On (Im)Perfect Subsitution

Another Econ 101 mistake people make, especially with regard to immigration and international trade, is some form of “foreigners (immigrants) can do all the work we do but for much lower prices!  Without subsidies/tariffs/minimum wage, they’re just going to take all our jobs!”  Other versions of this include “if a bunch of immigrants enter the nation, they’ll drive down wages!  Law of Supply and Demand!”

Both the above arguments make the same mistake, namely they assume foreign labor is a perfect substitute for domestic labor.  They treat all labor (or all low-skilled labor) as a homogeneous blob, one part easily replaceable with another.  But, alas, that is not the case, as price theory can show us.

Looking simply at the wages of laborers, we should ask the question “why do immigrants/foreigners command lower prices than domestic workers?” The fact that there hasn’t been wholesale replacement of domestic labor with foreign means we can rule out any cultural/biological/cost-of-living reasons such as “lower cost of living in 3rd world” or “they have a lower standard of life and thus demand lower pay” etc.  If this were indeed the case, domestic companies could just pack everything up and ship it overseas (that is, stuff that can’t be staffed by immigrants) and make tons of profits (while I have no doubt some people believe that is what is happening, the data say otherwise).

What’s more likely is that foreign workers and immigrants are simply less productive than domestic workers.  Immigrants coming into the country, legal or otherwise, face major barriers, not the least of which is the language barrier.  The manager at McDonalds cannot simply fire an American order-taker making minimum wage and hire a foreign worker for half the cost. The foreigner, simply by virtue of not knowing the language, will be less productive, thus his lower salary.  A similar argument for offshoring can be made: foreign workers, by virtue of less capital augmentation, will be less productive and thus command lower salaries.

In short, foreign workers/immigrants are not perfect substitutions for domestic labor!

It may make sense for some firms to replace/augment domestic labor with foreign labor, but the mere fact it is cheaper is not the reason why.  David Ricardo’s powerful idea shows there are times it is prudent to replace more productive resources with less productive resources, but to do so on a large scale with disregard to opportunity cost is a recipe for disaster, and why firms and individuals do not do it.

What Human Action Can Tell Us

As Ludwig von Mises taught way back in 1949, economics is, above all, the study of human action. The two main assumptions of economics back this up: 1) economic actors are rational (that is, with the knowledge they possess, they are working toward some goal), and 2) economic actors seek to improve their conditions (that is, their goal is improvement of wealth, utility, happiness, etc rather than the reduction of such).  Essentially, these assumptions boil down to: people, generally speaking, know what they’re doing (as the incomparable Walter Williams likes to say: “never assume someone is stupid until they prove themselves otherwise”).  One should deeply consider these two assumptions as what follows is derived from them.

The study of human action in the present can provide us with important insights. In this author’s opinion, I fear this study of present conditions is not done enough by economists.  Many economists focus too much on the future (what will the effect of this policy be, etc) rather than an analysis of the current situation.  Current-situation analysis can provide us insights into the future, too.  For example, an oft-heard defense of minimum wage is the “efficiency-wage theory,” that is, employers, when faced with a mandatory higher wage, will increase the productivity of their workers through training or other programs in order to meet the new wage.  Any lost profits from the higher wages would be offset by the higher profits from the increased productivity.  However, given the two assumptions mentioned in the first paragraph, we can look at the current situation and question the validity of the prediction: if employers could already increase productivity (and thus their profits) of workers, why aren’t they already doing it?  From this point, this current-situation analysis, should the conversation begin, rather than the future-situation analysis of a post-minimum wage world.  We should be further skeptical of any answer to the current situation question that involves tossing away one or both of the two main assumptions discussed in the first paragraph.

The current-situation analysis is also helpful in understanding why institutions and law pop up where they do.  Why was a private-property rights regime adopted in one area but not in another?  Why do people in New England act a certain way compared to people in North Carolina?  And so on.

The current-situation analysis prevents us from falling into the pretense of knowledge problem.  For future-situation analysis, there can always be models or logical steps that can come to all sorts of conclusions (eg, the efficiency-wage theory and minimum wage example earlier). Current-situation analysis helps us avoid this mistake.

An Important Caveat

The above discussion holds most true when the acting parties feel the majority of costs of their actions.  In situations where this is not true, where the costs of an individual’s actions are diffused over a large group that may not even involve the actor himself, it becomes harder to derive a clear picture from his current-situation actions.  For example, voting.  With voting, and politics in general, the cost of the action (or, more importantly, being wrong) is diffused among a large group of people that may not include the actor himself.  For example, if a voter votes to increase minimum wage, he is not paying the cost for such an action.  Rather, he is (potentially) compelling others to do his preferred action with no or minimal cost to himself.  His action is consistent with our two assumptions, but it is not a clear picture of what his preferred action is.  In other words, we cannot draw a conclusion from his action here as we could with the businessman in the above example.  For this reason, we should be careful drawing conclusions from political actions. Rather, his actions where he bares the brunt of the costs gives us more information.

What If We’re Wrong?

