The Economics of Liberty
1. Economic Truth vs. Political Power
Outlawing Jobs: The Minimum Wage, Once More
Murray N. Rothbard
There is no clearer demonstration of the essential identity of the two political parties than their position on the minimum wage. The Democrats proposed to raise the legal minimum wage from $3.35 an hour, to which it had been raised by the Reagan administration during its allegedly free-market salad days in 1981. The Republican counter was to allow a “subminimum” wage for teenagers, who, as marginal workers, are the ones who are indeed hardest hit by any legal minimum.
This stand was quickly modified by the Republicans in Congress, who proceeded to argue for a teenage sub-minimum that would last only a piddling 90 days, after which the rate would rise to the higher Democratic minimum (of $4.55 an hour). It was left, ironically enough, for Senator Edward Kennedy to point out the ludicrous economic effect of this proposal: to induce employers to hire teenagers and then fire them after 89 days, to rehire others the day after.
Finally, and characteristically, George Bush got the Republicans out of this hole by throwing in the towel altogether, and pumping for a Democratic plan, period. We were left with the Democrats forthrightly proposing a big increase in the minimum wage, and the Republicans, after a series of illogical waffles, finally going along with the program.
In truth, there is only one way to regard a minimum wage law: it is compulsory unemployment, period. The law says: it is illegal, and therefore criminal, for anyone to hire anyone else below the level of X dollars an hour. This means, plainly and simply, that a large number of free and voluntary wage contracts are now outlawed and hence that there will be a large amount of unemployment. Remember that the minimum wage law provides no jobs; it only outlaws them; and outlawed jobs are the inevitable result.
All demand curves are falling, and the demand for hiring labor is no exception. Hence, laws that prohibit employment at any wage that is relevant to the market (a minimum wage of 10 cents an hour would have little or no impact) must result in outlawing employment and hence causing unemployment.
If the minimum wage is, in short, raised from $3.35 to $4.55 an hour, the consequence is to disemploy, permanently, those who would have been hired at rates in between these two rates. Since the demand curve for any sort of labor (as for any factor of production) is set by the perceived marginal productivity of that labor, this means that the people who will be disemployed and devastated by this prohibition will be precisely the “marginal” (lowest wage) workers, e.g., blacks and teenagers, the very workers whom the advocates of the minimum wage are claiming to foster and protect.
The advocates of the minimum wage and its periodic boosting reply that all this is scare talk and that minimum wage rates do not and never have caused any unemployment. The proper riposte is to raise them one better; all right, if the minimum wage is such a wonderful anti-poverty measure, and can have no unemployment-raising effects, why are you such pikers? Why are you helping the working poor by such piddling amounts? Why stop at $4.55 an hour? Why not $10 an hour? $100? $1,000?
It is obvious that the minimum wage advocates do not pursue their own logic, because if they push it to such heights, virtually the entire labor force will be disemployed. In short, you can have as much unemployment as you want, simply by pushing the legally minimum wage high enough.
It is conventional among economists to be polite, to assume that economic fallacy is solely the result of intellectual error. But there are times when decorousness is seriously misleading, or, as Oscar Wilde once wrote, “when speaking one’s mind becomes more than a duty; it becomes a positive pleasure.” For if proponents of the higher minimum wage were simply wrong-headed people of good will, they would not stop at $3 or $4 an hour, but indeed would pursue their dimwit logic into the stratosphere.
The fact is that they have always been shrewd enough to stop their minimum wage demands at the point where only marginal workers are affected, and where there is no danger of disemploying, for example, white adult male workers with union seniority. When we see that the most ardent advocates of the minimum wage law have been the AFL-CIO, and that the concrete effects of the minimum wage laws has been to cripple the low-wage competition of the marginal workers as against higher-wage workers with union seniority, the true motivation of the agitation for the minimum wage becomes apparent.
This is only one of a large number of cases where a seemingly purblind persistence in economic fallacy only serves as a mask for special privilege at the expense of those who are supposedly to be “helped.”
In the current agitation, inflation—supposedly brought to a halt by the Reagan administration—has eroded the impact of the last minimum wage hike in 1981, reducing the real impact of the minimum wage by 23%. Partially as a result, the unemployment rate has fallen from 11% in 1982 to under six percent today. Possibly chagrined by this drop, the AFL-CIO and its allies are pushing to rectify this condition, and to boost the minimum wage rate by 34%.
Once in a while, AFL-CIO economists and other knowledgeable liberals will drop their mask of economic fallacy and candidly admit that their actions will cause unemployment; they then proceed to justify themselves by claiming that it is more “dignified” for a worker to be on welfare than to work at a low wage. This of course, is the doctrine of many people on welfare themselves. It is truly a strange concept of “dignity” that has been fostered by the interlocking minimum wage-welfare system.
Unfortunately, this system does not give those numerous workers who still prefer to be producers rather than parasites the privilege of making their own free choice.
The Scourge of Unionism
Llewellyn H. Rockwell
Any business owner whose employees deliberately set out to harass and even endanger customers could do only one thing: fire the offenders, and maybe sue them for damages as well. Nothing else would be compatible with free enterprise and private property. But thanks to a whole host of government interventions, unionized companies, like most airlines, cannot take the actions that morality and economics would dictate.
Long before the now-famous strike, Eastern Airlines was hobbled by a legacy of bureaucratic management. During the bad old days when airlines were fully regulated by the government, managements were cozily in cahoots with the government and the union bosses. The resulting featherbedding and other mandated inefficiencies were foisted off on the hapless flyer through higher prices and inferior service, as were the above-market wages extorted by unionized airline employees.
When partial deregulation came along during the Carter administration, sclerotic Eastern started a long downhill slide, guided by ex-astronaut Frank Borman, whose managerial nirvana was the obese NASA. Only the attempt of entrepreneurial chairman Frank Lorenzo to forcefeed some economic rationality into Eastern had a chance of saving the company from bankruptcy. But his efforts were hamstrung by politically-favored unions. And then they attacked Eastern’s customers by striking, as well as encouraging their cohorts in the rest of the industry to engage in a work slowdown designed to cause chaos.
Labor unions, it must be remembered, are not simple associations of workers. They are conspiracies against the public interest. In the past, striking union members have done everything from breaking kneecaps to sending out false air traffic control signals. And when they do so, they are immune from justice.
Through laws and court decisions, the federal government gives these organizations and their bosses a whole range of special-interest privileges. For example, unions are virtually immune from prosecution for assaults and property damage during strikes.
We all have the right to quit our jobs. We also have the right to quit as a group. But we emphatically do not have the right to set up harassing picket lines and criminally assault those who choose to work. Yet that is what a strike consists of: the threat and actuality of violence against workers who want to support their families rather than obey union bosses. Thanks to government-granted favors, unions get away with things that would send anyone else to the crowbar motel—and rightly so.
With the Eastern strike, and the union attempt to spread it to all other forms of transportation, the unions have taken a serious risk. Union power has dwindled in recent years and this could help it along. Tormented consumers must know who to blame for their purgatory: unions.
But that is not easy, since there is so much disinformation about unions—spread by union propagandists, leftists, and the government itself. Even the standard historical account is an accumulation of myths.
One myth says that unions have played a crucial role in representing U.S. workers. In truth, unions have historically represented only a small fraction. Today, only about 15% of the civilian workforce is unionized. Even at their height in 1955, unions comprised only 25%. And labor economist Morgan Reynolds says that union membership could drop in a few years below 10%.
Before 1860, there were virtually no unions in America. After the Civil War, socialists and communists tried to organize workers—from ideological rather than economic motives. But the organizations inevitably declined and disbanded amidst public hostility to widespread bombings and killings by union organizers.
The founding of the American Federation of Labor in 1881 gave a temporary boost to the nationwide craft unions, but 20 years later, with fewer than 500,000 members, unions still had little influence.
That all changed with World War I. As part of its central wartime planning, the U.S. government declared a national emergency and promoted unionism—as a useful adjunct to cartelized big business—through wage and labor boards.
In a precedent-setting move, the government even approved union violence by (1) outlawing “interference” with coercive union activities; (2) forcing companies to rehire violent union members with full back pay; and (3) seizing the assets of companies that refused to go along. At one point, the government even created a union, the Loyal Legion of Loggers and Lumbermen.
After the war—over the opposition of government contractors and their unions—the labor market was deregulated, and union membership plummeted, with the biggest losses in those industries closest to the government.
Contrary to another myth, union membership took a free fall with the Great Depression. It wasn’t until the New Deal labor legislation that union membership began to grow again. A flood of legislation authorized federal fixing of minimum wages, maximum hours, and working conditions, and bolstered union cartelization by allowing them to fix terms of employment.
Especially objectionable were the Norris-LaGuardia Act, which prohibited court injunctions against union violence, and the Wagner Act, which forced employers to “bargain in good faith” with unions, i.e., to give in to their demands.
As culpable as Franklin Roosevelt was for all this legislation, however, Herbert Hoover had actually laid the groundwork. As secretary of commerce under Harding and Coolidge—as Murray N. Rothbard has pointed out—he was an ardent union defender, praising their activities, encouraging collective bargaining, and preaching the “humanitarian” goals of union organizing. After the Crash, as president, Hoover used government power to keep wages high for unions—exactly the opposite of what should have happened during a depression.
