Category: Economics: Principles and Issues

The Economy Works, in Spite of Zany Economists

This post is from the archives of the pre-blog version of Liberty Corner. I wrote it in 1998. I still like it.

Even though Stephen Jay Gould once accused social scientists of “physics envy,” he did not deter economists’ efforts to practice the dismal science as if it were really a science. Thus, for example, a Robert Shiller of Yale University arms himself with data about the past performance of the stock market and warns us that the Dow will lunge from 8,000 (make that 9,000 . . . 10,000 . . . 11,000) to 6,000 or less. The problem with such analytical exercises is that they tell us what has happened but not what will happen. Statistics predict the past with uncanny accuracy.

Not that Professor Shiller is entirely wrong about the future performance of the stock market. He is almost certainly right, in principle, because the only known monotonic trends in the universe are its expansion and its aging — and a lot of physicists aren’t sure about the permanence of those trends. No, Professor Shiller will probably be right, some day, because — as the old saying goes — a stopped watch is right twice a day.[*]

John Maynard Keynes (created Lord Keynes for his services to economic thought and to some members of the Bloomsbury Set) averred that a government could spend an economy out of a depression. In spite of Keynes, the United States and Great Britain remained mired in the Great Depression for most of the 1930s. Some have argued that Keynes was vindicated by post-World War II prosperity, which they attribute to the the binge of consumer spending spawned by the massive infusion of government spending in wartime. That argument overlooks the inconvenient possibility that the Great Depresssion, like earlier depressions, would have ended without the benefit of government largesse. The argument also overlooks the fact that, unlike the United States, Great Britain did not plunge into prosperity at the end of World War II.

One could argue that Germany and Japan proved Keynes right because unemployment in those countries vanished in the face of their massive arms buildups. Yes, and one could say that the members of a chain gang are well off because they have “jobs.”

Enough of old feuds. Let us return to the present scene.

Today’s “green economists” advance the notion that free markets are all right in their place — but not when it comes to protecting the environment. Conjuring dire results for humankind if markets continue to cater to the crass demands of consumers, those economists would commandeer the economy in the name of future generations yet unborn. (Sound the trumpets! Wave the flag!) If one reasonably assumes that such economists know that there are market-based ways to solve the problems caused by pollution, what is one to make of their anti-market rhetoric? Answer: Just like any consumer of “political pork,” they’re perfectly willing to have the government aggrandize their own (psychic) income at the expense of the general welfare. That is, they simply don’t like economic growth and don’t care who is hurt by their anti-growth propoganda.

Consider, finally, the antediluvian agitators for antitrust actions against successful companies. The scions of Roosevelt the First seem to be stuck in a zero-sum view of the economic universe, in which “winners” must perforce be balanced by “losers.” Or perhaps they, like their green brethren, suffer a form of success envy.

Whatever the case, the antitrusters forget (or wish not to remember) that (1) successful companies become successful by satisfying consumers, (2) consumers wouldn’t buy the damned stuff if they didn’t think it was worth the price, and (3) “immense” profits invite competition (direct and indirect), which benefits consumers. On the third point, if the USPS — a government monopoly that claims to own my mailbox — can’t stave off competition from alternative delivery services and e-mail, what’s to keep a new Bill Gates from building a better mouse (pun) trap? Only the fear of being pursued by the almighty federal government. Thanks a lot, feds.

All of which underscores another old saying: A sucker is born every minute — and then he moves to Washington.
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* In fact, I agreed with Prof. Shiller and had already moved the bulk of my investments from the stock market to fixed-income securities. Better too soon than too late; when the market crashes, it crashes fast.

Class in America

The New York Times is running a series on “Class in America,” the introduction to which includes the usual Leftist cant,* and which assumes that class is tied to occupation, education, income, and wealth:

At a time when education matters more than ever, success in school remains linked tightly to class. At a time when the country is increasingly integrated racially, the rich are isolating themselves more and more.[**] At a time of extraordinary advances in medicine, class differences in health and lifespan are wide and appear to be widening.

And new research on mobility, the movement of families up and down the economic ladder, shows there is far less of it than economists once thought and less than most people believe….In fact, mobility, which once buoyed the working lives of Americans as it rose in the decades after World War II, has lately flattened out or possibly even declined, many researchers say….

One way to think of a person’s position in society is to imagine a hand of cards. Everyone is dealt four cards, one from each suit: education, income, occupation and wealth, the four commonly used criteria for gauging class. [Click here to see where you fit in the American population.] [***] Face cards in a few categories may land a player in the upper middle class. At first, a person’s class is his parents’ class. Later, he may pick up a new hand of his own; it is likely to resemble that of his parents, but not always.

Well, success in school, income, and health are linked tightly to intelligence, and those who have the genes for high intelligence tend to have more schooling, make more money, stay healthy, and pass their genes on to their children. Is that somehow wrong? The Times implies that it is.

In spite of the tight link between genetic inheritance and success, there is a lot on intergenerational mobility across the income distribution. (Who are you going to believe, the lying NYT or me?)

In any event, the Times swings and misses twice when it comes to defining and measuring class.

First, the Times deploys the card-game analogy quoted above, which suggests that life is a zero-sum game in which the winners win at the expense of the losers — when that isn’t the case. The Times reinforces the zero-sum notion by introducing a class scale that measures relative status; someone must move down the scale if someone else is to move up it.

