynesian Coin Toss

Hurricane Sandy wrought not only terrible destruction this past week, it likewise whipped a few economic fallacies to the surface. Chief among these was the unwarranted attacks on the “price gougers” and the stunning ignorance of those pontificating on the “prosperity through destruction” meme. I shall defer my defense of the gougers and turn my attention toward the “destructionists”. What pray tell might be the upside to destruction? Jobs. The same old hackneyed drivel that was laid to rest 160 years ago by Frédéric Bastiat (see “the fallacy of the broken window”) and yet it keeps popping up with every natural disaster like the game of Whack-A-Mole. Even Ph.D. economists (Duncan Black, USA Today) who should know better continue to espouse such drivel. His recent article is illustrative toward this way of thinking insofar as he seems to be suggesting that a storm is primarily beneficial not because of the illusory short term economic benefit, but rather because it is a useful tool to teach the unwashed masses how non-voluntary spending can spur economic expansion and job creation. Such an example can then be used to justify to those obstructionist dimwits in Congress that we need much larger and grander government sponsored non-voluntary (stimulus) spending. The core premise of this argument is akin to a eulogy in which the grieving are instructed to take solace in the fact that the undertaker will benefit financially from the death of their loved one.

To be sure, there will be a localized economic uptick following any rebuilding. That is the “seen” benefit. But as Bastiat taught, one must also consider the “unseen” losses. That is, all the things that could have been done but were not. This is called “opportunity” cost. We experience this every time we buy something insofar as we could have bought something else. There is nothing wrong with that. The problem arises when our will, our desires, are overridden by an outside force that corrals us into choosing something we would not, absent such coercion, freely choose. When that force is Mother Nature we don’t like it, but we accept it and move on. The Keynesian understands that if they can convince us that Mother Nature’s destruction might be positive then we will be that much more willing to accept it when Man (through his proxy the State) imposes his diversionary will upon us. In other words, if I can convince you that getting hit in the face isn’t all that bad, you’ll be much more willing to put up with having your foot stomped on.

The Keynesian tries to rationalize their position by suggesting that funds “tied up” by insurance companies or unpatriotic savers are simply “idle.” * Well, parked cars are “idle” too. Should we melt them down and make a bunch of toasters? That would certainly benefit the toaster makers and their employees, but somehow I don’t think the car owners would appreciate this. This is how the Keynesian’s sell their ideas, by dishonestly pointing at only what we can see and mumbling zombie-like “jobs” while conveniently ignoring those that provided the resources. Money is never idle. If it’s not being spent then it is being saved or invested. Saved money is lent out and spent. Invested money supports new and existing businesses and jobs. Consider what would happen if all of the “idle” stock of a company were converted to cash by a company and paid to shareholders. That company would cease to exist insofar as every asset would have been sold. I’ll say it again: money is never idle. Repairing destroyed property involves removing active resources from the economy. In order for insurance companies to pay claims they need cash, which they either (a) withdraw from a bank, thereby decreasing lendable funds or (b) they sell assets, thereby decreasing the ability of those that buy the assets to further spend. Each dollar devoted to repairs in one area of the economy represents another dollar removed elsewhere. In other words, there is no such thing as a free lunch.

Natural disasters and government stimulus are two sides of the same will-manipulating coin – wealth destruction on one side and wealth diversion on the other.

 

* Because these articles are published in newspapers where I am under a word count constraint sometimes I must leave out some discussions that are entirely germane but simply will not fit. But as this is the online mirror of the article I will include a bit more of the economics discussion here. There is in fact a legitimate route by which disasters and destructions can and do result in increased productive output. I’m not suggesting this is a good thing, but I would be remiss if I did not bring up this point and clarify that however true it can sometimes be there is a cost involved that is always overlooked when brought in the mainstream press. 

Natural disasters can in theory produce enhanced productive output, however whether you view this as good or bad depends on whether you view working 12 hours a day preferable to working 8 hours a day. The basic premise is this: if your house burns down and you have to rebuild it yourself while still carrying on all the other duties you previously had you will indeed be more productive. Not only are you building a house you are still producing enough to continue feeding and sheltering yourself as much as you were before. The obvious tradeoff here is leisure time. Formerly you could work 8 hours a day but now you must work 12 or 14, the excess time being devoted to recreating that which was destroyed. If this is indeed beneficial then perhaps the government should mandate everyone work 12 hours a day and we could grow GDP in this country by 50% in one year!

