Thursday, April 15, 2010

A Place for Prosperity

Thomas Hobbes observed that man’s life without government was no bargain:

In such condition there is no place for industry, because the fruit thereof is uncertain: and consequently no culture of the earth; no navigation, nor use of the commodities that may be imported by sea; no commodious building; no instruments of moving and removing such things as require much force; no knowledge of the face of the earth; no account of time; no arts; no letters; no society; and which is worst of all, continual fear, and danger of violent death; and the life of man, solitary, poor, nasty, brutish, and short.

Governments were instituted to solve the problems of uncontrolled competition, to, among other things, make "a place for industry." Why is a place for industry a good thing? Obviously, industry creates goods, the ones we need and the ones we want. It creates sustenance and it creates wealth. But, in a society in which the government gets its legitimacy from the consent of the governed, exactly what should that "place for industry" be? If we are to enable the production of goods, should we also permit the accumulation of wealth? And how should the goods, and such wealth as is permitted, be allocated among the people who have enabled their creation?

Production does not just happen, nor can it reasonably be compelled. It must be enabled by a legal infrastructure. First come enforceable property and contractual rights. But property and contractual rights merely do for production what geography and climate do for life: they make it possible, not good. Just as government regulates primal competition, it must regulate capitalism if the economy is to be anything more than a subset of Hobbes's mayhem. Government must not only create a place for industry; it must create a place for prosperity. But how?

If, as I and many Americans believe, that government is best that governs least, we should start by allocating the fruits of production to those who make it happen. And we should allow those who have capital to seek out those who have talent on their own to make it productive. And allow those with talent to organize enterprises as they see fit (for, if we could do better, we should be doing better).

Unfortunately, history teaches that this minimalist approach to political economy causes wealth to be created but also to be concentrated. The problem is labor. Aside from returns on capital, compensation for work is the only satisfactory alternative to largesse for delivering goods into people's hands. But there is no guaranty that the supply of labor will not outstrip the demand for it, that competition for jobs wil not force down the standard of living of those with only their labor to sell. That has been the case in the early days of all capitalist economies, including some now in their infancy.

The competing capitalist must extract the most he can from the labor pool at the least cost. Demagogs attribute such competition to some moral failing among capitalists, but unilaterally raising wages drives away customers or capital, so no other path is available in a laissez-fiare system. Consequently, where labor is abundant and competition for jobs unregulated, only the barest subsistence finds its way to the mass of people. As a result, much of their labor is directed toward producing luxury goods for the few who get to keep the fruits of the laborers' toil. Because the number of people needed to make such goods is limited by the relatively small size of the market, the system equilibrates at a level that is far from satisfactory for most of its participants.

How, then, is prosperity to happen? It won't do just to confiscate the capitalists' wealth and give it to the poor workers to make them rich. Wealth will not be created if capitalists and entrepreneurs are not allowed to benefit disproportionately for their risks and exertions. Still, shouldn't society aim to minimize the disproportional allocation of the fruits of production? We all voted to make capitalism possible, and we all pay taxes to support the enforcement of property and contractual rights. Shouldn't we all benefit from it?

How about laws protecting labor from the natural consequences of its meager bargaining position? Imposing a minimum wage (the simplest way to protect workers from selling their services too cheaply) would surely increase the money in the workers’ pockets, but then what? If the government orders capitalists to pay their workers enough money to buy a lot of stuff, will production shift to the things workers want and, thanks to the higher wages, have money to buy? Or even better, will new production of such goods be undertaken, requiring more labor and thus making the minimum wage merely a bridge, taking wage rates to where they would be set by the market if workers were customers, too. If so, business might see government's "intrusion" not as a restriction, but as a boon.

The "bridge" scenario assumes certain things about the nature of production and distribution. Capitalist systems equilibrate within technological limitations. What if we don’t know how to build a factory that can produce a car for every garage? What would then be the point of paying people enough money to buy a car, or of establishing a bank to lend them the money or insurance companies to insure them, or building roads on which to drive them? A minimum wage – any accommodation to workers, really – is only viable if the productive and distributive technologies are adequate to serve a nation of well-paid workers. Otherwise, we have the classic Soviet worker's lament: we pretend to work, and they pretend to pay us.

Certainly, the case could be made that labor laws would have hastened the invention of technologies that would make them affordable, but as things worked out, the opposite occurred. Henry Ford invented mass production, and American business faced the excellent problem of excess capacity. Rather suddenly, it became possible to produce enough stuff for a whole lot of people, but the people weren't earning enough to buy them. So, almost like magic, despite the assumed (feigned? half-hearted?) resistance of big business, we got anti-trust laws for the consumer and labor laws for our workers. The result was a massive, temporary diversion of revenue from master to servant, who then spent it on what the boss had to sell. The poor got less so, and the rich got more so. Together, Henry Ford, and We, the People, in Congress assembled, made a place for prosperity.

Laissez-faire types oppose economic regulation. They say that the market is a better regulator of excesses than is the government. They argue, for example, that if the economies of scale make higher wages more profitable than lower ones, then higher wages will emerge through market forces. I see two objections to that view.

