Monday, June 16, 2014

The Income Gap by Rick Kelo

The Income Gap by Rick Kelo
“The state is that great fiction by which everyone tries to live at the expense of everyone else”~ Friedrich Bastiat

There is a great problem facing America today.  As a nation we have been voting ourselves more and more benefits for the last 2 generations; benefits we don’t have enough money to pay for.  Any time governments get larger and more activist they drain and distort the economy.  Studies have shown that public policy widens the wealth gap.  A government that is an activist player in a free market economy creates many ill effects opposite of what its “do gooder” intentions set out to do.

Beyond that there are many places where you can read that the distribution of wealth is uneven in a capitalist economy.  It is one of the most common complaints about free markets: that they end up concentrating wealth in the hands of only a small proportion of the society.  Beyond the question of government policies that add to this gap scarcely has a soul considered if it must be this way, why the distribution of wealth occurs, what the alternative is, and whether it is a good or a bad thing.  So I will start by seeing if each point makes logical sense, and then give you some empirical evidence for each.

Must it be this way?  The definition of capitalism is private ownership of the means of production, with the goal of making a profit.  Let’s just imagine a world where there was balance.  In that world the consumer would spend all of his wage on buying things and the business owner would spend all of his on paying a salary.  So every time the worker spends his pay money leaves the economy/the system, every time the employer pays out wages money enters.  In that scenario the amount of goods being produced and trying to be sold just keeps going up.  There is no more money in the system but there are new goods being cranked out every day.  That leads to things being produced for which there isn’t enough money to purchase them. The business owner suffers a loss from the cost of unsold products, and must lower wages.  Now there is even less money able to purchase the rising amount of goods and we have a recession.

Now I hope I didn’t go too fast with that, but it’s a basic example that shows you there cannot be a balanced system.  The business owner must retain some of the money he makes.  If he pays out everything he makes the economy self-destructs.  Savings is what allows there to be spending on research of new technologies, it’s what allows the employee to keep his job when not all the goods he produces are purchased, and it’s what allows the business owner to expand and so on.  You cannot criticize those who have done a lot of saving because the economy that the worker depends on cannot exist without someone being rich.

Why does distribution of wealth occur?  Well in a free market the wealthiest people are the ones who produce something the common man wants to buy.  If you produce a product that only caters to the rich your business will never be very big.  When I drive down the road on any given day I see a lot of Fords; I don’t see a single Ferrari.  Why?  The reason is because capitalism caters to the common man.  In a free market every producer has an incentive to lower the price of their service so more people want to buy it.  The suggestion that capitalism is somehow against the common working person is a lie.
Now let’s look at every other area of human endeavor.  The best chess players could play thousands of games against you and me and never lose.  Professional golfers could golf against the rest of us forever and never lose.  Not everyone has equal talent.  Making money is no different: it is a specialized talent that not everyone possesses.

Now that deals with the entrepreneur… the business owner… and why he makes more than others.  But what about the rate of pay among employees?  Is it somehow unfair that the brain surgeon who can save your life from the most complex disease ever makes 100 times what the cashier performing a job anyone could do makes?  How about the pilot flying the last airplane you were on?  Is it unfair he makes more than the stewardess serving drinks?  Of course it isn’t.  Now compare that to the discussion of the employee named “the CEO.”  It’s no different; only envy of someone in a higher station of life makes it different.  And for that people blame capitalism; especially once they reach the point in their life that they see their more successful peers pass them by.  In reality though we are only seeing an application of the same principle of the pilot and the stewardess.
What is the alternative to wealth inequality?  Easy enough the alternative is “egalitarianism”.  It is redistributing wealth from the rich to everyone else.  There is a fatal flaw to this argument that no one considers.  Wealth inequality exists because of our social arrangement.  It is only because humans are incentivized to produce as much as they can under capitalism that any become rich in the first place.  Remove the incentive and you destroy the productivity that goes along with it.

