Too Few Jobs: Trade Is Not the Problem, Slow Growth Is

[Note:  This post originally appeared in American Thinker magazine on May, 27, 2016.]

The irrefutable evidence of economic history over several centuries is that the wealth of societies (later nation states) significantly increases as trade expands.  Scarce resources are conserved by being able to obtain goods from others who can produce those goods more cheaply.   The conserved resources then become available to be redeployed to other productive activities, thus adding to the total stock and diversity of a society’s wealth.

Notwithstanding this overwhelming evidence, however, expansion of trade is often singled out as detrimental to a society’s well-being.  Presumptive Republican presidential nominee, Donald Trump, for example, has made the alleged “costs” of trade a centerpiece of his campaign.  Mr. Trump cites current account deficits with China and Mexico as evidence that those nations are taking advantage of the U.S. and stealing U.S. jobs.  He says that, if elected, he will use his business skills to renegotiate existing international trade agreements so as to eliminate the deficits and bring jobs back home.

Regrettably, Mr. Trump sees the conservation of resources, especially labor, as a cost instead of a benefit to be exploited to the nation’s advantage.  This view is short-sighted, and it ignores the principal reason for the lack of new employment opportunities for resources that have been freed up because of trade, a near stagnant economy.

Economic systems are highly complex. In a market-based economy, all economic variables, including policy variables, are interconnected.  If you push on one variable, every other variable shifts — some imperceptibly, others measurably.  A consequence is that focusing on a specific perceived problem in isolation nearly always leads to a failure to grasp the actual causes of the problem.  Regrettably, politicians rarely learn this lesson.  As a result, they try to “fix” a specific problem that they can see with cocooned policy that does not account for other variables either unseen or incorrectly perceived to be unrelated.  In the end, the “corrective” policy more often than not does more harm than good.

Mr. Trump’s view about the “costs” of trade suffers from this short-sightedness. It focuses solely on what is visible, the displacement of resources (e.g., jobs) in those industries most affected by trade.  Such a restricted view has great emotional appeal because structural changes owing to trade can cause severe hardship to those whose lives are disrupted, and a compassionate nation should rightly address this result (I will come back to this).  Limiting one’s focus only to what is visible, however, excludes accounting for the benefit, on a macro level, of the nation’s enhanced capacity to grow by reallocating those conserved resources to other productive activities.

In this regard, a nation is no different from an individual. Most individuals find that it is cheaper to buy groceries at a supermarket than to produce their own food.  Because it is cheaper, money is conserved that then can be spent on other items that enrich one’s life.  Similarly, a nation that buys goods from abroad at a cost less than it would incur producing those goods at home can use those savings to expand output in other areas.  Moreover, when low-priced imports are intermediate goods, the gains extend to domestic industries using those goods, thus permitting, at the macro level, positive job creation.  Implementing restrictive policies (e.g., tariffs, quotas, duties, etc.) designed to “protect” jobs from being lost to trade (the visible problem) thus suppresses a nation’s wealth potential.

What’s more, this focus on the visible misdirects attention away from doing what is necessary to ensure that the wealth-enhancing gains from trade are fully realized and that trade-related structural change does not produce lasting localized hardships.  In other words, instead of forgoing resource savings and the gains to consumers (including industrial consumers) from low-priced imports in order to “protect” jobs, would it not be better to have a rapidly expanding domestic economy characterized by continuous new job creation?  It is no coincidence, I believe, that Mr. Trump’s pronouncements about the “costs” of trade come at a time when the U.S. has experienced an historically tepid recovery following a severe recession.  Had economic growth been anywhere close to historical norms since the 2008 crisis, it is doubtful that complaints about other nations “stealing” U.S. jobs would have nearly as much currency.

So, the real question to be asked is how do we restore economic growth. This is the problem to which Mr. Trump and others should direct their attention.  Undesired resource idleness does not occur in a vibrant economy with expanding job opportunities.  The goal should be to accrue all of the gains from low-cost imports while maintaining full employment at home.

Putting the economy back on a job-creating growth path will, in turn, require addressing the several significant self-imposed interconnected impediments to that path.  These include, among others, the massive and growing overlay of federal regulations on business; leviathan government spending that saps the economy of productive resources; and a tax system that hinders capital accumulation and is laden with special interest provisions that distort allocative efficiency.

Space here does not permit a full discussion of these yokes on growth and job creation, but a few facts illustrate the magnitude of the yokes.

Regulatory Costs:

According to estimates made by the Competitive Enterprise Institute (CEI), federal regulations imposed a $1.88 trillion cost on the U.S. economy in 2014.  Those costs include direct and indirect costs on businesses and higher prices on goods and services to consumers.  CEI estimates that, all told, the costs amount to nearly $15,000 per U.S. household.  This number would of course be even higher if state and municipal regulations are added in.

Of course, not all regulations are bad. Nonetheless, a $1.88 trillion burden on the economy certainly contains substantial overreach.   In turn, each dollar of unnecessary cost on businesses reduces the output rate at which a business maximizes its profit and thus reduces its demand for labor.  Moreover, the enormous compliance burden diverts resources away from more productive uses that would otherwise expand the size of the economy, and the higher prices on final goods mean that consumers’ real income is reduced.  The end result is stunted growth and fewer jobs.

Spending and Taxes:

Federal government spending for fiscal year 2015 was $3.7 trillion.  Total government spending (including state and local government) was $6.4 trillion. At the same time, the federal government took in $3.25 trillion in tax revenue.  State and local governments took in another estimated $3.1 trillion.  Such a huge diversion of resources away from private, productive uses robs the nation of both wealth and jobs.

In addition, the inefficiencies that spending and taxing policies impose on the economy hinder growth and job creation still more.  For example, special interest tax provisions and spending programs vitiate market-determined resource allocation.   The result is distortions throughout the economy.  Further, taxes on business income, capital gains, and income from savings reduce the returns on capital and make capital less desirable to accumulate.  Less capital accumulation means slower economic expansion and less demand for labor.

Summing Up:

Low-priced imports that American buyers find cost-effective and that provide the opportunity for expanding the total national wealth are a net benefit to the U.S., not a cost.  Restrictive trade policies that focus only on the visible hardships suffered by those most affected by trade misperceive the real problem, a near stagnant economy characterized by slow growth.  In the end, such polices will not only fail to stop inexorable structural change, but make the country poorer.  Far better would be to restore a vibrant, robustly growing economy in which there is continuous job creation that ensures an abundance of new opportunities for those otherwise displaced by expanded trade.  Of course, where short-term transition assistance is needed, that assistance should be provided, but long term unemployment need not be the norm. The next president will have a fresh opportunity to refocus on growth.  A good start toward this end is serious reduction in regulatory overreach, overhauling the tax system to remove anti-growth biases, and major cuts in the amount of national income that big government consumes. — The Chinese and the Mexicans are not the problem.  The problem is us.

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Paying One’s “Fair Share” of Taxes Redux

[Note:  This post is an update of an earlier one to take account of more recent developments, including President Obama’s news conference on May 6, 2016.]

In his news conference on Friday (May 6), President Obama reiterated his claim that, owing to tax loopholes, the wealthy do not pay their “fair share” of taxes, a claim he has made several times during his presidency.  Vermont Senator Bernie Sanders has made this same claim in most, if not all, of his presidential campaign speeches.  Former Secretary of State Hillary Clinton has also stated that, if elected president, she intends to institute a four percent “Fair Share Surcharge” on Americans who make more than $5 million a year.

I have always been puzzled when I hear politicians, particularly Democrats and others of the left, talking about people needing to pay their “fair share” of taxes.  What President Obama, Senator Sanders, and Mrs. Clinton mean by this idea is that those earning higher incomes owe society more in taxes than they already pay, notwithstanding that income tax rates are already progressive, i.e., marginal rates increase with income.  Rarely, however, do proponents of raising rates on high income earners say exactly what a “fair share” of taxes is or, more precisely, what the upper limit, if any, of a “fair share” of taxes is.  Even more vague is their philosophical basis, either in ethics or some other grounding, for what constitutes “fairness” in this context.

It seems to me that Obama, Sanders, Clinton, and others of similar views have the tables turned upside down.  In fact, rather good philosophical arguments can be made from both an ethics and an economics perspective that, if anything, high income earners are already paying well more than their fair share of taxes and that their absolute tax payments or marginal rates should therefore be reduced.

