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Anatomy of an Economic Ignoramus

Mises Daily: Thursday, September 10, 2009 by

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Stanczyk by Jan Matejko
Stanczyk by Jan Matejko (1838–1893)

We all encounter more than our share of foolish blog posts. Most of the time you simply have to let them be. You could spend the rest of your life correcting drones and automatons who will never have an original or unconventional thought no matter how much you prod them. Their seventh-grade teacher, who was also the track coach, taught them what they know, and they're sticking to it.

Once in a while, though, for your own sake and for the sake of readers who suspect the post is all wrong but aren't quite sure why, you let loose with a full-blown response. And that's what I'm doing here in reaction to a blog entry called "Peter Schiff: Medicare Recipients Are Lazy People Who Refuse to Pay for Their Own Health Care."

This is longer than my usual pieces, but I hope I am not trying the reader's patience too much. In block quotes are the words of a blog author who identifies himself, interestingly enough, simply as "Che."

Here we go.

I love it when right wing economists talk about "market forces" and "letting the free market run our economy." They make it sound like the free market is some altruistic being that always knows exactly what to do and when to do it.

I do not know of anyone who subscribes to this junior-camper caricature. For one thing, no free-market economist is dumb enough to use a phrase like "letting the free market run our economy." The free market is merely the matrix of free exchanges entered into by individuals. How can a matrix of free exchanges "run" anything?

Secondly, no free-market economist thinks the market "always knows exactly what to do and when to do it." If that were the case, how could free-market economists account for firms that go out of business?

The argument that free-market economists actually make is that on the free market, decisions regarding what to produce, in what quantities, using what methods, and in what locations, are made in light of satisfying the most urgent demands of consumers. Business firms find out very quickly what consumers want and what they do not want, and they adjust their production decisions accordingly.

Profits indicate that a particular industry is combining factors of production in a way that pleases consumers. As a result, production in that industry tends to expand. Likewise, losses indicate that value is being reduced or destroyed, and that factors of production are being employed in lines of production that please consumers less, at the expense of other lines of production where they might have produced something consumers wanted more.

There are limitless ways business firms can combine factors of production to produce an equally limitless potential array of goods. Thankfully, firms do not have to grope around in the dark amid these trillions of choices.

If their production process uses an input more urgently needed elsewhere, that input gets bid away from them and they find a substitute. If they produce too much of something, their resulting losses prompt them to produce less, thereby releasing resources for the production of another good that consumers value more highly. At all times, resources are directed, in light of consumer wants, to those production processes in which they are most urgently demanded.

So no, markets do not know "exactly what to do and when to do it" — a juvenile caricature — but feedback from consumers' decisions does constantly push markets toward a more efficient use of limited resources.

Government, on the other hand, has no rational basis for determining what to produce, in what quantities, and so on. It gets its money not by providing a good that people voluntarily choose to purchase, but by seizing the funds from its subject population.

Since it therefore lacks a profit-and-loss feedback mechanism, every single production decision it makes is absolutely arbitrary, and necessarily wastes resources. It operates completely in the dark. It cannot adjust to consumer demand, since it has no way of calculating the best, least wasteful way to produce. More than that, it cannot even know what to produce.

The free market is not some emotionless, all knowing entity. It is controlled by humans who are susceptible to greed, corruption, and exploitation. The free market is only as pure as the fallible human beings that control it.

As we've seen, the free market is just a matrix of exchanges, so no one in his right mind would describe it as any kind of "entity," whether "emotionless," "all knowing," or "yellow with purple polka dots."

We'll deal with "corruption" and "exploitation" below. But in keeping with Che's charming devotion to government, he doesn't consider that its own officials might be susceptible to greed, corruption, and exploitation. Later, he suggests that corrupt politicians can simply be voted out of office (how's that one working out for you so far, Che?). He does not consider the possibility that corporations that do not produce what consumers want can likewise be voted out of the economy by merely abstaining from buying their products.

If free market principles were allowed to rule, like Schiff wants, what that means is everything is based on maximizing profit.

At this point we are all supposed to gasp at what a terrible prospect this would be. After all, the track coach and Michael Moore have told us about the wickedness of "profits," so what more is there to say, really?