As a result of all this, union membership increased by 160% from 1933 to 1940.
Unions received yet another boost from World War II, when the federal government again cartelized the economy. Wages were set by government decree and business had to obey dictates from Washington, including the many that favored unions. By the end of the war, union membership had nearly doubled.
After World War I, when the wartime socialism-fascism was dismantled, unions fell apart. But this didn’t happen in the much milder dismantling after World War II. Thanks to the New Deal laws and pro-union government agencies, unions were able to avoid market competition and thus sustain their membership. As always, one of their major tools in this was violence and the threat of violence.
Eventually, however, a public outcry against this led Congress to pass another major piece of union legislation, this time over Harry Truman’s veto: the Taft-Hartley Act of 1947. It was a blow to union power, but rather than repeal existing pro-union laws, it gave the government even more power, especially to intervene in labor disputes and to force employees back to work.
Nevertheless, Taft-Hartley marked a turning point. Eight years later, union membership peaked, and it has fallen ever since. And in the absence of new federal interventions, it will continue to do so.
Many people are unaware of this decline, in part because of the visibility of public-sector unions like the postal workers and the National Education Association. These unions, observes Constitutional lawyer Edwin Vieira, have “quasi-governmental power” that is “incompatible” with “constitutional liberties.” Even here, however, unions represent a minority—34%—of government employees.
Another myth is that unions were founded to assist the poor and oppressed. In fact, they have always concentrated on high-wage, cohesive groups that are easy to organize, like construction tradesmen and railroad workers, and which can wreak broad havoc with strikes and other anti-competitive practices.
Today, the purpose of unions is largely to protect middle-upper class workers from wage competition. Typical are the Air Line Pilots Association, where some senior captains make $150,000 to fly less than 11 hours per week. The average annual salary of ALPA members is $85,000 for less than 19 hours of work a week. And no one thinks of Eastern’s $52,000 mechanics and $43,000 baggage handlers as the oppressed proletariat—especially when massive overtime caused by deliberate union makework is added to these high incomes.
This creates what Morgan Reynolds calls a “two-way dependency” between unions and wages: high-wage workers are more likely to unionize, which creates confusion about the sequence of causes. In truth, unions do not and cannot raise wages in general. Wages are determined by the productivity of the individual laborer, which in turn is largely determined by the amount of capital invested per worker.
The best way to raise wages is to increase the productivity of labor, which means creating a freer economy with more capital investment.
Unions can and do raise their own pay, but only at the expense of non-union and marginal workers. This is why unions promote such anti-competitive government interventions as minimum wages, which are designed to throw out of work those whose market worth is less than the minimum. This process enriches unions at the expense of the most vulnerable members of society.
Even with their limited numbers, unions enact a dreadful toll on our economy. They stymie competition, thwart the will of consumers, and promote misallocation of resources. Businesses and consumers have to bear the costs of arcane work rules and other mandated inefficiencies, absenteeism, and delays of new technology. And finally, there are the costs that strikes cause through disruption and violence.
It is impossible to measure precisely how much damage unions do to the U.S. economy. But Morgan Reynolds’s “unsubstantiated hunch” is that real income would rise 10% if unions disappeared.
The solution to union violence and inefficiency—as with all our economic problems—is simple: cut off the government’s tentacles. In this case, that means repealing the laws which grant the unions privileges and immunities. Justice for private property, working people, and consumers allows nothing less.
Keynesianism Redux
Murray N. Rothbard
One of the ironic but unfortunately enduring legacies of the eight years of Reaganism has been the resurrection of Keynesianism. From the late 1930s until the early 1970s, Keynesianism rode high in the economics profession and in the corridors of power in Washington, promising that, so long as Keynesian economists continued at the helm, the blessings of modern macroeconomics would surely bring us permanent prosperity without inflation. Then something happened on the way to Eden: the mighty inflationary recession of 1973–74.
Keynesian doctrine is, despite its algebraic and geometric jargon, breathtakingly simple at its core: recessions are caused by underspending in the economy, inflation is caused by overspending. Of the two major categories of spending, consumption is passive and determined, almost robotically, by income; hopes for the proper amount of spending, therefore, rest on investment, but private investors, while active and decidedly non-robotic, are erratic and volatile, unreliably dependent on fluctuations in what Keynes called their “animal spirits.”
Fortunately for all of us, there is another group in the economy that is just as active and decisive as investors, but which is also—if guided by Keynesian economists—scientific and rational, able to act in the interests of all: Big Daddy government. When investors and consumers underspend, government can and should step in and increase social spending via deficits, thereby lifting the economy out of recession. When private animal spirits get too wild, government is supposed to step in and reduce private spending by what the Keynesians revealingly call “sopping up excess purchasing power” (that’s ours).
In strict theory, by the way, the Keynesians could just as well have called for lowering government spending during inflationary booms rather than sopping up our spending, but the very idea of cutting government budgets (and I mean actual cut-cuts, not cuts in the rate of increase) is nowadays just as unthinkable, as, for example, adhering to a Jeffersonian strict construction of the Constitution of the United States, and for similar reasons.
Originally, Keynesians vowed that they, too, were in favor of a “balanced budget,” just as much as the fuddy-duddy reactionaries who opposed them. It’s just that they were not, like the fuddy-duddies, tied to the year as an accounting period; they would balance the budget, too, but over the business cycle. Thus, if there are four years of recession followed by four years of boom, the federal deficits during the recession would be compensated for by the surpluses piled up during the boom; over the eight years of cycle, it would all balance out.
Evidently, the “cyclically balanced budget” was the first Keynesian concept to be poured down the Orwellian memory hole, as it became clear that there weren’t going to be any surpluses, just smaller or larger deficits. A subtle but important corrective came into Keynesianism: larger deficits during recessions, smaller ones during booms.
But the real slayer of Keynesianism came with the double-digit inflationary recession of 1973–74, followed soon by the even more intense inflationary recessions of 1979–80 and 1981–82. For if the government were supposed to step on the spending accelerator during recessions, and step on the brakes during booms, what in blazes is it going to do if there is a steep recession (with unemployment and bankruptcies) and a sharp inflation at the same time? What can Keynesianism say? Step on both accelerator and brake at the same time? The stark fact of inflationary recession violates the fundamental assumptions of Keynesian theory and the crucial program of Keynesian policy. Since 1973–74, Keynesianism has been intellectually finished, dead from the neck up.
But very often the corpse refuses to lie down, particularly an elite which would have to give up their power positions in the academy and in government. One crucial law of politics or sociology is: no one ever resigns. And so, the Keynesians have clung to their power positions as tightly as possible, never resigning, although a bit less addicted to grandiose promises.
A bit chastened, they now only promise to do the best they can, and to keep the system going. Essentially, then, shorn of its intellectual groundwork, Keynesianism has become the pure economics of power, committed only to keeping the Establishment-system going, making marginal adjustments, babying things along through yet one more election, and hoping that by tinkering with the controls, shifting rapidly back and forth between accelerator and brake, something will work, at least to preserve their cushy positions for a few more years.
Amidst the intellectual confusion, however, a few dominant tendencies, legacies from their glory days, remain among Keynesians: (1) a penchant for continuing deficits, (2) a devotion to flat paper money and at least moderate inflation, (3) adherence to increased government spending, and (4) an eternal fondness for higher taxes, to lower deficits a wee bit, but more importantly, to inflict some bracing pain on the greedy, selfish, and short-sighted American public.
The Reagan administration managed to institutionalize these goodies, seemingly permanently on the American scene, and the Bush administration has continued the tradition. Deficits are far greater and apparently forever; the difference now is that formerly free-market Reaganomists and Bushonomists are out-Keynesianing their liberal forebears in coming up with ever more ingenious apologetics for huge deficits. The only dispute now is within the Keynesian camp, with the allegedly “conservative” supply-siders enthusiastically having joined Keynesians in devotion to inflation and cheap money, and differing only on their call for moderate tax cuts as against tax increases.
The triumph of Keynesianism within the Reagan and Bush administrations stems from the rapid demise of the monetarists, the main competitors to the Keynesians within respectable academia. Having made a series of disastrously bad predictions, they who kept trumpeting that “science is prediction,” the monetarists retreated in confusion, trying desperately to figure out what went wrong and which of the many Ms they should fasten on as being the money supply. The collapse of monetarism was first symbolized by Keynesian James Baker’s takeover as Secretary of the Treasury from monetarist-sympathizer Donald Regan. With Keynesians dominant during the second Reagan term, the transition to a Keynesian Bush team—Bush having always had strong Keynesian leanings—was so smooth as to be almost invisible.
Perhaps it is understandable that an administration and a campaign that reduced important issues to sound bites and TV images should also be responsible for the restoration to dominance of an intellectually bankrupt economic creed, the very same creed that brought us the political economics of every administration since the second term of Franklin D. Roosevelt.
It is no accident that the same administration that managed to combine the rhetoric of “getting government off our backs” with the reality of enormously escalating Big Government, should also bring back a failed and statist Keynesianism in the name of prosperity and free enterprise.