Leisure time also has value but this value, being subjective, is non-monetary. It is impossible for the state economists to account for the loss of this value when factoring in the apparent expanded productivity following a disaster. Obviously people aren’t rebuilding their own homes but the net aggregate effect is the same. If resources in the economy are devoted to (a) normal home building + (b) home reconstruction then those in the construction industry are either working more than they normally would choose to (with concomitant less leisure time) or if they are not working more then one must bid up the price of getting a home built which has the effect of you having to work more in order to afford what you want OR more people are attracted into construction keeping costs down but the loss of those employment resources from other sectors of the economy results in scarcity in those other sectors which drives wages up and hence prices, and thus we all must work more in order to afford what we used to afford in those other sectors: net result, we’re working and producing more but only obtaining the same amount of goods and services we used to get when we worked less prior to the destructive event.

 If we do not work more but borrow more then increased demand for borrowed funds will drive up interest rates which will still cost us more in the long term requiring us to work more than we otherwise would have or if money lending demand is met and interest rates stay low that means more people are saving and making do with less which is the functional equivalent of working more for the same. We either choose less leisure time and more work to have 100 units of “stuff” or we choose the same amount of leisure time and accept higher costs and therefore accept we can only now get 80 units of “stuff”. Either way the destructive event is a loss, either to goods or to leisure time.

Don’t blame people, blame the system Mitt

Poor Mitt Romney – apparently no one ever taught him the first rule of politics: always assume you are being recorded. The issue at hand though is not so much his ham-fisted point making, but rather that he, like so many other politicians, decries the effects of government policies while ignoring the underlying causes.

What government gives in benefits they take away in choice.

Both the left and the right work their constituencies into a lather by heaping denigration upon individuals rather than upon the system that fosters the behavior they impugn. When government intervenes they not only give but take as well. What they give in benefits they take away in choice. Government programs crowd out or eliminate private markets that would permit the individual to take personal responsibility. For example, Social Security participation is mandated by law. We cannot opt out. After being robbed of 12.4% of our income whom but the wealthiest has anything left for private retirement? Social Security offers supplemental income for children with disabilities (to help pay for care). There currently exists no private insurance market for disability/long term care for those under 18. Likewise, there is no private market for unemployment insurance. Is this surprising? Why opt to pay for something that is already “free.” Private disability insurance for adults exists however only a minority of workers have such coverage. It offers little to lower wage workers relative to the “free” offerings of Social Security disability. People are not stupid. You can’t blame them for choosing “free” over “not free” given the choice. And you certainly can’t blame them when there is no choice at all. The solution is to fix the system, not the people. Phasing out government monopolized programs like social security, unemployment insurance, and welfare would give people back their natural incentive to look out for themselves. They would purchase their own individual (a) disability policy, (b) unemployment policy and (c) save for their own retirement. Elimination of the taxes that pay for these programs would permit higher wages thus offsetting or eliminating net costs. These changes alone would mean the private market would cover 99% of what people are currently receiving as government “handouts.” Private charity would easily handle the 1% of cases where extreme bad luck has left some unable to care for themselves. And even if you believe in the government “safety net” concept, surely it should be for the bottom 1%, not the bottom 50%.

The left is no more immune to this chicanery then the right. They decry the evil one-percenters and crony-capitalists without addressing what created them. Their outrage is the moral equivalent of leaving all the windows and doors of your house wide open while on vacation and then being surprised that someone robbed you. Maybe hunting down the robbers and putting them in jail will make you feel better, but wouldn’t it make sense to just lock your house? The solution to combat cronyism and corporate welfare is to simply eliminate government authority in the arenas that the large corporations are controlling. End the bailouts, the money printing, fractional-reserve lending and bogus deposit “insurance”, the tariffs, the competition-eliminating regulations, the subsidies and the mandates. All of these are mechanisms by which government helps big business to the detriment of everyone else. Big banks and big business are big and powerful because of government standing behind them like the kid on the playground who has the big bully backing them up.

