Letter From America (About Essential Truths)

10 Essential Economic Truths Liberals Need to Learn

Jeffrey Dorfman

Forbes

5th June 2014

Jeffrey Dorfman teaches economics at the University of Georgia.  In this article he presents ten economic principles or verities, which, he says, "liberals" need to learn.  Synonyms for "liberal" would be "left wing", "progressive", or, in the case of New Zealand, an apt synonym would be "general population", such is our adulation of bad economic principles.

1) Government cannot create wealth, jobs, or income. Because government has to take money from somebody before it can spend it, there is no economic gain from anything the government does. Money collected in taxes or borrowed would have been either spent or invested in the private sector. Any jobs government claims to have created are only in place of other jobs the same money would have produced if people had been allowed to spend it themselves.

It is possible for government to own businesses which trade like any other company in the private sector.  These may make profits, can, therefore, grow in size and capital base and add jobs as a result.  These are truly exceptions to the general maxim that governments cannot create wealth, jobs or income.  And Dorfman's general point remains true: government enterprise comes into existence by expropriating property from citizens in the first place.  Governments are unable to create wealth from nothing; in the first instance governments must appropriate property from tax payers.  

2) Income inequality does not affect the economy. Poor people do spend more (or all) of their income while people with higher earnings save some of their income. However, saving is as good for the economy as consumer spending (or better). The basic identity is that national income equals consumer spending plus investment plus government spending on goods and services plus net exports. To make investments, money first must be saved; so savings contribute to national income, too. In fact, savings that lead to increased capital (a company borrows it to build a factory, for example) will lead to higher national income in the long run because the capital can produce income year after year.

3) Low wages are not corporate exploitation. In a free country, people voluntarily accept employment, so all workers believe their current job to be the best choice from among their opportunity set. If a business paid its workers much less than they were worth, a competitor would offer more and hire them away. As consumers, when we go shopping, we are happy to find low prices. We certainly do not go out of our way to pay more than we need to for things. Businesses are the same when they are buying labor; they do not pay more than they need to pay. Businesses exist to make profit, so a business will not, and should not, pay its workers more just because it has the profits available to do so. Workers get paid more only when they become more productive or when the price of what they make goes up. 

Whilst this is generally true, it must be qualified.  Where labour is in plentiful supply a different dynamic may operate.  In such a case, a worker may become more productive, but if he can be easily replaced by  many more equally productive workers, he is unlikely to get paid more. In fact he may lose his job to those who are prepared to produce the same or more for even lower wages.  

Such an outcome would be very hard upon the sacked worker.  But this cannot be regarded as exploitation, provided the same principle applies throughout the company.  If the CEO, for example, could be replaced by someone equal or better for a lower salary, the owners must act to fire the CEO.  Recently the successful CEO of a large New Zealand company publicly stated that he considered himself overpaid.  If that is true, there should be equally competent people who would be prepared to do the job for less, in which case the present incumbent should receive a paycut or  he should be replaced.  The efficiency of the company requires it.

The reality, however, is often very different.  A productive employee may be replaced by an equally productive employer for less, but there are always risks, transition costs, and intangible realities to consider.  The existing worker, for example, may be punctual, loyal, and harmonious in his or her relationships with colleagues and other staff. Such realities, whilst not easily calibrated in dollars and cents can be extremely valuable and contribute greatly to the productivity and success of the firm. 

4) Environmental over-regulation is a regressive tax that falls hardest on the poor. When we reduce pollution more than we should, worry about climate change more than we should, or over-restrict access to natural resources, prices go up. Because the poor spend a higher percentage of their income, forcing up prices is a bigger penalty on the poor. Blocking the Keystone XL pipeline is a perfect example of how environmental extremists are causing energy prices to be higher.

5) Education is not a public good. We provide publicly funded K-12 education to all (even to non-citizens), but the education provided produces human capital that is privately owned by each person. This human capital means more work skills, more developed talent, and more potential productivity. People with more human capital generally get paid more, collecting the returns from their education in the form of higher earnings. One common defense of education as a public good is worth refuting here. Yes, education helps people invent things that benefit society. However, they will expect to be paid for those inventions, not give them away for free in return for their education.


