Posts
From today's Open Europe news summary:
In the Telegraph, Ambrose Evans-Pritchard argues that, with the eurozone crisis seemingly turning to Spain and Italy, “Germany must now be willing either to buy or guarantee Spanish and Italian debt, and in doing so to cross the Rubicon to fiscal and political union, or accept that EMU must break up with calamitous consequences for German foreign policy. Large matters, beyond the intellectual vision of Germany's current leaders.”
Germany--and the rest of the world, for that matter--must face up to the fact that debt, once created, cannot be ignored. It must be repaid or written off. It is time for the world to recognize that more debt solves nothing and, in fact, is counter-productive. More debt forestalls reform and funds the failed inflationist and statist policies of the post-war years. I hope that Evans-Pritchard is wrong and that these matters are not beyond the intellectual vision of Germany's current leaders. The Euro project is a failure due to economic laws that cannot be ignored. Fiat, government controlled money is a failure at the national level; elevating it to a regional level solves nothing but merely masks the inherent fatal flaws.
Tuesday, July 12, 2011
Monday, June 13, 2011
The Fed Recruits Academia to Its "Brave New World"
On June 1, 2011 John C. Williams, president and CEO of the Federal Reserve Bank of San Francisco, delivered an address to the American Economic Association’s National Conference on Teaching Economics and Research in Education. He titled his address “Economics Instruction and the Brave New World of Economic Policy”. One wonders if Mr. Williams ever read Aldous Huxley’s chilling book, warning the world of the threat to individual freedom by a tyrannical one-world state. If he had I doubt that he would have included “Brave New World” in the title of his speech.
But perhaps he selected this title on purpose! For Mr. Williams’ speech was an unvarnished plea to recruit academia as co-conspirators to spread as economic truth the Fed’s latest, make-it-up-as-we-go-along, and increasingly panicking monetary interventions masquerading as well-thought-out policy. The speech was nothing less than an admission that the Fed’s monetary theories have failed, that it is experimenting with new ones, and that it wants academia to endorse whatever its latest policy experiments happen to be and incorporate them into college curricula! Here are his very words:
“We depend upon educators like you to explain how the Fed works and how our policies affect the economy. We all benefit when the public understands what we do and why, so we are very grateful for the work you do.”
A 1950s Grocer’s Account Book vs. a 2011 Credit Card Authorization
Mr. Williams launched into a rather disjointed defense of the reasons that the Fed had to employ new monetary policy tools. (Of the twelve policy tools on the Fed’s own website, Mr. Williams proudly proclaimed that nine of them did not exist four years ago.) I bet you didn’t realize that one reason monetary policy had to change was due to advances in the payment system. It seems that our ability to use debit and credit cards for purchasing goods and services has made traditional monetary aggregates obsolete. Again, in his own words:
“How do 1950s theories of cash and checks apply in a world in which you and I can instantly take out a loan of several thousand dollars with the swipe of a card at the cash register?”
It is obvious that Mr. Williams has never read Ludwig von Mises’ The Theory of Money and Credit. In Mises’ first great book he explains the differences between money and credit; thus, the name. Money represents final payment beyond which there is no recourse; credit must be satisfied via money. I’m certain that Mr. Williams would be surprised to learn that in early 1950s America credit was granted just as rapidly at some retail counters as it is today. Back then it was common for housewives to buy groceries on credit. The neighborhood grocer recorded the housewife’s almost daily purchases in a book kept under his counter. The transaction took less than a few seconds. Housewives settled their grocery accounts after their husbands were paid, usually in cash, at the end of the week. These credit transactions did NOT affect the money supply any more than do today’s credit card transactions. Furthermore, Mr. Williams may be surprised to learn that the debt card is simply “an electronic check”; it embodies all the legal risks and protections of a paper check. Of course, paper checks have been around long before 1950!