First, as Hobbes might have said had he been able to study game theory, the emergence of higher wages presents a coordination problem. Raising wages does not make a company more profitable unless other do it, too. So no one company could ever raise wages in the hope that national wages will rise. Or, as Hobbes did put it:

From this fundamental law of nature, by which men are commanded to endeavour peace, is derived this second law: that a man be willing, when others are so too, … to … be contented with so much liberty against other men as he would allow other men against himself…. But if other men will not lay down their right, as well as he, then there is no reason for anyone to divest himself of his: for that were to expose himself to prey, which no man is bound to, rather than to dispose himself to peace.

The laissez-faire supporter will purport to agree with Hobbes, but the liberty he is willing to grant other men against him exceeds what most people would allow. Maybe, he believes that he has the wherewithal to win the war that coordination would avoid. Or maybe he just doesn't understand how things work.

Second, and this is something laissez-faire capitalists refuse to recognize, politics is often just market economics continued by other means. If political action is seen as a tactic available to market participants, rather than as some external feature of the world, political action can be seen as the market’s response to business’s coordination problems.

How, for example, in the absence of government coordination, would the market bring about wage increases? Two thoughts come to mind: collusion and unionization.

By collusion, I mean all of the employers in America getting together and agreeing to raise the wages of all of their employees to a level that will produce enough demand for their products to offset the increase in costs. Obviously, not all employers will see the light, so getting such an agreement would be impossible. But even if only a substantial majority of employers need to join the wage cartel for it to be effective, think of the logistical difficulties in creating and enforcing such an agreement. (Let alone the genuine anticompetitive collusion such a scheme might engender.) A far better approach for the same employers would be to go to Washington and lobby for a minimum wage, or at least not to object too strongly when labor does so.

And what about unionization? Employees are an even more fractious bunch than employers. How would union discipline be enforced short of thuggery? Would employers negotiate with a union that purports to speak for a whole industry but has no legal status? Would a collective bargaining agreement be enforceable? (Early "labor law" consisted of court rulings that treated unionization as a tortious interference with the employer's business.) The emergence of a practical labor-relations scheme cries out for codification. And, because of the aforementioned economies of scale and all, employers really have no reason to resist, if the productive and disributive technologies to exploit a well-paid workforce exist.

Labor laws provide a mechanism for allowing wages at all skill levels to keep up with gains in productivity and distributive capacity. It’s what the market would do if it could. So, perhaps political action regarding at least some labor laws should be seen not as intrusions by government but as enlistment of government. (I refer here to some labor laws, not all of them, so don’t tell me about every silly OSHA rule that makes your life needlessly difficult.)

Because of (in my view), or despite (in others' view), government action, the diffusion of prosperity in the US over the past 100 or so years was remarkable. The inherent tension remained between the need to create wealth and the need to distribute it in a politically satisfactory way, but, until recently, and with some notable busts, the wealth kept growing and the income disparity kept shrinking. The movement toward equality, however, must at some point end lest the incentive disappear and the revenues with it. From that point, expansion of the pie, everyone getting richer, becomes the source of perceived improvement in our national lot.

One thing that can contribute to growth is international trade. Natural resources and the skills to turn them into useful products give localities comparative advantages in the production of those goods. Trade between countries in the goods as to which each has such a comparative advantage can bring additional revenue to each country, maximizing the aggregate revenues of the traders (but not necessarily maximizing the revenue of each). If trade brings more revenue to a country, then that country is better off, but only if the usual revenue allocation structures apply. Otherwise – if, for example, the trade process itself adversely affects the revenue allocation mechanism within the borders of the trading partner – trade cannot be counted as “advantageous,” no matter how much revenue it generates. And if trade causes revenue to fall, and the allocation mechanism comes to be perceived as less equitable, and the financial system becomes overburdened by capital seeking repatriation, then trade can be a very bad thing indeed.

If economic benefit is defined as increasing national revenue (or decreasing national expense) without decreasing the politically perceived equity of the revenue distribution, then free trade can fail to benefit a trading partner in two ways.

First, if a nation runs an aggregate (i.e., worldwide) trade deficit, repatriation of money spent abroad must occur through the capital markets. That process may or may not be benign, depending on those markets' ability to process that money into revenues that are shared consistently with the pre-trade regime. For example, if the US ran a trade deficit equal to its deficit with oil exporters, and the petrodollars were invested to make housing more affordable for people with otherwise good credit, the trade for oil might be beneficial as I have defined the term. But if the deficit is so large that the money cannot be invested soundly, it will either be invested unsoundly, or it will be lent to the government, which then incurs ongoing interest costs until tax revenues increase, which cannot happen if money is leaving the country and returning as loans to the government.

Alternatively, repatriated trade deficit dollars can be invested in corporations. But that brings us to the second way that trade can fail to benefit us. Trade is trade, but competition is competition, and the two can co-exist most unhappily. The classic Ricardian example of comparative advantage posits England’s advantage in wool vs. Portugal’s in wine. In Frederic Bastiat’s defense of free trade, Belgium is said to have a comparative advantage in iron, presumably for geographic reasons. In neither case is it assumed that a country has an advantage in labor per se. Rather, for any skill level, the assumption is made that each trading partner has a comparative advantage in a product that will employ anyone who might otherwise be employed in making the imported product.