If we are going to have wealth distributed equally then we are going to have to force people to work for free.  Do you think Steve Jobs would have slaved away for 20 hours a day to produce what he did if he could have been paid the same to sit in a cubicle from 9-5?  Of course not, the incentive of money is what generates advances in mankind.  And look next at how many people his company now provides jobs for, and how many consumers benefit from using their products?

There is a deeper problem at play though: redistributing wealth cannot be egalitarian like its proponents suggest.  Egalitarianism suggests you treat everyone equally.  But if you are only taking from some you are not treating all equally.  If I am taking money from the rich and giving it to the poor I am admitting they are not equal, because if they were equal they would have equal rights.  So if the poor & wealthy are equal human beings under the law then the poor have no more right to lay claim to the riches of the wealthy than do the wealthy to exploit the poor (for which we have a great many laws & protections in place).

Is unequal wealth distribution bad?  No it isn’t.  People who claim it is overlook the fundamental issue.  If it were bad then the quality of life of the average person would not be constantly improving.  Why is that happening?  Because you do not have to own a means of production in order to benefit from it.  If the rich own it the common man still benefits from it.  None of us own a clothing factory yet we have, at our disposal, the widest variety, style, materials and price ranges of clothing imaginable.  We are not in need for clothing even though none of us has a way to produce it.

Now most people default to their opinion that unequal wealth distribution is bad because they equate it to the majority of human history when the common man was unable to change his social station.  He was never going to become a king, or the chief of the tribe.  But not so in the capitalist economy!  There is no job in the American economy any person is employed in that has not produced a millionaire in that industry.  And even beyond that just one change in technology can radically alter the landscape of wealth and make entire functions that had been “sure things” obsolete.  Don’t think so?  Go ask Bill Gates how many people were using Internet Explorer 5 years ago.  Then ask him how he now has only 20% of the browser market and lost it to two free, open source products.  That is the power of the innovation inherently inspired under free market capitalism.

Also, many of the people who claim wealth inequality is “unfair” are still using the knowledge of what money is that they learned as a child.  I have 3 kids and when the family has a resource it gets divided equally.  When one kid earns an allowance for doing a chore the others have to be given the same opportunity to make an identical amount.  If not, then they claim things are “unfair.”  Sound familiar?  Except the world isn’t the family you grew up in.  You can’t use the viewpoint of a child to understand the world of adulthood.  Why?  Because wealth is not fixed.  Wealth is created all the time.  Back in the Middle Ages if we surveyed an agrarian village we’d see that some people had granaries and some did not.  Why?  Because only some decided to work hard enough to build them.  They created wealth, and the process is no different today.  But please, no one tell Barack Obama that someone “didn’t build that.”

Thursday, June 12, 2014

Capitalism vs. Socialism: A Crash Course in World History

Monday, June 9, 2014

On Free Trade 5: Tariffs by Rick Kelo

Tariffs: Free Trade Isn't About Jobs, Its About Which Jobs

This is the most common barrier to free trade.  We allow foreign imports, but we slap a tax on the goods coming in.  This has the effect of protecting the few American workers who make that good at the expense of everybody in the world.  Everyone in America now has to pay a higher price to buy the tariffed foreign good, but they also have to pay a higher price to pay the US made version because now the US companies protected by the tariff can sell their product at a higher price too.  The tariff hurts everyone outside the US because we buy our imported goods with our exported goods.  The tariff makes our trade partners able to buy fewer American made goods.

Ignoring the Constitutionality of it for a moment, just to make this easy to picture suppose Florida & Idaho are engaged in trade.  Florida trades oranges in return for Idaho potatoes.  Id
aho does grow some of its own oranges, but due to the temperatures the trees have to be grown in expensive hot houses.  Florida does grow some of its own potatoes but because of its close elevation to sea level and water tables the potatoes have to be grown in special raised gardens up on stilts.

Article Photo
People are mad!!  The special interest Idaho Orange Growers Union has organized a protest.  They are becoming unemployed because they cannot compete with these low-priced imported oranges from Florida.  If Idaho imposes a high tariff on imported oranges from their trade partner they can prevent job losses at home.  Now tell me how much sense it makes to do that?