The Keynesian Dream
Murray N. Rothbard
For a half-century, the Keynesians have harbored a Dream. They have long dreamed of a world without gold, a world rid of any restrictions upon their desire to spend and spend, inflate and inflate, elect and elect. They have achieved a world where governments and Central Banks are free to inflate without suffering the limits and restrictions of the gold standard. But they still chafe at the fact that, although national governments are free to inflate and print money, they yet find themselves limited by depreciation of their currency. If Italy, for example, issues a great many lira, the lira will depreciate in terms of other currencies, and Italians will find the prices of their imports and of foreign resources skyrocketing.
What the Keynesians have dreamed of, then, is a world with one fiat currency, the issues of that paper currency being generated and controlled by one World Central Bank. What you call the new currency unit doesn’t really matter: Keynes called his proposed unit at the Bretton Woods Conference of 1944, the “bancor;” Harry Dexter White, the U.S. Treasury negotiator at that time, called his proposed money the “unita,” and recently, the London Economist has dubbed its suggested new world money the “phoenix.” Fiat money by any name smells as sour.
Even though the United States and its Keynesian advisers dominated the international monetary scene at the end of World War II, they could not impose the full Keynesian goal; the jealousies and conflicts of national sovereignty were too intense. So the Keynesians reluctantly had to settle for the jerry-built dollar-gold international standard at Bretton Woods, with exchange rates flexibly fixed, and with no World Central Bank at its head.
As determined men with a goal, the Keynesians did not fail from not trying. They launched the Special Drawing Right (SDR) as an attempt to replace gold as an international reserve money, but SDRs proved to be a failure. Prominent Keynesians such as Edward M. Bernstein of the International Monetary Fund and Robert Triffin of Yale launched well-known Plans bearing their names, but these too were not adopted.
Ever since the Bretton Woods system, hailed for nearly three decades as stable and eternal, collapsed in 1971, the Keynesians have had to suffer the indignity of floating exchange rates. Ever since the accession of Keynesian James R. Baker as Secretary of the Treasury in 1985, the United States has abandoned its brief commitment to a monetarist hands-off the foreign exchange market policy, and has tried to engineer a phase transformation of the international monetary system. First, fixed exchange rates would be obtained by coordinated action by the large Central Banks. This has largely been achieved, at first covertly and then openly; the leading Central Banks picked a target point or zone, for, say, the dollar, and then by buying and selling dollars, manipulated exchange rates to stay within that zone. Their main difficulty has been figuring out what target to pick, since, indeed, they have no wisdom in rate-fixing beyond that of the market. Indeed, the concept of a just exchange-rate for the dollar is just as inane as the notion of the “just price” for a particular good.
A tempting opportunity for mischief has been offered the Keynesians by the European Community. The Keynesians, led by now-Secretary of State James Baker, have been pushing for a new currency unit for this United Europe, to be issued by a European-wide Central Bank. This would not only mean an international economic government for Europe, it would also mean that it would become relatively easy for the post-1992 European Central Bank to become coordinated with the Central Banks of the United States and Japan, and to segue without too much trouble to the long-cherished goal of the World Central Bank and world currency unit.
Inflationist European countries, such as Italy and France, are eager for the coordinated European-wide inflation that a regional Central Bank would bring about. Hard-money countries such as West Germany, however, are highly critical of inflationary schemes. You would expect Germany, therefore, to resist these Europeanist demands; so why don’t they? The problem is that, ever since World War II, the United States has had enormous political leverage upon West Germany, and the United States and its Keynesian foreign secretary Baker have been pushing hard for European monetary unity. Only Great Britain, happily, has been throwing a monkey-wrench into these Keynesian proceedings. Hard-money oriented, and wary of infringements on its sovereignty—and also influenced by Monetarist adviser Sir Alan Walters—Britain might just succeed in blocking the European Central Bank indefinitely.
At best, the Keynesian Dream is a long shot. It is always possible that, not only British opposition, but also the ordinary and numerous frictions between sovereign nations will insure that the Dream will never be achieved. It would be heartening, however, if principled opposition to the Dream could also be mounted. For what the Keynesians want is no less than an internationally coordinated and controlled world-wide paper money inflation, a fine-tuned inflation that would proceed unchecked upon its merry way until, whoops! it landed the entire world smack into the middle of the untold horrors of global runaway hyperinflation.
The Free-Rider Confusion
Tom Bethell
If property is not privately owned, then it must be either state owned or communally owned. We know state-owned property results in economic failure. What happens when we consider the case of communal property? Why does this too not seem to work very well?
A main reason is that common ownership encourages “free riding” by the joint owners. There is no satisfactory way to assure the communal owners of a just “ratio” between the effort they individually expend producing goods and their ultimate consumption of goods. What one person sows another can reap. Before long, this results in a general laziness—the bane of communes. He who toils finds that the fruits of his labor are tossed into a common pool, where they may be consumed by his less industrious brethren. Slackers profit from the conscientious. This is a classic illustration of the free-rider problem—a problem that arises when the institutional setting does not permit property rights to be well-defined.
The free-rider problem arises because it is a characteristic of human nature that if we are offered a free good, we are strongly inclined to accept it. By the same token, we are strongly disinclined to labor if the fruits of our labor are promptly made available to others, free of charge.
If you turn to economics textbooks, however, and look up “Free-Rider Problem,” you find something quite unexpected. You find that the concept of free riding is always discussed in a context of “market failure,” almost never in a context of “collective failure.” Indeed, current economics textbooks do not so much as entertain the idea that there is any such thing as a “common-pool problem” or “collective failure.” They point out that a problem of “public goods” arises when it is technically difficult to prevent those who do not pay for certain goods from using them. One example frequently given, albeit historically inaccurate, is that of lighthouses.
It is true, of course, that in certain situations it is technically difficult to confine the use of certain economic goods to those who pay for them. In such cases, there is said to be a “positive externality,” in which non-payers receive an “external benefit.” To the extent that this is true, a theorist may well perceive a “market failure.” But it is not a particularly serious problem. It does not prevent commercial (i.e., private) radio stations from operating profitably. And technological changes make private security and roads increasingly practical.
The mere technical difficulty of confining the use of goods to those who pay for them is as nothing compared to the institutional difficulties that arise when property is owned in common. Here the free-rider problem strikes with a vengeance. It becomes (in any commune above family size) impossible to apportion consumption to production, and a great sense of injustice begins to take hold. But try to find an economics book that uses the free-rider problem to illustrate the concept of collective failure.
Some would say that communal ownership is so limited in the modern world that it is not particularly relevant or important. Economists argue that in socialist countries, such as the Soviet Union, the free-rider problem does not exist because the ill-defined ownership of common property has been replaced by the monopoly ownership of the state—or by a “single will,” as Ludwig von Mises put it.
In practice, however, the free-rider problem exists on a giant scale in all socialist countries. F.A. Hayek has drawn attention to the difficulties of organizing production in centrally planned economies, pointing out that the central planning authority can never have at its disposal sufficient information to issue intelligent commands.
The problem with Hayek’s objection to planning is that it implies that people are willing slaves, eager to toil for socialist construction if only their masters at the central planning bureau would issue the right commands. But people, including Soviet people, are not made that way. In the Soviet Union, as in all institutional settings in which the individual is not primary, people are reluctant to work when they can’t capture the fruits of their labors, and when they are paid (minimally, it is true) whether they work or not.
The Associated Press reported the following from Moscow: “‘The food problem is far from solved,’ Gorbachev said in one of his frankest admissions of the Soviet Union’s problems. ‘The housing problem is acute. There is a dearth of consumer goods in the shops. The list of shortages is growing. The state’s financial position is grave.’” He diagnosed the problem in this way: “Many people have forgotten how to work. They got used to being paid,” he said, “just for coming to work.”
And there, in spades, you have the free-rider problem posing difficulties for socialism: state socialism, not just communitarian socialism. By comparison, the problem that the free riders pose for markets is minimal. But you wouldn’t know it from our economics texts.
In his famous text Economics (11th edition), Paul Samuelson notes that “wherever there are externalities, a strong case can be made for supplanting complete individualism by some kind of group action.” He does not seem to realize that these externalities above all arise in a setting where individualism has in fact been supplanted by group action, or perhaps never existed in the first place.
“Because of their characteristics,” Robert Heilbroner and James K. Galbraith argue in The Economic Problem (8th edition, 1987), “all public goods share a common difficulty: their provision cannot be entrusted to the decision-making mechanism of the market.” This is true, but tautological. Public goods are so defined in their book. The authors’ discussion of the problem of externalities is confined to the negative externalities that arise in a free-market system (e.g., pollution), and overlooks the positive externalities that arise in a communal system (the institutional arrangement that permits me to reap what you sow). Hence the free-rider problem is seen as causing difficulties only for the market, and their discussion arises in a chapter entitled “Where the Market Fails.”
“Externalities lie at the heart of some of society’s most pressing problems,” William J. Baumol and Alan S. Blinder write in Economics: Principles and Policy (2nd edition, 1982). They cite “the problems of the cities, the environment, research policy and a variety of other critical issues. For this reason, the concept of externalities is one of our 12 Ideas for Beyond the Final Exam. It is a subject that will recur again and again....” Even so, their discussion is limited to the kind of “externality” that is alleged to cause a problem for the market. All this is in a chapter headed “Shortcomings of the Market Mechanism and Government Attempts to Remedy Them.” They do not bring up the severe externality problem that arises when the “market mechanism” is supplanted by collectivism.