Where a country has a comparative advantage in labor costs, it will tend to make the things that require the most workers, and its trading partners will make the things that require the fewest. Such trade can be entirely balanced. Indeed, China is running a trade deficit against the world, primarily because it is importing natural resources, which no amount of cheap domestic labor can produce. But the US is not a major exporter of natural resources (maybe because we’re too dumb to use our natgas and sell our oil, but that’s for another day). So, we export food, which has become increasingly capital intensive, and we export high-tech things made by other high-tech things. That trade, too, could be balanced; it’s not, but, even if it were, it would still be a problem for us, because it would mess up our revenue allocation mechanism, aka the labor market.

So we have another of what so-called perfect storm: a massive global trade deficit that generates larger capital inflows than we can put to productive use and massive trade with low-wage countries, which disrupts our labor market’s ability to distribute the revenue such trade generates (such as it is).

Again, free traders assert that absolute free trade is best, that displaced workers will find new work, funded by trade deficit dollars, if a deficit there be. I have never understood the economic basis for the claim by laissez-faire supporters that government intervention hurts business but trade with low-wage partners does not. If you say that cheap foreign labor destroys jobs, they say that the workers need only find something else to do in a more productive industry. But then they turn around and say that labor laws cost jobs by raising costs. I don't see how foreign labor's downward pressure on prices and domestic government's upward pressure on costs can be distinguished in terms of the adjustments that businesses and workers can make to them.

Free traders also complain that protective tariffs on cheap-labor goods transfers wealth from those who have it to those who don’t. They argue the case as if the alleged transfer were from the oppressed consumer, who would have to pay more for imports, to the entrepreneurs who own the protected industries. Such a transfer, they say, is morally indefensible. Sort of like bailing out European counterparties to US banks. Or bailing out the banks themselves. Of course, such transfers are only incidental. The real transfer – the one that makes a tariff good policy – is the one from consumers to the workers whose jobs are protected, people who not only are like those consumers, but sometimes are those consumers, or would be, if they could get jobs.

Finally, the free traders get all upset about their liberty. But I think Hobbes (and Kant) put that one to rest. There are no formal lines between liberties we are willing to give up (e.g., murder) and those we are not. Libertarians try to draw bright lines, but at the end of the day, the matter is entirely subjective: we are willing to give up the liberties to do what we would not want done. Unfortunately, not only is that judgment contingent on our own perception of our strengths and vulnerabilities, but it is also dependent on our grasp of how things work.

Free traders, who are, of course, laissez-faire capitalists, simply do not get that an economy exists at the political sufferance of the citizenry, and that it has two purposes, the creation and distribution of outputs, both of which are essential to analysis of any economic policy. Viewed through the right lens, then, protectionist tariffs, here and now, however they might in other places and times, protect neither workers nor industries as such. They protect our national system of distributing revenues in a politically acceptable way. That distribution is as essential a goal of government as enabling the creation of wealth in the first place.

Without a politically viable distribution of revenue, why would We, the People, give a rat’s patoot about the creation of wealth? We wouldn’t, and that’s a scary thought, because if the golden eggs aren’t getting to the far end of the table, the only logical move for the folks down there is to rise up and cook the goose.


  1. Labor is how we distribute goods: we go to work to get the bread to get the strength to go to work.

    Then what is the source of goods? Do they just exist as gifts from nature?

    Seems like, to me, we go to work to create goods and are rewarded for what we create by the good we create. In modern times we often trade our labor with other people to maximize output.(Division of labor)

  2. Oh, the workers make the goods, but many, worldwide, are not rewarded with the goods they make.

    I am making a straightforward argument. Pay for work is the engine whereby goods are distributed in America. Therefore, we can only be prosperous if we have an abundance of good-paying jobs. Maximizing production is merely a means to that end. By lowering prices, free trade increases the distribution of goods to employed Americans. But if, in so doing, free trade makes it impossible for many other Americans to find good work, the end - prosperity - is not achieved.

    Arguments for free trade pretty much fall into three categories:

    1. Free trade maximizes production. So what if the Chinese get jobs and we lose jobs? It's my prices, not your job, that matters.

    2. And anyway, displaced workers can find good jobs in more productive industries or in non-importable service industries. I know that doesn't seem to be happening, but who're you gonna believe - me or your lyin' eyes?

    3. Buying cheap goods is my God-given right. Tariffs take my money, and therefore, my liberty, and therefore (standing at attention, eyes to the heavens), everything I hold sacred. Economics has nothing to do with it.

    Yes, they're all as silly as they sound.

  3. Brent - The language you quoted doesn't really help the post, so I have removed it.


Comments are moderated and will be posted if approved. This blog is for real people. Please use your real full name. Disagreement is welcome; disagreeableness, not so much.