A technocracy is a style of governance where experts make the rules.  America is very much a technocracy: experts determine what medicine you can take (FDA), what jobs you can hold (licensing boards), what wages you may work for (NLRB, DOL), how you may build your home (permits), what food you may eat (USDA), who you may buy from (tariffs, DOC), and so on.  Like its religious cousin, theocracy, there are heretical questions one mustn’t ask, lest the whole system of faith it is built upon collapses.  In the technocracy, that question is “What if we’re wrong?”

The beginnings of the American technocracy started with the “Progressive Era,” a time where the leading minds in the universities, the government, business, religion, and social circles fancied themselves smart enough to run American lives.  They determined they were educated enough and the American experiment in laissez-faire had failed; America needed to be ruled by them.  Armed with such scientific methods as eugenics, Darwinism, and the like, they set themselves out to save America.  The results were horrific: minorities, immigrants, women, mentally ill or retarded, and all those deemed to be weakening the Anglo-American race were kept out of the workforce and forcibly prevented from reproducing (forced sterilization was a common practice during the Progressive Era).  Legislation like minimum wage was passed to prevent minorities from working. Mixed-race relations were strictly forbidden to prevent “race suicide.”  And these are just some of the crimes committed in the name of technocracy.

We now know eugenics is bunk, but lest we make the mistake of saying “this time it is different” with our 20/20 hindsight, we must remember that these were the leading scientists, economists, and thinkers of the day.  This was not a small movement of kooks, but what was honestly thought to be real science. And many people suffered.

And we see the same today, even in the 21st Century.  For years, FDA and other “food experts” told us eggs were bad.  That’s been changed.  Same with sodium.  And fat.  We were told ethanol would save our environment and car engines; turns out the opposite is true.  Other examples are legion.

A technocracy is just as dangerous to the secular Man as a theocracy is to the immortal Man.  Both rely upon unassailable priests to interpret the Scriptures and who give orders that must be obeyed without question.  Both promise Heaven but deliver Hell.  And both cannot tolerate heretics and freedom of thought.

Make no mistake, the experts and those who support them likely believe themselves to be correct.  They likely do want what is best for humanity.  But they make one simple, but highly flawed, assumption: that they have reached the pinnacle of knowledge.  They all suffer from hubris, which applied to a single man is a sin.  Applied to a whole nation, it is damnation.

A technocrat being wrong can have disastrous consequences.  That is why I advocate for freedom.

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.

 

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.

Illegal Immigration Follows The Laws of Supply and Demand. Who Knew?

Writing at CATO, David Bier has an excellent article on illegal immigration.  The whole thing is worth a read, but there are two particular points I want to focus on:

Border patrols and deportations were increased to stop the flow of unauthorized immigrants, but they had little effect. “I’ve no doubt whatever that the man finally deported is back here,” the Assistant Secretary of Labor told the Times. “Easily 50 per cent of them return.” In July 1929, Congress gave in and provided “amnesty” or citizenship to the undocumented immigrants. Then, the Great Depression dried up demand for workers, temporarily resolving the issue.  When the economy finally picked up again following World War II, illegal immigration returned.

Illegal immigration finally nosedived after the housing bubble burst, and the illegal population shrunk from 2007 to 2014.

[Emphasis Added]

Lest I be accused of cherry-picking, the trend of immigration tapering off during recessions and increasing during booms holds throughout history (obviously, the more severe the recession, the more pronounced the decline in immigration).

This pattern is exactly what one would expect: when the economy is growing, labor demand is growing, and the wage rate (the cost of labor) is increasing, more supply (immigration) is attracted to the market.  When the economy is shrinking, labor demand is shrinking, and thus the wage rate is falling, supply is repulsed from the market.  Just a simple analysis of the labor market.

Money Can’t Buy Me Fear

What follows is yet another economics lesson from The Simpsons.  The show has been on for nearly 30 years and is just packed full of tidbits like this:

Episode 11, Season 3 Burns Verkaufen der Kraftwerk (air date 5 December 1991) involves Mr Burns selling his plant to Germans and going into retirement.  Throughout the episode, Mr Burns’ retirement antics lead to public ridicule (in one scene, Burns is playing boccie with some other old folks.  He is barely able to throw the ball a foot, and the others laugh insultingly).  The culmination is when Burns and Smithers walk into Moe’s, where Homer and the other plant employees are drinking.  Homer had just been fired by the German plant owners and lashes out at Mr Burns.  The whole bar joins in mocking Mr Burns, and he leaves embarrassed.  Outside the bar, Mr Burns has a revelation: “What good is money if you can’t inspire terror in your fellow man?

Mr Burns learns an important lesson, one so often forget in conversations of wealth inequality and “the 1%.”  Money affords one no power.  Mr Burns is the richest man in town by far, and certainly wealthier than Homer, and yet that matters not one bit in their exchange.  Homer is able to cut Burns down to size without any fear of repercussions.  What can Mr Burns do?  Throw money at him?

Mr Burns’ power came from his owning the plant, not from his money.  As plant owner, he has power over his employees (to the extent they decide to work for him) and he has a legally protected (and connected!) monopoly, which affords him some level of power, but that is more due to political connections.  Strip those away, and Burns is powerless (even though he is richer.  He sold the plant for $100,000,000).

Money does not give power, inspire fear, or destroy individuals.