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.

Right to Work vs Right to Contract

One of the local ballot issues in Tuesday’s election here in Virginia was a constitutional amendment to the state barring “closed-shop”, that is barring agreements between firms and unions to require union membership or dues as a condition of employment.  Such legislation, referred to as “right to work” (RTW) are common in the US. However, the ballot measure was defeated here in Virginia, an outcome which I support and voted for.

On the surface, this could be seen as a violation of my free market (free from coercion) principles.  Aren’t such agreements coercive?  Why should a worker be compelled to join a union?  These questions are legitimate, but ultimately inaccurate to describe closed shops.  In fact, the RTW legislation is coercive.

I will make a simple case.  Firms should be allowed to enter into voluntary agreements as they wish.  They have property rights, just like people.  If a firm wishes to enter into an agreement of its own free will with a union for a closed shop, then it should be able to.  Legislation to prevent such agreements violates the firm’s right to contract.  If a worker voluntarily agrees to take a position in a closed shop knowing full well of the requirements, he has no right to complain or challenge the agreement between the firm and union.  This would be akin to a person buying a home in a HOA knowing the rules require it to be painted green and then complaining he can’t paint it orange.

Firms, unions, and individuals all have the right to enter freely into contracts.  None of them have the right to use government coercion to change the terms of the contract after the fact.

PS: please forgive any typos.  I am typing this on my phone while trapped underground on the Metro

Update: Fixed typos and grammatical errors.

Correlation, Causation, or No Connection?

The question posed in the title of this post is what makes the task of interpreting economic data (indeed, any scientific data) very difficult.  It is also why it is impossible to just “follow the data.”  Theory, properly rationalized, must be present in order to make sense of data and evaluate whether it makes sense or not.

Allow me to start with a silly, but 100% true, example:

Every time I have watched a New England Patriots game from start-to-finish on TV for the past 16 seasons, the Patriots have won.  That’s quite a lot of data points over a decently long period of time.  It’s a correlation of 1 (perfect correlation).  If we were to just “follow the data,” one could claim that I somehow cause the Patriots victories.  After all, the correlation is there.  Of course, such a conclusion would be erroneous.  By simply pointing to the theory that it is good coaching and good players that affect the outcome of the game, not someone watching a game in Massachusetts/New Hampshire/Virginia, one could easily refute the claim.  Further, if the claimant replied “you’re just being ideological!” in defense of his argument, he would be rightfully ridiculed.

While rightfully derided in sports situations, this kind of analysis is distressingly common in economic situations.*  A perfect example is this NELP study and response by Nick Hanauer.  Both do exactly the kind of poor analysis I mentioned above; by only looking at minimum wage’s correlation with employment growth (and no other factors), it leads to the incorrect conclusion that the Law of Demand is a “scam.”  It’s pretty strong words to call a scientific law a scam based off of one flawed study’s conclusions.  Going back to my example above, this would be akin to claiming “Bill Belichick and Tom Brady are scammers because this study proves Patriots victories are related to Jon Murphy watching the game!”

Unfortunately, these same kind of poor analytical outcomes are legion.  To quote a list provided by Don Boudreaux:

 Forcing wages up by legislative diktat helps workers exclusively at the expense of business owners or rich consumers – or maybe even at the expense of no one at all?  Check!  Allowing people to buy especially low-priced imports harms the domestic economy?  Check!  Trade deficits are both a signal and a source of domestic economic decline?  Check!  The destruction by natural disasters of buildings, inventories, and infrastructure is really an economic blessing?  Check!  Markets unregulated by politicians and bureaucrats poison consumers with foul foods, kill homeowners with shoddy construction, maim workers with perilous workplace conditions, and cheat savers with fraudulent investment services?  Check!  The simple key to a booming economy is maximum spending, especially by government?  Check!  Government debt held by that government’s citizens is no burden upon that economy because we owe it to ourselves?  Check!  Growing income and wealth inequality means stagnant economic fortunes for the middle class and increasing poverty for the poor?  Check!  In markets lightly regulated and lightly taxed by governments, the rich get richer and the poor get poorer?  Check!  In markets women, blacks, and other minorities are underpaid because of discrimination – a problem that can be solved only by government regulation?  Check!  Economic growth devours precious resources, making these resources ever-more scarce?  Check!  The more you “buy local” the more you enrich your community and protect the natural environment?  Check!  Free lunches abound?  Check!!

Each one of these conclusions, which fly in the face of theory, are very popular (for various reasons), and yet they all suffer from the same problem I mentioned earlier.

Economic analysis is difficult.  One shouldn’t be so willing to discard theory lightly.  The important question to ask, regardless of the field, is this: “Does this make sense?  What else could be influencing this?”

*I suppose other sciences it is as well, but I do not know enough about them to say anything definitive.

Value is What Matters

There is one mistake I keep seeing over and over again, in the media, by politicians, by laymen, etc.  I feel it is my duty as an economist to correct this mistake.

Not all resources are equally productive.  The purpose of economic activity is to maximize benefit (output) while minimizing costs (input).*  However, not all mix of factors of production will get you there.  In short, when discussing economic activity, we must be sure to stress productive factors of production.

Consider the following: A nation has an army of ditch diggers (assume ditches are a useful output).  Each is employed with steam shovels.  Then something happens, and the steam shovels are replaced by an equal number of spoons.  What would happen?  The productiveness of the ditch diggers would fall, thus reducing the value of each ditch digger.  This is true even though the numerical amount of capital in the nation (its capital stock) has remained unchanged.  Why?  The productive capital has been replaced with less productive capital.  The value of the capital has been reduced.

Of course, it is possible to maintain the same level of output by adding in more ditch diggers, but since resources are scarce this would mean less laborers for other outputs.

Why do I bring this up now?  Well, a common mantra heard throughout this election is that “jobs are good.”  The US needs protectionist tariffs and closed borders to maintain jobs here in the United States.  But no one asks the important question: are the jobs being “lost” unproductive compared to alternative use of the resources?  A job program is easy: just ban all labor-saving devices: eliminate electric fans, washing machines, automobiles, elevators, computers, construction machinery, light-bulbs etc etc etc.  You’d easily create millions of jobs overnight.  But these jobs wouldn’t be productive!  Indeed, I predict one would see standards of living fall considerably should these measures be implemented.

The goal of economic activity is to maximize benefits, not maximize efforts.

*Not everyone constantly operates in this “profit-maximization” fashion, but that doesn’t mean it’s an unreasonable assumption.  Consider this: if you were offered two identical cars, one was $10k and the other was $5k, which would you choose?

Protectionism Does Not Guarantee Jobs

A repeated trope heard throughout this election cycle is how foreign nations (specifically China) are “stealing” American jobs.  Supposedly, they are “beating” us at trade because they supply many cheap goods to Americans, rather than have the goods made in the States.  There are, of course, many things wrong with this, but for the sake of argument I will grant it to be true.

Assuming that importing more than exporting is bad for the economy, and that it is a universally desirable goal to pay more for domestically-produced goods in order to protect jobs, protectionist measures (tariffs, quotas, etc) are unlikely to generate substantial job gains (if any at all).  The reason is simple: automation.

We must ask ourselves the question: why were elements of manufacturing “moved” overseas (that is, why did it become easier to import vs produce domestically)?  The standard economic answer is that the relative* cost is lower to manufacture overseas and import than manufacture here.  The relative cost of labor domestically was rising compared to internationally.  A tariff seeks to fix this by raising the relative cost of imports, making the relative cost of domestic goods fall.

However, domestic labor is not merely competing against international labor.  It is also competing against other domestic substitutes, such as automation machinery.  If the relative price of labor remains higher than the relative price of its substitutes (in this case, automation machinery), then labor will still be substituted when production is brought back domestically.  In other words, protectionism may bring back physical plants, but there is no promise whatsoever jobs will follow!

Even assuming the politicians right, that trade deficits are bad, it’s quite likely you end up in a lose-lose situation: the costs of goods are higher (since tariffs block out lower-priced imports), and there are few/no additional jobs created.

*I emphasize “relative” here as it is the key for this, and indeed all, economic discussions.  Absolute costs are less important; what matters are the options.  For example, say you are buying a car.  You have two options, Car A and Car B.  Car A costs $10k, Car B costs $12K.  In relative terms, B is more expensive than A, so you will opt to buy A.  Now, let’s say there is a third option: Car C.  Car C sells for $8k.  In relative terms, A is now higher priced even though its absolute price hasn’t changed.  This is because its price relative to the alternative options is higher.  This is key for the discussion in this post.

Restricted Immigration Will Not Protect Liberal Values

This comment fragment was left on this AEI blog post today:

Of course, many, if not most, commenters here are acolytes of diversity and scream RACISM at the top of their lungs with any suggestion that having large amounts of immigrants who have a culture the polar opposite of life, liberty, and the pursuit of happiness is a dumb idea.

The commentator’s point is that an influx of immigrants from what is deemed illiberal cultures will ultimately change America’s liberal* culture into a carbon copy of wherever they came from.

The arguments against this are legion.  I’ve written on them multiple times here on this blog.  But there is a larger, more fundamental error contained in the argument: illiberal values can coexist in a liberal society.  However, liberal values cannot coexist in an illiberal society.

