An Open Letter on Economic Thought
The following is a partial reprint of a letter that I sent. It was in response to several economic inquiries.
What folows are some simple rules I use to scruinize the claims of politicians, bureaucrarts, and financial pundits.
Dear …..
In answer to some of your inquiries about healthcare and education, I find it best to give you some of the basic tools of logic that I use to investigate an economic problem. I am sure the answer to your questions lie within the context of what is written below.
The Austrian School of Economic thought is unique because it revives the idea of natural law and how these laws govern human action (economics). Natural forces, no different for example than gravity, dictate the manner in which we transact with one another. Fortunately, just like gravity, you do not have to a Ph.D in quantum physics to understand the concepts. A mathematical equation is not necessary to foresee what will happen when we jump from the 30th floor or why a plane falls out of the sky.
The same applies to the natural laws of economics. The economic maladies that you ask about are a result of people believing figuratively that the forces of gravity do not exist. In reality, politicians and government officials of every kind, including the Chairman of the Federal Reserve and the Treasury Secretary, run around believing that they can make natural forces disappear (except Ron Paul of course). The consequences for this faith can be as devastating as ignoring the laws recognized by Isaac Newton.
Standing in front of an economic classroom, I would lecture daily about the following concepts. Once comprehended and verified, these laws would reduce Keynesian and Monetarist economics to rubble. The following laws are what true economic investigation is built upon. The first law is absolute and upon what the others revolve around.
1. The Law of Scarcity. It is the keystone of economic thought. But the one most often ignored, which means any concept that avoids this principle is fraudulent. Resources of every kind, including land, labor, capital, and even time are finite. One note to be covered later is that money and capital is not the same thing. The use of the word has been totally prostituted by the press and politicos.
You know as an individual that you allocate your money among many wants and your activities against time. Like all other natural laws, what applies to you as an individual also applies to every other individual. Gravity does not distinguish between socioeconomic classes, sex, or body size, and neither do the laws of economics.
Some people believe they can extend their money by borrowing, but in reality all they are doing is using resources yet to come in the future. Having many needs to fulfill and limited resources, we must ration our wants against our ability to acquire.
2. The Law of Value. In rationing, we list our preferences for goods, including money, and non-goods (time, health, love). Human exchange is based upon trading something of less importance for something greater or as an economist would state it, we trade something of less value for something of greater value. When you work, in reality you are exchanging leisure time for money. In this example, time is less valuable to you than the money received. Going one step further, the money you earn is exchanged for groceries. Again, it can be stated that in this exchange you value something to eat more than money. It makes little sense to trade for something of less importance.
The important point is that the value of any item cannot be determined until a transaction takes place. We may view our time to be worth $1 million, but until someone actually forfeits that sum of money for our time, and then we are merely engaging in fantasy. In today’s environment, a house only has value when someone actually makes an exchange for it.
3. The Law of Opportunity Cost. Again this is one of the most ignored principles of economics and is direct derivative of the Law of Scarcity. Because of limited resources we must choose among many wants. Give a child fifty cents and let them walk through Knoke’s Candy Store. You will see the law of economics in action; so many yummy treat with only fifty cents in hand. If they choose the chocolate malted balls, then there will not be enough money left to buy the red licorice. The true cost of an item is not the money, but what other good has to be sacrificed.
When government spends money on grants to study cow farts, then something has to be sacrificed. Not noticeable are the tax dollars some family was forced to give up for this project and the little red bicycle that will not be under the Christmas tree.
Like a bad uncle, opportunity costs usually never see the light of day. Nevertheless, they do exist. We always hear the political wails over a special project and the harm that will be done if it is voted down. Nary is a word ever spoken about what is truly being sacrificed because of its passage.
The most disingenuous phrase ever used is one that uses the word “free” or it costs nothing.
4. The Law of Marginality. The easiest example of this law lies in the context of employment. We are employed in the free market because our labors produce more revenue to the company than our cost in wages and benefits. It is not rational to hire someone who will cost more than the revenues they generate. In essence, you would not trade $10 for $5.
As long as each additional employee generates more in revenue than they cost, companies will continue to expand. At the point where the marginal revenue of an additional employee equals the marginal cost, then employment expansion will cease.
Marginality also plays a part in consumer spending. We look for the best quality at the lowest price because it allows us to allocate more of our resources. We buy a Toyota instead of a like car from General Motors because we save a few thousand dollars that can be allocated elsewhere.
Mixed the business and the consumer together and you will see that firms must keep their marginal cost, the cost of producing additional items, to the minimum.
Additionally, any change to prices will cause an alteration in our individual preferences.
5. Subsidizing Causes Over Use. To see this law in action, go to the Friday night all you can eat buffet. In the all-you-can-eat fest, you will spy people who are normally controlled diners with plates piled high. Since no price restriction exists on the amount of food that a person can take, individuals can over indulge past the point of waste because any penalty in the form of shelling out more money has been removed.
At some point in time, the restaurant facing heavy demand may be forced to raise prices or discontinue the practice in order not to cannibalize the operation.
The same principle applies to healthcare or education. Both are subsidized by non-users where the true cost is not borne directly by the user. I would suspect that Friday night buffets are in some manner subsidized by diners eating on other nights.
The state of Hawaii last spring instituted universal health care for children under the age of 18. Seven months later the program was shut down due to over use. If continued, the program would have bankrupted the state. State officials were shocked at the demand. Why? Have they never been to a buffet?
State university systems and local school districts operate under the same principle where non-users through taxes subsidize the cost of the user. Since the student or their family do not bear the full brunt of the cost, education becomes a virtual smorgasbord of curriculum. At our local high school we have ten sections of food and fashion, Freshman Year initiative (God only knows what that is), classes on baby-sitting, and fly-fishing to name a few. Some of these classes have less than ten students in them. Why do they exist? Free food can bring out the strangest culinary items.
The demand for “free classes” drives the cost of the system up.
6. Take the Illogical to Its Logical Conclusion. A lot of economic myths exist today cloaked in mathematical deception. Sometimes the best counter-argument is to take a premise to its logical conclusion.
Proponents of the minimum wage tout its benefits of raising the standard of living. But using the concept of marginality, we can deduce that at a higher wage some people will become unemployable because the cost, which includes wages, benefits, and FICA tax, outstrip their productive benefits. Counter-intuitive to natural law, supporters of minimum wage will deny such possibilities.
If the minimum wage does not cause unemployment, then why set it at $10 per hour; why not make everybody rich and have the minimum wage be $1,000 per hour. If the standard of living can be raised without consequence, then why doesn’t Ethiopia or any poor country solve the despair by simply raising the minimum wage?
A little over two years ago, the City of Chicago thought gravity could be defied. Wal-Mart was looking to open some stores within the city of Chicago. The unemployed from some of the city’s downtrodden neighborhoods lined up for blocks to apply. Target was also planning expansion within the city limits.
The Chicago City Council passed a special minimum wage, I believe of $10/hr., for stores operating within the city boundaries. The outcome was predictable. Both Wal-Mart and Target canceled plans for expansion. The unemployed never got a chance to become productive. Statistics would show no effect on the City’s unemployment rate. But the underlying truth is that many people were denied a chance to be gainfully employed because of the ordinance.
I love this gem from Ron Paul the other day. He was being interviewed about his opposition to the bail-out plans. He of course rhetorically asked where the money was coming from. He stated that printing money has severe consequences. The journalist rebutted that Bernanke assured people that future inflation would not be a problem
Paul replied by taking the illogical down its logical path, if the printing of money does not have a consequence, then why don’t we print trillions upon trillions and distribute them among the people. That way everyone can retire and live the good life.
6. Solution Do Not Exist Only Trade-offs. Like fingernails on a chalkboard, I cringe every time a politician, bureaucrat, or financial pundit talk about solutions. Their phraseology or ideas totally dismiss the reality of natural economic law. Every action causes a chain reaction of infinite effects that may not become evident for some period of time. The surfacing of unknown outcomes is often referred to as unintended consequences.
Calls for healthcare plans, energy plans, education plans, and myriads of other government planning never include what the trade-off will be. When the government developed an energy plan that placed an emphasis on corn ethanol did it come with a warning that such a plan will cause higher food prices and even starvation in some areas of the world?
When the government imposed price controls for certain vaccines, did they warn us that the result would not only be lower prices, but also lower supplies?
Returning back to the sixth postulate, if planned economic activity is such a virtue, then why did Eastern Europe collapse? Or why was it that Chinese economic activity picked up only after some forms of capitalism were introduced.
Governmental pied-pipers call us to follow them to the cliff. Like Peter Pan’s pixie dust, they claim that their melodies will allow us to leap and never hit the ground below. But when we meet our demise at the end of a screaming fall, the pied-pipers will place the blame entirely on gravity.