About that Economic Inequality

I address this essay to two groups. One group is those among the liberty movement, who believe that there’s nothing wrong with inequality. These are often Objectivists, who unknowingly defend a regime that artificially suppresses working people. The other group is those among the Left who still call themselves liberals. They say they don’t like inequality, but nevertheless continue to support this regime, and they often demand more of its interventions.

I am talking, of course, about our regime of the Federal Reserve and its zero-interest policy.

I have written before about how falling interest rates have pushed up the prices of stocks, bonds, and real estate (also artwork, antique cars, etc.) This is seemingly good for those who own capital assets (it’s not, but go try to tell someone it’s not good that his house doubled). At the same time, falling interest causes falling wages if not mass layoffs.

In other words, the Fed drives down interest. This drives up asset prices and drives down wages. The minority who own assets seemingly get richer (an illusion) and everyone else suffers.

That is not the only way that falling interest rates cause inequality. Nor is it the only way that it targets certain groups for greater harm than it brings to others. Consider that zero interest makes it impossible to save. I don’t mean hard to save. I don’t mean excuse-making for lazy people who don’t plan for their futures. I mean impossible in the full context. Let me explain.

When I started my career in 1990, the standard advice was to set aside 10% of your salary and put it in the bank. By the time you reached 65, you would have a big nest egg. The key to this strategy was earning interest. Every bank had brochures showing that by age 65 most of your nest egg would be the accumulation of compounded interest.

Let’s put it in human terms. Suppose you’re a young worker, just starting out. You make the median income of $52,000 a year. You set aside 10% of your gross paycheck before tax. Over 45 years, your salary set-aside adds up to $234K.

Back in 1990, a 1-year Certificate of Deposit paid 8.1 percent. At this rate, you would have about $2.4M by the time you retired at age 65. Over 90% of that total is the compounded interest.

However, today, the same 1-year CD yields less than ¼ percent. At this scant rate, you can expect to have only $246K. Over your entire career. Of that sum, just $12,000 is interest. Let that sink in.

Needless to say, $246K is not enough to live in retirement. If you can’t keep working, you’re going to have to go on the dole. And this leads us to an underappreciated point.

Business consultants, writers, deal makers, and many other white-collar professionals can easily continue to work for 10 or 20 years past the conventional retirement age. So long as you’re healthy, why not keep working? Aside from the money, it gives you something to do, keeps your mind engaged, and you’re contributing to society.

However, there are many jobs where you cannot keep working. Think about brick layers, plumbers, and roofers. These jobs both take a toll on the body and demand more than most 75-year olds can give. Whereas a business consultant may continue to grow his network and expertise even as he gets older, a worker in a physical job is slowing down as well as wearing out.

There is never a good reason for government to intervene and attempt to prevent people from experiencing the consequences of their actions (whether good or bad). Many of those crying about income inequality, just use it as a rationalization to move America down the socialist road.

That said, there is an inequality problem. It is not due to lack of government intervention, as the socialists would have you believe. It cannot be cured by yet more taxes and interventions. Its cause is intervention. I refer to the most pernicious and least-appreciated kind of intervention.

Monetary policy.

You Didn’t Build That!

“There is nobody in this country who got rich on his own — nobody.” – Elizabeth Warren, campaign speech 2011

“If you’ve got a business – you didn’t build that. Somebody else made that happen.” – Barack Obama, campaign speech 2012

The Left is clear about their view. You do not get credit, and you do not own your business by right. When the government taxes you, taxes you some more, regulates you, and licenses you, it has the right. Because you didn’t build that.

As with so many issues, the Right seemingly opposes the Left. Certainly, there was outrage at the outright, open expressions of communist ideology from Warren and Obama. But let’s drill a bit deeper. Let’s look at a litmus test to see if conservatives really believe that you own your business. Or perhaps they accept that you are a mere steward of the people’s resources, for the good of the people.

Can you hire or not hire anyone? After all, if you did build that, then it’s yours by right. And as a matter of right, you can decide who to hire. Right?

Not so fast. Here is what President George Bush, considered to be a conservative, said at the signing of the Americans With Disabilities Act in 1990.