The left and the right have something to learn from Mitt’s gaffe: don’t blame people for simply using the bad tools government gives them. Destroy the bad tools.

Crackle, SNAP, Pop(ular) goes the entitlements!

Do “food stamps” mitigate hunger among the American poor? No. Although with a name like “food stamps” one can be forgiven for falling into the trap of believing so. Following the current cutesy trend that apparently requires government programs have clever acronyms that describe their purpose (PATRIOT Act, HIRE Act, etc.) it has been renamed SNAP (get it, “snap” your fingers and food appears courtesy of the US taxpayer!) But I digress. Why do they not help? Three reasons: (a) fungibility & marginal utility, (b) socialized costs and (c) dehumanization through dependency.

Fungibility means that any given unit of something is indistinguishable from any other unit of the same material. For example, grain, silver or dollars are fungible, however diamonds or tires are not (as they vary in quality). Marginal utility is the concept that given some good, as one procures more of said good one values each subsequent unit less. So if you have a small amount of water, you value it highly as you must satisfy your most urgent needs first (thirst). But, as you gain access to more water you may then opt to “waste” it on less urgent needs, e.g. washing your car. Ok, so with that little economics lesson out of the way, how does this relate to food stamps? The food stamp money is fungible with regular money. In other words food stamps are no different than cash. Why? Absent food stamps the marginal value of the money recipients possess is very high and they will spend it on the most urgent needs (food) first. People in poverty aren’t going to NOT buy food and instead buy sneakers, movie tickets and haircuts. That would just be stupid. If we then give them money earmarked for food, they will still buy food (with food stamp money) AND NOW other (less urgent) goods with the money they used to spend on food. We are just playing a shell game, pretending this money is for this and that money is for that. It’s all just mixed together. Fungibilty is the reason some recipients can afford fancy nails and cell phones.

A secondary issue is that of socialized costs. Because the program exists people are willing to work for less than they would absent the program because they know they can count on it. If I know I need $15k/year to survive but I know the government will give me $5k/year in food stamps, then I’m going to be a lot more willing to work for $10k/year. So the employer pays less because the employee is willing to accept the lower wage BECAUSE OF the program. Then the government taxes the employer and hands the money over to the employee as food stamps. So in the end both end up with the same amount of money. So what did we accomplish here? Why not just cut out the middleman (the government) and pass the savings onto everyone? Once again we are just playing a shell game where the only beneficiary is the government.

The state is our shepherd, we (the sheeple) shall not want.

The final issue is the social harm the program engenders through the promotion of an entitlement mentality (literally – the government is running ads trying to get people to join the SNAP rolls). This mentality dehumanizes the recipient by promoting the idea they are merely wards of the state who cannot survive without suckling at the state’s communal teat. The state is our shepherd, we (the sheeple) shall not want. Inherent to the structure of any entitlement program is an economic feedback incentive that promotes attachment. The more money you make the less benefits you qualify for. I think U2 captured the idea well, “running to stand still.” Why expend great effort to obtain that which you can obtain from no effort at all?

I know politicians mean well, but their complete ignorance of basic economics and incentives creates problems bigger than the ones they were trying to solve. Just because something seems intuitively obvious (state sponsored welfare helps people) doesn’t mean it is correct. The notion that the sun revolved around the earth was intuitively obvious for centuries until someone took the time to apply some thought to the question. Big problems require deliberate, contemplative analysis, not thoughtless, knee-jerk, feel-good solutions.

All the world is a game…

Perhaps one of the best metaphors for the free-market and good governance is that of team sports. I recently came upon this revelation as I was watching my eldest son’s soccer team playing. Two teams on the pitch are a microcosm for society. Markets are represented by the presence of both competition (between teams) and cooperation (within teams). Any player not acting in the best interests of the team is rapidly replaced so that the efforts of the team are not affected. Governance is represented by the presence of simple rules understood by all and which are enforced through the mutual consent of all via the arbiter of said rules (the referee). All players are governed by these rules and any transgression results in an equivalent punishment (equal protection) for all. However not all players are equal in skill. Even on this elite team there is a bell-curve distribution of natural skill and earned abilities. On an elite (non-rec) non-professional team ability is rewarded with that which is most sought by these young players: playing time. In other words, playing time is the currency that all seek to maximize.

Two teams on the pitch are a microcosm for society.

Let us now test proposed policies on our model to see the outcome. To test “minimum wage laws” we will propose a minimum playing time rule whereby a coach is not required to play an individual but if he does they must play a minimum amount. What effect would this have? The weakest players (those this rule was trying to help) would never be played because the team could not “afford” to have such a weak player on the field for that long. All other players would then have greater playing time (same time but fewer players).

Now test income redistribution in the name of “fairness”: Let us propose a “player equalization” (aka “maximum skill”) rule. Since we can’t “take” skill away we will artificially limit skill to a maximum level by using weights, elastic restraints, etc. What effect would this have? Would it make the less skilled players better players? No. It would slow the game down thus making it less productive (fewer goals per game). It would also decrease any incentive a player has to improve his skill set beyond the maximum mandated level.

Now, onto governance: Let us propose that the referee be granted absolute authority to conjure up any new rule he desires and enforce it in any way he desires (remember the referee embodies all branches of government) which is what we see today with lawmakers completely ignoring the constraints on power found in the Constitution. The referee could write up hundreds of new rules. Rules as arcane as “players may only wear green socks” are strictly enforced even though they have absolutely no relevance to the game. The referee feels he knows best because green socks will cut down on grass stains therefore he feels it is in everyone’s interest that this rule be enforced for the “good of all.” A rule of “all players must pay the referee” whatever sum the referee deems necessary would not be far behind (remember he has absolute authority on the field in ALL matters). Anyone who questions the magnitude of said fee would be targeted with the straw man argument of “you do not value the service I perform” even though it is not the service being performed but the size of the fee being demanded that is questioned (i.e. “fair share” is whatever I say it is).

If an issue can be sufficiently abstracted such that it can be applied to this “team” model and the outcome is obvious at the team level then it logically follows that the same result will occur in the larger sphere of society from which it was abstracted. People are people and incentives will be followed no matter the scale.

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

A Wasted Protest

The “Occupy <insert city name here>” protestors are certainly an eclectic bunch. From what I can gather they blame “the wealthy” and “corporate greed” (whatever that means) for a myriad of the problems this country faces, not the least of which is that they don’t have a job. Give me a break. If they have time to travel across the country and camp out in a park for weeks on end, then they have time to find a job. The protestors have one slender thread of a justifiable grievance: the “too big to fail” crony capitalist policies of our political system. The problem is that they should be protesting the government that bailed out big businesses (the financial and auto sectors). Those businesses made risky investments because they knew Uncle Sam would back them up if things went south. Ask yourself, if you could go into a casino and gamble as much as you wanted knowing that any losses would be repaid to you, would you really restrain yourself from not simply gambling as much and as fast as you could?

This protest is a wasted opportunity to raise national awareness of what really ails this country: big government. The protestors are simply too ignorant of basic economics (“let’s just get rid of all money” said one) and the nature of free-market capitalism (as distinguished from crony-capitalism) to advance any kind of legitimate, useful agenda. For example, some constructive demands would be:

1) end the Fed and the ability of the government to print money: this brings an end to the “business cycle” which is an artificial result of government money manipulation

2) end all government subsidies: this would lower taxes by eliminating corporate welfare

3) repeal all government regulation of business: this would put all the lobbyists out of work and would then create a boom in new businesses and new jobs (as regulations are the tool that big business uses to raise the barrier to entry by new competitors)

4) repeal all business taxes: a lack of income tax would create a huge increase in rate of return on invested capital thereby attracting thousands of US and foreign companies to the US which would in turn create millions of new jobs.