Next Mr. Williams bemoans the failure of some cherished monetary theories, such as the breakdown in the link between additional reserves and a growing money supply via the money multiplier. The volatility of the velocity of money gives him the vapors. Both theories assume that there is a mathematical linkage between the quantity of reserves, the quantity of money, and GDP. The thinking is thus--increase reserves, observe an increase in money; increase money, observe an increase in GDP. But, according to Mr. Williams:
“Despite a 200% increase in the monetary base—that is reserves plus currency—measures of the money supply have grown only moderately...(the) mechanical link between reserves, money supply, and ultimately inflation no longer hold…”
Driving down the interest rate hasn’t worked either.
“…model simulations recommended setting the feds funds rate below zero…”
So, what to do? Let’s try quantitative easing! The Fed bought $1.7 trillion in assets (many of dubious value), starting in late 2008 and will have added an additional $600 billion by June of this year. According to Mr. Williams, this is working. Based upon his “econometric analysis and model simulations…GDP will go up by three percent and the economy will add three million jobs…” Yes, this must be true--his econometric models say so, and who are we to argue with an econometric model? All of this nonsense would have been enough to get Mr. Williams laughed out of any Mises Circle gathering.
Defining “Growth” as an Increase in GDP
Embodied in Mr. Williams speech is the assumption that an increase in GDP represents an increase in economic output. That is why the Fed is unconcerned about inflation (what we Austrians call “rising prices”) and more concerned about deflation (what we Austrians call “falling prices”) If there really is some link between money and economic output via a money multiplier, then increasing money is as simple a way ever invented to bring on prosperity. (By this reasoning, Zimbabwe was tremendously prosperous.) So if prices rise by five percent and people are buying the same volume of goods and services, then according to the Fed the real economy improved by five percent. If it doesn’t happen—that is, if measured GDP fails to increase by five percent--then the government must deficit spend and the Fed must provide the funds at zero interest. As the Staples ad says, That was easy!
Of course, the Fed’s fixation with nominal GDP is the problem. As Jesus Huerta de Soto masterfully explains in Money, Bank Credit, and Economic Cycles, nominal GDP measures only final sales, and the majority of sales are NOT final sales but intermediate sales between companies. In fact a growing economy in which people extend their time preference, save more, and consume less may actually record a falling GDP! The structure of production is widened and lengthened, meaning that there are more stages of production and each stage gets larger. But GDP does not measure these intermediate stages.
Furthermore, in a sound money environment GDP would be flat to perhaps slightly rising, because real money—that is, commodity money such as gold—increases very slowly. Yet economies can boom with increased real production; prices fall, meaning that an unchanged volume of money simply does more work. But we see the political problem here. Nowhere in this real world is there a need for a central bank manipulating money. In fact, money manipulation by a central bank can cause only mischief, as explained so eloquently by Mises, Hayek, Rothbard, Huerta de Soto, and many, many others of the Austrian school. But don’t expect to hear that from the likes of Mr. John C. Williams or, unfortunately, many college professors attending the AEA conference. Austrian monetary theory is just too difficult for them; they’d rather reside in the Fed’s Brave New World and take a Soma Holiday.
But perhaps he selected this title on purpose! For Mr. Williams’ speech was an unvarnished plea to recruit academia as co-conspirators to spread as economic truth the Fed’s latest, make-it-up-as-we-go-along, and increasingly panicking monetary interventions masquerading as well-thought-out policy. The speech was nothing less than an admission that the Fed’s monetary theories have failed, that it is experimenting with new ones, and that it wants academia to endorse whatever its latest policy experiments happen to be and incorporate them into college curricula! Here are his very words:
“We depend upon educators like you to explain how the Fed works and how our policies affect the economy. We all benefit when the public understands what we do and why, so we are very grateful for the work you do.”
A 1950s Grocer’s Account Book vs. a 2011 Credit Card Authorization
Mr. Williams launched into a rather disjointed defense of the reasons that the Fed had to employ new monetary policy tools. (Of the twelve policy tools on the Fed’s own website, Mr. Williams proudly proclaimed that nine of them did not exist four years ago.) I bet you didn’t realize that one reason monetary policy had to change was due to advances in the payment system. It seems that our ability to use debit and credit cards for purchasing goods and services has made traditional monetary aggregates obsolete. Again, in his own words:
“How do 1950s theories of cash and checks apply in a world in which you and I can instantly take out a loan of several thousand dollars with the swipe of a card at the cash register?”
It is obvious that Mr. Williams has never read Ludwig von Mises’ The Theory of Money and Credit. In Mises’ first great book he explains the differences between money and credit; thus, the name. Money represents final payment beyond which there is no recourse; credit must be satisfied via money. I’m certain that Mr. Williams would be surprised to learn that in early 1950s America credit was granted just as rapidly at some retail counters as it is today. Back then it was common for housewives to buy groceries on credit. The neighborhood grocer recorded the housewife’s almost daily purchases in a book kept under his counter. The transaction took less than a few seconds. Housewives settled their grocery accounts after their husbands were paid, usually in cash, at the end of the week. These credit transactions did NOT affect the money supply any more than do today’s credit card transactions. Furthermore, Mr. Williams may be surprised to learn that the debt card is simply “an electronic check”; it embodies all the legal risks and protections of a paper check. Of course, paper checks have been around long before 1950!
Next Mr. Williams bemoans the failure of some cherished monetary theories, such as the breakdown in the link between additional reserves and a growing money supply via the money multiplier. The volatility of the velocity of money gives him the vapors. Both theories assume that there is a mathematical linkage between the quantity of reserves, the quantity of money, and GDP. The thinking is thus--increase reserves, observe an increase in money; increase money, observe an increase in GDP. But, according to Mr. Williams:
“Despite a 200% increase in the monetary base—that is reserves plus currency—measures of the money supply have grown only moderately...(the) mechanical link between reserves, money supply, and ultimately inflation no longer hold…”
Driving down the interest rate hasn’t worked either.
“…model simulations recommended setting the feds funds rate below zero…”
So, what to do? Let’s try quantitative easing! The Fed bought $1.7 trillion in assets (many of dubious value), starting in late 2008 and will have added an additional $600 billion by June of this year. According to Mr. Williams, this is working. Based upon his “econometric analysis and model simulations…GDP will go up by three percent and the economy will add three million jobs…” Yes, this must be true--his econometric models say so, and who are we to argue with an econometric model? All of this nonsense would have been enough to get Mr. Williams laughed out of any Mises Circle gathering.
Defining “Growth” as an Increase in GDP
Embodied in Mr. Williams speech is the assumption that an increase in GDP represents an increase in economic output. That is why the Fed is unconcerned about inflation (what we Austrians call “rising prices”) and more concerned about deflation (what we Austrians call “falling prices”) If there really is some link between money and economic output via a money multiplier, then increasing money is as simple a way ever invented to bring on prosperity. (By this reasoning, Zimbabwe was tremendously prosperous.) So if prices rise by five percent and people are buying the same volume of goods and services, then according to the Fed the real economy improved by five percent. If it doesn’t happen—that is, if measured GDP fails to increase by five percent--then the government must deficit spend and the Fed must provide the funds at zero interest. As the Staples ad says, That was easy!
Of course, the Fed’s fixation with nominal GDP is the problem. As Jesus Huerta de Soto masterfully explains in Money, Bank Credit, and Economic Cycles, nominal GDP measures only final sales, and the majority of sales are NOT final sales but intermediate sales between companies. In fact a growing economy in which people extend their time preference, save more, and consume less may actually record a falling GDP! The structure of production is widened and lengthened, meaning that there are more stages of production and each stage gets larger. But GDP does not measure these intermediate stages.
Furthermore, in a sound money environment GDP would be flat to perhaps slightly rising, because real money—that is, commodity money such as gold—increases very slowly. Yet economies can boom with increased real production; prices fall, meaning that an unchanged volume of money simply does more work. But we see the political problem here. Nowhere in this real world is there a need for a central bank manipulating money. In fact, money manipulation by a central bank can cause only mischief, as explained so eloquently by Mises, Hayek, Rothbard, Huerta de Soto, and many, many others of the Austrian school. But don’t expect to hear that from the likes of Mr. John C. Williams or, unfortunately, many college professors attending the AEA conference. Austrian monetary theory is just too difficult for them; they’d rather reside in the Fed’s Brave New World and take a Soma Holiday.
Tuesday, May 31, 2011
My Letter to the Wall Street Journal re: Cyber Combat: Act of War
From: patrickbarron@msn.com
To: wsj.ltrs@wsj.com
Subject: Re: Cyber Combat: Act of War
Date: Tue, 31 May 2011 06:01:53 -0400
Re: Cyber Combat: Act of War
Dear Sirs:
Despite the Pentagon's assessment of the threat from cyber warfare, it is up to Congress to declare war (Article I, Section 8 of the Constitution). In our constitutional republican form of government the military is strictly subservient to civilian authority via the president as commander in chief (Article II, Section 2 of the Constitution). Needless to say, the president may not delegate an authority that he does not possess.
Patrick Barron
To: wsj.ltrs@wsj.com
Subject: Re: Cyber Combat: Act of War
Date: Tue, 31 May 2011 06:01:53 -0400
Re: Cyber Combat: Act of War
Dear Sirs:
Despite the Pentagon's assessment of the threat from cyber warfare, it is up to Congress to declare war (Article I, Section 8 of the Constitution). In our constitutional republican form of government the military is strictly subservient to civilian authority via the president as commander in chief (Article II, Section 2 of the Constitution). Needless to say, the president may not delegate an authority that he does not possess.
Patrick Barron
Friday, May 27, 2011
My Letter to National Review re: Too Big to Win, by Mark Steyn
Nobody assimilates so much diverse information and finds the common thread better than Mark Steyn. And nobody writes with such wit and style.
Here is my two-cents' worth of insight into why the U.S. hasn't won a war in two-thirds of a century:
There is a link between the advent of central bank-produced fiat money and war. Prior to 1913 the U.S. did not fight a foreign war, with the exception of the brief Spanish-American War, which Professor Ralph Raico has shown to be a trumped up affair with the U.S. taking over a tottering Old World power's colonial empire. With almost unlimited access to the nation's resources through its power to monetize the debt via the Fed, the federal government does not have to go to the people or the peoples' representatives to get the money to wage war. This has two serious problems. One, we fight at the drop of a hat anymore and, two, we do not fight to win...which would mean a shorter, cheaper war. So, to answer Mark Steyn's question about why we fight so badly, we do not have to win or even have a strategy to win, because the funding will continue as long as we do not lose. As for the U.S. spending 43 percent of the world's military budget, I believe this reflects the enormity of the waste and corruption at the federal level. It is similar to claiming that we are serious about the war on poverty, because we throw so much money down the welfare rat hole. Everyone knows that the war on poverty is a failure, yet the funding continues. Take the Air Force's "new" F-35. It has been under development by Lockheed for years, yet its projected operational date is still six or seven year away...and I'll bet dollars (for what they are worth) to doughnuts that that date will be extended. So procuring much needed new military hardware has become a very well-paying welfare assignment for top federal officials, top Air Force officers, and, of course, military contractors like Lockheed. All know that the funding will continue, despite their failure to produce. The Fed sees to that. So, they don't produce. The private sector would have fired everyone long ago and found a different way to procure military resources.Patrick Barron
Here is my two-cents' worth of insight into why the U.S. hasn't won a war in two-thirds of a century:
There is a link between the advent of central bank-produced fiat money and war. Prior to 1913 the U.S. did not fight a foreign war, with the exception of the brief Spanish-American War, which Professor Ralph Raico has shown to be a trumped up affair with the U.S. taking over a tottering Old World power's colonial empire. With almost unlimited access to the nation's resources through its power to monetize the debt via the Fed, the federal government does not have to go to the people or the peoples' representatives to get the money to wage war. This has two serious problems. One, we fight at the drop of a hat anymore and, two, we do not fight to win...which would mean a shorter, cheaper war. So, to answer Mark Steyn's question about why we fight so badly, we do not have to win or even have a strategy to win, because the funding will continue as long as we do not lose. As for the U.S. spending 43 percent of the world's military budget, I believe this reflects the enormity of the waste and corruption at the federal level. It is similar to claiming that we are serious about the war on poverty, because we throw so much money down the welfare rat hole. Everyone knows that the war on poverty is a failure, yet the funding continues. Take the Air Force's "new" F-35. It has been under development by Lockheed for years, yet its projected operational date is still six or seven year away...and I'll bet dollars (for what they are worth) to doughnuts that that date will be extended. So procuring much needed new military hardware has become a very well-paying welfare assignment for top federal officials, top Air Force officers, and, of course, military contractors like Lockheed. All know that the funding will continue, despite their failure to produce. The Fed sees to that. So, they don't produce. The private sector would have fired everyone long ago and found a different way to procure military resources.Patrick Barron
Sunday, May 22, 2011
My Letter to the Wall Street Journal--re: There's No Such Thing as "Natural Unemployment"
From: patrickbarron@msn.com
To: wsj.ltrs@wsj.com
CC: jeremyg@fins.com
Subject: No Such Thing as "Natural Unemployment"
Date: Sun, 22 May 2011 07:14:51 -0400
Re: Jobs Harder to Find as Natural Unemployment Shifts
Dear Sirs:
There is no such thing as "natural unemployment". Government interventions and union coercion create "artificial unemployment" by denying all to work at the price that they and their potential employers would agree. The only true scarcity is the scarcity of labor.
Patrick Barron
To: wsj.ltrs@wsj.com
CC: jeremyg@fins.com
Subject: No Such Thing as "Natural Unemployment"
Date: Sun, 22 May 2011 07:14:51 -0400
Re: Jobs Harder to Find as Natural Unemployment Shifts
Dear Sirs:
There is no such thing as "natural unemployment". Government interventions and union coercion create "artificial unemployment" by denying all to work at the price that they and their potential employers would agree. The only true scarcity is the scarcity of labor.
Patrick Barron
Wednesday, May 18, 2011
Why Were There Boom/Bust Cycles in the 19th Century Gold Standard Era?
(Last month I gave a brief talk to a group of students at the University of Northern Iowa. The organizer, Mark, asked me an interesting question.)
Pat:
Thanks for coming to UNI and discuss Austrian economics to a group of students. I was wondering if you could recap your argument on why the depressions occurred in the late 19th century and why they were not as severe.
Mark
Dear Mark,
My pleasure. Any time. The cause of all boom/bust cycles is the expansion of bank credit not financed by real savings. Fractional reserve banking allows banks to expand credit by manufacturing money out of thin air. This practice was challenged in England in the early 19th century, when some depositors asked the courts to force bankers to repay their deposits out of their personal funds. The depositors wanted the courts to treat deposit banking in the same legal manner as a bailment; that is, just as if a farmer deposited corn or wheat in a grain elevator. The elevator cannot speculate with this "deposit". But the courts ruled that the depositors had "lent" the banker the money rather than entrusted him with their money as a bailment. This is the legal side of the explanation to your question. The economic side is that when the bank loans money in a fractional reserve, rather than a one hundred percent reserve, system, the money supply increases without an increase in savings. Eventually reality reveals the problem, as prices start to rise in consumer goods, forcing resources back from more time consuming investments. These investments never were funded with real savings, only monetary expansion. This is what caused the several depressions of the late 19th century. But research has shown that these depressions were not nearly as onerous as those of the 20th and now 21st centuries, because the underlying reserves themselves--gold and silver--could not be inflated. This provided a limit to the expansion. But now the reserves themselves may be expanded by the Fed to infinite amounts. That is one source of the credit expansion. Then the fractional reserve banking system adds a second source of expansion.
For example, if reserves are 1 monetary unit (m.u.) and the reserve requirement is 100%, then the money supply is 1 m.u. Let's assume that we are under a gold standard and the banks keep only 10% reserves. Now the money supply can be inflated to 10 m.u.'s. But, if reserves are not gold and the Fed inflates them to 2 m.u.'s and the reserve requirement is lowered to 10%, the money supply can be inflated to 20 m.u.'s. So, under a gold standard with fractional reserve banking, the reserves themselves cannot be inflated, which limits the extent of money inflation. But when reserves themselves are nothing more than blips on a computer screen, the money supply can be inflated to infinite amounts. This is the worst of all monetary worlds, because there now is no institutional check on monetary expansion.
Sincerely,
Patrick Barron
Pat:
Thanks for coming to UNI and discuss Austrian economics to a group of students. I was wondering if you could recap your argument on why the depressions occurred in the late 19th century and why they were not as severe.
Mark
Dear Mark,
My pleasure. Any time. The cause of all boom/bust cycles is the expansion of bank credit not financed by real savings. Fractional reserve banking allows banks to expand credit by manufacturing money out of thin air. This practice was challenged in England in the early 19th century, when some depositors asked the courts to force bankers to repay their deposits out of their personal funds. The depositors wanted the courts to treat deposit banking in the same legal manner as a bailment; that is, just as if a farmer deposited corn or wheat in a grain elevator. The elevator cannot speculate with this "deposit". But the courts ruled that the depositors had "lent" the banker the money rather than entrusted him with their money as a bailment. This is the legal side of the explanation to your question. The economic side is that when the bank loans money in a fractional reserve, rather than a one hundred percent reserve, system, the money supply increases without an increase in savings. Eventually reality reveals the problem, as prices start to rise in consumer goods, forcing resources back from more time consuming investments. These investments never were funded with real savings, only monetary expansion. This is what caused the several depressions of the late 19th century. But research has shown that these depressions were not nearly as onerous as those of the 20th and now 21st centuries, because the underlying reserves themselves--gold and silver--could not be inflated. This provided a limit to the expansion. But now the reserves themselves may be expanded by the Fed to infinite amounts. That is one source of the credit expansion. Then the fractional reserve banking system adds a second source of expansion.
For example, if reserves are 1 monetary unit (m.u.) and the reserve requirement is 100%, then the money supply is 1 m.u. Let's assume that we are under a gold standard and the banks keep only 10% reserves. Now the money supply can be inflated to 10 m.u.'s. But, if reserves are not gold and the Fed inflates them to 2 m.u.'s and the reserve requirement is lowered to 10%, the money supply can be inflated to 20 m.u.'s. So, under a gold standard with fractional reserve banking, the reserves themselves cannot be inflated, which limits the extent of money inflation. But when reserves themselves are nothing more than blips on a computer screen, the money supply can be inflated to infinite amounts. This is the worst of all monetary worlds, because there now is no institutional check on monetary expansion.
Sincerely,
Patrick Barron
Wednesday, May 11, 2011
What Drives Higher Unemployment
One of my economics students traveled to India during spring break this year. Upon her return to class I asked if she had any observations about the Indian economy from an Austrian School of Economics perspective. She thought for a moment and then said that the Indians seemed to be very inefficient. For example, instead of using a backhoe to dig ditches or building foundations, Indian contractors used dozens of men with picks and shovels. I found this to be a wonderful observation, and the class discussed possible reasons for this phenomenon, which ranged from government regulations geared to increasing employment to the obvious surplus of cheap, manual labor.
Kevin D. Williamson addressed this subject in his May 2nd National Review article titled “A Nation of Sharecroppers”. He pointed out that one hundred and fifty years ago picking cotton was a job for slaves; fifty years ago it was a job for the rural working class, and now it is a job for a handful of very wealthy entrepreneurs driving monster John Deere cotton picking machines. What happened to the slaves and the rural working poor? Were all of them driven to destitution? My student worries about this possibility should Indian contractors get wise and buy backhoes, and Mr. Williamson worries that America’s working poor would be driven to dependency alongside the current welfare-dependent underclass. He provides no answers and ends his essay with the lament that for
“…a 21-year old man of average intelligence with a high-school education and a bit of training…his main attractions will be the sedative of dependency or the stimulant of underclass moral anarchy, and we cannot afford much more of either.”
I agree, but I think I know the source of the problem. (Here’s a hint: the word begins with “g” and ends in “ment”.) What Mr. Williamson and my student describe was observed by David Ricardo two hundred years ago and took the name “Ricardo Effect”. This term describes the phenomenon whereby labor is replaced by machinery and occasionally vice versa. Many have twisted Ricardo’s observation for their own purposes. For example, labor unions have justified striking for higher pay by claiming that such actions actually encourage businessmen to invest in productivity-enhancing capital, which raises the productivity of labor and labor wage scales. At the other extreme are the Luddites, who advise prohibiting businessmen from investing in these very same productivity-enhancing capital goods, because machinery causes “technological unemployment”. Both misunderstand what Ricardo observed.
Ludwig von Mises explains the Ricardo Effect, starting on page 767 of his magnum opus, Human Action. Mises explains that machinery replaces men only when the market is driving the cost of labor higher. Labor costs are rising because labor is more productive elsewhere. To remain in business the businessman must invest in capital goods to boost the productivity of labor in his industry, too. Therefore, labor has a choice between equally attractive alternative employments. In an unhampered free market system the Ricardo Effect is benign and just an interesting observation.
However, the Ricardo Effect turns malignant when the cost of labor is rising not due to improved productivity elsewhere but by non-market forces. To the businessman the result is the same; i.e., the cost of labor is rising and he must invest in productivity-improving capital goods. Ah, but here’s the rub. The productivity of labor is NOT rising, only its cost. Government regulations such as minimum wage laws, workers’ compensation insurance, matching social security taxes, family leave benefits, etc. are driving costs higher, not alternative employment at higher wages elsewhere. And these are just the seen costs. There are the unseen costs as well: such as the cost of defending oneself against wrongful employment termination, a new government-invented right to a specific job. Gone forever, apparently, is the concept of employment at will, whereby, absent an employment contract, jobs are “owned” by the employers, since employers create them, and are “offered” and withdrawn at their pleasure.
Today, this malignant Ricardo Effect is something for concern, as my student and Mr. Williamson articulate. Rather than being a product of a more productive labor market with alternative employment for workers whose employers fail to invest, this modern Ricardo Effect offers workers only welfare dependency and societal pathology.
Furthermore, it is not at all clear that elevating low end worker productivity--a goal that Mr. Williamson does perceive but fears cannot be achieved--would reduce unemployment for those at the low end of the wage scale. Government itself needs the unemployed in order to perpetuate its labor-regulating empire that provides it with high paying and secure jobs. What would all those labor lawyers, judges, advocates, investigators, insurance providers, and record-keepers do, if the country scrapped all labor laws and sent the departments of labor at all government levels to the scrap heap? A more likely scenario is that government will do what it has done since the Great Depression—keep raising the bar in all categories to provide itself with a steady supply of welfare dependents to nanny and goldbricks and slackers to defend in its kangaroo courts. After all, human nature has not changed…there is a disincentive to work, which can be abetted with government payments, and government has an infinite ability to rationalize its self-serving and predatory interventions. No wonder that capitalists are becoming more innovative in moving formerly “non-tradable” jobs into the “tradable” category. For example, x-rays can be read in India as easily as the office down the hall. Even shoe salesmen are not immune. Zappos has built a mail order empire selling shoes sans salesmen.
So, what’s the answer to this modern day malignant Ricardo Effect? As usual it is getting government out of the free market, which includes not just eliminating labor laws but also eliminating the entire welfare industry. It is a fallacy that our nation has millions of people who cannot provide for themselves and must ride through life on the backs of others or starve. All willing workers can find gainful employment, compete, and thrive without any government program or policy whatsoever. Jean Baptiste Say explained this phenomenon two hundred years ago. But that is a lesson for another time.
Kevin D. Williamson addressed this subject in his May 2nd National Review article titled “A Nation of Sharecroppers”. He pointed out that one hundred and fifty years ago picking cotton was a job for slaves; fifty years ago it was a job for the rural working class, and now it is a job for a handful of very wealthy entrepreneurs driving monster John Deere cotton picking machines. What happened to the slaves and the rural working poor? Were all of them driven to destitution? My student worries about this possibility should Indian contractors get wise and buy backhoes, and Mr. Williamson worries that America’s working poor would be driven to dependency alongside the current welfare-dependent underclass. He provides no answers and ends his essay with the lament that for
“…a 21-year old man of average intelligence with a high-school education and a bit of training…his main attractions will be the sedative of dependency or the stimulant of underclass moral anarchy, and we cannot afford much more of either.”
I agree, but I think I know the source of the problem. (Here’s a hint: the word begins with “g” and ends in “ment”.) What Mr. Williamson and my student describe was observed by David Ricardo two hundred years ago and took the name “Ricardo Effect”. This term describes the phenomenon whereby labor is replaced by machinery and occasionally vice versa. Many have twisted Ricardo’s observation for their own purposes. For example, labor unions have justified striking for higher pay by claiming that such actions actually encourage businessmen to invest in productivity-enhancing capital, which raises the productivity of labor and labor wage scales. At the other extreme are the Luddites, who advise prohibiting businessmen from investing in these very same productivity-enhancing capital goods, because machinery causes “technological unemployment”. Both misunderstand what Ricardo observed.
Ludwig von Mises explains the Ricardo Effect, starting on page 767 of his magnum opus, Human Action. Mises explains that machinery replaces men only when the market is driving the cost of labor higher. Labor costs are rising because labor is more productive elsewhere. To remain in business the businessman must invest in capital goods to boost the productivity of labor in his industry, too. Therefore, labor has a choice between equally attractive alternative employments. In an unhampered free market system the Ricardo Effect is benign and just an interesting observation.
However, the Ricardo Effect turns malignant when the cost of labor is rising not due to improved productivity elsewhere but by non-market forces. To the businessman the result is the same; i.e., the cost of labor is rising and he must invest in productivity-improving capital goods. Ah, but here’s the rub. The productivity of labor is NOT rising, only its cost. Government regulations such as minimum wage laws, workers’ compensation insurance, matching social security taxes, family leave benefits, etc. are driving costs higher, not alternative employment at higher wages elsewhere. And these are just the seen costs. There are the unseen costs as well: such as the cost of defending oneself against wrongful employment termination, a new government-invented right to a specific job. Gone forever, apparently, is the concept of employment at will, whereby, absent an employment contract, jobs are “owned” by the employers, since employers create them, and are “offered” and withdrawn at their pleasure.
Today, this malignant Ricardo Effect is something for concern, as my student and Mr. Williamson articulate. Rather than being a product of a more productive labor market with alternative employment for workers whose employers fail to invest, this modern Ricardo Effect offers workers only welfare dependency and societal pathology.
Furthermore, it is not at all clear that elevating low end worker productivity--a goal that Mr. Williamson does perceive but fears cannot be achieved--would reduce unemployment for those at the low end of the wage scale. Government itself needs the unemployed in order to perpetuate its labor-regulating empire that provides it with high paying and secure jobs. What would all those labor lawyers, judges, advocates, investigators, insurance providers, and record-keepers do, if the country scrapped all labor laws and sent the departments of labor at all government levels to the scrap heap? A more likely scenario is that government will do what it has done since the Great Depression—keep raising the bar in all categories to provide itself with a steady supply of welfare dependents to nanny and goldbricks and slackers to defend in its kangaroo courts. After all, human nature has not changed…there is a disincentive to work, which can be abetted with government payments, and government has an infinite ability to rationalize its self-serving and predatory interventions. No wonder that capitalists are becoming more innovative in moving formerly “non-tradable” jobs into the “tradable” category. For example, x-rays can be read in India as easily as the office down the hall. Even shoe salesmen are not immune. Zappos has built a mail order empire selling shoes sans salesmen.
So, what’s the answer to this modern day malignant Ricardo Effect? As usual it is getting government out of the free market, which includes not just eliminating labor laws but also eliminating the entire welfare industry. It is a fallacy that our nation has millions of people who cannot provide for themselves and must ride through life on the backs of others or starve. All willing workers can find gainful employment, compete, and thrive without any government program or policy whatsoever. Jean Baptiste Say explained this phenomenon two hundred years ago. But that is a lesson for another time.
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