“It will guarantee fair and just access to the fruits of American life which we all must be able to enjoy.”

This is a law forcing businesses to do what they did not agree to do. Who built that business again, Mr. Bush? But this conservative does not think that way. He thinks of it as “access” to the “fruits of American life.”. Access to what? Fruits grown by whom, Mr. Bush??

He continued:

“And then, specifically, first the ADA ensures that employers covered by the act cannot discriminate against qualified individuals with disabilities.”

Clearly a mere steward has no right to hire based on his own preferences.

Then he made it even more clear:

“Second, the ADA ensures access to public accommodations such as restaurants, hotels, shopping centers, and offices.”

Who built that? No matter! Mr. Bush declared your business to be “public accommodations.” And in his view, it’s the role of the government to grant people “access”—to force you to give it to them. How far is the view of Mr. Bush from that of Ms. Warren and Mr. Obama?

OK who else, aside from the Conservatives and the Left, thinks you didn’t build that? Consider the following recent dialog:

“If we discriminate on the basis of religion, to me, that’s doing harm to a big class of people.” – politician
“The Jewish baker should have to bake the cake for the Nazi wedding?” – Moderator
“That would be my contention.” – politician

The politician is, of course, Libertarian Gary Johnson. He does not necessarily think that you built that business any more than Bush thinks it or Obama thinks it. Johnson sees the question in terms of whether “we” should discriminate.

Who is this “we”? One is left to conclude that he means those people who really built your business. The public, presumably.

The Left may be more brazen, more willing to go there, more shameless in taking your business away from you. First in theory, morally, by declaring that you are not a creator or hard worker or whatever it takes to build a business. The in practice, by setting no limits to taxation, regulation, permits, and compliance.

However, the Right and even the Libertarians are on board the same boat. They may stick to humanitarian imagery. They typically prefer to couch their desire to control your business in more palatable terms. But government control of your business stinks all the same.

At root, it necessarily comes back to the same principle. The only way to justify coercing you to “grant access”, the only justification to force a Jewish baker to serve a Nazi cake, is on grounds that it’s not really yours.

You didn’t build that, so shut up and let the government manage it for the benefit of others!

 

This essay is a followup to my previous post, Antidiscrimination Law.

Antidiscrimination Law

“We need to make it illegal for companies to discriminate.” This applies to employees, and even customers.

Well, either such discrimination—really bigotry—is good for the company, or it isn’t. Either companies benefit from racial or gender preferences in employees, or they don’t. Either bakers benefit from turning away paying customers who want cakes, or not (without discussing those rare cases where someone wants to force the baker to bake a cake with a hateful message on it).

If you believe that corporate decisions made by bigotry are good for companies, then that would seem to justify laws to ban it. Well, it would justify it if you believe that the proper purpose of law is to force people to act against their own interest for the sake of someone else’s good…

…Wait, why is it in the interest of employers to fire the blacks (to name one legally protected group)? If you want go there, then realize that there is no way to make this case without promoting overt racism. Think about it. Take as long as you need.

Perhaps you believe that corporate decisions made by bigotry are not good for companies. Then why the need for a law at all? Do you seriously argue that people need to be forced to use cars rather than horses, to use computers rather than do their books using paper ledgers, and to live in houses rather than be exposed to the elements? Self-interest is its own motivator.

And if the purpose of this law is to help companies, how do you justify fining them, punishing them, and or even bankrupting them?

Antidiscrimination law is entirely uncontroversial. It’s universally supported by the Left, nearly universally on the Right, and even some Libertarians promote it. Yet it’s based on logic so flawed that in a rational culture that actually taught logic in school, middle school students would all be able to write essays explaining why such law is contradictory.

Everyone supports it, yet it’s simple to show it’s bad. Hmm, think about that for a while.

Regulation, Thy Nature is Flawed

Regulation has several inherent flaws.

1. One agency acts as legislative, judicial, and executive branch. It makes the rules, decides who is breaking them, and punishes offenders.

2. Regulation is based on the doctrine of prior restraint. Instead of retaliating by force against criminals, the government initiates the use of force against innocents–because they might commit a crime. So it criminalizes non-crimes.

3. Regulation forces businesses to prove a negative–often at great expense.

4. It ossifies the status quo. It is easy (well relatively) to get permission to do the same thing that everyone else is doing. Much harder to get permission to change how business is done.

5. It is an engraved invitation for cronies to use regulation and regulators to suppress competitors.

6. It gives the unscrupulous a place to hide. Bernie Madoff was highly regulated. Regulation didn’t stop him.

7. It prevents startups from forming in the first place (doubly so because raising capital is itself highly regulated, and startup founders don’t typically have the capital and legal sophistication to navigate the regulations).

8. Regulation makes it impossible to know in advance what is legal and what is not. This is because regulation attempts to control actions A, B, and C in an indirect way to prevent crime X. So it can make arbitrary distinctions between two essentially similar things–but one is illegal.

9. Regulation makes it illegal for you to do something that someone else can do legally.

Should Government Give Us the Infrastructure?

An argument against absolutely free markets comes up often. What about so called natural monopolies? So called infrastructure (e.g. sewage plants) have high barriers to entry, and are a challenge to true competition. Therefore if left to private companies, they would become bad monopolies. So it is best for government to provide them.

I think there are answers on several levels.

  1. Moral. The argument is saying that men need to be forced, like brutes. Horses will do no work unless harnessed, and led around by a bit in their mouth (if not whipped). Haven’t we proven beyond a shadow of a doubt that this is wrong?
  2. Economic. The question of how men coordinate their actions–how they CAN coordinate–is one of the major questions of economics. The answer is: each must pursue his own interest, which in an economics context means profit. Pursuit of profit and only this pursuit leads men to work together. Adam Smith may have used an unfortunate phrase “the invisible hand”. I describe in my dissertation the mechanics of it. But no matter how you slice it, economics is about people coordinating based on their individual interests and individual knowledge. Central planning is about the negation of coordination, and the destruction of economics as such.
  3. Scope. There is an analogy to when people demand of philosophy to explain the latest observation from astronomy or a particle accelerator. It is outside the scope of philosophy. It is not the job of the philosopher to answer what it means when you see a super massive black hole. Similarly, it is not the job of the economist to envision every business model in a free market. It is the job of a million entrepreneurs, each developing his own unique business model. Indeed, economists often make lousy entrepreneurs.
  4. The 8th grader. I love using the standard of a precocious 13 yr old. “So you’re saying that government is smarter than the people, and only government is smart enough to figure out how to build a sewer!?”

Look Beyond Supply and Demand to Understand Labor

We’re all familiar with the Law of Supply and Demand. There is a supply curve that goes up as price goes up, and a demand curve that goes down as price goes up. It’s often drawn like this:

Supply and Demand

 

Using this idea, one would expect immigration to cause wages to fall. It seems obvious. Increasing the supply of labor will push the equilibrium price down. Won’t it?

Not so fast. At best, Supply and Demand is an approximation. If the market were frozen in time and all variables were somehow fixed except supply, then sure, a rising supply of workers would cause a falling price of labor. Maybe. I call this kind of thinking the most common economic error. Just how are we to freeze the economy the way a camera freezes a scene, and yet change that very economy by adding more workers?

There is no such thing as Economic Photoshop.

Static thinking is tempting because it’s easy and seems to appeal to common sense. To borrow a phrase coined by Wolfgang Pauli, it’s not even wrong.

As with every kind of aggregate quantity that economists like to measure, supply and demand are not forces that impel market participants. Hiring managers don’t input the quantity of workers into an equation, and get the wage from that. They’re concerned with something quite different, and much easier. They want to make a profit.

Suppose a worker can make 10 hamburgers an hour. The non-labor costs add up to $3.50, and the customer is willing to pay $5.00. A simple calculation tells the manager that a worker will generate $15.00 per hour ($5.00 – $3.50 = $1.50 x 10). He therefore cannot pay more than $15, or even close to that. He has to offer at least $8 to attract workers. That leaves him a tight profit margin because there are work breaks and slow times during the day.