Stanley Fischer and Rudiger Dornbusch (Economics, 1983) likewise confine their discussion of the free-rider problem to the realm of market problems.
Roy J. Ruffin and Paul R. Gregory (Principles of Economics, 2nd edition, 1986) note that “externalities are a classic example of market failure,” adding: “Many externalities are the result of poorly defined property rights.” They proceed to give examples of the failure of communal ownership—overfishing of communally owned fishing grounds, and so on. But their whole argument is set in a chapter entitled “Market Failure, Environment, Energy.”
Oddly, in light of this chapter title, their diagnosis of the problem of externalities is the same as that of Harold Demsetz in his famous article “Toward A Theory of Property Rights,” (American Economic Review, May 1967). Demsetz really did establish the key point that free-riding undermines communalism. The Labrador Indians overhunted beavers on communal hunting grounds because the benefits of such hunting were enjoyed by individual hunters (i.e., were privatized), while the costs were borne by other members of the tribe (i.e., socialized, or “externalized”). The solution, Demsetz said, was to establish private hunting grounds, which would save the beaver.
Communal ownership, Demsetz wrote, “fails to concentrate the costs associated with any person’s exercise of his activities on that person.... The effect of a person’s activities on his neighbors and on subsequent generations will not be taken into account fully. Communal property results in great externalities.” Privatizing the land would “internalize the externalities,” Demsetz wrote.
Ruffin and Gregory write, “the solution is to internalize, or put a private price tag on, externalities. This price must be paid by the one imposing the cost or received by the one imposing the benefit.” In the 20 years that separate Demsetz and Ruffin & Gregory, what has changed? The problem under discussion, formerly perceived as a problem of communalism, has been construed as a problem of the market.
James Gwartney and Richard Stroup discuss the free-rider problem in Chapter 28 of their Economics: Public and Private Choice (4th edition, 1987). They point out that where there are external benefits, people can become free riders (true). They add that “the problems caused by externalities stem from a failure (or an inability) to clearly define and enforce property rights” (also true). They do discuss the externality problems that arise with communal property—the overgrazing of English commons in the 16th century, the overhunting of beavers by the Montagnais Indians in the 17th century—and here they are indeed making the case that massive free riding, hence over-use, tends to destroy communal property. What is misleading is that all this information is conveyed in a chapter entitled “Problem Areas for the Market.”
Unexpectedly joining the crowd is Paul Heyne, whose lucid text The Economic Way of Thinking (5th edition, 1987) is unusually free of professional group-think. But like everyone else, he uses the free-rider problem to illustrate public goods and market failure—e.g., the difficulty of forming a volunteer police force.
Property Rights, Taxation, and the Supply-Siders
Tom Bethell
It was a decade ago that most of us began to hear about the supply-side movement, although its origins go further back than that. The movement was given great impetus by the inflation of the 1970s, which combined with the progressive income-tax code to shift everybody into higher tax brackets. Since purchasing power was not increasing, this was widely understood to be unjust. Notice that it was the unlegislated nature of the tax increase that was deemed unfair; not the progressive tax code itself.
In retrospect the claims then made by supply-siders were extremely modest. They argued that tax rates above a certain point are counter-productive from the point of view of the revenue collector. In effect, supply-siders proposed the following deal with the socialists (now called liberals in the U.S.): “You want more revenue, and we want to be able to keep a greater percentage of what we earn at the margin. Both objectives can be attained by reducing the top income tax rates.” But what extraordinary rage and scorn poured forth from the liberals in response to this mild observation, offered in a spirit of compromise.
Perhaps the liberals were angry because they suspected supply-siders were insincere in their pose as the pragmatic allies of the revenue collector. Perhaps, indeed, the supply-siders ought to have opposed the progressive income tax as immoral in itself rather than unproductive at the margin.
Nonetheless, the supply-siders’ suggested compromise with the advocates of big government contained at its core an analysis that was highly unwelcome to the statists and the mainstream economists. The supply-siders were saying that incentives do matter after all, that if the government takes away too much of what people have worked for, they will not in the future be so productive.
At that time, economists had reason to believe that the whole subject of incentives had been eliminated from economic analysis; as outmoded as the cavalry charge, and as little likely to return. The pretense was that “the economy” was a machine, activated (like a water mill) by an “income stream.” Human psychology had nothing to do with this purely mechanical and scientific action. That was the fond pretense. (To some extent it still is.) In the 1967 edition of his textbook, Paul Samuelson writes that the question whether high income tax rates discourage effort is “not an easy (one) to answer. For we shall see later that taxation will cause some people to work harder in order to make their million.” Samuelson never demonstrates this dubious proposition (sometimes called the “income effect”).
In any event the supply-siders dealt it a devastating blow simply by questioning it, and by asserting that human rationality must be a part of economic analysis. People will not work hard to further other people’s ends that are both unknown and unknowable. I will not work to earn $100 if I am told that I must leave 50 of those dollars on the sidewalk for the benefit of the next person who happens to come by. Refusing to work to attain such an unknown end is not “greed” or “selfishness.” It is simple rationality. Very much the same analysis applies to toiling for dollars which are to be thrown into the trillion-dollar common pool that is the federal budget.
Advocates of the free market should also insist that the individual’s desire to dispose of his own earnings may well be wholly unselfish. He may, after all, want to keep his earnings so that he may give them to Mother Teresa. A man who earns money to spend on his family is likewise acting unselfishly.
There was often a kind of euphoria and excitement in those early discussions between supply-siders, as I recall from my own experience. This was before they fragmented into unseemly recriminations and rivalry in the mid-1980s.
Since then I have thought about these ideas a good deal and I have come to the conclusion that they should be restated.
Supply-siders have been on a great treasure hunt for information about Third World tax rates. These were found to be shockingly high in almost every case. The Agency for International Development was scorned for not knowing the first thing about such matters; the World Bank and the International Monetary Fund were likewise excoriated. Indeed, such agencies have tended to favor raising taxes. All this tended to confirm the idea that tax rates—particularly income tax rates—were the key to understanding the great mystery that has bedeviled development economics since World War II: Why is it that some countries have prospered, while most have stagnated (in Africa, actually declined in many instances)?
It is clear, however, that this diagnosis is inadequate. There is another way of expressing the problem, at a level of greater generality, which gives us a much better grasp of the matter. The key is not taxation but property rights: private property is (comparatively) secure in some countries, highly insecure in others, while in still others (the Communist countries) it has been abolished outright as a matter of ideology. In any country, I believe, the extent and security of private property will be found to correlate closely with economic performance there.
The necessary studies have not been undertaken, however, because it has been dogma among professional economists (except Austrians) for almost a century that private property is an “optional extra.” The piece of machinery called “the economy” can come equipped with or without it. If anything, higher rates of economic growth can be achieved without it. (That is what they claim, gentlemen.) Incidentally, one reason why so many academic economists are unenthusiastic about property as an analytical tool is that it is difficult to quantify. Furthermore, it threatens to throw economics into reverse gear, back into the “political economy” of the 19th century and away from the “economic science” of the 20th.
Once we examine the “way the world works” from the vantage-point of property, however, we find that it casts new light not just on economic development but on taxation itself. It is true, of course, that all taxation is an abridgement of property rights, and the high levels of taxation encountered in all Western countries today in general impair property rights more seriously than anything else. (The property rights of certain classes of citizens, e.g., apartment owners in New York, Santa Monica, Brookline, and Berkeley are even more gravely impaired, but for the population as a whole taxation tops the list of property infringements.) This accounts for the overall accuracy of the supply-siders’ prognosis a decade ago. Property was (and is) the key, but in the Western countries in which supply-side theory has primarily been tested (by reducing tax rates) it is precisely the tax code that constitutes the most serious attack on property.
In many Third World countries, however, it is not sufficient to reduce the income tax rates (as was done in the Philippines, for example). If regulations prevent the acquisition of property, or its voluntary transfer, or effectively confine it to presidential cronies, as in some Latin American countries, then reducing the progressivity of the tax code won’t work magic. As for Communist countries, it is more or less meaningless to analyze economic problems in terms of taxation. They are more fundamental than that. Thus we may say that reform of the tax code is a necessary but not a sufficient condition of economic revival.
Finally, it is worth noting the economic bias that has created the system that now prevails throughout the West, in which up to one third of income property is subject to legal confiscation (more than a third, if you add in social security taxes, state taxes, and the taxation of interest on savings), but real property is secure (as long as you don’t rent it out in certain jurisdictions). The effect is to promote a class system—the very evil that Karl Marx claimed a progressive income tax would eliminate. Old money is pitted against new. Those with valuable properties, acquired at a time of lower taxation and now safe from confiscation, are placed at a great competitive advantage over those who must toil to acquire income, and then surrender one third of it before they have accumulated enough to convert it into real property.
The French, interestingly enough, understood this diagnosis and actually decided to change the rules, shortly after Francois Mitterand was elected in 1981. Objets d’art and antiques inside those nice old chateaux would be assessed and taxed for a change! But somehow, the enthusiasm for this attack on the class system encountered unexpected resistance—from the socialists. It was as though all that talk about the desirable egalitarian effects of the progressive tax code was a mere smokescreen, disguising the point that what the socialists really want is a system in which some people (the better class of person, you understand) can lord it over others—the uppity, bourgeois, nouveaux riches.