This simple example is exactly what all tariff debates are about: the conflict of nonsense over reason. 

Raising a tariff on Florida oranges will protect the jobs of the greenhouse workers in Idaho, but only by making everyone suffer under much higher prices.  Now consider that same effect (protecting the jobs of Idaho orange growers) from the angle of opportunity cost.  If those Idaho workers weren't wasting their time & resources trying to very inefficiently force oranges to grow oranges in huge greenhouses when better, cheaper oranges are available through trade then those exact same people would instead be employed in another area of the Idaho economy.  They would be working in a higher demand area of the economy making something that Idaho has an advantage in.  If there is no tariff against imported oranges then everyone in Idaho benefits because the overall Idaho economy becomes larger and grows more quickly.  True the Idaho greenhouse workers will slowly lose their jobs as the free market naturally shifts them into another area.  Idaho citizens now get cheap oranges and cheaper goods in all the other areas the orange farmers went to work.

This is what economists mean when they say its about "which" jobs an economy is most benefited by having.  Free trade diverts labor slowly, gradually and naturally into the most efficient areas.  The result is that overall output is increased.  This is HUGE for an economy because an economy isn't made up of all the money in a system, that's why things like trade deficits don't actually matter.  An economy is made up of all the goods and services produced.  Produce more goods & services than before and your whole society becomes richer, cleaner, has less unemployment, more vacation time, a cheaper grocery bill and on and on it goes.

Think about the 2.5% tariff on imported cars.  Government decides it is going to privilege the auto industry by protecting it partially from competition, thereby protecting American workers in the auto manufacturing industry.  This can only do so by hurting workers in every industry outside the privileged industry.

Now the waitress, construction worker and cashier all must pay more for a car.  They pay more not only if the buy the foreign car, they also have to pay more if they buy an American car because now Detroit auto manufacturers can charge higher prices due to the tariff.  We make the waitress pay more of her hard earned tips to buy a less fuel efficient, lower performing, more expensive to maintain car in return for the privilege of protecting the auto manufacturer from competition.

The alternative to the tariff is to force American car makers to compete by producing cars Americans actually prefer.  Here's one example: Honda.  Due to superior entrepreneurial foresight Honda correctly anticipated consumer preferences and started selling very fuel efficient cars in the US about 10 years ago.  Demonstrating very inferior entrepreneurial foresight American car manufacturers were busy peddling gas guzzling SUVs.  We can have a tariff to try and force Americans to buy cars they don't want, or we can eliminate the tariff and force American companies to design cares people actually want for a change.

A tariff is nothing more than a tax paid at the cash register the proponents of tariffs would have you believe that we can make America richer by raising taxes on Americans.  Suppose the government fined you $20 every time you watched a movie at home... that would definitely give a nice bump to the movie theater industry.  People who wanted to watch a movie would go to the theater instead, they would have to hire more workers for the increased demand.  The movie theater industry would pay higher wages in order to reduce business disruption due to turn-over, etc.  In spite of all that no one in their right mind would think it was a good idea for the nation.  Tariffs make as much sense as putting a tax on every meal people cook for themselves at home in order to boost the restaurant industry.

Monday, June 2, 2014

On Free Trade 4: Outsourcing... They Took Our Jobs! by Rick Kelo

On Free Trade 4: Outsourcing... They Took Our Jobs! by Rick Kelo

Our own econometric work at the IIE refutes, in particular, the contention that US direct investment has the effect of "exporting jobs."  We find that actually new US outward investment stimulates US exports rather than suppressing them.  Thus, outward US FDI (foreign direct investment) results in job creation in the export sector, which generally commands a wage premium in the United States.
Dr. Edward M. Graham, Professor of Economics, Columbia; "The Cause of AntiGlobalists Is Wrong in the Aggregate"