Second, and more fundamentally, class is something that one possesses independently of job, education, income, and wealth. A super-rich person can inhabit the lowest class, while an extremely poor person can inhabit the highest class. We could be a nation composed entirely of high-class persons. There’s nothing to prevent it — nothing, that is, but the choices each of us makes about three facets of life:

  • Tastes – our likes and dislikes. A high-class person eschews loudness, crudeness, and ostentation and adopts reflective pursuits (e.g., writing, reading demanding works of fiction and non-fiction, understanding music and art).
  • Manners – overt behavior toward others. A high-class person is polite toward and considerate of the feelings of others, even in fleeting encounters.
  • Ethics – the rules by which we live. Regardless of tastes and manners, a person cannot be high-class without also being honest, fulfilling obligations, and avoiding the temptation to use power to dictate to others.

Money makes it easier to have good taste and good manners, but money is no guarantee of either; Paris Hilton and scores of rock musicians, sports stars, movie stars, and other celebrities are cases in point. Ethics seems to have little do with money or high station, as business and political “leaders” are wont to remind us by their actions, year after year.

Consider the presidents of the U.S. from FDR through Clinton. Based on their tastes, manners, and ethics, I rate them as follows:

  • Low-class: Roosevelt, Johnson, Nixon, Clinton
  • Middle-class: Truman, Eisenhower, Kennedy, Carter
  • High-class: Ford, Reagan, Bush 41

In other words, it’s entirely possible to be something less than high-class even if one has held the most prestigious job in the world, earned a college degree (or two), made a high income, and possessed considerable wealth (as have most modern presidents). Class comes from within, not from the material attainments by which the Times would judge us.
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* Leftists like Charlie Rangel like to think that by attacking the rich they are helping the poor, when just the opposite is true. Well, Rangel is evidently a lot richer than I am, so I guess he is going to hell, if I am to believe this exchange with Chris Matthews on 04/07/05:

Matthews: “I mean Charlie, Jesus didn’t hang around with the swells- the rich people.”

Rangel: “Well, he said the rich people are going straight to hell.” [Courtesy Trey Jackson]

Just the place for him. He’ll like the company, which undoubtedly includes at least one other infamous racial demagogue.

** What people do with their money is — or should be — a personal matter, subject only to the proviso that they do no harm to others. Gated community? Fine. I’d like to live in one, as would many if not most of the poor with whom the Times seem to identify. What’s wrong with keeping the riff-raff at bay? Do you think that law-abiding poor people enjoy living where they do? When the poor finally make enough money to afford a move to the suburbs, they do so to escape their former neighbors, not to mingle with them.

*** I followed the link (bracketed in the original) to learn my “class standing” and wound up in the 87th percentile, based on my pre-retirement job and (in today’s dollars) income and wealth. By the same criteria, my father was somewhere in the 40th to 50th percentile. Not bad. But my grandfather undoubtedly was somewhere near the bottom. I didn’t steal from anyone to move up, nor did my father, nor did the vast majority of those who now stand higher than their parents and grandparents on the Times‘s class scale. But my standing on the Times‘s scale would be meaningless had I the tastes, manners, and ethics of a Lyndon Baines Johnson.

Illusory Progress

Ed Brayton, who writes Dispatches from the Culture Wars, opined recently:

I am a passionate advocate for the principles of natural rights as expressed in the Declaration of Independence. But I am also firmly convinced that our nation is far closer to living out those ideals today than at any time in the almost 230 years since that document was written. It has taken the extraordinary sacrifice of many great men and women, an enormous amount of social upheaval and even a civil war to put those principles into action, but it has brought us closer to making the promise of those self-evident truths a reality for a far higher proportion of our people.

What Brayton overlooks is the vast amount of damage government has done to the social and economic fabric of this nation. It’s easy to see the “good” that government action has wrought (or the “good” that its proponents claim for it), but hard to see the evil it has done, unless you know where to look. (See my series on “Practical Libertarianism for Americans,” especially Part V and its addendum.) On the whole, government’s intrusiveness in our social and economic affairs has made us much worse off than we could have been.

But what about the end of segregation and the social and economic progress made by blacks and women? To the extent that progress on those fronts came about through government action, it came about because of the inevitable evolution of social attitudes. Government’s ability to force social change is limited by the a people’s ability to circumvent social engineering — as we have seen in the case of campaign finance “reform.”

In fact, programs such as affirmative action — which impose unequal treatment under the law — have backfired, to the extent that they have fomented resentment of and doubts about the qualifications of their intended beneficiaries. It is easier for an employer to reject a black or female applicant than it is for that same employer to fire a black or female employee. The employer may be making a mistake in rejecting a black or female applicant, but the operation of the law encourages such mistakes.

So, my contention is that we would be much better off, socially and economically, if government intervention were limited to the equal protection of everyone’s life, liberty, and property. Such a regime would enable persons of ability — regardless of race or gender — to prove their worth and earn the trust of others. That is true progress.

Traffic-Congestion Hysteria

The construction and maintenance of streets and highways — a government-dominated enterprise — is experiencing “government failure”:

Congestion delayed travelers 79 million more hours and wasted 69 million more gallons of fuel in 2003 than in 2002, the Texas Transportation Institute’s 2005 Urban Mobility Report found….

“Urban areas are not adding enough capacity, improving operations or managing demand well enough to keep congestion from growing,” the report concluded….

The report was released Monday, the same day the Senate resumes debate on a bill that would spend $284 billion on highways over the next six years.

But that’s not enough money to solve traffic problems, according to highway and transit advocates.

The American Association of State Highway and Transportation Officials estimated it would take as much as $400 billion in federal spending over the next six years to solve traffic problems, based on a 2002 study.