The Regulatory Attack on the Market
Llewellyn H. Rockwell
Ever since the October 1987 stock-market crash, government officials have demanded more control over the securities industry. As usual, their claim has been bolstered by “disinterested” scientific analysis by economists.
In its post-crash study, the Securities and Exchange Commission blamed stock-index futures, and advocated higher margin requirements and more regulatory powers for itself. The New York Stock Exchange’s study condemned futures, especially portfolio-insurance programs, and also advocated higher margins on stock-index futures and more enforcement authority for the SEC.
Reagan’s stock market commission, headed by now-Treasury Secretary Nicholas Brady, implicated portfolio insurance, mutual fund redemptions, computers, and unchecked price swings. It urged that the Federal Reserve be given supra-regulatory powers over stocks, futures, and options, and that price controls (“circuit-breaker mechanisms”) be instituted in case of massive market movements.
In accord with these domestic developments, Great Britain’s Wilton Park Group—composed of regulators from the ten major industrialized countries—called for global standards on insider trading, market shutdowns, and margin requirements, plus increased sharing of confidential financial information. In April 1988, the U.S. orchestrated an agreement between the Japanese market and the Chicago Board of Trade, and in September, between the London market and the Commodity Futures Trading Commission.
As then-SEC Chairman David Ruder noted: “I find myself voting more clearly for intervention...into all kinds of activities.”
Except for 1934, when it banned all new stock issues at the behest of old-line firms and began to cartelize the securities industry, the SEC has never been more interventionist than it is today. As we know from economic theory, as well as the history of similar activities, such intervention will undermine the economic functions of the stock and futures markets.
In the academic world, most economists believe that the financial markets as a collective entity are all-knowing—not only about present events but also about the future. The markets discount everything, so there can be no profits or losses through better or poorer forecasting, only through good or bad luck. The markets are a giant gambling casino, with no real economic function.
The more accurate Austrian view sees securities markets as efficient, but also imperfect, functioning as they do in a world of uncertainty. Within the division of labor, there are more successful forecasters, and one function of the markets is to convey financial assets from the less efficient in this area to the more efficient. The far-seeing traders profit while others do not, and that serves an important economic purpose; Wall Street is not the equivalent of Caesar’s Palace.
The markets also must coordinate complex price relationships among the many stages of production over time. It is a job that no regulator can perform, no matter what his intentions or how many computers he has.
The price system is like a communications network that transmits signals about possible profits and losses. Through this network, producers learn from consumers about how they value the various goods and services available, and therefore how best to make use of the available capital, land, and labor.
These signals also affect the perceived outlook for company profits, and therefore stock prices. Entrepreneurs respond to the signals by trying to outcompete their rivals in better meeting consumer demand, and thereby reap higher profits. But this communications network can only be sensitive to consumer desires and transmit undistorted signals when it is free and open.
Prices—especially in the stock and futures markets—must be allowed to reflect real market conditions. Higher stock prices, for example, signal that more capital can be raised for a particular industry or firm, and that its output can be expanded. Lower stock prices show us the less desired industries and firms, and lead to the shifting of resources into more productive endeavors.
Consumers can change their subjective valuations of goods and services because of their expectations about the future, their preference for a new product over an old, or simply changing tastes. Regardless, economic efficiency requires a price system that can accurately reflect these adjustments in changes of value on the markets.
Only the unhampered market allows entrepreneurs to efficiently meet and even anticipate consumer preferences. In the frozen world of government econometric models, all possible economic data, present and future, is known. There is no experimentation, creativity, or discovery. All consumer prices are determined by the costs of production—rather than supply and demand—and the prices of capital are “given.” It is not surprising that these models show no ill effects from regulation.
In the real markets, the prices that consumers are willing to pay determine every price through the many stages of production. This “imputation” process, which enables entrepreneurs to build the long-term production processes characteristic of an advanced economy, cannot take place efficiently when there are regulatory barriers.
As in the rest of the economy, economic freedom in the stock and futures markets is essential for productivity, efficiency, and innovation. More regulation can cause only discoordination and stagnation, as the desires of regulators take precedence over the buying public.
Circuit-breaker mechanisms, for example, temporarily block this flow of information. Radical price corrections, such as the one in the 1987 crash, are just as necessary as small ones. Since they are almost always caused by Federal Reserve credit manipulation, these radical swings (“clusters of errors,” as F.A. Hayek termed them) are unnatural phenomena. That is another reason why the markets must be allowed to adjust.
Higher margin requirements in the futures markets will make trading stock index-futures prohibitively expensive and reduce competition.
All the current attempts to add to the already elaborate regulatory apparatus are no service to the economy. Rather than erecting new barriers, a clear understanding of markets instead requires elimination of all the present ones.
Are Savings Too Low?
Murray N. Rothbard
One strong recent trend among economists, businessmen, and politicians, has been to lament the amount of savings and investment in the United States as being far too low. It is pointed out that the American percentage of savings to national income is far lower than among the West Germans, or among our feared competitors, the Japanese. Recently, Secretary of the Treasury Nicholas Brady sternly warned of the low savings and investment levels in the United States.
This sort of argument should be considered on many levels. First, and least important, the statistics are usually manipulated to exaggerate the extent of the problem. Thus, the scariest figures (e.g., U.S. savings as only 1.5% of national income) only mention personal savings, and omit business savings; also, capital gains are almost always omitted as a source of savings and investment.
But these are minor matters. The most vital question is: even conceding that U.S. savings are 1.5% of national income and Japanese savings are 15%, what, if anything, is the proper amount or percentage of savings?
Consumers voluntarily decide to divide their income into spending on consumer goods, as against saving and investment for future income. If Mr. Jones invests X percent of his income for future use, by what standard, either moral or economic, does some outside person come along and denounce him for being wrong or immoral for not investing X + 1 percent? Everyone knows that if they consume less now, and save and invest more, they will be able to earn a higher income at some point in the future. But which they choose depends on the rate of their time preferences: how much they prefer consuming now to consuming later. Since everyone makes this decision on the basis of his own life, his particular situation, and his own value-scales, to denounce his decision requires some extra-individual criterion, some criterion outside the person with which to override his preferences.
That criterion cannot be economic, since what is efficient and economic can only be decided within a framework of voluntary decisions made by individuals. For the criterion to be moral would be extraordinarily shaky, since moral truths, like economic laws, are not quantitative but qualitative. Moral laws, such as “thou shalt not kill” or “thou shalt not steal,” are qualitative; there is no moral law which says that “thou shalt not steal more than 62% of the time.” So, if people are being exhorted to save more and consume less as a moral doctrine, the moralist is required to come up with some quantitative optimum, such as: when specifically, is saving too low, and when is it too high? Vague exhortations to save more make little moral or economic sense.
But the lamenters do have an important point. For there are an enormous number of government measures which cripple and greatly lower savings, and add to consumption in society. In many ways, government steps in, employs many instruments of coercion, and skews the voluntary choices of society away from saving and investment and toward consumption.
Our complainers about saving don’t always say what, beyond exhortation, they think should be done about the situation. Left-liberals call for more governmental “investment” or higher taxes so as to reduce the government deficit, which they assert is “dissaving.” But one thing which the government can legitimately do is simply get rid of its own coercive influence in favor of consumption and against saving and investment. In this way, the voluntary time preferences and choices of individuals would be liberated, instead of overridden, by government.
The Bush administration has begun to propose eliminating some of the coercive anti-saving measures that had been imposed by the so-called Tax Reform Act of 1986. One was the abolition of tax-deduction for IRAs, which wiped out an important category of middle-class saving and investment; another was the steep increase in the capital gains tax, which is a confiscation of savings, and—to the extent that capital gains are not indexed for inflation—a direct confiscation of accumulated wealth.
But this is only the tip of the iceberg. To say that only government deficits are “dissaving” is to imply that higher taxes increase social savings and investment. Actually, while the national income statistics assume that all government spending except welfare payments are “investment,” the truth is precisely the opposite.
All business spending is investment because it goes toward increasing the production of goods that will eventually be sold to consumers. But government spending is simply consumer spending for the benefit of the income, and for the whims and values, of government’s politicians and bureaucrats. Taxation and government spending siphon social resources away from productive consumers who earn the money they receive, and away from these consumers’ private consumption and saving, and toward consumption expenditure by unproductive politicians, bureaucrats, and their followers and subsidies.
Yes, there is certainly too little saving and investment in the United States, as a result of which the U.S. standard of living per person is scarcely higher than it was in the early 1970s. But the problem is not that individuals and families are somehow failing their responsibilities by consuming too much and saving too little, as most of the complainers contend. The problem is not in ourselves the American public, but in our overlords.
All government taxation and spending diminishes saving and consumption by genuine producers, for the benefit of a parasitic burden of consumption spending by non-producers. Restoring tax deductions and repealing—not just lowering—the capital gains tax, would be most welcome, but they would only scratch the surface.
What is really needed is a drastic reduction of all government taxation and spending, state, local, and federal, across the board. The lifting of that enormous parasitic burden would bring about great increases in the standard of living of all productive Americans, in the short run as well as in the future.