Within a liberal society, many kinds of value systems can coexist.  Indeed, that is the emphasis of liberalism: individual freedom to live as he so chooses so long as he doesn’t involuntarily violate the rights of anyone else.  Mini dictatorships, communist societies, socialist, they all can (and, in fact, do exist) within relatively more liberal societies.  Corporate structures can be dictatorial.  Family structures tend to be communist.  Religious organizations can be socialist.  And yet, none of these illiberal institutions threaten the overall liberalism of a society.

However, in an illiberal society, liberalism cannot exist.  Illiberal societies require conformity and homogeneity.  They tend to ruthlessly squash dissent (and that ruthlessness need not be overtly violent.  For example, imagine a social-democratic society.  They vote to build a bridge.  One person dissents and refuses to pay.  The others throw him in jail for tax evasion.  This is an example of the kind of ruthlessness I mean).  Liberalism is not tolerated in this kind of a society, even as a sub-culture.

To bring this back to immigration, people who make the argument like I quoted above, under the guise of liberalism, advocate for very illiberal policies.  While an immigrant can come from an illiberal place and have an illiberal culture all his own, in a liberal society he cannot foist that upon anyone else. He can live as he so chooses, but cannot compel anyone else.  Liberal values are preserved.  However, in an illiberal society, such as the one advocated for by the commentator quoted above, by necessity destroys liberal values (in this particular case, the right to pursue property and liberty of both the domestic citizen and immigrant) and indeed promotes illiberal values (hegemony).

The restriction of immigration will not, indeed cannot, preserve liberal values.  It can only seek to undermine them.

*Please note I am using the word “liberal” in its classical sense.

Thinking about Wage Gaps

Over the last few days, two new items have been making their way around the Internet: one, a video with Kristen Bell by the Huffington Post discussing the female wage gap, and two, a report by the Economic Policy Institute on the increasing black-white wage gap .  In both cases, the creators/authors attribute the gap to discrimination.

Discrimination certainly is possible, but is it a likely explanation for these gaps?  From an economic point of view, it doesn’t make sense.  If we assume that firms are profit-maximizing organizations, then we could reasonably conclude that if wage gaps did exist, and were not some statistical aberration, then firms could easily lay off white men and hire females and minorities to perform the same work for far less, thus increasing profit (indeed, this is suggested as a reasonable course of action in Ms. Bell’s video).

And yet, this does not happen.  Why?  It certainly is possible that a chauvinistic attitude is rampant throughout the United States and that it is so powerful as to override the profit motive.  Were that true, our initial assumption that firms are profit-maximizers would not hold true and would make any policy designed to end this gap difficult to implement since the firms’ operators have a high cost tolerance to the point of sacrificing profit.  I suspect that, as the Department of Labor showed some time ago, much of the wage gaps are due to different characteristics and preferences among people.

To the extent that the wage gaps do exist, I suspect they are largely due to policy as opposed to outright discrimination.  Policies nominally in favor of women, such as maternity leave or special health benefits increase the cost of female employees relative to men (this is true even if the policy is gender-neutral, but more likely to be used by women). Given the relative cost, men are more attractive to potential employers at a lower price point.  Women, to remain competitive, then need to lower their salary expectations.*

There is a similar situation with black-white wages, but this comes about more due to policies like minimum wage.  Walter Williams (who is a professor of mine at GMU), has done extensive research on black-white employment and wages since the Bacon-Davis Act (the Act that effectively established a minimum wage).  In the decades prior to the Act, unemployment rates and wages were similar among black and white workers.  Since the Act, the black unemployment rate has skyrocketed, and with it came falling wages.  Since the minimum wage limits teenage unemployment for blacks (a time where valuable skills are learned which do have a dramatic effect on future earnings potential), it trickles down into adult earnings, leading to the gap.

Of course, pure discrimination could be the answer here (although if it were, it’d violate several laws already on the books.  Considering no lawsuits have been filed, I doubt it).  But, as an economist, I look at things from the point of view of economics: I assume people are, generally speaking, rational, profit-maximizing, self-interested individuals.  This assumption is useful enough, and broadly true for the whole population on a number of issues.  Furthermore, the idea of price theory (discussed in this post in terms of the cost of discrimination) is broadly true.  For either of those assumptions to be overturned, we’d need very compelling evidence.  Unfortunately, there mere existence of a wage gap is not compelling enough.

*As an aside, this also makes the cost of discrimination fall.  These sorts of policies make it easier for hiring managers to discriminate since there is less of a cost to do so.  This is also true for racism.