Roads aren’t being built fast enough to carry all the people who now drive on them, according to the Transportation Development Foundation, a group that advocates transportation construction.

Well, of course a group that advocates transportation construction would say that roads aren’t being built fast enough. The Transportation Development Foundation, as you might have suspected, is an arm of an industry lobbying group, specifically the American Road & Transporation Builders’ Association, which bills itself as “the U.S. transportation construction industry’s representative in Washington, D.C.” Its mission: “advocating strong federal investment in the nation’s transportation infrastructure to meet public demand for a safe and efficient business transportation network.” Enuff said.

Anyway, the likely outcome of a study sponsored by highway builders is the pouring of more tax dollars into the soil of America, in a futile effort to reduce traffic congestion.

That’s a bad and unnecessarily costly solution to a so-called problem. Why? Because there is no problem. If people are willing to endure long commutes in snarled traffic, they’re revealing a preference for that activity over other uses of their time. In short, it’s worth it to them; otherwise, they wouldn’t be doing it.

Instead of paving America — at vast expense — we should simply let the market solve the problem. When commuters have truly had enough they will turn to alternatives that will arise to meet the demand. Those alternatives — if government will stay out of the way — will be offered by private transportation companies, automobile manufacturers, employers (who may finally get serious about telecommuting, for example), and workers (some of whom will opt for simpler lives or forms of employment that don’t require commuting).

How Not to Fix Social Security

On reading Mickey Kaus’s post, “Let’s Not Save Social Security,” I had the following reactions to his nine points:

1. There’s nothing inherently wrong with having a “universal” Social Security program that pays benefits to rich and poor. Yes there is, because Social Security itself is inherently wrong.

2.The only problem with this system is we can’t afford it! We can “afford” it in the sense that we can impose ever-larger taxes on workers. But why should we do that when privatization would eventually remove the burden from workers?

3. We should be sticking it to today’s recipients! Well, yes, if you think it’s all right to renege on promises made, however rash those promises were.

4. Bush’s proposed plan isn’t quite ‘means-testing’. So what? Means-testing may appeal to quasi-hardboiled socialists, but it’s just a symptom of an essentially corrupt system.

5. Democrats would fiddle with the benefit schedules too! You bet they would. But why should they be given the chance to do so? Let’s privatize Social Security before Democrats regain power.

6. Indeed, the Democrats’ solvency plans are grimmer than you’d think. Any “solvency” plan that tries to preserve the essential character of Social Security — a transfer-payment Ponzi scheme — is bound to be grim. (See #2.)

7. We could radically cut the cost of Social Security. If complete privatization is out of the question, politically, the best way to cut the cost of Social Security is to make it a “safety net” for the truly poor.

8. Even a radical means test wouldn’t turn Social Security into welfare. Any scheme that takes from the “rich” and gives to the “poor” is a form of welfare.

9. Do we really want to save Social Security now? Absolutely not! What we want to do is phase it out, as quickly as possible, in favor of a scheme that enables workers to make real investments in growth-producing stocks and bonds.

Libertarian Paternalism

UPDATED TWICE BELOW

There’s a fuss about “libertarian paternalism,” which its proponents (Richard Thaler and Cass Sunstein of the University of Chicago) say is intended to help individuals make better decisions by having corporations and governments shape choices more artfully. Zimran Ahmed (Winterspeak) defends the concept because he

spoke to Thaler about this and read the monograph he [Thaler] wrote with Sunstein.

“Libertarian Paternalism” is noting that people often just take whatever default choice is offered and therefore working hard to come up with good default choices. This does not limit choice because you don’t need to stick with the default. But since *something* has to be the default, you might as well put effort into making it something good.

I don’t think it’s quite that easy to defend libertarian paternalism, which strikes me as another paving brick on the road to hell.

Consider an example that’s used to explain libertarian paternalism. Some workers choose “irrationally” — according to libertarian paternalists — when they decline to sign up for an employer’s 401(k) plan. The paternalists characterize the “do not join” option as the default option. In my experience, there is no default option: An employee must make a deliberate choice between joining a 401(k) or not joining it. And if the employee chooses not to join it, he or she must sign a form certifying that choice. That’s not a default, it’s a clear-cut and deliberate choice which reflects the employee’s best judgment, at that time, as to the best way to allocate his or her income. Nor is it an irrevocable choice; it can be revisited annually (or more often under certain circumstances).

But to help employees make the “right” choice, libertarian paternalists would find a way to herd employees into 401(k) plans (perhaps by law). In one variant of this bit of paternalism, an employee is automatically enrolled in a 401(k) and isn’t allowed to opt out for some months, by which time he or she has become used to the idea of being enrolled and declines to opt out.

The underlying notion is that people don’t always choose what’s “best” for themselves. Best according to whom? According to libertarian paternalists, of course, who tend to equate “best” with wealth maximization. They simply disregard or dismiss the truly rational preferences of those who must live with the consequences of their decisions. Richard Thaler may want you to save your money when you’re only 22, but you may have other things to do with your money, such as paying off a college loan.

Libertarian paternalism incorporates two fallacies. One is what I call the “rationality fallacy,” the other is the fallacy of centralized planning.

As for the rationality fallacy, I once wrote this:

There is simply a lot more to maximizing satisfaction than maximizing wealth. That’s why some people choose to have a lot of children, when doing so obviously reduces the amount they can save. That’s why some choose to retire early rather than stay in stressful jobs. Rationality and wealth maximization are two very different things, but a lot of laypersons and too many economists are guilty of equating them.

Nevertheless, many economists (like Thaler) do equate rationality and wealth maximization, which leads them to propose schemes for forcing us to act more “rationally.” Such schemes, of course, are nothing more than centralized planning, dreamt up by self-anointed wise men who seek to impose their preferences on the rest of us. As I wrote more recently:

The problem with [rules aimed at shaping economic behavior] is that someone outside the system must make the rules to be followed by those inside the system.

And that’s precisely where [central] planning and regulation always fail. At some point not very far down the road, the rules will not yield the outcomes that spontaneous behavior would yield. Why? Because better rules cannot emerge spontaneously from rule-driven behavior….

Of course, the whole point…is to produce outcomes that are desired by planners…

…and to hell with what the individual thinks is in his or her own best interest.

“Libertarian paternalism” consists of paternalism and a rather subtle form of socialism. There’s no libertarianism in it, no matter what its proponents may say.

Free people, free markets, no compromise.

UPDATE: And here comes “libertarian” paternalism — from the left, of course:

Rep. Rahm Emanuel, D-Ill., who this year has proposed three pieces of retirement savings legislation, said Monday, “We need to work on strengthening Social Security, but if you look at where the immediate problems are, it’s not in Social Security, it’s in their ability to save for retirement and the amount they have saved.”….

…Peter Orszag, an economic policy adviser in the Clinton administration who now heads the Retirement Security Project.

…is recommending Emanuel’s proposals to extend the savings tax credit and automatically enroll workers in 401(k)s. Orszag also wants automatic increases in the percentage of income directed toward 401(k)s and the automatic diversification of assets in them as workers near retirement.

“This is an area where there is strong bipartisan interest,” Orszag said. “Why not do something that both sides agree on, and do something that will build a sense of bipartisanship, as a precursor to dealing with some of the more difficult issues down the road?”

So, instead of allowing workers to invest 12.4 percent of their income in a real retirement plan, they will be forced to continue paying that amount into the Social Security Ponzi scheme. On top of that, a chunk of their income will be forcefully diverted to 401(k) plans — because Big Brother thinks that’s the “rational” thing to do. Workers will have no say in the matter, because socialist paternalists know what’s best for them.

UPDATE II: Then there’s this, from an article about “neuronomics”:

The problem, of course, is that people don’t always behave rationally. They make decisions based on fear, greed, and envy. They buy plasma TVs and luxury vehicles they can’t afford. They don’t save enough for retirement. They indulge in risky behavior such as gambling. Economists understand this as well as anyone, but in order to keep their mathematical models tractable, they make simplifying assumptions.

As Steve Antler (EconoPundit) explains:

Look: economics teachers with good sense tell students they’re talking about how people would behave if they were rational.

Whether people actually are rational is another matter entirely.

And, to repeat myself, rationality isn’t the same thing as wealth maximization.

Today’s Quiz

1. Choose your preferred GDP per capita (in year 2000 dollars):

a. $36,000

b. $63,000

2. Choose between:

a. government that provides “free” services (most of which you don’t use), guarantees you a minimum income and a certain level of medical care when you retire, and tries to remove risk from your life

b. government that protects you from foreign enemies and domestic predators but otherwise leaves you alone to make the best of your life, which includes earning more money, enjoying a more comfortable retirement, and living at less risk (e.g., enjoying better health because health care and drugs are more readily available and affordable; enjoying less crime because there wouldn’t be government programs to keep people mired in poverty)

3. Choose between:

a. the level of taxation and regulation now extant in the United States

b. the level of taxation and regulation extant in the United States until about 100 years ago

If you choose “b” in question 1, you must also choose “b” in questions 2 and 3.

Tolerance and Poverty

Wikipedia gives this definition of tolerance:

Tolerance is a social, cultural and religious term applied to the collective and individual practice of not persecuting those who may believe, behave or act in ways of which one may not approve….It is usually applied to non-violent, consensual behavior, often involving religion, sex, or politics.

I would go further. One may tolerate persons who engage in certain types of harmful behavior, without tolerating the behavior. We do it all the time; for example, parents continue to love their children even though parents often disapprove of — and punish — their children’s behavior.

Tolerance of a particular kind of behavior encourages more of that kind of behavior. That is why conservatives and libertarians oppose income redistribution, which is a legal form of theft. Income redistribution encourages the belief among those who are on the receiving end of it that rewards come without the acquisition of skills and the diligent application of those skills in gainful employment. (Income redistribution also discourages diligence, innovation, and job-creating investments among those who are on the “giving” end of it.) Conservatives and libertarians tolerate (and sometimes love) the poor, but conservatives and libertarians do not wish to tolerate the bad behavior of legal theft.

Liberals — ironically, in view of their increasingly rude and thuggish behavior toward their political enemies — often accuse conservatives and libertarians of being “haters,” because conservatives and libertarians oppose the cheap “compassion” of income redistribution. That such opposition arises from a supportable belief that it actually harms everyone — including its intended beneficiaries — is of no consequence to liberals. They would rather impugn the motives of conservatives and libertarians than face two uncomfortable facts: (1) It is liberal policies that are largely responsible for poverty. (2) In spite of those policies, and in spite of liberal propaganda to the contrary, most of the poor manage to escape poverty, though the fact remains that everyone (including the poor) is made worse off by liberal policies.

It seems to me that liberals ought to go back to tolerating the poor (in their condescending way) and leave the business of helping the poor to those “intolerant” conservatives and libertarians.

Taxation for Taxation’s Sake

“Jane Galt” of Asymmetrical Information proposes an alternative to the estate tax:

Why don’t we just get rid of the estate tax entirely, and set the basis on anything one inherits to $0? That way, if you sell whatever it is you inherited, you have to pay 20 percent or so of its value to the taxman, while if you just use it (i.e. a family small business) you pay no inheritance tax.