Taxes are the cost of financing government.  In our democracy, every qualified voter is afforded one vote, no more and no less.  Just as this political shareholding is allocated equally among citizens, it would seem intuitively fair that the burden of the cost of government should similarly be allocated equally.  That is, everyone should pay the same amount in taxes in the form of a simple per capita tax.  This way, each person contributes the same amount toward the cost of government, much like dues assessments in a club.  At the least, it would be interesting to ask President Obama, Senator Sanders, and Mrs. Clinton to explain, from an ethics standpoint, why their proposals to make taxes even more progressive, i.e., even more unequal, are fairer than an equal per capita tax.

Of course, as a practical matter, given the current size of government, an equal per capita tax would necessarily mean that many, if not most, taxpayers would owe more than they earn or have in savings and, in some cases, likely much more.  Such a tax thus would be unworkable unless government were shrunk substantially.  The cost of government would have to shrink at least to the point where the per capita tax would be affordable by each taxpayer, a goal unlikely to be shared by the political class, left or right.  Even so, the size of government and the practical ability to have fairness in the tax code would seem to be inextricably linked.

Admittedly, I am uneasy to render judgments on purely ethical grounds about whether the amount of taxes a particular taxpayer pays is fair for that taxpayer.  I do, however, claim some expertise in economic reasoning.  On that basis, I think an argument can be made that, in the alternative to a per capita tax, a regressive income tax is actually fairer than a progressive one.

The argument rests on the idea that whenever there is voluntary exchange, every transaction creates wealth.  A voluntary transaction will not take place unless each party becomes better off as a result of the transaction.  It follows therefore that, so long as high income earners obtain their income through voluntary exchange of their labor, services, or other resources, each dollar of that income is the product of a wealth-creating transaction.

Significantly, however, the high income earner does not keep all of the created wealth, but only a fraction.  The rest of the new wealth necessarily accrues to everyone else with whom the high income earner engaged in voluntary exchange, either directly or indirectly.  Thus, the higher the income of the high income earner, the greater the earner contributes to other people’s wealth.  It follows then that high income earners benefit society more than lower income earners before any taxes are taken out of those earnings.

Based on this reasoning, one possible way to measure tax fairness would be on the basis of relative additions to aggregate social wealth.  Under such a definition, people who contribute less to social wealth would be required to make up for the deficit by paying more in taxes, while those who contribute most to social wealth would be rewarded by lower taxes.  Put another way, fairness would require that high income earners be taxed less than low income earners.  The former have already made a disproportionate positive contribution to social welfare.

Of course, as with the per capita tax, a regressive income tax would require considerable downsizing of government.  Such a tax simply could not finance the current government.  Once again, the size of government and the practical ability to have tax fairness are inextricably linked.  But that practical consideration aside, a fairness argument for a regressive income tax that rests on economic reasoning, unlike the Obama, Sanders, and Clinton fairness arguments, at least has an analytical grounding.  It would be interesting to learn how they would respond to the argument.

In that regard, I will myself volunteer one necessary exception to the general conclusion.  The exception owes to the fact that many high income earners today derive their high incomes not from contributing to aggregate wealth but rather by using the machinery of government to expropriate the wealth created by others.  Rent seeking can be very lucrative.  Thus, if “paying one’s fair share” in taxes is inversely related to one’s contribution to social wealth, these high income rent seekers should be taxed at a 100% marginal rate.  Given that the Democratic left has its own set of favored rent seekers, however, I am not sure that Obama, Sanders, and Clinton could even agree to this exception.

To be sure, I write all of the above with a considerable amount of tongue in cheek.  I stand by the larger point, however, that tax “fairness” is hardly a known parameter, and that one can construct ethical and/or syllogistic arguments leading to completely opposite conclusions as to what is fair.  In view of this conundrum, it seems to me that we all would be better served if politicians and policy makers purged “fairness” from their thinking (and speeches) and simply focused on a tax system that finances essential government functions in the most efficient manner possible and impedes economic vitality and long-term growth as little as possible.  I suspect that, in a prosperous and growing economy, questions of “fairness” will lose much of their political cachet and recede to the academic lounges where they belong.

Demagoguery and the Minimum Wage

[This post was originally published by American Thinker magazine on April 2, 2016.]

On Monday (Mar. 28) California Governor Jerry Brown announced that he would sign a bill to raise the state’s minimum wage to $15/hr.  The increase from the current minimum of $10/hr. would be fully completed by 2022.  Last year, New York passed legislation raising the minimum wage for fast food workers to $15/hr.  At the local level, the city of Seattle has mandated a minimum wage of $15/hr. to be fully phased in by 2021.  In the presidential campaign, Hillary Clinton and Bernie Sanders have proposed raising the federal minimum wage from $7.25 to $12/hr. and to $15/hr. respectively.

Particularly among politicians of the left, raising the minimum wage has long been a staple as a campaign talking point.  Mrs. Clinton and Senator Sanders claim, for example, that raising the wage floor is necessary to help people to move into the middle class.  The argument rests on the idea that if incomes are too low for some people to reach the middle class, a law mandating higher incomes is justified.  Certainly, the argument has strong emotional appeal.  Regrettably, it is also subject to significant demagoguery.

As economists have taught for generations, price controls (wages are prices) never achieve their intended ends.  Simply put, there are irrefutable laws of economics that cannot be repealed by political action.  Demagoguery and emotional appeal may produce short-term political advantage, but ultimately claims based on unsound economics must disappoint those who put faith into those claims.  Minimum wage laws are an exemplar of political action that cannot live up to its claims.

A fundamental law of economics is the law of demand, which states that as the price of something rises, the quantity purchased decreases in a given time period, and vice versa.   The law rests on the fact that, in the real world, resources are scarce, and thus the process of satisfying human wants requires making choices among alternative uses of those scarce resources.  Relative prices determined in free markets facilitate this process by permitting persons to make spending decisions according to the incremental value they obtain per extra dollar spent on a good or service.  The lower the price, the higher is that ratio.  The higher the price, the less is the ratio.  Hence, if the price of something goes up – thus reducing the value per dollar spent – less will be purchased as substitutes become a better bargain.

Artificially controlling specific prices distorts this process and creates inefficiency in resource allocation, as relative prices no longer fully reflect market forces.  Wages are prices.  Hence, if wages for unskilled labor are artificially set above the market wage by means of legislation, less unskilled labor will necessarily be purchased per period of time.  Moreover, the structure of wages throughout labor markets – skilled as well as unskilled – will be distorted, and economic efficiency will be compromised.  These outcomes are givens, and economists have known about them for a long time.

Why then do minimum wage laws persist?  Are not the harmful effects sufficient for voters to reject politicians who push these laws?  The answer, I believe, is that, although the harmful effects are real, they are generally not immediately visible, while the superficial, demagogic appeal of minimum wages is easy to articulate.  For example, both Mrs. Clinton and Senator Sanders claim that raising the minimum wage will help to elevate people – particularly unskilled workers — into the middle class. Senator Sanders further claims that raising the minimum wage will have a desirable redistributive effect that will lessen income inequality.

Neither of these contentions, however, lives up to its full billing.  As for elevating lower income people permanently into the middle class, minimum wage laws are highly inefficient because they focus on symptoms and ignore causes.  In this regard, vast amounts of evidence indicate that rising incomes are best achieved by education, stable families, and cultural factors such as personal discipline and a strong work ethic.  Entry level jobs – even at low wages – help to foster the personal characteristics, especially among young people new to the workforce, necessary to succeed in a work environment and eventually advance into higher paying positions with greater responsibility.  Minimum wage laws that price these persons out of the labor market remove the opportunity to develop these traits.  In addition, in few households is the primary income earner a minimum wage worker. Hence, even for households where jobs are retained, raising the minimum wage will have little impact on household income.  A far better emphasis for public policy directed toward building the middle class would be on augmenting incentives for skills acquisition and maintaining stable families.

Raising the minimum wage is a similarly inefficient means to address income inequality. This is not controversial among economists.  Any income redistribution that raising the minimum wage achieves is likely temporary, as employers adjust to the higher wage rate over time by substituting to other inputs such as labor-saving technology.  In addition, the higher wage rate only raises the income of those who continue to keep their jobs.  For workers who, at the margin, lose their jobs, income falls to zero.  And, finally, the redistribution comes at the expense of distorting relative prices, which can be considerable depending on the size of the wage hike.  There are far better ways to achieve income redistribution (assuming that’s the goal) such as simple cash payouts or a negative income tax.  Either of these measures ensures that the incomes of the entire targeted group increase, and both mitigate against compromising efficiency because of price distortion.

Regrettably, demagoguery on the minimum wage is not limited to political candidates seeking electoral advantage. Minimum wage laws also receive strong support from organized labor under the guise of helping out all workers.  The California legislation, for example, was backed strongly by unions.  At first glance, such support would seem odd as union jobs, after all, are typically at hourly wages much higher than the minimum wage.  Even so, there are at least two reasons why unions can be counted on to advocate for higher minimum wages.  First, many union contracts contain clauses that structure union wages relative to the minimum wage.  That is, the union pay scale is set, in relative terms, to be some percentage above the lowest pay scale.  Hence, when minimum wages are hiked, the union pay scale is similarly adjusted upwards.  Second, even aside from contract terms, it is in the interest of skilled union workers to have the wage rates of unskilled workers continually increase.  The higher the wage of the unskilled worker, the less that worker competes for the same job as the more productive skilled worker.  In the end, despite contrary rhetoric, both of these factors work against greater employment of unskilled workers.  Once again, legislated wage floors produce perverse consequences for those intended to be helped.

To sum up, higher minimum wages cannot be justified in sound economics. Fundamental economic laws simply cannot be overridden by political action.  Unskilled labor in California, New York, and Seattle will, in the end, suffer the most from the economic demagoguery of their elected officials.  Moreover, if Mrs. Clinton or Senator Sanders succeeds in raising the federal minimum wage, the perverse consequences will be spread across the nation.  This result would be unfortunate because it need not be so.

Indeed, higher real wages for all workers (unskilled as well as skilled) and permanent rises in standards of living have been the historical norm in the U.S. The drivers of this experience have been ever-increasing labor productivity and an expanding economy in which competition for labor services remains intense.  The proven recipe to those ends is a vibrant and growing free-market private sector incentivized by low taxes and minimal regulation, and a culture that encourages skills enhancement and personal responsibility.  Demagoguery over the minimum wage is no substitute.

Donald Trump v. Adam Smith

[This post originally appeared in American Thinker magazine on March 1, 2016]

In the 1980s Reagan Republicans were fond of wearing Adam Smith neckties.  (I personally still have two hanging in my closet that hail from that era.)   Adam Smith, of course, was the 18th Century Scotsman who wrote An Inquiry into the Nature and Causes of the Wealth of Nations, a book considered by many to be the founding work of modern economics.  Wearing the Adam Smith neckties was intended to display fidelity to Smith’s ideas and, in particular, fidelity to free markets and free trade.

One does not see many Republicans wearing these neckties anymore.  Perhaps this loss of ubiquity is to the good, considering how far removed the Party’s front runner in the presidential race, Donald Trump, is from the free market ideas of Smith.  For example, in response to the announcement earlier this month by the air conditioning products manufacturer, Carrier Corporation, that it would be closing a U.S. production facility and relocating to Monterrey, Mexico, Mr. Trump stated on Sean Hannity’s Fox News Channel program that, if elected, he would impose a 35% tariff on Carrier products re-entering the United States.  In the same vein, Mr. Trump made a similar threat last year with regard to Ford Motor’s announcement that it will double its Mexican-based production capacity.  Mr. Trump asserts that the threat of high re-entry tariffs is necessary to discourage these and other American companies from seeking lower-cost production outside of the United States.

Mr. Trump also claims that the Chinese government engages in unfair trade practices by intentionally devaluing the yuan in order to impose a de facto tariff on all imported goods from the U.S., which he says is “costing millions of American jobs.”   He says that, unlike the “stupid politicians” in Washington, he will use his superior deal-making skills to stop this job loss by negotiating a U.S.-friendly trade agreement with China.  While those negotiations are taking place and to encourage the Chinese to come to the table, he will designate China a “currency manipulator” on day one of his presidency and impose countervailing duties on “cheap Chinese imports.”

Adam Smith would be alarmed by Mr. Trump’s retaliatory threats. The central thesis of The Wealth of Nations is that a nation’s economic well-being is measured not by its store of gold or currency, the amount of goods it exports, or the number of jobs that exist within its borders, but rather by the quantity of goods and services available for consumption by its populace.  Smith makes the point that the ultimate purpose of all economic activity is to satisfy human wants and needs.  The reason that economic activity takes place is so that people can consume.  Work and production are means to that end, but not ends in themselves.  In a world in which resources are scarce, employment of labor and other factors of production is the cost that a nation incurs in order to consume.

Thought of in this way, it becomes clear that if a nation can reduce the employment of any resource, including labor, required to yield a given rate of output of consumer goods, those freed up resources can then be used to produce even more goods, thus making the nation wealthier.  Such a result can come about because of several reasons, including the discovery and adoption of new technology that raises resource productivity, trade that derives from comparative advantage, and the free flow of capital to those uses and locations where it is employed most efficiently.

Thus, for example, American wealth stands to gain when Carrier can produce air conditioners at lower cost in Mexico and Ford can do the same with cars.  The gain comes about in two ways.  First, absent re-entry tariffs, as Mr. Trump proposes, more air conditioners and cars can be made available to American consumers at a lower price.  Second, the resources freed up in the U.S. become available for other output-expanding uses.

Trade also increases the wealth of nations by permitting them to take advantage of each other’s relative productive efficiencies.  So, for example, a nation’s wealth grows whenever it purchases goods from those nations that supply them most cheaply.  Hence, notwithstanding Mr. Trump’s outrage at “cheap Chinese imports,” American consumers are better off because of those imports.  By their own actions, consumers have revealed that they prefer spending their dollars on the Chinese goods to spending the dollars on anything else.  In addition, because the U.S. does not have to use up scarce resources to produce these goods, those resources are available to produce other goods that otherwise could not be produced.  Instead of harming the U.S., the “cheap Chinese imports” generate an increase in American wealth.

But what about the trade deficit that is created by importing all of these goods from China?  Isn’t Mr. Trump’s alarm justified on this ground?  The answer is “no.”

Of critical importance here is the fact that the dollars obtained by the Chinese sellers have value only because they represent a claim on American-produced goods and services. Because in the modern global economy, exchange does not take place by barter of goods for goods but by goods for currency, final settlements need not, and rarely do, occur instantly.  Rather, they take place over time, often many years.  Ultimately, however, the dollars in Chinese hands will find their way back to the U.S., either directly or through multinational trade, to be redeemed for real goods and services.

What Mr. Trump fails to grasp is that voluntary trade is always beneficial to both sides regardless of current account deficits or surpluses.  Moreover, he misses Adam Smith’s key insight, namely that exports are a cost to a nation; imports a benefit. When a nation imports, it is enjoying the consumption of goods produced from the scarce resources of some other nation. Although settlement may not occur immediately, ultimately a nation must pay for that enjoyment with exports of real goods and services produced out of its scarce resources.  In the end, trade allows each nation to obtain goods that yield greater consumer surplus than could be obtained if the goods were produced domestically.

The principal lesson here is that a nation that can become more efficient in supplying consumer goods to its people becomes wealthier.  The free flow of capital and international trade are two ways that increased efficiency can come about.  (There are others, of course.)  Tariffs and other policies that impede the potential gains in efficiency ultimately make a nation poorer.

Regrettably, Mr. Trump evinces no awareness of these principles from The Wealth of Nations.  His repeated promises to “be the greatest jobs president ever” and seek “fair trade, not free trade” are founded on long-discredited mercantilist ideas that confuse costs with benefits and focus solely on observable metrics while ignoring the less observable perverse consequences.

To be sure, international movement of capital and goods often has severe localized effects on individuals and communities. These are the observable costs that Mr. Trump sees and seeks to prevent.  For example, the lives of those individuals who will lose their jobs at Carrier and Ford will be disrupted, perhaps severely so.  Far better than Mr. Trump’s steep tariff penalties, however, would be policies that make it possible for these individuals to find other jobs quickly.  In the short term, taxpayer funded retraining and other transitional assistance are in order; in the longer term, free market policies that promote a more efficient and expanding economy will assure continuing employment opportunities for everyone.

By contrast, policies that focus directly on protecting and creating jobs, such as Mr. Trump’s tariff penalties and duties, will in the end fail to do either.  Although visibly protecting some jobs in the short term, these policies will diminish the efficiency of the economy, make American consumers poorer, and reduce the nation’s wealth.  Ultimately, they will cost jobs and harm American living standards.  Bearing out Adam Smith’s insights, economic history and experience show that job opportunities expand most when a society focuses first on increasing efficiency over time.  This is the recipe for a growing and ever wealthier economy.  More jobs are, in turn, the byproduct of this process.

I won’t be sending one of my Adam Smith ties to Mr. Trump.

Justice Antonin Scalia — RIP

I did not know Antonin Scalia, who passed away unexpectedly February 13 at the age of 79.  I did, however, have the opportunity to meet the Supreme Court justice from time to time at Federalist Society events in Washington, but only long enough to shake hands and exchange pleasantries.  More significantly for me in remembering Justice Scalia is the dramatic impact he had on the law.

Largely in the 1980s — and spurred in significant measure by then-Attorney General Edwin Meese — conservative and libertarian legal scholars began to formalize the study and key principles of the judicial philosophy known as “originalism”  Originalism holds that a judge should seek to interpret the Constitution solely on the basis of the meaning that its drafters (including the drafters of amendments) had at the time of the drafting.  Justice Scalia, who took his seat on the Court in 1986, was an originalist, and by dint of his appointment, was in a position to bring that judicial philosophy to bear on actual law.  He did so with great effect over the course of nearly 30 years on the Court.  Today, even those justices and lower court judges who do not subscribe to originalism must be prepared to account for it and be able to defend their constitutional law opinions in the face of it.

Importantly, originalism is not a single idea with firm boundaries.  Over the years, legal scholars have developed various strains of the philosophy.  Justice Scalia self-identified as a “textualist,” by which he meant that he looked principally, if not solely, at the text of the provision of the Constitution that he was interpreting.  In so doing, he looked to the meaning of the words as they were understood at the time that they were written  Although with considerable overlap, another strain of originalism has taken on currency today as well.  This strain holds that, to give proper meaning to the words of the Constitution, one must read them within the context of the natural law and natural rights principles found in the Declaration of Independence.  That is, the natural rights principles in the Declaration informed the Constitution’s drafters understanding of what they were writing, and thus must similarly inform subsequent judges who are interpreting the document.  Some believe that Justice Clarence Thomas represents this originalist perspective.

Significantly, Justice Scalia applied his textualist brand of originalism with equal vigor to statutory interpretation.  Here too he sought to examine only the words within the four corners of a statute to find its legal force.  He considered such things as “legislative intent” — derived, for example, from the record of congressional debate — to be extraneous material and therefore not to be consulted by judges.  One of the more celebrated recent examples of his application of textualism is his dissent last year in King v. Burwellthe case upholding the Internal Revenue Service’s interpretation of the word, “Exchange,” within the meaning of the Affordable Care and Patient Protection Act, i.e., “Obamacare.”  In that case, the Court’s majority, in an opinion written by Chief Justice John Roberts, found it proper to define “Exchange” on the basis of the spirit and intent of the statute.  In stark contrast, Justice Scalia read the words of the statute literally and, in uniquely Scalia-esque language, vigorously critiqued the majority’s departure from those words.  (If readers are interested in more detail, I have written on that case and Justice Scalia’s dissent here.)

Last Friday, along with thousands of others, I was honored to be able to pay my respects to the late justice as he lay in repose in the Great Hall of the Supreme Court building.  As I exited the building, a reporter asked me about my impressions.  The brief interview with me and his story about the day can be found here.

 

 

Economic Libertarians Will Have a Friend in Ted Cruz

[This post was originally published in American Thinker magazine on Feb. 11, 2016]

In considering the current crop of presidential candidates, economic libertarians and others who place a high value on property rights, the right to earn a living, and the right to open a business will find no better friend than Texas Senator Ted Cruz.  Cruz demonstrated his commitment to these values when he was a senior official at the Federal Trade Commission during George W. Bush’s Administration.  Significantly, his work at the FTC established a foundation on which the cause of economic liberty progresses still today.

Leading a team of senior FTC lawyers, Cruz used his considerable advocacy skills to fight relentlessly against state laws conferring privilege on politically and economically powerful interest groups.  Many of these laws do little more than protect entrenched incumbents from small entrepreneurs seeking to open a business and earn a living.  Cruz and his team vigorously opposed unjustified state government privilege in such diverse occupations as attorneys, funeral directors, opticians, and mortgage brokers.  The goal was always to open up markets to entry by anyone with the talent and desire to compete on a level playing field.

The legal theories that Cruz and his team developed from 2001 – 2003 continue to pay dividends.  For example, last year those theories helped secure economic rights for small entrepreneurs providing teeth whitening services in North Carolina shopping mall kiosks and similar venues.  These entrepreneurs entered this service market coincident with the growing popularity of teeth whitening in the mid-2000s.  Practicing dentists in the state also offer teeth whitening services, but generally at much higher prices than the small operators.  As a result, the new competitors began taking business away from the incumbent dentists.

In response to this emerging competition, the North Carolina State Board of Dental Examiners (NCSB), a North Carolina state-sanctioned agency controlled and elected by practicing dentists and charged with regulating the practice of dentistry, sent letters to the small operators threatening them with potential criminal liability for the unauthorized practice of dentistry.  The letters effectively closed down the new competitors.  Significantly, North Carolina law did not include teeth whitening in the statutory definition of dentistry, nor was there credible evidence that non-dentists offering whitening services created a significant health or safety hazard.

In 2010, the FTC filed an antitrust complaint against the NCSB charging it with unlawful collusion to exclude the non-dentists from the teeth whitening market.  After an administrative hearing, in 2011 the full Commission found the NCSB’s tactics to violate antitrust law.  Key to that finding was that the NCSB did not conform to proper procedures under North Carolina law and was largely motivated by a desire to protect incumbent dentists’ economic interests.  The FTC ordered the NCSB to stop sending the threatening letters, to send new letters to previous recipients admitting error and rescinding the earlier threats, and to notify prospective non-dentist teeth whiteners that they would not be violating the law.

Relying on a 1943 Supreme Court decision holding that state actions to suppress competition are immune from the federal antitrust laws under the constitutional principle of federalism, which provides for both state and national sovereignty, the NCSB went to federal court arguing that, as a state agency, it had sovereign immunity and therefore was not bound by the FTC’s findings.  Armed with the legal theories that Ted Cruz and his team developed, which were later memorialized in a formal Report, the FTC defended the constitutional legitimacy of its antitrust suit all the way to the Supreme Court.  In an opinion handed down just a year ago, the Court held that, although a creature of the state, the NCSB nonetheless was a non-sovereign body, being controlled by private parties and elected by market participants, and acted without significant state supervision. It therefore did not enjoy state action immunity from the federal antitrust laws.  The FTC’s prior finding of unlawful anticompetitive conduct thus stood, as well as its order enjoining the NCSB from prohibiting non-dentists from competing in the North Carolina teeth whitening market.  In other words, property rights, the right to earn a living, and the right to open a business prevailed.

Without Ted Cruz’s earlier efforts to develop the legal theories used by the FTC to defend the constitutionality of its antitrust suit, it is doubtful that these important values could have been protected in the face of politically powerful local interests.  What’s more, this important clarification of the law has led to increased scrutiny of state-sanctioned boards in other states, thus further securing economic liberty rights against the politically connected.

For example, just last month, relying on the FTC’s 2015 win, an antitrust action was filed against the Nevada State Board of Pharmacy, an administrative agency of the state.  The complaint contends that that the Board exceeded its authority in finding direct shipment of pet medicines unlawful.  The effect was to exclude the plaintiff, a direct shipper, from competing with incumbent pharmacists, allegedly because such competition would mean a loss of business for the incumbents.  Similarly, resting on the NCSB decision, a Texas telemedicine business brought an antitrust suit against the state’s medical board, alleging that the board promulgated a rule for the unlawful purpose of protecting state-licensed physicians against competition from telemedicine providers.  The rule prohibits doctors from treating people over the telephone.  The court issued a temporary injunction requiring the medical board to suspend the rule pending the outcome of the litigation.  In North Carolina, after the NCSB decision, LegalZoom settled a long-running dispute with the N.C. State Bar over whether its online provision of certain legal documents constitutes the unauthorized practice of law.  The settlement permits LegalZoom now to offer these documents, subject to certain conditions.  

What all these developments say is that Ted Cruz’s FTC legacy continues to have positive results in advancing the cause of economic liberty.  Much work, however, remains to be done, as government privilege persists at both the state and federal level.  Contrary to maintaining the status quo, a Cruz Administration will assuredly expand the fight for economic liberty by using all legitimate means to challenge such government privilege.  Based on Ted Cruz’s history, economic libertarians can be confident of that commitment and would do well to support the Texas Senator in his presidential quest.

[Full Disclosure:  Senator Cruz and I were colleagues at the FTC from mid-2001 to 2003.]

The Federal Reserve and the Inflation Tax

[This post was originally published in American Thinker magazine on Feb. 6, 2016.]

Article I, Section 7 of the Constitution states, “All Bills for raising Revenue shall originate in the House of Representatives.” In other words, the Framers wanted to make sure that, when taxes are imposed on the people, the legislation giving rise to those taxes springs from the people’s House, the body closest to the nation’s citizens.  No doubt the Framers thought that the taxing power of the federal government should not be taken lightly or at a distance from the people.

Just last Monday, speaking in New York to the Council on Foreign Relations, Federal Reserve Board Vice Chairman Stanley Fischer reiterated the Fed’s long-standing position that monetary policy should achieve an annual rate of price inflation of two percent.  This targeted inflation is specifically in consumer prices.  As anyone with common sense understands, such deliberate price inflation amounts to a tax on income earners, savers, and holders of cash assets — essentially all Americans.  Moreover, this two percent tax falls on top of all other properly enacted taxes.  The consequences are severe.  An annual two percent inflation rate means that the purchasing power of a dollar will decline by almost a third over 20 years.  As far as I know, no citizen voted for this tax, nor endorsed a member of the House of Representatives campaigning on such a tax.

Under what authority does the Fed have this power to tax? Ostensibly it derives from the so-called “dual mandate” that Congress assigned to the Fed in 1977 when it passed the Humphrey-Hawkins Act.  At that time, Congress told the Fed that its job is to promote maximum employment and stable prices.  To most people, stable prices means, well, stable prices, i.e., no price inflation.  Torturing the English language, however, the Fed defines stable prices to mean its targeted two percent inflation rate.  The Fed holds that maintaining this rate satisfies the price stability prong of its dual mandate.

The economic theory justifying this inflation tax is grounded in modern monetary thinking, which is a synthesis of traditional Keynesianism and Monetarism (hereinafter, “modern Keynesianism”). This theory holds that economic well-being and prosperity come about through spending.  Therefore, spending, and especially consumer spending, must be encouraged.  Indeed, saving is anathema to the theory.

One sure way to encourage spending is to punish financial prudence and frugality on the part of individual households. A positive inflation rate continuously maintained by design achieves this objective.  People are incentivized to forego saving and spend now before the value of their income and cash assets decline even further.

A second way to encourage spending is to incentivize debt-taking. Continuous inflation, especially accompanied by artificially low interest rates, achieves this objective too.  Debt-takers obtain relatively high value money to spend in the current period, and pay it back with relatively devalued money in a later period.

Another factor in this modern thinking is the idea that prices adjust faster than wages. Although a few prices may be fixed for a period by contract, most prices, especially consumer prices, can change quickly, if not immediately.  By contrast, wages, more often fixed by contract, are usually slower to adjust to inflationary pressure.  Even when not fixed by contract, burdens on both employees and employers can be severe with frequent turnover.  Thus, even when higher wages might be had elsewhere, small gains in income may not be worth the burden of changing jobs.

Given this price/wage adjustment disparity, household incomes do not keep pace with price inflation, which creates still another incentive to accelerate spending.  In addition, business earnings increase because revenues are rising faster than costs (i.e., prices are going up, while wages remain sticky). Hence, stock values inflate.  This asset inflation, according to the modern thinking, produces a wealth effect that also encourages spending.  That is, stockholders see their investments rise in nominal value, feel richer, and spend more.  In addition, the sticky nominal wages mean that real wages decline over time, thus creating more demand for labor by businesses.  Taken together, all of these behaviors – households spending now rather than later, asset holders feeling wealthier and spending more, and businesses increasing demand for labor — bring about prosperity in the form of higher nominal GDP and full employment.

So goes the modern Keynesian story. The core premises of the story survive despite the historically slow recovery of the economy in the aftermath of the 2008 financial crisis.  In fact, even allowing for fiscal policy failures, the evidence since 2008 is that monetary policy has done little to benefit middle and lower-income Americans by comparison to wealthier Americans with significant holdings of financial assets.  Still, the Fed persists in its desire to tax Americans by boosting inflation through artificially low interest rates and perhaps even another round of quantitative easing.

Nonetheless, there are several grounds on which to question the soundness of the Fed’s inflation tax. First, even taking the Fed’s monetary theory as valid notwithstanding its failures, no prominent economist of which I am aware has explained why two percent is the appropriate inflation rate to target.  Why not three percent?  Or, one percent?  In fact, there is nothing in the analytics of the theory itself that determines this precise rate.  At a minimum, if the people are to be taxed an extra two percent a year, there should be a firmer foundation for that tax than simply the guesswork of unelected central bankers.

Second, the theory’s focus on consumer spending neglects capital accumulation. Capital accumulation is essential to economic growth.  It is the basis for productivity gains in the economy.  Capital accumulation, however, requires saving to finance the new capital.  By making saving unattractive by means of the inflation tax, the rate of capital accumulation will be lower than what it otherwise would be.  Although the inflation policy may give the illusion of stimulating economic activity in the short term, the longer term consequences of diminished growth prospects are a lasting social cost.

Third, according to the Bureau of Labor Statistics, in the 100 years since the Fed’s founding, the price level in the U.S. has increased by over 2300%.  This means that the value of the dollar has dropped by over 95%.  This record is hardly one to be proud of.  More significantly, it shows just how severe an inflation tax is over time.

Fourth, aside from economic and theoretical defects, an inflation tax that punishes prudence and thrift creates a culture that discourages personal responsibility. This result comes about in two ways.  First, prudent saving for a rainy day or for retirement requires a willingness to see those savings depleted in real terms every year.  Certainly at the margin, fewer people will choose to save, or save as much, with this looming prospect.  Second, the inflation tax encourages debt-taking.  Debtors are rewarded by inflation by being able to pay back loans with cheaper money.  As a cultural phenomenon, widespread debt-taking leads to irresponsible spending, especially as it relates to short term spending by “maxing” out one’s credit cards, which often have among the highest interest rates.  With thrift and saving being irrational, instant gratification becomes the norm.

Where does this leave us?  Regrettably, a court is unlikely to find the Fed’s desired tax on the American people to be unconstitutional, as it does not derive directly from a “Revenue Bill” within the meaning of Article I, Section 7. Therefore, removing this taxing power will require legislation, a doubtful prospect.  Even so, in this political season, it might not be too much to ask that the presidential candidates weigh in on the topic.  Monetary policy being arcane to most in the media, however, I am not optimistic that the people will get answers.  

 

Capital Accumulation: The Missing Variable in Economic Policy Debates

[This post appeared originally in a slightly shorter form in American Thinker magazine on Feb. 3, 2016.]

Americans are rightly concerned about their current and future economic well-being. For several years, middle class household incomes have seen little overall growth, and tepid growth in hourly wages has meant that the purchasing power of incomes for some families has actually declined.   A consequence is that too many Americans live largely paycheck to paycheck.  Although on the macro level, there has been some deleveraging of debt on the part of households since the 2008 financial crisis, debt remains a significant problem for many.  It is not therefore surprising that polls show that Americans are deeply worried about their ability to sustain their standard of living, let alone pass on a better standard of living to their children.

In this political season, exposure to debates on economic policy for most Americans centers around what the presidential candidates in both parties have said about the economy and about what their economic plans will be, if elected.  In this regard, all of the Republican candidates have proposed tax plans of one form or another that either reduce marginal tax rates on businesses and individuals or, in the case of former Arkansas Governor Mike Huckabee, would replace the income tax all together with a national consumption tax.  Differences among those advocating reform to the income tax are largely in matters of degree, focusing on how much rates can be reduced, what deductions and tax credits should be retained, and how flat tax rates should be.  The common thread is that these reforms are necessary to incentivize work by allowing people to keep and spend more of what they earn, which will generate economic activity and job creation.

As for the Democrats, both Vermont Senator Bernie Sanders and former Secretary of State Hillary Clinton also want to adjust taxes.  Both say that income inequality is a serious national problem that the federal government needs to address through the tax system.  Specifically, taxes should be raised on higher income earners in order to pay for additional government services that will principally benefit the middle class.  Details, of course, differ between the two candidates respecting the extent of the additional services and the degree to which tax rates should rise, but the overall aim of their respective programs rests on a common belief that tax rates are too low on many higher income Americans.

The presidential candidates’ proposed tax reforms, having now entered the public discourse, regrettably focus almost exclusively on short term considerations.  Not surprisingly, presidential candidates seek to appeal to what they perceive as the current desires of voters.  What this has meant is that consideration of a crucial variable is missing from the public discussion, namely the impact of tax policies on capital accumulation.

Capital accumulation is essential to long-run growth and rising standards of living.  As most every student learns in the first week of an introductory economics course, a nation’s production possibilities – that is, its total potential output — at any given point in time is determined by its endowment of natural resources (including labor), current technology, and its capital stock.  At full employment of all of these factors, there is a near infinite range of alternative mixes of final goods and services that can be produced.[1]  Each of these mixes of goods and services, however, resides at a frontier.  With all resources fully employed, no more goods and services can be produced in the aggregate.  A boundary has been reached.  Thus, at full employment, the only way by which the output of any single good or service can be increased is to take resources away from the production of other goods and services.  That is to say, the cost of consuming more of one good or service is less consumption of other goods or services.[2]

At first glance, the concept of production possibilities seems to suggest that standards of living are fixed in place or, possibly worse, must decline over time because of depreciation of the capital stock.  In fact, experience tells us that this result need not be the case.  New natural resources can be discovered, the labor force can increase through immigration and natural population growth, technology can advance, and the capital stock can expand.[3]  It is the last of these on which tax policy can have the most significant impact.

To see why, consider that plant and equipment wear out over time.  Some plant and equipment may also simply become obsolete with the introduction of new technology.  If the capital stock is not replaced as it depreciates, production possibilities must necessarily decline to the extent not compensated by increases in the stock of other productive factors.  In the modern economic world, however, sufficient amounts of such compensation are highly unlikely.  Therefore, just to maintain current production possibilities, it is essential that some of a nation’s productive factors be devoted on an ongoing basis to replacing the capital stock that is wearing out.  What this means is that some amount of the production of final goods and services for current consumption must be sacrificed in order that resources can be diverted to producing capital goods.  In other words, a nation must consume less in the present and save more in order to sustain its capacity to produce.

Carrying this fundamental principle one step further, it becomes clear that, to grow (i.e, to expand its production possibilities over time), a nation not only must replace its depreciating capital stock, but it must accumulate capital at an even greater rate.  Of course, to do so means that still more sacrifice of current consumption is required.  Hence, society must save even more in the present.

Taxes on savings and investment discourage both and thus slow long run growth.  So, for example, taxes on business income, capital gains, and income from dividends and savings accounts reduces the returns on capital, makes capital less desirable to accumulate, and thus slows expansion of a nation’s production possibilities boundary.  Hence, such taxes rob future generations of goods and services that otherwise would have been forthcoming.  When taxes on saving and investment are claimed by the political class to be necessary to pay for additional government services, it is simply a claim that current needs are of higher priority than future needs.  More bluntly, it is a claim that future generations be damned.

In this regard, of the proposed tax reforms offered by the candidates, Senator Sanders’ and Mrs. Clinton’s rob the future the most.  Their proposals specifically aim to feed current gluttony for government services at the expense of capital accumulation.  Although considerably better in that they reduce marginal rates across the board, the Republicans’ tax proposals nonetheless would continue to tax income from saving and investment.  With the possible exception of former Governor Huckabee’s national consumption tax (flawed in other respects), none can be genuinely called pro-growth.  None fully replaces the anti-growth tax system that has hindered the U.S. economy for way too long.

At bottom, little or no economic growth can occur without capital accumulation.  Taxes that discourage saving and investment slow capital accumulation and thus adversely affect long run growth potential.  Surely during this political season, at least one member of the political class can muster the courage to explain the importance of capital accumulation and make clear that every new government service promised today robs the future.  I am not holding my breath, however.

__________________________

[1] In a free market economy, the mix of final goods and services actually produced is determined by consumers expressing their wants and desires with their spending votes in the marketplace.  Relative prices adjust to reflect such consumer preferences, signaling producers as to which goods and services will be most profitable to produce.  Although this is an important economic principle, it is not essential to the point at hand.

[2] This is a stark illustration of the principle of opportunity costs and tradeoffs in a world of scarcity.

[3] International trade can also increase production possibilities by permitting nations and economies to specialize in producing those goods and services for which their respective endowments are best suited.  This principle is tangential to my main point, however; so I will not explore it further in this post, but readers may want to see my earlier post discussing the benefits of trade linked here.

Why I Am Supporting Ted Cruz for President

[This post originally appeared under the title of “The Real Ted Cruz” in American Thinker magazine on January 25, 2016.]

Contrary to some who have expressed concerns about Ted Cruz’s temperament and qualifications to be an effective President, my experience in working with the Texas Senator and Republican presidential candidate during the early 2000s convinces me that he is the right person at the right time for the job.

Although not a close friend of Senator Cruz, I learned to know him reasonably well as a colleague at the Federal Trade Commission from mid-2001 until he left the Commission to return to Texas in 2003.  During that time, we worked together on a number of projects, including efforts to curtail anticompetitive legislation pending in several states to protect incumbent businesses such as gasoline retailers and automobile dealerships, and a task force established by the FTC’s Chairman charged with looking into litigants’ abuses of legal immunities to the antitrust laws.  The Chairman appointed Cruz to lead that task force, and I was one of several members.

In this capacity, I was able to observe Ted’s professional skills, his personal characteristics, and, significantly, his commitment to constitutionalism, the rule of law, and free-market economics.  These personal observations impel me to conclude not only that Ted possesses the qualifications to be President in terms of intellect, temperament, and knowledge of the issues facing the country; but even more importantly, that he is uniquely the right person to lead America at this time in its history.

Ted Cruz’s Intellect Is Extraordinary 

Ted’s academic credentials are well known: Princeton, Harvard Law, and Clerk to the Chief Justice of the United States Supreme Court.  Even these outstanding credentials, however, do not fully reveal Ted’s extraordinary brain power.  Indeed, the first impression that I had of Ted was provided by that extraordinary brain power as demonstrated by his ability to move down a learning curve of a new subject at lightning speed and acquire knowledge and skills that most people take years to acquire.

Ted and I arrived at the FTC on the same day in 2001.  At that time, I had had over twenty-five years’ experience in the antitrust field.  Ted had none.  He came to the agency at the behest of the White House as a reward for the work he did on behalf of George W. Bush in the Bush v. Gore recount litigation in Florida, not because of any significant antitrust background.  Indeed, the Chairman had not previously known Ted.

Upon arriving, however, Ted immediately immersed himself in self-study of antitrust law, consulting the major legal treatises in the field as well as reading and absorbing critical antitrust case law.  Amazingly, within a few short months, Ted made himself into a superb antitrust lawyer and policy thinker.  Observing this feat first hand left me in awe of Ted’s superior intellect. He is surely one of smartest persons I have ever known.

Ted Cruz Has a Winning Temperament

Since becoming the junior Senator from Texas, Ted has been labeled – at least by some in the media – as the most disliked Senator among his colleagues.  It is reported that he eschews many Senatorial “courtesies,” and abjures the posture expected of a junior Senator to defer to more senior members and “to go along to get along.”   I personally find this attitude refreshing because I see it arising out of Ted’s total commitment to the principles on which he campaigned in Texas, fidelity to which he sees as taking precedence over warm feeling from his fellow Senators.

In my own experience as a colleague, I found Ted to be very easy to work with. I never knew him to tout his own resume, talk down to anyone, or insist on deference to his position.  To the contrary, I knew him to be consistently pleasant, generous with his time, and most importantly, always respectful of others’ views and work-product.  I remember, for example, that Ted often dropped into my office to follow up on some comment or idea that I had offered during an earlier task force meeting.  Those meetings generally permitted only limited discussion because of the number of people present, and Ted wanted to explore my thinking further.  Unlike many persons holding titles in government, it never occurred to Ted that, because of his higher position as head of the task force, protocol would demand that I be called into his office.  Such ego-driven attachment to hierarchy never mattered to Ted.  To the contrary, he was only interested in getting the best ideas out of the people around him.  All in all, I cannot recall a single instance when I did not enjoy interacting with Ted professionally.  He not only displayed a consistent winning temperament throughout the time we were together, but did so in a way that drew out the highest quality of professional thinking from those with whom he worked and supervised.

Ted Cruz’s Knowledge of the Issues Is Deep

There is no question that today the country is in bad shape.  On the domestic economic front, during the Obama years we have experienced near stagnant economic growth, a decline in labor force participation and middle class prosperity, and a dramatic increase of big government intrusion into the economy in the form of regulatory overreach, Obamacare, and massive market distortions owing to the failed $800 billion “stimulus” package.   Many elites have accepted perpetual stagnation as the new normal.

One only need listen to Ted Cruz’s speeches or consult his detailed policy papers on his website to realize that he not only rejects this new normal but also that he understands its causes and therefore what needs to be done to bring back the dynamism that the United States’ economy has historically exhibited.  In particular, Ted understands that free market capitalism is the engine that drives growth and prosperity.  He also understands that future growth and prosperity require savings and capital accumulation, not a culture of government handouts and spending coupled with a tax system that discourages work and saving.  And perhaps most critically, Ted understands the importance of institutions such as the rule of law and sound money to the efficiency of free market capitalism.  The free market engine only works when it is well lubricated and when it rests on a solid legal and monetary foundation.

Contrast these principles with those articulated by Hillary Clinton, the likely Democratic presidential nominee.  Among other anti-free market policies, Mrs. Clinton proposes price controls in the form of higher federal minimum wages, increased health care regulation that goes beyond even the morass of Obamacare, higher taxes, massive increases in government spending on social programs, and a federal government that intrudes into nearly all avenues of economic life.  On this score, the data of economic history are clear.  Never has there been a society in which such command and control policies have resulted in continuing prosperity.  To the contrary, Mrs. Clinton’s economic programs would assure that the new normal of stagnation will persist indefinitely, if not become even worse.

Significantly, among all the Republican candidates, Ted Cruz is the only one who can be counted on to remain fully committed to the kind of economic freedom that the country desperately needs to restore its economic dynamism.  Consider, for example, the contrast with Donald Trump who shows a near total absence of economic literacy as exemplified by his pronouncements on trade, healthcare markets, and property rights.  Or consider the stark contrast with Senator Marco Rubio, who, despite lauding free markets in nearly every campaign speech, could not wait, in the interest of political expediency, to vote for continuation of the New Deal era anti-free market sugar program after arriving to the Senate.  By contrast, Ted Cruz has never deviated from a commitment to free trade and unimpaired markets.  Indeed, in Iowa he rejected all temptation to pander to Iowa voters, despite the likely adverse political consequences, by lending support to the market-distorting federal ethanol mandates that are so important to certain rent-seeking segments of the Iowa farm economy.  Whereas Donald Trump’s and Marco Rubio’s blatant hypocrisy brings into doubt the extent to which either can be trusted to hold steady to free market principles in the face of political opposition, Senator Cruz’s courage and commitment to economic freedom cannot be questioned.

In addition to economic issues, it is clear that Ted Cruz is superior to all other candidates respecting his understanding of and commitment to America’s founding constitutional order, including federalism, the separation of powers, and the protection of individual liberty against government coercion.  One only need observe Ted’s passion whenever he talks about religious liberty, the rights given under the Second Amendment, and the most fundamental of all liberty rights, the right to life and self-ownership.  Compare Ted, for example, to the constitutionally challenged Donald Trump, who wants to disregard the rule of law and the separation of powers as much as President Obama, and instead simply substitute his own version of an imperial presidency.  This is not the place to list the near endless examples of Obama’s lawlessness or list the ways that Donald Trump would mimic that lawlessness, but I think that it is evident that a Ted Cruz administration would be the antithesis of such lawlessness.  The founding principles anchored in individual liberty would be the focal point of a Cruz administration.

I will not dwell on foreign policy because it is outside of my area of competence.  As a citizen, however, I share the dismay of many of my fellow Americans at the decline in American prestige in the world and respect as a beacon of liberty that has occurred during the Obama years.  Knowing Ted Cruz as I do, I have every confidence that, as President, he would restore America’s leadership among the world’s democracies.  I have no such confidence that Mrs. Clinton would achieve such a result.  Indeed, I would expect America’s decline to accelerate under a Clinton presidency.  Similarly, I have little confidence that any of the other Republican candidates, and surely not the carnival barker Donald Trump, would have the seriousness of purpose that Ted Cruz would have toward securing America’s safety, restoring its world leadership role, and maintaining the fear and respect of its enemies.

Ted Cruz Is Uniquely the Right Person for President at this Time in History

America has traveled along the path of ever-increasing statism for the better part of a century.  From the progressive era onwards, the left has fostered the view that the founders’ Constitution, which was focused on the protection of individual liberty by constraining the powers of government, needs to be reinterpreted to encompass an ever-growing state that solves problems, awards new rights at the expense of others’, and redistributes wealth.  The result is a behemoth and intrusive federal government, a constantly increasing dependency on government handouts, a stagnant economy, and a long period of declining American influence in world affairs.  America is presently in bad shape and on a wayward course.  In my view, America’s will continue to decline and, indeed, ultimately implode if it continues on the same course.  To prevent this outcome, it is imperative that Americans, collectively as a nation and individually, restore respect for and fidelity to our founding principles, most importantly the rule of law as embodied in the original meaning of the Constitution and its amendments.  No other candidate comes close to having the qualifications, the depth of constitutional knowledge, and the commitment to the American founding as Ted Cruz.  If America is to survive as a reservoir of liberty, prosperity, and human dignity, it is crucial that we turn away from the errant path that we have been on too long and elect a man like Ted Cruz.

The Democratic Presidential Debate, Economic Literacy, and the Minimum Wage

During last Saturday’s Democratic presidential debate Vermont Senator Bernie Sanders, Former Maryland Governor Martin O’Malley, and Former Secretary of State Hillary Clinton vigorously competed to display which one is most earnest in his or her support of raising the federal minimum wage.  In so many words, each claimed that it is necessary, as well as compassionate, to raise the minimum wage so that people can more easily rise to the middle class.  The argument is that if incomes are too low for some people, a law mandating higher incomes is justified.  Mrs. Clinton was a bit more nuanced, noting that the cost of living differs locally and thus, according to her reckoning, states and cities should implement minimum wages even above her proposed higher federal minimum wage of $12 an hour, if appropriate for a given locality.

Notwithstanding the substantial intrusion into economic affairs that governments at all levels undertake in contemporary times, I have long ago foregone any hope that political figures will take it upon themselves to obtain even a modicum of economic literacy before formulating their economic policy proposals.  Many, if not nearly all politicians, claim that reason and science should inform government policy, but few, if any, manifest any understanding that there are irrefutable laws of economics that cannot be repealed or altered by political action.  As a consequence, few areas of public policy are subject to more demagoguery than economic policy.  Minimum wage laws are a poster-boy-like example of such demagoguery.  Such was on great display in the presidential debate.

One of the most fundamental laws of economics is the law of demand, which states that as the price of something rises, the quantity purchased will decrease in a given time period, and vice versa.  The law rests on the fact that, in the real world, resources are scarce, and thus the process of satisfying human wants and desires requires making choices among alternative uses of those scarce resources.  Relative prices determined in free markets facilitate this process by permitting persons to make spending decisions out of a limited income according to the value they obtain per dollar spent on a good or service.  The lower the price, the higher is the value per dollar spent.  The higher the price, the less is the value per dollar spent.  Hence, if the price of something goes up – thus reducing the value per dollar spent – less will be purchased as other goods and services become a better bargain.

Artificially controlling specific prices in the economy distorts this process and creates inefficiency in resource allocation, as relative prices no longer fully reflect market forces driven by consumer preferences.  Wages are prices.  Hence, if wages for unskilled labor are artificially set above the market determined wage by means of minimum wage legislation, less unskilled labor will necessarily be purchased per period of time.  Moreover, the structure of wages throughout labor markets – skilled as well as unskilled – will be distorted, and economic efficiency will be compromised.  These outcomes are givens, and economists have known about them for a long time.