The supply-and-demander will at this point demand, “well if you add more workers competing for the same job, won’t the hiring manager be all too happy to pay less than $8?” That’s the same fallacy I described above. It presumes that we can hold constant the number of restaurants, burger-eating consumers, and even the percentage meals people eat out. We cannot presume that we can change only the number of workers.

Labor doesn’t work as the so called Law of Supply and Demand predicts. America once had by far the greatest immigration, and at the same time it had by far the fastest wage gains. To understand why, we have to look at what supply demand is trying to approximate.

Marginal utility.

Let me explain. The first unit of a good is bought by the consumer who places the highest value on it. For example, bakeries have long bought wheat to make bread. No higher use of wheat exists than eating it. We need food to live.

When farmers increased efficiency and output, then pet companies could put wheat into dog food. With further price cuts, home decor companies could put wheat into wallpaper paste. As it gets cheaper still, toymakers could make it into a sculpting material for toddlers. And so on (these examples are just my suppositions, so take then with a grain of salt).

The price of wheat is set by this marginal user, because that’s the buyer who will walk away on the first uptick. In other words, the price of wheat is what the maker of Play-Doh can afford to pay.

If farmers can produce even more and sell it to the market, who knows what the next lower use of wheat is? Maybe someone will make recyclable boxes out of it.

The principle for every commodity is the same. As more is produced, the price has to drop to accommodate the next lower use. The marginal utility of wheat declines. So does the marginal utility of copper, crude oil, iron ore, and every other commodity (except gold, but that’s a whole ‘nother discussion).

People say that the price has to fall to find a new equilibrium on the demand curve, but they do not see the cause, declining marginal utility. They see only the effect.

This brings us to human labor. Is work like wheat, descending from high uses to ever-lower uses?

No.

The exact opposite is true. Before the Industrial Revolution, the vast majority of people worked as laborers in agriculture. The work was not only back-breaking, but offered very low value. Ever since then, developed economies have employed more and more people. But they are not employed in lower and lower jobs for them (question: what’s lower than mucking out a stall for a horse?) They are employed in higher and higher jobs. Work is so advanced today, we produce such high value products, that people from the 18th century could not have even imagined it.

The marginal utility of human work does not diminish, as the number of workers increases. As the size of a market grows, the value of firms and workers within it rises.

Why Does the Left Support Wall Street?

The rhetoric from the Left is intransigent in its denunciation of wealth. As long as someone is wealthy, there is inequality. This is because there has always been and will always be someone who is poor. So the very existence of a rich man serves as a rebuke to the Left’s worldview, and a fly in the social justice ointment.

However, Leftists in power behave differently than their rhetoric would lead us to expect. They enact legislation and regulation which actually helps enrich crony businesses, such as big banks. The common refrain is that these politicians are corrupt, and on the take. Wall Street is simply buying their favor.

While this is true to some extent—certainly Wall Street spends a lot on lobbying—it’s not a satisfying answer. How do we fully explain the seeming anomaly between ideas and action on the Left?

It is no anomaly at all. To see why, look at it from the Left’s point of view. It has to be frustrating when the voters reject the policies of Marxism. Unlike in many other parts of the world, the American people do not hate wealth—not yet. If you were a Leftist, how would you go about changing this?

Even today, many Americans if not most of them, feel at a basic gut level that if you work hard you can get rich, and you deserve it. The Left has to find a way to undermine this. The Left wants to migrate Americans to the attitude held in socialist countries: the feeling that if someone is rich then he must be on the take.

If you wanted to devise a strategy to get the population on board your socialist agenda, I can think of no better way than to create a class of very rich people who get their riches off the backs of the people. Create thousands of real-life fat cats whose villainy is infamous. Show the people that this is what it means to be rich: to be on the take. That the rich do not produce, but amass a fortune at the expense of others, at your expense. Put that in the public spotlight.

Once the voters believe this, deep down in their hearts, it’s over. The free market is done. Stick a fork in it. Support for the rights of property or contract will fade away. Then, the path is paved for some kind of socialist takeover and totalitarianism.