The “We” Fallacy
Sheldon L. Richman
In discussions of international trade, there is no word more pernicious, more responsible for the inanities heard daily, than we: “We have a trade deficit. We are a debtor nation. We must do something about it.” Reporters and commentators endlessly drone on about these things. But who is we? The people living under the jurisdiction of the U.S. government may be conveniently referred to as we, but the uncritical use of this term infects thinking about political-economic subjects. Careless aggregation is the enemy of good sense.
For example, it is said that we have a merchandise trade deficit of over $4 billion with Japan. In other words, the dollar value of the products sold by some Americans to some Japanese was $4 billion short of the dollar value of what some Japanese sold to some Americans. Who exactly suffered this deficit? Maybe I did. I probably bought some Japanese-made products that month, but I cannot recall selling anything to a Japanese person. On the other hand, there are probably Americans around who sold things to Japanese people, but didn’t buy anything from them; they had a trade surplus, according to the statisticians. Although I seem to have a trade deficit with “Japan,” I can’t say this was any kind of disadvantage. I bought what I wanted, period. The same is true for those with a “surplus.” They could have bought Japanese products had they preferred, but they didn’t.
What does it mean to statistically combine all the transactions of Americans and Japanese (ignoring transactions with people in other groups) in order to determine the status of the two groups? All of us in the “deficit” group are still as happy as we were when we were considered individually. To be sure, some people wish they sold more to the Japanese than they did. But it has nothing to do with the rest of us. What they did not sell in no way offsets the benefits of what any of us bought. Lee Iacocca’s failure to sell more Reliants to people in Tokyo has no great implications for “the nation,” though it may mean something for a specific, identifiable group involved in producing Reliants.
But this is not the way the policymakers and news media see it. When the trade figures are reported, the increase in the “deficit” is always lamented across the land. True, American businesses had record exports, but this was said to be undercut by the larger volume of imports and thus the overall picture was reported bleak. How absurd! For any level of exports, there can always be a higher level of imports. More important, the media’s analysis implies that it is better to be on the money side rather than the goods side of a transaction. Put that way, no one would believe it. But drape it in the mantle of statistics and it’s time to crack down on buyers of excessive imports.
There are other ways in which the pernicious we infects people’s thinking about trade. It is often said that foreigners should open their markets to “us” because “we’ve” opened ours to them. We do them a favor by letting them sell here? Do you buy things as a favor to the seller? I don’t, and I’m sure no one else does. But if that is true, what happens when the U.S. government closes a market in the United States in retaliation for some misdeed abroad? It might be a favor to those seeking shelter from competition, but must it hurt other Americans? There is no indivisible we.
This policy of hurting some Americans to help others is known officially as strategic trade policy; it is really protectionism prettified by the claim that its motive is free trade. Not only does it play fast and loose with the right of Americans to buy what they want, but it also fails on it own terms. In the 1960s, the American government and the producers of chickens complained that European countries had barriers to chicken imports. In the name of open markets, the U.S. government imposed a 25% tariff on light trucks, which Europeans exported here. That tariff not only remains in effect today, it is applied to light trucks from Japan as well.
If the Europeans had removed their barriers to chickens, do you suppose the American producers of light trucks would say, “Okay, the chicken market is open; time to abolish the truck tariff?” Of course not. And that’s the point: a nation is not made up of a single set of interests. There is no we.
As much as it might pain Lee Iacocca and his cohorts, most Americans have a harmony of interests with producers in other countries. What comes between them hurts some of us. These Americans do not necessarily benefit by everything that benefits Chrysler or USX or Harley Davidson. They certainly do not benefit when companies win political privileges, because they must come at the expense of everyone else. Anytime someone invokes patriotism to get you to buy his product (“Made in the U.S.A. It Matters!”), bolt your door and get out the shotgun.
Once aggregates are banished from discussions of trade, everything is clearer. Take foreign investment: there is suddenly great concern that foreigners are investing in American businesses, even buying them out. This is supposed to spell danger for us. How so? All that is happening is that foreign capitalists are bringing their money here and putting it to work. The results are new opportunities and new products. Is that bad? Note that you rarely hear complaints about British or Dutch investment. The danger seems exclusively Japanese. But British and Dutch holdings combined are three times those of the Japanese. There is undoubtedly some racism at the bottom of this, and I expect the New Yellow Peril to be a major issue in the 1990s.
What about this business that America is a debtor nation? Same fallacy. Some Americans are debtors, some are creditors. America is neither. (I exclude from consideration the government’s debt, which is another story.) As a matter of fact, the statistics being bandied about are misleading. Assets are recorded at book, or historic value, and the foreign holdings of Americans are older than foreigners’ holdings here. Thus, it appears, falsely, that Americans’ holdings are worth less than foreigners’ holdings. Last year, Americans’ total income from foreign assets exceeded that of foreigners’ from American assets.
But even if it were true that foreigners’ holdings were worth more or that they had more income, so what? Freely chosen investment here by anyone cannot possibly be bad. And if investment produces large incomes for foreigners, it must mean that it’s profitable—that the goods and services being produced are popular with consumers.
Ludwig von Mises taught that we must be methodological individualists. Economic phenomena are invariably the products of individual persons acting for chosen objectives. Two persons come together for exchange if and only if each expects to come out ahead. And, assuming neither has erred, each can and does come out ahead. That is virtually all one needs to know to make sense of international trade.
U.S. Trade Law: Losing Its Bearings
Alex Tabarrok
We hear that consumers are the major victims of protectionism. This is true if we remember that businesses are also consumers, and that protectionism can hurt them as much as retail consumers. In fact, protectionism has become a major threat to American firms. For example, the “voluntary” restraint agreements in steel and semiconductors have hurt Caterpillar, General Motors, and Atari, which need steel and semiconductors to produce goods and services. These firms have lost profits and customers because their production costs have been increased by U.S. trade laws.
Most protectionism results from the lobbying activities of domestic manufacturers. A recent example is a decision by the U.S. International Trade Commission (ITC) to impose massive duties on hundreds of types of bearings and ball bearings—at the behest of an American producer. The duties are currently wreaking havoc at many American firms.
At present, the world-wide demand for commodity bearings—the mass-produced sort used in many household appliances—is extremely high. Although U.S. manufacturers are producing at capacity, they cannot begin to meet the requirements of U.S. users, so firms like Penn Fishing Tackle, Black and Decker, G.E., and many others have turned to foreign suppliers.
Penn Fishing Tackle, for example, bought from the French producer SKF because domestic firms could not deliver the bearings they needed. In one case, an order placed by Penn with a domestic supplier—Torrington Co.—took two years to deliver.
Alcoa, Dana Corp., and Xerox, among others, have also had problems with Torrington. William R. Wilson of Xerox reports that Torrington “has taken around 44 weeks to supply an initial order.” When “domestic sources prove to be unreliable suppliers, as Torrington has, we have no alternative but to seek alternative suppliers abroad.”
Not surprisingly it was Torrington that initiated the ITC investigation of foreign producers who were “dumping” ball bearings, i.e., selling them too cheaply. True to form, the ITC decided in favor of Torrington and imposed duties—in spite of the fact that their own survey showed that “the most common reason for purchasing imported bearings...was the inability of the domestic manufacturers to meet delivery and availability requirements.”
These duties unjustly injure productive American firms. But according to the ITC, this is unimportant because duties should be imposed if “imports contribute, even minimally to [the] material injury” of the domestic producer. The ITC has found even this lax and irrational standard difficult to prove. It claims that bearing producers have been materially injured by foreign dumping—a necessary finding for the imposition of duties. However, ITC data show that the U.S. bearing industry was consistently profitable over the investigation period. Even as the ITC found injury, the U.S. bearing industry was spending more on research and development. Furthermore, ITC vice-chairman Ronald Cass, the sole dissenter in the case, points out that “capital expenditures increased dramatically from 1985 to 1987.” Firms experiencing difficult times rarely invest in research and development or new plant and equipment.
While the “injury” done to the domestic bearing industry is invisible, the injury perpetrated by the duties is crystal clear. One of the most popular fishing reels produced by Penn uses a bearing that has nearly tripled in price because of the duties. Penn may have to stop making it because they are having difficulties competing with lower-priced offshore manufacturers.
Pittman, a U.S. producer of miniature motors, has also been injured by Torrington and the ITC decision. The bearings they use have risen in price by 40–50%—a burden their world competitors do not have to bear.
On the opposite end of the spectrum from commodity bearings are “super-precision” bearings. These are made from specialized materials, are very expensive, and must be produced in small batches to high tolerance levels. However, the ITC ignored all these important distinctions and imposed duties on a wide variety of super-precision bearings—even though many are not even produced in the United States!
“Tenter bearings,” for example, are made to withstand extreme heat and stress. Torrington, the petitioner, doesn’t produce these bearings. The 3M Company uses these bearings to produce specialty film products. Although 3M has tried to encourage U.S. producers to supply the bearings, demand is not high enough to justify the considerable investment in specialized machinery needed for their production.
It will probably take U.S. industries a year or two to build the factories and train the workers needed to make tenter bearings. In the meantime the government is forcing 3M to pay a debilitating 132% duty.