What's that guy in the quote talking about?  I'll translate it:
Industries where workers are more productive pay better wages.  The worker isn't more productive because he works any harder or longer hours than in the other industry, but that industry has a more developed & superior capital structure, which allows for a higher "marginal productivity of labor" overall in that industry.  Its that added efficiency from the capital structure & that added demand of having foreign demand added on top of our existing domestic demand that pays more.  The less efficient industry that loses jobs due to free trade is also the industry that - because it has lower productivity - was paying less.
Example: the guy digging a ditch with a shovel gets paid a lot less than the backhoe operator.  Both can input the same hours of labor in a day, but one is more productive because he has a superior capital structure of equipment behind him (just picture all the machines it took to produce that backhoe).
When foreign companies invest in the US by building, say a manufacturing plant, it obviously creates jobs here.  When we invest abroad, as Dr. Graham points out, it creates jobs here.  So that's the flow of money... but how about the impacts on jobs from the flow of goods?
When nation's open up to free trade two things happen:
  1. There are "adjustment costs" in that nation.
  2. There are "welfare gains" in that nation (the country grows in both new jobs & wealth due to trade).

Adjustment costs are commonly called "outsourcing" meaning the country loses some jobs due to trade.  Welfare gains come in two forms.  The first is the country becomes a lot richer because it not only gets cheaper foreign goods thus saving money, but jobs shift into better paying domestic industries creating higher overall wages in the nation.  Those two things together (lower cost products + higher wages) are termed welfare gains.
OVERALL the total jobs in the country DOES NOT CHANGE.  Free trade is never about how many jobs there are going to be.  Its about which jobs.  It's about using the power of the market to shift people into more efficient - and just like the backhoe operator - higher paying jobs.  As you can see in the graph of imports as a % of GDP America's import of goods/services has grown steadily.  Our unemployment rates haven't, on average, changed very much over time because imports don't cause unemployment as we'll look at in more detail below.
We are commonly led to believe that the costs of free(r) trade are much higher than the gains.... except... they aren't.  When a national liberalizes its trade policies (adopts freer trade), then for every $1 of trade adjustment costs that same nation experiences $30 in welfare gains.  That's right.... the benefits outweigh the costs 30:1.
There has never been a single news story reporting this fact.  Ever.  Neither will there ever be one.  Why?  It's very easy to report on 120 people who lost their job because their company was inefficient and couldn't compete with cheaper foreign goods.  That's visible.  But what about the invisible?  It is very hard (and a lot less interesting if you care about ratings) to report on new jobs that spring up due to trade.  
Those new jobs created are in America's most productive, and therefore highest paying, industries.  The jobs lost are in our lowest paying, most outdated, and least efficient industries.  So those are the "welfare gains."  Shown below in Figure 1 are America's trade costs for the last 12 years.  I included this table to demonstrate to you that its mostly a myth that jobs are lost due to them going overseas.  There is some job loss for this reason but its, overall, very minor.... nothing like you've been led to believe. 

Figure 1: Trade Doesn't Cause Unemployment; source:

At its core trade is an issue of using resources more efficiently.  When America gained its independence in 1776 over 85% of the nation worked in agriculture.  Today less than 2% does.  This ability to use resources more efficiently allowed 83% of the labor force to do additional things we couldn't previously do.  Its called the division of labor, and free trade is the division of labor on a multi-national scale.
OUTSOURCING: COSTS VS. GAINSNow that we've considered the 30:1 gains for engaging in trade let's look at the costs of erecting artificial barriers to free trade.  The costs of using these crude & ineffective "protectionist" measures averaged a quarter million dollars for each job we artificially delay adjusting into a higher paying, more profitable industry.
This graph is taken from a study the Dallas Federal Reserve assembled for its Annual Report:

Figure 2.