But you won’t hear any of the protestors calling for such reforms. Their solution to “income inequality” is not to raise those on the bottom up (by promoting an environment conducive to job creation) but rather to cut those at the top down (by promoting punitive taxation under the mantra of redistribution following a misguided appeal to “fairness.”) Income inequality is a natural consequence of being human. It is the same as inequality in a foot race. In fact the statistical distribution in both a race and income is identical: a handful are wealthier or faster than everyone else, a large portion are average and a handful are very slow or poor. Government mandated redistribution of wealth is no different than forcing the fast runners to carry sandbags on their back, so as to remove their “unfair” advantage over slower runners. Capitalism is like the foot race; those that come in first do not gain their speed by sapping the speed of the slower runners.

To insist that income must be equal for all or have a very narrow distribution is to tilt at the windmill of biology: we all have equal natural rights but we are not created with equal abilities. Those with skills in high demand or low supply (doctors, lawyers, actors, sports stars, etc) will always earn much more than those with skills in low demand or high supply. That’s life, get used to it. The solution the protestors should be seeking is to improve their skill set rather than promoting government-sanctioned solutions that use threat of violence (taxation) in order to “right” their perception of a “wrong.”

 

Social Security = Ponzi Scheme

Social Security is an inter-generational Ponzi scheme predicated on the assumption that population demographics would remain in a pyramid shape; a large base of workers supporting a tiny apex of retirees (diffuse costs and concentrated benefits). The “baby-boom” generation changed all that: the pyramid now looks like the Washington Monument. In 1950 sixteen workers supported one retiree, today that ratio is a mere 3 to 1. By 2030 it will only be 2 to 1.*

The argument that Social Security is a Ponzi scheme is so common that the Social Security Administration actually has a webpage devoted to debunking this question. Let’s analyze their arguments and see where they get it wrong.

1) A Ponzi scheme must offer extravagant returns. WRONG: Although extravagant returns are typical (otherwise why invest!) they are not necessary for it to be fraudulent. The fraud is that funds are stolen. It is a form of theft by deception, with the underlying deceit (hook) being that reported returns are entirely fictitious because no investment has occurred. The returns aren’t real so their magnitude is irrelevant. The “return” could be 5% and it would still be a Ponzi scheme.

2) A geometric increase of new investors is needed to sustain a Ponzi scheme. WRONG: Or rather only correct if ALL the “returns” are paid in cash. But not all returns are paid in cash. If statements show satisfactory returns then a majority of investors leave their money alone. To cover withdrawal requests it is necessary to procure new investors at a rate proportionate to the ratio of investors withdrawing funds to investors leaving funds alone. That rate is not geometric if the ratio is < 1.

3) Social Security is described as a “pay-as-you-go” program wherein “money from later participants goes to pay the benefits of earlier participants” and that such programs have an inherent vulnerability to “demographic ups and down.” RIGHT: These statements describe attributes that are true for both systems, so I’m not sure how this is supposed to support their argument. Mathematically there is no difference between the two systems: to be sustainable money going out must equal money coming in. It would be more accurate to say the cash flow of a Ponzi scheme functions by employing a pay-as-you-go system. So, if both systems’ sustainability depends on an identical cash flow model then the two systems are functionally equivalent. In other words, a distinction without a difference is no difference.

These are the common characteristics of both systems:

1) Funds are not invested, merely collected by the perpetrator (government)

2) Excess deposited funds (trust fund) are stolen (“borrowed” by government)

3) Required new funds = (excess funds) – (stolen funds) – (funds paid out)

New funds must equal the funds paid out because any excess is pilfered. As long as those values are equivalent both systems are “sustainable.” The problem arises when one of those values changes and equilibrium cannot be restored. A Ponzi scheme could last for forever if the perpetrator had the ability to compel new investors to join. Social Security has endured for so long only because of the government’s ability to legally force more people to participate and extract ever-increasing sums from the participants. At least in a Ponzi scheme the “investors” are not coerced with violence. With Social Security we have no choice. This is very odd indeed. If Social Security is such a wonderful, successful and loved program why is it not optional? Why is participation forced on us at gunpoint?

Privatize Regulation and Relief

The mainstream media misunderstands the role of the federal government as outlined in the US Constitution. They routinely ask questions to the libertarian leaning Republican candidates (Ron Paul, Gary Johnson) that betray this ignorance. For example, of the seven questions MSNBC asked Ron Paul at the last debate (Sept 7, 2011) four of them focused on this.