To which I say: What’s the purpose of the tax? To penalize those who choose to work hard and invest prudently in order to leave something to their children? “Counterproductive” is the mildest epithet that comes to mind.

But “Jane” seems bent on proving that she’s “not against taxing people; [but] against the special, complicated, economic-value-destroying structure of the estate tax.” So, she’d rather have an economic-value-destroying capital-gains tax. Same thing.

Rich Voter, Poor Voter, and Academic Liberalism

Alex Tabarrok at Marginal Revolution points to a presentation in which this graphic appears:


Standard deviations from mean income on the X-axis, probability of voting Republican on the Y-axis. Data plotted here are for counties in Mississippi, Ohio, and Connecticut (being “poor,” “average,” and “rich” States, respectively).

That graphic is supposed to clinch this point (Tabarrok is writing):

We all know that in the recent election poorer states tended to vote Republican while richer states tended to vote Democrat. On the basis of the famous maps many people jumped to the conclusion that poorer individuals were voting Republican (Nascar Republicans) while richer individuals were voting Democrat (trust fund Democrats). But the inference is a fallacy, the ecological fallacy. In fact, high-income individuals, as opposed to high-income states, vote Republican with greater likelihood than low-income individuals (the effect is not huge and it may be declining but it is significant). It’s even true that rich counties tend to vote Republican with greater likelihood than poorer counties. Gelman links to this graph which nicely illustrates the ecological fallacy. The three lines show that within each state higher-income counties are more likely to vote Republican but when you look between states the correlation between income and voting Republican is negative.

Actually, when I saw the geographic distribution of votes in the 2004 election, by State and county, I didn’t “jump[ ] to the conclusion that poorer individuals were voting Republican (Nascar Republicans) while richer individuals were voting Democrat (trust fund Democrats).” I drew the more reasonable inference that there is a strong geographic correlation between values and voting preferences; that is, adherence to the tenets of the regulatory-welfare state is stronger in richer States, at every income level. And that’s precisely what the graphic indicates: Where you live does make a difference in how you vote.

It may be true that the higher your income in a rich State, the more likely you are to vote Republican. But for any given level of income, a person who lives in a rich State you is less likely to vote Republican than a person who lives in a poor State.

Why? Here’s my take: The “rich” in the rich States — as is obvious from casual reading about limousine liberals and wannabe limousine liberals in New York and California — have by and large bought into the regulatory-welfare state, which is mainly a creation of the Democrat Party. So, the rich-State rich vote their “consciences” or, rather, they tend to vote Democrat because the think they can

  • keep the unwashed masses at bay with the modern equivalent of bread and circuses.
  • salve their (misplaced) guilt about the “good luck” that made them rich.

At the other end of the scale, low-income NASCAR fans who live in rich States are more likely to vote Democrat than low-income NASCAR fans who live in poor States.

Why does it work like that? Because where you live has a lot to do with your values. People tend to adapt (“go along and get along”) or migrate.

The same principle applies to academia. Conservative and libertarian intellectuals tend to avoid academic careers (call it pre-emptive migration) because they don’t want to adapt their thinking to fit in with the liberal supermajority on most campuses. Thank goodness there are some campuses (such as George Mason University) that are friendly havens for libertarian-conservative academics like Tabarrok and his blogging partner, Tyler Cowen.

Social Security Transition Costs, in a Nutshell

Milton Friedman explains it in a few sentences:

Q: If the federal government does move to private accounts, does the $3 trillion that President Bush says he would have to borrow to get that moving cause a greater stress on the American economy?

A: No, because we already have that obligation. What we are talking about is replacing an unfunded debt with funded debt. We already have an obligation to all the people like myself who are currently on Social Security. The difference is it is not written out as funded debt. So when you talk about borrowing, they are not really changing the total government debt, they are only changing how much they recognize, and what is open and above board and how much of it is hidden in other funding.

From an interview with Nobel laureate Milton Friedman in the Jackson (Tennessee) Sun. (Thanks to Donald Luskin for the pointer.) Read the whole interview if you’re unfamiliar with Friedman’s incisive analysis of matters economic.

Apropos Bankruptcy Reform

As I was saying about bankruptcy reform…

…here’s the dialogue from Zits (the comic strip) of March 10:

Jeremy: You expect me to pay a $400 cell phone bill?

Dad: Who incurred the charges?

Jeremy: Me.

Dad: Who promised to be responsible for any overages?

Jeremy: Me.

Dad: Who assured me that this would never happen?

Jeremy: Me.

Dad: So then who should pay the bill?

Jeremy: I’m not sure I follow your logic.

Then on March 12:

Friend: A $400 cell phone bill?? Dude!

Jeremy: How was I supposed to know that text messages cost 10 cents each?

Jeremy: Okay, I knew that.

Jeremy: But how was I supposed to know that they charge for sending and receiving?

Jeremy: Okay, I guess I knew that, too.

Friend: I was going to say life is unfair. But I guess it really isn’t.

Jeremy: I hate it when rules apply to me.

Thus spake the opponents of reform.

Reversed Causality

Jim VandeHei of The Washington Post — writing in the usual, no-liberal-bias mode of that “august” rag — complains:

Fortune 500 companies that invested millions of dollars in electing Republicans are emerging as the earliest beneficiaries of a government controlled by President Bush and the largest GOP House and Senate majority in a half century.

MBNA Corp., the credit card behemoth and fifth-largest contributor to Bush’s two presidential campaigns, is among those on the verge of prevailing in an eight-year fight to curtail personal bankruptcies. Exxon Mobil Corp. and others are close to winning the right to drill for oil in Alaska’s wildlife refuge, which they have tried to pass for better than a decade. Wal-Mart Stores Inc., another big contributor to Bush and the GOP, and other big companies recently won long-sought protections from class-action lawsuits.

Republicans have pursued such issues for much of the past decade, asserting that free market policies are the smartest way to grow the economy. But now it appears they finally have the legislative muscle to push some of their agenda through Congress and onto the desk of a president eager to sign pro-business measures into law. The chief reason is Bush’s victory in 2004 and GOP gains in Congress, especially in the Senate, where much of corporate America’s agenda has bogged down in recent years, according to Republicans and Democrats.

“These are not real high-profile, sexy issues like the war or Social Security, but these are issues that have huge economic consequences,” said Charles R. Black Jr., a GOP lobbyist and one of the president’s top fundraisers. “And there is more to come on that score.”

The implication, of course, is that Bush’s corporate supporters were buying favors. That’s not how it works. You support the candidate who’s most aligned with your interests, not because you can buy favors from that candidate but because you don’t have to buy favors from that candidate.

As for Bush’s “pro-business” bias, it’s a pro-growth, pro-jobs bias. But liberals wouldn’t understand that. It’s too complex for their allegedly nuanced minds to grasp. They’d rather have welfare and crime.

False Advertising

Prof. Gavin Kennedy of Edinburgh Business School, Heriot-Watt University, Edinburgh, Scotland — who presumes to lecture us about the meaning of Adam Smith’s writings — is in fact a professional bull**** artist:

His books on Negotiating include:

  • Managing Negotiations (co-author) (1980; 3rd edition, 1987 Business Books Ltd)
  • Everything is Negotiable (1983) (2nd edition, 1990 Arrow Books)
  • Negotiate Anywhere (1985 Arrow Books) Superdeal
  • How to Negotiate Anything (1986 Hutchinson)
  • The Economist Pocket Negotiator(1988 Basil Blackwell and the Economist Publications)

He is a co-author of the Negotiating Skills Portfolio (1986 Scotwork) and The Art of Negotiation, a Rank Training film, (1983) which is now available in the interactive format. He is also author of the video package: Everything is Negotiable, from Guild Sound, and Vision, 1987. Currently, he is working on Beyond Selling , a new training video for Rank. Professor Kennedy is a Fellow of the Chartered Institute of Marketing.

And what does Prof. Kennedy have to say about Adam Smith? Among Kennedy’s pearls of wisdom are these:

Smith never wrote a word about “capitalism”, yet he is hailed as the “high priest of capitalism”….He is alleged to be an advocate of “Laissez Faire” though he never used these words….

Yes, and the American Constitution doesn’t include the phrases “checks and balances” or “limited government,” but it demonstrably incorporates checks and balances and aims to limit the power of the central government.

Does the word “Bible” appear in the Bible? I doubt it. But the Bible is the Bible, nevertheless.

Poor Prof. Kennedy. If his name weren’t painted on his forehead he wouldn’t know who he is. Perhaps he doesn’t. Perhaps he thinks he’s Adam Smith.

Social Security, in a Few Words

I’ve argued at length in favor of the privatization of Social Security, and I’ve offered my solution to the looming crisis. (Go here for the solution and links to my posts about privatization.) Now comes Thomas R. Saving to explain the crisis and the need for privatization in two pages.

Funding the Welfare State

Arnold Kling points to a debate between Tyler Cowen and Max Sawicky about the future of the welfare state, at WSJ Online. Tyler would have won the debate hands down if he had shown, as I have, that free markets — protected by strict enforcement of laws against force and fraud — would make almost everyone wealthier. So much wealthier that they could easily afford to buy off the few remaining free-loaders.

But reason and facts seem unlikely to prevail. Sawicky is probably right when he says “Social Security and Medicare spending will increase faster than GDP, requiring increases in taxes, and there is not a damn thing anyone can do about it.” Consider this headline: “Senate Passes Budget With Medicaid Intact.”

I fear that we’re faced with this:

Here’s the prospect: In the coming decades the productive sectors of the economy will be taxed another 15-20 percent of GDP for the support of the nonproductive sectors of the economy. That will bring the total bill for government to something like 60 percent of the output of the productive sectors of the economy (see this). Why will it happen? Because Congress is afraid to make the transition from unproductive transfer payments to productive investments.

Where will it end? The United States will become a third-rate economic power, burdened by a massive welfare state and tied in knots by social and economic regulations. We are on The Road to Serfdom — no doubt about it — unless Congress takes my advice.

The Social Welfare Function

Arnold Kling asks:

Does the usefulness of the concept of a social welfare function stand or fall on its mathematical properties?

And I answer:

The concept of a “social welfare function” (with or without mathematical properties) is meaningless. You can write equations until kingdom come, but no equation you write can make commensurate the happiness or unhappiness of individuals.

Consider the case in which a nation (call it US) is formed in order to defend its citizens from outside attack by an enemy nation (call it AQ). (That’s the main reason the United States was formed, strange as it may now seem.) Assuming that the citizens of US are unanimous in their opposition to AQ, and unanimous in their support of measures taken to deter AQ, each of them will be happier if their unified support actually deters an attack by AQ. But AQ will be unhappy (or less happy) because it can’t attack US with impunity. The happiness of US (even if it could be expressed mathematically), isn’t offset by the unhappiness of AQ (even if it could be expressed mathematically). In fact, US’s happiness is increased by AQ’s unhappiness, even though neither can be quantified.

Suppose, however, that a faction of US citizens (call it LW) is unhappy because of certain actions being taken to prevent an attack by AQ. The actions that make LW unhappy don’t make me unhappy. In fact, they add to my happiness because I despise LW; anything that makes LW unhappy makes me happier. Thus, I’ll continue to be happy, despite LW’s unhappiness, unless and until (a) LW’s unhappiness leads to a political decision to stop defending US against AQ or (b) AQ attacks US successfully.

I could go on, but I think you get the idea. My happiness (or unhappiness) is mine, and yours is yours. The best we can say is that voluntary exchange in free markets, protected by strict enforcement of laws against force and fraud, would make almost everyone happier — and wealthier. So much wealthier that there’d be plenty of money with which to buy off the free-loaders. But that’s another story.

(See also this post.)

The Destruction of Income and Wealth

PRACTICAL LIBERTARIANISM FOR AMERICANS

ADDENDUM TO PART V:
THE DESTRUCTION OF INCOME AND WEALTH BY THE STATE
(Links to previous entries in this series are at the end of this post.)

The Destruction of Income

I wrote in Part V about the loss of income that has resulted from the intrusions of the regulatory-welfare state into America’s economy.

Real (inflation-adjusted) GDP began to rise sharply after the Civil War, thanks mainly to the Second Industrial Revolution. Despite the occasional slump — which the economy worked its way out of, thank you — things continued to go well until about 1906. Then the trajectory of GDP growth fell suddenly, sharply, and (it seems) permanently. The Panic of 1907 coincided with, but did not cause, the deceleration of America’s economy.


Data on real GDP for 1870-2003 are from Louis Johnston and Samuel H. Williamson, “The Annual Real and Nominal GDP for the United States, 1789 – Present.” Economic History Services, March 2004, URL: http://www.eh.net/hmit/gdp/. Real GDP for 2004 estimated by deflating nominal 2004 GDP (source at footnote a) by increase in CPI between 2000 and 2004 (from Bureau of Labor Statistics).

The stock market — an accurate, if volatile, indicator of the nation’s economic health — corroborates my judgment about the downward shift in economic growth. After 1906 the S&P 500 (as reconstructed back to 1870) dropped to a new trendline that has a shallower slope and an intercept that is 48 percent lower than that of the trendline for 1870-1906.


Real S&P price index constructed from annual closing prices of the S&P 500 Composite Index (series “S&P 500® Composite Price Index (w/GFD extension)”), available at Global Financial Data, Inc., and the GDP deflator (see notes for previous chart).

What happened around 1906? First, the regulatory state began to encroach on American industry with the passage of the Food and Drug Act and the vindictive application of the Sherman Antitrust Act, beginning with Standard Oil (the Microsoft of its day). There followed the ratification of the Sixteenth Amendment (enabling the federal government to tax incomes); the passage of the Clayton Antitrust Act (a more draconian version of the Sherman Act, which also set the stage for unionism); World War I (a high-taxing, big-spending, economic-control operation that whet the appetite of future New Dealers); a respite (the boom of the 1920s, which was owed to the Harding-Coolidge laissez-faire policy toward the economy); and the Great Depression and World War II (truly tragic events that imbued in the nation a false belief in the efficacy of the big-spending, high-taxing, regulating, welfare state).

The stock-market debacle of 1916-20 was as bad as the crash of 1929-33 (see second chart above), and the ensuing recession of 1920-21 was “sharp and deep,” as the unemployment rate rose to 12 percent in 1921. But Americans and American politicians didn’t panic and scramble to “fix” the economy by adopting one perverse scheme after another. Thus prosperity ensued.

But less than 10 years later — at the onset of the Great Depression — Americans and American politicians lost their bearings and joined Germany, Italy, and Russia on the road to serfdom. Most Americans still believe that government intervention brought us out of the Depression. That bit of shopworn conventional wisdom has been debunked thoroughly by Jim Powell, in FDR’s Folly: How Roosevelt and His New Deal Prolonged the Great Depression, and Murray N. Rothbard, in America’s Great Depression. The bottom line of FDR’s Folly is stark:

The Great Depression was a government failure, brought on principally by Federal Reserve policies that abruptly cut the money supply; unit banking laws that made thousands of banks more vulnerable to failure; Hoover’s tariff’s, which throttled trade; Hoover’s taxes, which took unprecedented amounts of money out of people’s pockets at the worst possible time; and Hoover’s other policies, which made it more difficult for the economy to recover. High unemployment lasted as long as it did because of all the New Deal policies that took more money out of people’s pockets, disrupted the money supply, restricted production, harassed employers, destroyed jobs, discouraged investment, and subverted economic liberty needed for sustained business recovery [p. 167].

All we got out of the New Deal was an addiction to government intervention, as people were taught to fear the free market and to believe, perversely, that government intervention led to economic salvation. The inculcation of those attitudes set the stage for the vast regulatory-welfare state that has arisen in the United States since World War II. (See footnote c.)

You know the rest of the story: Spend, tax, redistribute, regulate, elect, spend, tax, redistribute, regulate, elect, ad infinitum. We became locked into the welfare state in the 1970s (see the chart at footnote a), and the regulatory burden on Americans is huge and growing. The payoff:

  • Real GDP (in year 2000 dollars) was about $10.7 trillion in 2004.
  • If government had grown no more meddlesome after 1906, real GDP might have been $18.7 trillion (see first chart above).
  • That is, real GDP per American would have been about $63,000 (in year 2000 dollars) instead of $36,000.
  • That’s a deadweight loss to the average American of more than 40 percent of the income he or she might have enjoyed, absent the regulatory-welfare state.
  • That loss is in addition to the 40-50 percent of current output which government drains from the productive sectors of the economy.

And that is the price of privilege — of ceding liberty piecemeal in the mistaken belief that helping this interest group or imposing that regulation will do little harm to the general welfare, and might even increase it.

The Destruction of Wealth

The destruction of income necessarily results in the destruction of wealth; income not received cannot be saved and invested.

How much wealth has been forgone because of the vast amounts of income that have been destroyed in the past 100 years? I can’t hazard a guess. But by drawing on the data presented in the charts above I can estimate how much higher stock prices would be today if government were no more intrusive than it had been a century ago. Consider this chart of the relationship between GDP and the S&P index (data for 1870-1906 are plotted in green, data for 1907-2004 are plotted in red):

As I noted above, GDP in 2004 might have been $18.7 trillion if government had grown no more intrusive after the early 1900s. Taking that level of GDP and using the relationship between GDP and the S&P for 1870-1906 (shown in green), the S&P price index for 2004 would have been 30.8 (with 1870 = 1). The actual S&P price index for 2004 stood at 20.4.* In other words, the stocks of corporations in the S&P 500 are currently undervalued by one-third because of the depradations of the regulatory-welfare state, which have lowered investors’ expectations for future earnings.** The effect of those lowered expectations is shown in the difference between the green (1870-1906) and red (1907-2004) trendlines.

And that’s only the portion of wealth that’s represented in the S&P 500. Think of all the other forms in which wealth is stored: stocks not included in the S&P 500, corporate bonds, mortgages, home equity, and so on.

If government had left its grubby hands off the economy, there never would have been a Great Depression, Social Security, Medicare, Medicaid, and the myriad regulations that have us tied in knots.
__________
* The index for 2004 is significantly out of line with the trendline for 1907-2004, which suggests that there is still some air in the stock market bubble. Or it could be that the market is anticipating the expected growth surge I wrote about toward the end of Part V — a surge that may not take place if environmental hysteria prevails and Social Security taxes are raised.

** As Jeremy Siegel, author of Stocks for the Long Run, explains in a piece at the Library of Economics and Liberty:

The price of a share of stock, like that of any other financial asset, equals the present value of the expected stream of future cash payments to the owner. The cash payments available to a shareholder are uncertain and subject to the earnings of the firm….

[T]he price of a stock can rise even if the firm does not pay a dividend and never intends to do so. If and when the assets of these firms are sold or liquidated, a cash distribution will be made and shareholders will realize a capital gain. Some firms pursue this policy to enable their shareholders to realize lower taxes, since taxes on capital gains are deferred and often paid at a lower rate.

LINKS TO PREVIOUS ENTRIES IN THIS SERIES

I. Introduction

II. Terminology

Addendum to Part II: Notes on the State of Liberty in American Law

III. The origin and essence of rights

IV. Liberty and its prerequisites

Addendum to Part IV: More Hayek

V. The economic consequences of liberty

Get Ready for Higher Social Security Taxes and Slower Economic Growth

From “Beltway Buzz” at National Review Online:

Senate Splits On Early Social Security Vote

The Senate voted 50-50 yesterday on a nonbinding measure declaring Congress should reject a Social Security reform plan that requires “deep benefit cuts or a massive increase in debt.”

Five Republicans voted with all 44 Democrats and one independent.

The Senate also voted 100-0 to declare strengthening Social Security is a “national priority.”

There’s a lot of political posturing in those votes, of course, but they point to this outcome: Congress will not go along with any sort of privatization scheme. Congress will instead vote to raise Social Security taxes so that it can avoid “deep benefit cuts or a massive increase in debt.”

Precisely how will Congress raise Social Security taxes? Most likely it will raise the salary cap, in order to collect more taxes from the “rich” who make more than $90,000 a year. The predictable result: Money will be diverted from private purchases of stocks and bonds, which finance growth-producing capital investments, and directed to the elderly, who will apply it toward the consumption of non-producing goods and services.* That will impede economic growth and make it even harder to fund “promised” Social Security benefits, which will trigger further increases in Social Security taxes, etc., etc., etc.

I weep.

UPDATE: But perhaps I should dry my tears of rage and frustration:
Numbers You Don’t See Everyday

Rasmussen Reports, who were very accurate in their 2004 presidential election prediction, have some contrarian numbers on Social Security.

In their poll of 2,000 adults, Rasmussen finds that only 28 percent prefer doing nothing about Social Security, while 60 percent favor change.

38 percent favor personal retirement accounts, while 46 percent are opposed. A percentage large enough to lift either side above 50 percent remains undecided.

When asked if they prefer personal accounts or “no change”, 45 to 37 percent favor personal accounts.

Finally, 51 to 27 percent favor personal accounts with no benefit changes to those over 55.

Thanks, again, to “Beltway Buzz.”
__________
* Alex Tabarrok of Marginal Revolution, writes about Public Finance and Public Policy, a new textbook by Jonathan Gruber. According to Tabarrok, one of Gruber’s findings is that “Social security crowds out about 35 cents of private savings for every social security dollar.”

Bankruptcy Reform Update

I’ve updated an earlier post about the bankruptcy-reform bill that’s making its way through Congress. An e-mail from a reader prompted the update.

Oops. I remembered a point I meant to make in the first update, so now there’s a second update.

And a third one.