These rulings are unjust. Why should innovative companies like Penn and 3M be penalized because the government kowtows to the greed of a company that wants profits by federal fiat?
Anti-dumping laws shift resources from one set of American firms to another: from smaller, dynamic, and entrepreneurial firms to large, politically well-connected, but inefficient firms.
Retail consumers are, of course, also injured by duties. In this case they can expect large price increases on products that use bearings, from heavy-duty construction machinery to office equipment, power tools, fishing reels, and household appliances.
The ITC should stop undermining efficient American companies and consumers with this nonsense. They should start considering the harmful effects that duties impose on consumers, be they companies or individuals. But if that occurred, they would have to vote themselves out of existence.
Statistics: Destroyed from Within?
Murray N. Rothbard
As improbable as this may seem now, I was at one time a statistics major in college. After taking all the undergraduate courses in statistics, I enrolled in a graduate course in mathematical statistics at Columbia with the eminent Harold Hotelling, one of the founders of modern mathematical economics. After listening to several lectures of Hotelling, I experienced an epiphany: the sudden realization that the entire “science” of statistical inference rests on one crucial assumption, and that assumption is utterly groundless. I walked out of the Hotelling course, and out of the world of statistics, never to return.
Statistics, of course, is far more than the mere collection of data. Statistical inference is the conclusions one can draw from that data. In particular, since—apart from the decennial U.S. census of population—we never know all the data, our conclusions must rest on very small samples drawn from the population. After taking our sample or samples, we have to find a way to make statements about the population as a whole. For example, suppose we wish to conclude something about the average height of the American male population. Since there is no way that we can mobilize every male American and measure everyone’s height, we take samples of a small number, say 500 people, selected in various ways, from which we presume to say what the average American’s height may be.
In the science of statistics, the way we move from our known samples to the unknown population is to make one crucial assumption: that the samples will, in any and all cases, whether we are dealing with height or unemployment or who is going to vote for this or that candidate, be distributed around the population figure according to the so-called “normal curve.”
The normal curve is a symmetrical, bell-shaped curve familiar to all statistics textbooks. Because all samples are assumed to fall around the population figure according to this curve, the statistician feels justified in asserting, from his one or more limited samples, that the height of the American population, or the unemployment rate, or whatever, is definitely XYZ within a “confidence level” of 90 or 95%. In short, if, for example, a sample height for the average male is 5 feet 9 inches, 90 or 95 out of every 100 such samples will be within a certain definite range of 5 feet 9 inches. These precise figures are arrived at simply by assuming that all samples are distributed around the population according to this normal curve.
It is because of the properties of the normal curve, for example, that the election pollsters could assert, with overwhelming confidence, that Bush was favored by a certain percentage of voters, and Dukakis by another percentage, all within “three percentage points” or “five percentage points” of “error.” It is the normal curve that permits statisticians not precisely to claim absolute knowledge of all population figures, but instead to claim such knowledge within a few percentage points.
Well, what is the evidence for this vital assumption of distribution around a normal curve? None whatever. It is a purely mystical act of faith. In my old statistics text, the only “evidence” for the universal truth of the normal curve was the statement that if good riflemen shoot to hit a bullseye, the shots will tend to be distributed around the target in something like a normal curve. On this incredibly flimsy basis rests an assumption vital to the validity of all statistical inference.
Unfortunately, the social sciences tend to follow the same law that the late Dr. Robert Mendelsohn has shown is adopted in medicine: never drop any procedure, no matter how faulty, until a better one is offered in its place. And now it seems that the entire fallacious structure of inference built on the normal curve has been rendered obsolete by high-tech.
Ten years ago, Stanford statistician Bradley Efron used high-speed computers to generate “artificial data sets” based on an original sample, and to make the millions of numerical calculations necessary to arrive at a population estimate without using the normal curve, or any other arbitrary, mathematical assumption of how samples are distributed about the unknown population figure. After a decade of discussion and tinkering, statisticians have agreed on methods of practical use of this “bootstrap” method, and it is now beginning to take over the profession. Stanford statistician Jerome H. Friedman, one of the pioneers of the new method, calls it “the most important new idea in statistics in the last 20 years, and probably the last 50.”
At this point, statisticians are finally willing to let the cat out of the bag. Friedman now concedes that “data don’t always follow bell-shaped curves, and when they don’t, you make a mistake” with the standard methods. In fact, he added that “the data frequently are distributed quite differently than in bell-shaped curves.” So that’s it; now we find that the normal curve Emperor has no clothes after all. The old mystical faith can now be abandoned; the Normal Curve god is dead at long last.
The Truth About Economic Forecasting
Graeme B. Littler
Astrologers, palmists, and crystal-ball gazers are scorned while professional economists are heralded for their scientific achievements. Yet the academics are no less mystical in trying to predict the direction of interest rates, economic growth, and the stock market.
Forty years ago, Thomas Dewey was defeated by Harry Truman, stunning the political experts and journalists who were certain Dewey was going to win. While questions about “scientific” polling techniques naturally arose, one journalist focused on the heart of the matter. In his November 22, 1948, column in Newsweek, Henry Hazlitt said the “upset” reflected the pitfalls of forecasting man’s future. As Hazlitt explained: “The economic future, like the political future, will be determined by future human behavior and decisions. That is why it is uncertain. And in spite of the enormous and constantly growing literature on business cycles, business forecasting will never, any more than opinion polls, become an exact science.”
We know how well economists forecast the eighties: from the 1982 recession and the employment boom to the Crash of 1987, no major forecasting firm came close to predicting these turns in the market. And following the Crash, virtually every professional forecaster revised his economic forecasts downward, all because the historical data suggested that the stock market was a reliable barometer of future economic activity. The economy then continued to expand and the stock market eventually reached new highs.
After President Eisenhower’s heart attack on September 24, 1955, the stock market experienced a massive drop. The stock market later recovered as the president recovered; like 1987, 1955 turned out to be one of the statistically best in economic history.
Despite the sorrowful record, most economists remain die-hard advocates of forecasting. Most have spent years in college and graduate school learning the tools of their trade, and can’t bring themselves to admit their own entrepreneurial errors. As one investment advisor put it: “No matter how many times they fail, their self-assurance never weakens. Their greatest (or only) talent is for speaking authoritatively.”
Of their errors, the forecasters contend that it’s only a matter of time before they master the techniques. Though that day will never arrive, economic forecasting remains an integral part of the economics mainstream. The original motto of the Econometric Society still holds sway: “Science is Prediction.”
Whether one uses a ruler to extend an economic trend into the future, or a sophisticated econometric model with dozens of equations, the problem is still the same: there are no constant relations in human affairs.
Economics, unlike the natural sciences, deals with human actions, plans, motivations, preferences, and so on, none of which can be quantified. Even if it were possible to quantify these things, changing tastes (and all the factors that affect tastes) would make the data almost instantaneously useless to the forecaster. And then there are the millions of “unimaginable” things, like Eisenhower’s heart attack, which constantly crop up, influencing people in unpredictable ways.
Economic statistics (i.e., history) do not imply anything about the future. Because data show the relation between price and supply to be one way for one period of time doesn’t mean that it cannot change. As Mises pointed out, “external phenomena affect different people in different ways” and “the reactions of the same people to the same external events vary.”
Some economic forecasters like to argue that economic forecasting is not unlike predicting the weather (and should also be equally difficult). Not only is the nature of these two problems entirely different, but one can reasonably expect that as scientific methods become more sophisticated, weather prediction could theoretically approach perfection. This is because there are constant relations among physical and chemical events. By experimenting in the laboratory, the natural scientist can know what these relations are with a high degree of precision. However, human society is not a controlled laboratory. This fact makes the forecaster’s job of accurately predicting future events impossible.
Forecasters try to get around this problem by linking events in historical chains, and randomly guessing that if one variable reoccurs, then the others will necessarily follow. But this is a sophisticated version of the logical fallacy, post hoc ergo propter hoc (after this, therefore, because of this). This has led major forecasters to seriously study astrological patterns and to build mathematical models that correlate weather patterns with business cycles. Once the forecaster throws out economic logic, anything could have caused anything else, and all variables in the universe are open to study. One mainstream forecasting theory for investors, for example, is based on the rate at which rabbits multiply.
Does this mean we can know nothing about the future? No, the best forecasters are successful businessmen, whose entrepreneurial judgment allows them to anticipate consumer tastes and market conditions. As Murray N. Rothbard points out: “The pretensions of econometricians and other ‘model-builders’ that they can precisely forecast the economy will always flounder on the simple but devastating query: ‘If you can forecast so well, why are you not doing so on the stock market, where accurate forecasting reaps such rich rewards?’” Forecasting gurus, instead, tend to disdain successful entrepreneurs.
The myth that economists can predict the future is not just harmless quackery, however. Central planners use the same theories to direct the economy. Yet by setting production goals with the data collected by the planners themselves, they destroy the very process that directs free-market production.
Central planners try to overcome uncertainty by substituting formulas for entrepreneurial judgment. They believe that they can replace the price system with commands, but they miss the whole purpose of individual action on the free market. As Ludwig von Mises said, they make “not the slightest reference to the fact that the main task of action is to provide for the events of an uncertain future.” In that sense, central planners are no different from professional forecasters.