The questions presuppose that we need the federal government to provide a cornucopia of services that (mistakenly believed) the private sector could not provide. The underlying accusation in these questions is that if you don’t think the government should do these things then you must think no one should do these things and you are clearly a heartless SOB. To highlight the lack of imagination the questioner (Brian Williams) actually suggested that if the government did not run air traffic control then the only alternative would be that pilots would be doing it themselves in their planes! If he had employed a little investigative journalism he would have easily discovered that Canada actually privatized their air traffic control system in 1996 and has consistently received higher marks than the antiquated government run US system.

In short, the answer to this question is that just because one doesn’t believe the government should be providing a particular service doesn’t mean it should not be done. There is NOTHING that the government does that the private sector can’t do better. Not because somehow the individuals in the private sector are somehow magically smarter and better people. Rather because the private sector is constantly receiving feedback through the profit/loss system. Companies that provide things their customers want receive money and stay in business, companies that don’t lose money and go out of business. What remains are those companies best suited to provide the service. Government has no such feedback; failure is simply an excuse to ask for more money since obviously the failure was entirely due to a lack of money.

For those that believe “some things are just too important to let the private sector run them” and that therefore government must run them, then ask yourselves this: Why doesn’t the government nationalize our food industry? Why aren’t all farms and food processing and distribution government run? Why isn’t food allocated “equally” to local government grocery stores with “fair” prices? Surely food, that product without which we would all die, is important enough that we couldn’t possibly trust the market to handle it? Yes, government does stick its nose into agriculture quite a bit but certainly nothing on the scale of a nationalized government run monopoly of food distribution. Yet somehow the market, with no central planner, is able to magically make food available to everyone in this country. So if we allow the market to handle food (the most important of all goods), why then are we not willing to allow the market to handle other goods, such as education? Retirement? Air traffic control? Health insurance? Product regulations?

But what about drug safety, surely we need the government to handle this? No, we don’t need a monopoly on drug safety. We need several “FDAs” competing with each other. Those that do a good job evaluating drug safety and efficacy will stay in business, and the ones that do a poor job (like the FDA that approved drugs that killed people, but for which they have no accountability) would go out of business. How would this work? We already have an existing model: Underwriters Laboratory. UL is a private organization that is not affiliated with any government. The UL inspired private regulation model is simple and works with any product or service. Here’s how:

Companies sell products. The products might cause harm so companies buy insurance. Insurance companies want to ensure against losses so they require companies be certified by a private certifying agency. If the certifying agency does a good job (preventing damaging products) they make money. The insurer is happy because they aren’t paying out claims. The company is happy because they aren’t getting sued. If the certifying agency does a poor job (allowing damaging products to be sold) then the insurer has to pay claims and the company is sued. That agency goes out of business because no one wants to use them anymore. The good agencies remain, the bad ones go away. It is a positive feedback loop of ever improving self-imposed regulations.

What about national disaster relief? Even easier – ever hear of the Red Cross? I think Ron Paul said it best – “What happened before 1979? We didn’t have FEMA.” Before 1979 did people just lay down and die because there was no federal aid? No, organizations like the Red Cross provided assistance as well as local groups that know their areas much better than the feds. FEMA has created a moral hazard that provides an incentive for people to not take responsibility for themselves (i.e. not buying flood insurance, building fancy homes on hurricane prone beaches, etc.). Private organizations like the Red Cross have a vested interest in seeing their efforts only go toward those that truly need help as they must answer to their donators. Donators don’t want to see their money wasted or swindled away as has happened with FEMA. Unhappy donators = no donations. FEMA answers to no one (or rather it answers only to a bloated government bureaucracy that can’t keep track of the waste, fraud and abuse).

We who believe in liberty of the individual are sympathetic towards our fellow man. We recognize the need for oversight of goods and services. We simply do not accept the proposition that government is the only way to provide such relief or oversight. We think it is the least efficient way to do so. The private market is more efficient due to inherent incentives that provide continuous positive feedback.

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.