AN EXAMPLE: CARSLet's look at outsourcing. It is the primary complaint levied against free trade.  If we have free trade then all our "good" jobs will leave the country and other countries will get them instead and America will be worse for the exchange.
A 25% Tariff Makes This US- Made Truck More Expensive
As I write this America has a 25% tariff on the price of any imported pick-up trucks and a 2.5% tariff on imported cars.  To take the car tariff as an example the obvious effect it has is to make everyone in America who does not buy from Ford or GM pay a higher price.  So the tariff serves to enrich the special interest of 2 companies by impoverishing the general interest of everyone else who has to suffer higher prices.
That's only the surface level effect, but how about the real effects?

SOCRATES MEETS JOB OUTSOURCINGBefore I delve into this let's apply some good ol' fashion Socratic logic and apply some reductio ad absurdam.  Suppose Americans gave up their interest in pick-up trucks and instead favored some other type of vehicle in the future.  Pick-up truck sales fell to 0.  It would be silly for the Detroit auto industry to keep cranking out Ford F-150s and it would be a gigantic waste for the government to keep a 25% tariff to "protect truck manufacturing jobs."  Why?  Well obviously the purpose of producing something is for it to be consumed.  If people no longer prefer to consume something then it doesn't make any sense to produce.  
Now let's take that same line of thought and dial it back to the partial position: if people decide they no longer prefer American pick-up trucks and instead prefer trucks made in South Korea then those manufacturing jobs have lost their purpose: to produce something people demand to consume.  That labor is no longer being used efficiently and those companies should (and will) switch to making a more desired product.  
For this reason we see that free trade isn't really about America losing jobs... its about people moving from jobs in less desirable areas into jobs in more desirable sectors of the economy.  Does anyone reading this really think the occupation of chimney sweep, a booming job 100 years ago, is going to exist 100 years from now?  Really think Americans are going to be manufacturing cars 100 years from now?   I personally even doubt that human beings of any nation will be manufacturing cars 100 years from now, its likely to all be done by robots and the few humans employed in that endeavor will be in today's undeveloped regions of the world.
As one final point on that note here is a graph of import penetration compared to unemployment so you can plainly see for yourself that the level of imports has no bearing on the level of unemployment:
Figure 3.  Imports Don't Cause Unemployment.

JOB LOSSES TO ROBOTSSince we've talked about jobs being outsourced to other countries what about jobs being outsourced to other methods of production?  A lot of people complain about the use of robots to do work humans used to do so I felt this merits addressing at the same time as job outsourcing since its related.
Picture Robinson Crusoe stranded on his island.  He has to provide his own fish, sheer sheep to make clothes, shepherd them, build his shelter, cook his own food and forage for berries (or whatever else he does).  One day a plane flies over and drops him a robot that will do all his cooking for him.  Now instead of cooking he has more free time to engage in an extra activity he previously couldn't do.  Now maybe he can plant a vegetable garden or build a chicken coop.  
Robinson Crusoe's standard of living is increased by having the robot, and so it is with us.  If America can outsource its least productive work, whether its to a machine or to other nations, our standard of living increases.  Now we get the benefit of the work that we outsourced plus the benefit of the new work we're free to do that we couldn't before.  That brings us to this quote:
“Over the long sweep of American generations, we simply have not experienced a net drain of jobs to advancing technologies or to other nations.”
~ Alan Greenspan

This is one industry I'm going to look at in detail because it is a favorite for protectionist lies & propaganda.  What determines if America has a strong manufacturing sector?  The amount of things produced, or in technical terms "manufacturing output."  The more productively we can produce the higher wages become.  A backhoe operator can dig a hole much faster than a guy with a shovel.  That's why he's paid more.  So if we want a thriving manufacturing sector then we require those two things: more output and greater productivity.  
The quantity of people employed in manufacturing is irrelevant, and to consider why just remember that in 1776 some 85% of Americans were employed in agriculture and food shortages were commonplace.  As productivity improved year after year we eventually ended up in 2013 where less than 2% of the nation is employed in agriculture and we produce more food than we can eat.  The improvements in the manufacturing sector we're about to look at follow along those lines, I just wanted to give you another analogy to help you picture it.
Below is manufacturing output, and productivity is below that:
Figure 4.  Source: