Ideas not Diktats

My post yesterday on central planning has an important implication, one which I suspect some of you, dear readers, may not like: free markets will not be advanced through the ballot box.  Voting is, generally speaking, an exercise in futility.  It’s not just because the odds of your vote changing anything is virtually zero, for from a cost-benefit viewpoint voting is irrational.  It’s that, without a change in culture, no free market legislation will survive long term.

Take, for example, this article written in EconLog today by Emily Skarbek.  She tells us the story of Richard Nixon’s price controls in the 70’s.  Nixon knows the costs of price controls.  Knowledge of the politician is not in question here.  But he goes ahead with the scheme anyway for “pragmatic” reasons (to use his term).  Nixon knew if he took a stand and refused price controls, his political career would be in danger, so he submitted to the general culture, despite his principles and knowledge of price controls.  If he had refused, he may have lost the following election and the controls implemented anyway.

That is why I, along with so many of my laissez-faire brethren, focus our attention on changing the climate of ideas rather than effect ballot-box changes.  Any effort at the ballot-box is doomed to fail until the general culture changes to become more freedom friendly.  Liberty cannot be sustained when imposed top-down; it must be grown bottom-up.

Ruminations on Central Planning

Since the semester ended, I have had some more free time on my hands to read for pleasure, not just for work.  One of the books I picked up was Don Lavoie’s 1985 book Rivalry & Central Planning: The Socialist Calculation Debate Reconsidered.  While I have only just started reading it, it’s an interesting reexamination on the age-old central planning question.  What follows are two thoughts of mine on the same matter.

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Multiplication by Division

In economics, one of the less intuitive aspects is why the division of labor leads to a multiplication of wealth.  “Less work is being done!” people cry.  “This means people are poorer!  How can fewer jobs mean more wealth?”  We hear this question in particular with regards to international trade.  The question steams from misunderstanding the very basics of economics: resources are scarce.

Since we do not live in Eden, resources are scarce.  What this means is there simply are not enough resources to satisfy every want and need a person might have.  One of the scarcest resources out there is time.  We’re always running out and we can never get it back.  Division of labor is economizing on time.  A simple example: by dividing necessary labor (in other words, “outsourcing”) to satisfy my wants and needs among other people, I have more free time to spend as I wish.  By not having to worry about growing my own food, making my own clothes, composing my own music, building my own home (but rather outsourcing those jobs to farmers, grocers, tailors, musicians, and carpenters), it frees up my time to work on other things: educating myself, writing a book or blog, etc.  Things that can improve my wealth and/or society.  By dividing labor, we can get more out of the fixed time we have in life.

Division of labor is a good thing, not a bad thing.  Division of labor is what has allowed man to rise above his beginnings as a hunter-gatherer and has nearly eradicated true poverty in the world.  If we want to enrich Americans, to make America great, then we need more division of labor, not less.  We need to maximize our hours on this planet, not minimize them.

 

Are High Prices Necessary for Innovation?

Writing in Bloomberg, Megan McArdle says:

America’s high pharmaceutical prices are what compensates pharmaceutical firms for the risk of developing drugs. If we drive them lower, we’ll get fewer new drugs….After a few years of obscene profits, most of these innovations will be pretty cheap and widely available. Every useful weapon we decide not to try to produce for that arsenal comes at a cost to future people’s health.

Megan’s argument is a common one, and is often used to justify government-granted monopolies through patients. Although it pains me to do so, I must disagree with her here.

Drug research certainly is expensive, but as David Henderson and Charles Hooper point out, regulatory burden is also a major cost for firms:

Economists have shown that the cost to get one drug to market successfully is now more than $2.8 billion. Most of this cost is due to FDA regulation. Some potentially helpful drugs don’t ever make it to market because the cost the company must bear is too high. Drug companies reguarly “kill” drugs that could be effective because the potential profits, multiplied by the probability of collecting them, are less than the anticipated costs.

In other words, firms make a simple probabilistic Net Present Value calculation and the cost of regulation tends to be the deciding factor to cancel a project.  The high prices firms receive are a reflection of both the cost of innovation, but primarily the cost of regulation.  As Henderson and Hooper discuss, drug prices could be lowered (by changing the regulatory regime) and have it not affect innovation.

In a more general sense, high prices/profits are not necessary to spur innovation.  Competition can do the same thing.  In competitive markets, firms must always be on the look out for competitors cutting into their profits.  They look to gain any edge they can, which includes innovation.  Innovation can mean improving the current mousetrap or building a better one.  This is why we continue to see innovation even in highly competitive markets like retail/wholesale even though they do not earn extra-normal profits.

An easy way to test this theory would be, as Henderson and Hooper suggest, reduce regulation.  Standard monopoly theory says that a firm would develop into a monopoly if (among other reasons) there are significant technological barriers preventing entry into the market (in other words, if innovation is so expensive only one firm can efficiently conduct it). If the regulations are lifted and prices remain high and drug companies meld into a monopoly, then we can conclude Megan’s hypothesis is correct.  If, however, drug prices fall (as I suspect they will), we can conclude Henderson & Hooper’s hypothesis correct.

Who Gives A Damn About Jobs?

Good, now that I have your attention I will begin:

Jobs tend to dominate the economic punditry:  President-Elect Trump’s touts about bringing jobs back from overseas (or, inversely Bernie Sander’s admonishes for sending jobs overseas), this company or that company is killing jobs, etc etc etc.  But all this misses the point.

Creating jobs is easy.  Simply ban all labor-saving devices:  washing machines, cars, computers, calculators, shovels, TVs, sound equipment. Basically anything mechanical.  Ban it. If a President were to get such legislation passed, he’d have the greatest job creation record of all time.  You will have tons of jobs, but lots of poverty, too.

Labor is a cost.  It is an input.  The goal of any cost is to minimize it with regards to the ideal level of leisure (leisure time being the opposite of labor time) and maximize one’s returns.  A simple example:  Dr. Doofenschwirtz invents a machine that produces everything anyone could want just by pressing a button.  Out of the kindness of his heart, he gives one to everyone on the planet.  The proliferation of such a machine would necessarily eliminate jobs, but people would be better off because of it.  This would allow people to focus on other things.

Lest I be accused of fantasizing, my above example is a simplified, and extreme, version of how trade works.

In conclusion, it is not the number of jobs that matter.  That is a pointless statistic.  Rather, it is how people can maximize their wealth by minimizing their labor.