Don’t expect unemployment among forecasters, however. Many have cushy jobs with the Congress, the White House, and virtually every agency of the U.S. government, and will happily issue predictions to no end.
In the Austrian view, on the other hand, economists have three functions: to further our understanding of the free market, to identify possible consequences of government policies, and to counter economic myths.
Economic forecasting has nothing to do with these objectives. In fact, by presenting itself as the only scientific dimension of economics, forecasting has helped discredit the whole discipline, and fueled an exodus of economists from the more mundane academic world to the arena of state control and coercion, to the detriment of every American.
Michael R. Milken: Political Prisoner?
Llewellyn H. Rockwell
The Dom Perignon must be flowing in the boardrooms of New York: the feds finally got the kid from Encino.
To avoid a worse fate, Michael R. Milken agreed to say he was guilty of six regulatory offenses, manufactured transgressions typical of the Alice-in-Wonderland world of big government.
Crimes are supposed to have victims. But who exactly was harmed by the dread offense of “stock parking?”
Yet Milken will pay a $600 million fine and be sentenced to prison with other “white-collar criminals.” After a years-long federal envy campaign, he felt he would be convicted by a Bonfire of the Vanities jury for being rich. But he kept his brother Lowell out of jail and avoided 28 years in a federal pen where homosexual rape is the major pursuit, and AIDS, the normal blood condition.
David Rockefeller, said the New York Times, had been furious over Milken’s earnings. They indicated “something unbalanced” in “our financial system.” Indeed, when it comes to unbalancing the status quo that has served Rockefeller so well, Milken is guilty.
His entrepreneurial discovery was the use of high-yield bonds (called “junk” by his old-line competitors) to finance corporate takeovers. In the past, would-be raiders had to get financing from such big banks as Rockefeller’s Chase Manhattan. This meant profits and control, both of which shrunk with the advent of Milken.
In the reduced competition of a regulated economy, corporate managers tend to put their own interests before the stockholders. If an entrepreneur can get financing, he can take over the company—that is, buy it from its owners—and try to improve it. Everyone benefits, except the tossed-out managers.
Managers of big corporations, not surprisingly, hate and fear this process, and they lobbied to pass the Williams Act introduced by Harrison Williams (D-NJ), later convicted as a bribe taker. This law requires anyone buying more than 5% of a company’s shares to stop and announce his intentions. This raises the price of the shares, as intended, making it far more expensive to acquire control. It also gives management time to erect barriers (“greenmail” and “poison pills”) to thwart the will of stockholders who might want to sell.
The Williams Act and related regulations worked all too well. For more than a decade, there were few challenges to the ensconced managements of big companies, and U.S. competitiveness nosedived. But in the early eighties, a group of outsiders like Carl C. Icahn and T. Boone Pickens were able to challenge the system, thanks to Milken.
As the London Financial Times noted, this made Milken “enemies all over corporate America.” Not surprisingly, said the Washington Post, since he was an “an adversary of Wall Street’s leading investment firms and blue-chip corporations.”
Milken was “the ultimate outsider,” working 3,000 miles away in Drexel Burnham Lambert’s Los Angeles office, said the New York Times, living a “relatively modest life” while donating “hundreds of millions of dollars to charity.”
But didn’t he make too much money? In a free market, such a question makes no sense. Milken single-handedly raised Drexel from a third-tier firm to one of the giants. It was happy to pay for the results, although it too has been destroyed in the government’s anti-Milken vendetta, with thousands of people losing their jobs.
The humiliation of Michael Milken “will send the right message to the financial community,” said Assistant Attorney General John Carroll. Exactly. Don’t rock the boat. And don’t threaten entrenched interests.
If we had a free-market Amnesty International, Michael Milken would be listed as a political prisoner of special-interest big government.
Richard Breeden, head of the SEC, says that Milken “stood at the center of a network of manipulation, fraud, and deceit.” To me, that sounds like a good working definition of Washington, D.C.
The Economic Wisdom of the Late Scholastics
Jeffrey A. Tucker
Free markets are most often threatened by both economic and ethical considerations. Even if statists grant that free markets are productive, they claim it is at too high a price. And they say mere economic analysis is not enough to satisfy the demands of “social justice” or “compassion” to the poor. The answer to both criticisms is government intervention or even socialism.
To answer these charges, new writers have begun to show that free markets have economic and moral justification, and that these are compatible. Both Michael Novak and Ronald Nash have shown that Christian morality and tradition are more supportive of free markets than state coercion.
Most impressive is the work of Alejandro A. Chafuen in bringing to light a great—if hitherto lost—tradition of the late scholastics, a school of thought active in Spain from the 14th to 17th century. They taught that the free market was always practically and morally superior to statism, and did so without compromising their emphasis on economic science.
In his groundbreaking Christians for Freedom: Late-Scholastic Economics (1986), Chafuen shows that this school was even pre-Austrian in subjective value, marginal utility, prices, the quantity theory of money, economic calculation, and the problems of collective ownership.
Jesuit Juan de Mariana (1535–1624) wrote that the king may spend his own personal wealth, but he has “no domain over the goods of the people, and he cannot take them in whole or in part.” Further, “how sad it is for the republic and how hateful it is for good people to see those who enter public administration when they are penniless grow rich and fat in public service.” Mariana demanded to know, “where is this money coming from if it is not from the blood of the poor and the flesh of the businessmen?”
Balanced budgets, Mariana said, should be the “main concern” so that “the republic is not entangled in more evils because of its inability to pay its debts.” But taxes are not the solution to debt because, as Mariana noted, “taxes are commonly a calamity for the people and a nightmare for the government. For the former they are always excessive; for the latter they are never enough, never too much.”
Writing in 1619, Fernandez Navarrete, chaplain to the king, advised him that, “The origin of poverty is high taxes. In continual fear of tax collectors, [the farmers] prefer to abandon their land, so they can avoid their vexations. As King Teodorico said, the only agreeable country is one where no man is afraid of tax collectors.”
Regarding bureaucrats, Navarrete said “it is good to dismiss many of them.” It is not sufficient to stop the growth of bureaucracy. Rather, “we need to...purge it of its present excess of hangers-on. People may say that this is an extreme suggestion since the court supports so many people, but the disease has become so grave and so evident that we have no excuse not to employ the remedy.”
On inflation, Mariana pointed out that “if the legal value of the currency is reduced, the prices of all goods will, without fail, increase in the same proportion.” He concluded that “any alteration of money is dangerous. It can never be good to debase currency or to fix its price higher than its natural valuation and common estimation.” Martin de Azpilcueta, a Dominican, noted in 1553 that “other things being equal, in countries where there is a great scarcity of money, all other saleable goods, and ever the hands and labor of men, are given for less money than where it is abundant.”
Another Dominican, Tomas de Mercado (1500–1575), condemned inflation because it rearranges debtor-creditor relations so that “the poor become rich and the rich poor.” His solution: “the value” of money, and “even its seal and design, must be durable and as invariable as possible.” Not for just a short time, but for “twenty generations, and the great-grandsons will know what they inherited from their great-grandparents and what in their goodness they increased, gained, and left to their children.”
What about the common claim that scholastics from St. Thomas Aquinas forward believed in a “just price” and a “just wage” set outside the market? Chafuen shows that this is a myth. The Jesuit scholar Luis de Molina (1535–1600) captured the prevailing view: “the just price of goods depends principally on the common estimation of the men of each region. When a good is sold in a certain region or place at a certain price (without fraud or monopoly or any foul play), that price should be held as a rule and measure.”
To these scholastics, the “common estimation of market” theory of pricing also applied to wages. Molina said, “if the wage that is set for him is at least the lowest wage that is customarily set in that region at the time for people in such service, the wage is to be considered just.” The just wage cannot be judged on “what is sufficient for his sustenance, and much less for the maintenance of his children and family.” The Dominican scholar Domingo de Soto (1495–1560) wrote that workers cannot steal from their employers “with the excuse that they are not sufficiently well paid.” This is because “no injury is done to those who gave their consent.” He advised workers, “if you do not want to serve for that salary, leave!”
They also understood that value is not inherent in a good; it resides in the minds of individuals who use it. Molina writes, “a price is considered just or unjust not because of the nature of the things themselves...but due to their ability to serve human utility.” That is “why rats, which according to their nature are nobler than wheat, are not esteemed or appreciated by men. The reason is that they are of no utility whatsoever.”
On value, Adam Smith said we could never understand why diamonds sell for a higher price than bread, even though bread is more necessary for life. Almost 400 years earlier, St. Bernardino of Siena (1380–1444) solved that problem. He said that prices are a function of relative scarcities: “Water is usually cheap where it is abundant. But it can happen that, on a mountain or in another place, water is scarce, not abundant. It may well happen that water is more highly esteemed than gold, because gold is more abundant in this place than water.”
The scholastics were, of course, in favor of private property and rejected common ownership. Domingo de Soto notes in 1567 that “private interest” works where “universal love” doesn’t. “Hence, privately owned goods will multiply. Had they remained in common possession, the opposite would be true.”
Chafuen shows that the late scholastics found a perfect harmony between the demands of economic logic and Christian morality. By restoring the wisdom of this school, we undermine the Christian socialists and left-liberals, and renew the credibility of those who find no contradiction—indeed, a harmony—between morality and good economics.