6) High CEO pay is no worse than high pay to athletes or movie stars. Yes, CEOs are paid a lot, maybe too much. The top professional athletes, television and movie stars, singers, lawyers, and hedge fund managers also all make lots of money. High CEO pay does not reduce the pay average workers get any more than high athlete pay means that the equipment manager gets paid less or the roadies on a Rolling Stones tour make less when the Rolling Stones make more. The high pay of CEOs, movie stars, and athletes all come out of the pockets of the owners of the business, movie studio, and team, respectively. Such pay reduces profits, but not the pay of other workers who are paid what they are worth in the marketplace. Shareholders have a right to complain about CEO pay, but other employees and labor activists do not.

7) Consumer spending is not what drives the economy. An extra dollar of investment, government spending, or net exports adds just as much to GDP as does a dollar of consumer spending. In fact, until recently, consumer spending was 65 percent of GDP (find an old economics textbook and look it up for yourself). Then, as savings fell beginning in the 1980s and consumer credit became more widely available and less expensive, consumer spending rose to 70 percent of the economy. This is actually a bad thing. Robert Solow, who won a Nobel Prize in Economics, showed that nations are the wealthiest in the long run if they save a share of their income known as the Golden Rule Savings Rate. This is tricky to estimate, but all economists are sure that the U.S. is well below it. So if we save more and spend less of our income, our children and grandchildren will be better off.

8) When government provides things for free, they will end up being low quality, cost more than they should, and may disappear when most needed. Public education, free health care, welfare programs; does anybody think these programs are high quality, reliable, and have no waste in their budgets? Most states fund the majority of their technical and community college programs. Thus, in the recent recession, right when lots of people wanted to get some new job skills, technical and community colleges had to cut their budgets and offer fewer classes. The freebie disappeared at just the wrong time. The sad reality is: when the customer does not pay, the product is rarely any good.

The economic reality is that government owned and operated enterprises, whether schools, hospitals, or electricity generators, do not have customers to win, satisfy and retain, and usually face very little, if any, competition.  They thus lack the two key disciplines to force efficiency and excellence into the operation. 

9) Government cannot correct cosmic injustice. Esteemed economist Thomas Sowell wrote a fabulous book on this topic. Nobody likes to see cosmic injustice: kids with serious health problems through no fault of their own, families whose homes are destroyed in natural disasters, etc. However, when government steps in to correct a cosmic injustice, the price must be paid by someone else—a someone else who had nothing to do with causing the injustice being addressed. Thus, every time government fixes or eases a cosmic injustice, it creates a new one by sticking somebody with the bill—either a financial one or one measured in some other sort of cost. For example, each affirmative action college admission by definition mean some other applicant must be turned down. We may be willing, as a society, to bear an injustice in order to fix some cosmic injustices (e.g., many will willingly chip in to pay for a child’s medical care), but we cannot create a world free from all cosmic injustice.

10) There is no such thing as a free lunch. In America today the number of free lunches being served is at an all-time record high. People on food stamps, households receiving a government check of some kind, the number of people collecting disability, need-based financial aid for college expenses; all either hit highs recently or are at all time highs right now. Yet, somebody is paying that bill; no free lunch is really free. This is true more broadly about all regulations that promise to provide us with something good; the costs are lurking somewhere in the background. Raising the minimum wage does not just take money out of employers’ pockets, but also raises prices for all customers and will cost some low-wage workers their jobs. If we protect voting rights, we get more voter fraud. If we help underwater homeowners, it will be harder for future borrowers to get a mortgage. Sooner or later, those free lunches get paid for and often the bill lands in an unexpected or unintended place.

Liberals love to talk about their compassion. Compassion is great, but no amount of caring can repeal the simple facts of economics. It is fine to support raising the minimum wage, but understand that jobs will be lost and prices will rise. Protecting the environment is a wonderful thing, but it is also expensive and hurts the poor in particular. Politicians love to claim the government spending which they direct creates jobs, but it only moves jobs from one place to another. Greedy businesses cannot exploit workers because another greedy business would be happy to exploit them a little less until greed removed all the exploitation.