But as we've seen above, profit is simply society's way of ratifying a firm's past production decisions. It indicates what consumers want, and (by the process of imputation) the best process for producing it. Profits attract further investment in a given line of production, until the increased supply of goods in that industry brings the rate of return there back down to the level that exists elsewhere in the economy. This is how we ensure that our limited resources are not wasted, and that the most urgently desired goods are produced.

In the absence of profit as a driving force, how exactly would Che like to see resources allocated? We can either allow consumer preferences to guide production, or let the personal preferences of a monopolist (i.e., government) dictate what should be produced and how. When the question is posed this way, the choice is pretty clear, which is why the question is never posed this way.

Incidentally, would Che prefer to base economic decision making on maximizing losses instead? Would that be better?

Two major byproducts occur when the only concern of an economy is profit.

1. Quality goes down because corners must be cut to save money and compete (See China).

Now Che, think about this for a minute. Suppose you had an economy in which profit was of no concern whatever. Would quality go up, then? Would we enjoy products of ever-increasing quality if businesses were not required to satisfy the consuming public (which is what earning profits means) in order to stay in business?

You don't think their freedom from the need to make profits might make them lazy, or unresponsive to consumer demand? You think they'd work overtime on high-quality products for the sake of the brotherhood of man, or the great fatherland, or whatever abstraction the regime proposes?

If the consumer wants high-quality merchandise, producers will compete to provide him with it. If everyone is producing low-quality garbage, there is a gigantic profit opportunity awaiting a newcomer who simply improves product quality. Don't you believe those evil corporations would jump at the chance to profit? Why in your scenario do those wicked, wily, greedy characters suddenly lose their drive to earn a return?

You will say that consumers won't pay higher prices for quality merchandise. But where does that arbitrary assertion come from? If they won't pay the higher prices, then that means they are satisfied with the existing level of quality, and that the money they might have spent on nicer things is in their view more urgently spent on something else — basic, no-frills products, say.

"We can either allow consumer preferences to guide production, or let the personal preferences of a monopolist (i.e., government) dictate what should be produced and how."

You, Che, are not in a position to judge their decision. If they will pay higher prices, then more upscale firms will cater to them — which, if you'd turn your head slightly and glance around a bit, you'll notice is how the economy already works.

There is, after all, no logical limit to the potential quality of merchandise. Following Chester Lampwick on The Simpsons, someone may purchase a solid-gold house. Now most people, in their search for higher-quality dwellings, may not want to live in a straw hut, but they are likewise prepared to stop well short of a solid-gold house. There is no nonarbitrary way to decide, apart from the voluntary spending streams emanating from consumers and the production decisions made on that basis, what ratio of quality to affordability people should choose.

Again, though, all we need to do is look around to find the refutation of Che's strange claim. Are automobiles today of lower quality than they were in, say, 1977? Would anyone care to trade in his Blu-ray player for a 1981 VCR? The Blu-ray also costs a teensy-weensy bit less, in real terms, than the 1981 VCR, I might add. I trust you that there is something wicked in all this, Che, but I'm just not seeing it.

2. Wages go down, because it [employers' drive for profits] pits workers against one another. For example, if there are no labor regulations, I can pay a woman significantly less than a man to do the same job. This forces wages down, because now a man must settle for a depressed wage if he wants a job.

This is why nonchemists do not write about chemistry, and nonbotanists stay out of botany. At this point our author is simply making things up.

An enormous amount could be said here, including the obvious point that although laborers do compete with each other (just as all factors of production do), employers have to compete for labor, just as much as they have to compete for steel or any other input. But for a simple reply to the claim that under competitive conditions wages will fall, we ask the simple question: has this in fact happened?

During the 19th century, without any of the institutions that Che thinks make wages rise, real wages quadrupled. This is not supposed to happen, according to him — competition among workers should make wages go down. But whom are you going to believe, Che or your own eyes?

But now let's proceed to the second sentence: on a free market, Che could pay a woman less than a man, which means in turn that men would have to accept lower wages.

I'm not surprised Che believes wage rates are determined at the arbitrary whim of employers — it's the conventional wisdom among the general public, after all, and it would be unthinkable to deviate from that. We're hanging on for dear life to what our social-studies teacher taught us, evidently.

But if on a genuine free market, businesses can arbitrarily lower women's wages, followed in turn by men's, why don't they lower both men's and women's wages right now? Equal-pay legislation has nothing to say about lowering wages for both sexes, so why don't employers go ahead and use their magical wage-lowering powers right now? Why should they wait until equal-pay legislation is repealed, and then follow Che's convoluted path to this same outcome by first lowering women's wages and then forcing men to accept low wages as well?

The answer, of course, is that wage rates are not arbitrary. If businesses tried to do what Che proposes, the result would not be that male wages would be bid down. The competition for labor would drive women's wages back up.[1]

There is no point in pretending that the level of compensation workers enjoy today has anything to do with the minimum wage or labor unions; the vast majority of Americans earn much more than the minimum wage, and labor unions have always been a negligible factor in the United States. US workers' wages have consistently outpaced those of the much more heavily unionized countries of Europe. Che can account for none of this; we should, according to his logic, all be earning minimum wage.

Also completely neglected in Che's account is the tendency for real incomes to increase on a free market.

How does this process occur? When firms increase and improve the equipment and machinery at the disposal of workers, their labor becomes more productive. Imagine someone using a forklift, as opposed to stacking pallets with his bare hands, or producing books with modern equipment as opposed to a 16th-century printing press. The amount of production the economy is capable of is thereby increased, often dramatically, and this increase in production puts corresponding downward pressure on consumer prices (relative to wage rates).

Now there is nothing natural or inevitable about the availability of this productivity-enhancing capital equipment. It does not fall out of the sky. It comes from the wicked capitalists' abstention from consumption, and the allocation of the unconsumed resources in capital investment.

This process is the only way the general standard of living can possibly rise. Only in this way can the average laborer produce the tiniest fraction of what today he is accustomed to producing. It follows that only under these conditions can he expect to be able to consume the tiniest fraction of what today he is accustomed to consuming.

The increases in the productivity of labor that additional capital brings about push prices down relative to wage rates. By increasing the overall amount of output, such increases raise the ratio of consumers' goods to the supply of labor.[2] Put more simply, improvements in the production process that lead to an increased supply of output make that output cheaper and easier for people to acquire.

That's why, in order to earn the money necessary to acquire a wide range of necessities, far fewer labor hours are necessary today than in the past. Thanks to capital investment, which is what businesses engage in when their profits aren't seized from them (to the cheers of people like our friend Che), our economy is far more physically productive than it used to be, and therefore consumer goods exist in far greater abundance and are correspondingly less dear than before.

In 1950, for example, Americans had to work six minutes to earn the money that would buy them a loaf of bread; by 1999 that was down to just three and a half minutes. To be able to buy a dozen oranges in 1950 took 21 minutes of labor. It was only nine minutes by 1999. Paying for 100 kilowatts of electricity required two hours of labor in 1950, but only 14 minutes in 1999. Someone in 1900 would have had to work nine hours, as compared with four hours in 1950, and three hours in 1999, to earn the money to buy a pair of jeans. For a three-pound chicken, it was 160 minutes in 1900, 71 in 1950, and 24 in 1999.[3]

When Che wants to tax business firms, as you can be sure he does, he is advocating the direct sabotage of the process by which everyone in society sees his purchasing power rise. American society, in short, would have been far wealthier had top income tax rates been lower throughout the 20th century.

Had government not seized so many resources to squander on consumption, those resources would have been available for investments that would have made the economy permanently capable of producing far more wealth than otherwise. Everyone's standard of living would, as a result, have been far higher.

If there is no regulation of the "market forces" by the government, you essentially place the power in the hands of CEO's who have no accountability to anyone but their share holders, and in order to keep the share holders happy, profit must be maximized by any means necessary. If that means exploitation and corruption, so be it.

Since "exploitation" and "corruption" are not defined here, we have no way of knowing what Che is talking about. By "exploitation" he is presumably referring to the Marxian theory that intensified competition leads to lower wages, an absurdity we've already addressed.

By "corruption" he could mean one of two things. He could mean the use of fraud, theft, or some other violation of the law. If this is what he means, he is no longer speaking about the unhampered market, which punishes nonmarket, criminal behavior like that, and thus his comment is irrelevant. If someone violates the law, punish him. If he is guilty and isn't punished, that's hardly the market's fault — after all, who monopolizes the provision of courts and police? (I'll give you a hint: it isn't the free market.)

He could also mean the use of lobbying in order to win special privileges from government, or to hobble one's competitors. Once again he is not actually criticizing the free market, even though he thinks he is. Here his criticism is not of the free market but of government itself.

The free market contains no coercive mechanism to grant special privileges to any one party. Only government has the power to initiate coercion. You want a single, monopolistic institution to have plenary power to order society as it sees fit, and you're going to pretend to be surprised when it turns out to be dominated by antisocial forces?

If government regulations are allowed to control an economy, those who installed the regulations can be held accountable if the regulations are too intrusive.

Consider the Code of Federal Regulations.  Every year the Federal Register adds about another 70,000 pages to the Code.  If even one of these pages were to be eliminated, we would all die instantly. They were put there to keep us safe! According to Che, not one of these regulations could possibly be "too intrusive" — we would surely have repealed it if it were!

That reminds me of the student I once had who, upon learning that the Job Corps was a complete and utter failure by any conceivable standard, innocently asked why it wasn't repealed. I don't blame that student — with that question she was starting to figure things out for the first time. Che actually runs a blog without ever asking a single unconventional question.

In Che's world, the entire "capture" literature on regulation, which describes how industry and large firms in particular influence regulation to benefit themselves, does not exist. Regulation is solely for the public good.

Here, on the other hand, is a small taste of reality.

In the usual caricature, if you support the free market then you support pollution and various other forms of property invasion. To the contrary, someone who believes in the free market opposes these things because they damage other people's property without their consent. That does not mean the only solution is "regulation." Here's a genuinely free-market way to think about these issues.

Che may also be referring to regulation of banking and the financial markets, which is actually quite heavy despite all the talk of "deregulation." Deregulation is almost always phony, as when financial institutions are allowed to make riskier bets while the government still insures their deposits.

Complaints about a lack of regulation are also beside the point. If you have a toppling house of cards, you don't need tape or glue — the functional equivalent of "more regulation." You need a whole new house, built on a solid foundation. In other words, you need a hard-money system that cannot be manipulated by governments or their central banks. That option does not exist in Che's world, since in his world the system we have now is already a free-market one. I've covered this a little bit here and here.

"You want a single, monopolistic institution to have plenary power to order society as it sees fit, and you're going to pretend to be surprised when it turns out to be dominated by antisocial forces?"

Moreover, existing regulators saw nothing wrong with the way the securitization model was working, and in fact financial institutions were in line with the various capital requirements proposed by international regulatory standards. The system of regulations itself gave banks an incentive to hold on to securitized loans, thereby undermining the risk dissipation function it existed to provide. Is the solution to add more regulators? Or could there be something wrong with the system itself — a system at war with the free market, a system that yields the extreme leverage and instability we periodically observe?

Another obvious question routinely overlooked in this context is why a regulator with no financial stake in an enterprise would know better how to satisfy consumer demand than a business owner whose own wealth depends on getting it right. How superstitious can you get?

Yet dime-a-dozen commentators calling for more regulation attribute magical powers to people who in the real world tend to be unworthy of these exaggerations. As Robert Higgs put it, "Had they been given even greater powers, budgets, and staffs, what enchantment would have transformed the regulators into smart, dogged champions of the public interest, rather than the time-serving drones and co-conspirators with the regulated firms that they have always been?"

How many business school or other graduate students aspire to become regulators? We'll put it kindly and simply observe that it's the slower ones who wind up in the regulatory agencies, and the brighter ones who wind up as successful businessmen. We expect a kid who graduated #505 out of a class of 508 not to get his clock cleaned by a kid who graduated #12?

Finally, the free market doesn't pump up the money supply and push interest rates down to levels that promote unsustainable bubbles. Had there been no Fed-created housing bubble in the first place, there could have been no resulting crash. The free market punishes reckless risk-takers, while it is government that bails them out (thereby encouraging them to take greater risks in the future). It was the Federal Reserve System, not the free market, from which the "Greenspan put" — the implicit promise to bail out major Wall Street players — emerged. The Financial Times warned that these guarantees were encouraging dangerously risky investments.

The free market makes no such guarantees, and thereby cultivates a more cautious and sensible class of entrepreneur. Might there be a lesson here?

Holding the government accountable for its actions is called Democracy.

Holding a CEO accountable for his or her actions is called impossible.

Could these be the most laughable lines of the whole piece? Che has swallowed the propaganda he got in school without a peep of independent thought. Our wise public servants are concerned for the common good, and anything they might do against the interests of the people are unfortunate aberrations — mere "corruption" that can be punished in the next election. For our political system holds government accountable to the people!

I could write a whole book on this, so let's stick to a couple obvious points. Our government launched a war in 2003 on ludicrous and transparent pretenses that led to as many as a million people dead and four million displaced. Prior to that, in the 1990s, we had a bipartisan sanctions regime that killed half a million Iraqi children. (Note that our leaders do not deny that statistic; they merely say the price was "worth it.")

Who, my dear Che, was held "accountable" for that? Anyone? What alleged sins of any US corporation even approach that?

The Federal Reserve System, which enjoys a government monopoly on the creation of legal-tender money, created the conditions that led to the present economic crisis. (I give some of the contours of the argument here and in Meltdown, my latest book.) Was anyone held "accountable" for that? In fact, who in government has been held accountable for anything relating to the financial crisis?

Are you telling us that the government bailouts were an example of public-spiritedness, rather than a transparent payoff to friends and allies of the regime? The bailouts, in fact, were an example of government intervention to prevent the free market from holding CEOs accountable.

The regime regularly kills, maims, destroys, steals, and, for good measure, spies on the people. How exactly is "democracy" keeping this thing "accountable," Che? Are you referring to the electoral process, in which Americans recently had a choice between a pro-empire, pro-bailout, pro-war Republican and a pro-empire, pro-bailout, pro-war Democrat?

You want to keep a CEO accountable? Stop buying his product. How do I stop buying the government's "product"? Oh, I forgot, I don't buy it — the money to fund it is seized from me.

"The bailouts, in fact, were an example of government intervention to prevent the free market from holding CEOs accountable."

There is a market for corporate control, by the way, but the very people who complain the loudest about unaccountable CEOs tend to be most opposed to, and want to place the greatest barriers in front of, corporate takeovers. Here again, government erects roadblocks in the way of the market's attempts to correct misallocations of resources.

Now, you may say I am being too hard on Che. The poor kid is just repeating what he learned in junior high. How can I blame him? This sort of propaganda is what kids are taught, and we can't fault Che for simply repeating whatever his teacher said.

I blame him for being so incorrigibly incurious. The brighter kids figure out they're being fed propaganda of the crudest and most obvious kind, which is designed to make them obedient little servants of their overlords, who claim to protect them from the evil exploiters they read about in their textbooks. These kids seek out the truth, and discover that the real exploiters are the overlords themselves, parasites on the productive economy, who live on the fruits of other people's labor while blaming the resulting social ills on the various bogeymen the kids have been taught to hate.

The slower kids, by contrast, memorize what the teacher tells them, reproduce it on the test, and repeat it like drones for the rest of their lives.

Notes

[1] Factor pricing on the market, including original factors like labor, occurs by reverse imputation from consumer valuations of the finished product. Production theory is covered in Murray N. Rothbard, Man, Economy, and State: A Treatise on Economic Principles (Auburn, Ala.: Ludwig von Mises Institute, 1993 [1962]), chs. 5–9. The various myths about labor's inequality of bargaining power and the importance of labor unions to laborers' material wellbeing are discussed in Thomas E. Woods, Jr., The Church and the Market (Lanham, Md.: Lexington, 2005), pp. 73–78.

[2] George Reisman, Capitalism (Ottawa, Ill.: Jameson Books, 1996), p. 621.

[3] Michael Cox and Richard Alm, Myths of Rich and Poor (New York: Basic Books, 1999), p. 43.