Why then do minimum wage laws persist?  Are not the harmful effects sufficient for voters to reject politicians who push these laws?  The answer, I believe, is that, although the harmful effects are real, they are generally not immediately visible, while the superficial, demagogic appeal of minimum wages is easy to articulate.  This appeal has several components, each of which was stated during the Democratic debate.  First, it is argued that raising the minimum wage will have a (politically) desired redistributive effect (Bernie Sanders).  Second, it is argued that raising the minimum wage will help to elevate people – particularly unskilled workers — into the middle class (Martin O’Malley and Hillary Clinton).  Third, it is contended that the empirical data show no significant adverse impact on employment because of raising the minimum wage, and therefore there is no downside to doing so (Hillary Clinton).

None of these claims, however, lives up to its full billing.  For example, even accepting a goal of income redistribution, minimum wage laws are a highly inefficient means to accomplish this end.  This is not controversial among economists.  Whatever income redistribution raising the minimum wage achieves, that redistribution is likely temporary at best, as employers adjust to the higher wage rate over time by substituting to other inputs such as new technology.  In addition, it only raises the income of those who continue to keep their jobs.  To the extent that the higher wage rate causes, at the margin, others to lose their jobs, their income falls to zero.  And, finally, the distribution comes at the expense of distorting relative prices, which can be considerable depending on the size of the wage hike.  In point of fact, there are far superior mechanisms to achieve income redistribution such as simple cash payouts or a negative income tax.  Either of these measures ensures that the incomes of the entire targeted group increase, and both avoid compromising efficiency because of price distortion.

As for elevating lower income people into the middle class, raising the minimum wage again is highly inefficient.  Vast amounts of evidence indicate that rising incomes are best achieved by education, stable families, and cultural factors such as personal discipline and a strong work ethic.  Entry level jobs – even at low wages – help to foster the personal characteristics, especially among young people brand new to the workforce, necessary to succeed in a work environment and eventually advance into higher paying positions with greater responsibility.   In addition, in few households is the primary income earner a minimum wage worker.  In fact, most minimum wage workers are younger than 24 years old.  (See here.)  Hence, although raising the minimum wage may have some impact on household income, the impact will be small.  A far better emphasis for public policy directed toward building the middle class would be on augmenting incentives for skills acquisition and maintaining stable families.

Mrs. Clinton’s assertion that the empirical evidence “shows” that there is little or no impact on employment following a hike in the minimum wage is similarly flawed.  It is indeed possible to construct studies that yield this result.  In so doing, the studies seemingly refute the basic law of demand.  In fact, however, they do not.  Rather, such studies rest on highly selective data (undisclosed by Mrs. Clinton) that severely cabins the contours of the analysis to exclude either one of two critical factors, or both, that otherwise explain the anomaly.  The first is that when the market wage for unskilled labor has risen above the existing minimum wage because of inflation the latter has no effect on employment rates.  The minimum wage is no longer a floor.  It serves no purpose.  Under these conditions, if the minimum wage is raised anywhere up to but not exceeding the market wage, it is perfectly consistent with the law of demand that there will be no significant employment effects.  Only when the minimum wage is hiked above the market wage, will employment effects take place.  Hence, data that selectively exclude wage hikes that actually exceed the market wage necessarily mislead on the question of employment impact.*

A second explanation for selective data showing little or no employment effects concerns the time frame considered.  In the immediate aftermath of an increase in the minimum wage, many, if not most, employers have capital equipment fixed in place.   In the short run, it will not be possible in many instances to substitute away from labor to a more capital-intensive production environment.  Thus, there may be little immediate job loss.  Over time, however, this will change as equipment wears out and is replaced, and as entry of new capital takes place.  For example, when I was growing up, most elevators required full-time human operators, engaging personally with bank tellers was the only way to withdraw funds from an account, and there were no self-checkout lines at grocery stores.  Today, none of these conditions is true.  Of course, one cannot claim that each of these changed conditions was solely caused by successive hikes in the minimum wage over the years, but undoubtedly those hikes contributed to the long run substitution away from low and unskilled labor in these occupations.  Moreover, this transition certainly took place in innumerable other sectors of the larger economy.

Finally, I want to close with a comment about union support for the minimum wage.  Although historically unions have been a strong Democratic Party constituent, it would seem odd, at least on the surface, that unions would much care about minimum wages.  Union jobs, after all, are typically at hourly wages much higher than the minimum wage.  There are at least two reasons, however, why unions can be counted on to advocate for higher minimum wages.  First, many union contracts contain clauses that structure union wages relative to the minimum wage.  That is, the union pay scale should always, in relative terms, be some percentage above the lowest pay scale.  Hence, when minimum wages are hiked, the union pay scale is similarly adjusted upwards.  Second, it is in the interest of skilled union workers to have the wage rates of unskilled workers continually increase.  Suppose for example that a particular task could be performed by two unskilled workers in an hour or one skilled union worker in an hour.  If the wage rate for unskilled work were $5 /hour and the wage rate for skilled work were $11/hour, the employer can be expected to employ two unskilled workers to do the task at a total of $10/hour.  Now suppose the minimum wage is hiked to $6/hour.  Under this circumstance, the employer will hire the skilled union worker at $11/hour, as the two unskilled workers would now cost $12/hour.  The higher minimum wage not only priced the unskilled workers out of the market, it also created a demand for union work.

In sum, the Democratic presidential debate on Saturday night revealed a great deal of departure from economic science among the three candidates.  This departure was especially apparent in the Q&As concerning the minimum wage.  Even more troubling is the possibility – and perhaps even probability as it concerns Mrs. Clinton – that the economic hokey pokey did not entirely owe to economic illiteracy, but rather owed simply to deliberate political demagoguery to gain votes at the expense of serious thought.

Addendum:   In watching the debate, I could not help but be reminded of the incessant cant from the political left about the alleged consensus among scientists concerning climate change and global warming.  On the basis of this alleged consensus, the science is supposedly settled, and outlying views are to be shunned and ridiculed.  Yet, as the basis for her assertions about the minimum wage, Mrs. Clinton solely cited former Obama White House adviser Alan Krueger, who co-authored a study of the impact on fast food employment in New Jersey and Pennsylvania following an increase in the minimum wage in those states.  The study, published in 1994 and using early 1990s data, claimed to find insignificant employment effects.  This study, however, is the poster boy of outlying studies concerning minimum wages, has often been criticized on methodological grounds, and runs contrary to the “consensus” among economists about the actual employment effects of minimum wage laws.  Mrs. Clinton’s hypocrisy on this score is stunning.

Notes:

* A simple example demonstrates the law of demand in this context.  Suppose the tasks performed by a worker earning $5/hour contribute $5.25/hour in incremental revenue to the employer.  Each hour thus generates $0.25 in accounting profit for the employer.  In fact, under this circumstance, it would pay the employer to pay the worker any wage up to $5.25/hour.  Now suppose the minimum wage is hiked to $5.50/hour.  Absent any concurrent increase in productivity on the part of the worker, it no longer pays the employer to keep the worker and the job is lost.  At the margin, all such workers will be let go.

Mrs. Clinton seems to understand this concept.  At Saturday night’s debate, she stated that she favored an increase in the federal minimum wage to $12/hour, but not to $15/hour.  But why?  From a worker’s standpoint, $15/hour is better than $12/hour, and will produce a higher annual income.  Indeed, why not increase the minimum wage to $100/hour and elevate everyone to the higher end of the middle class?  Implicit in Mrs. Clinton’s reluctance to go higher than $12/hour, at least at the present time, is surely a recognition of the adverse employment effects that the minimum wage produces.

Business Acumen and Economic Understanding

In a recent Wall Street Journal op-ed, Republican presidential candidate Donald Trump asserted that the Chinese government imposes a de facto tariff on all imported goods by intentionally devaluing the yuan.  (“Ending China’s Currency Manipulation,” Nov. 10, 2015)  According to Mr. Trump, the undervalued yuan makes international trade unfair and hurts China’s trading partners.  By Mr. Trump’s reckoning, it particularly hurts the United States by weakening American industry and costing millions of jobs.  He goes on to say that he will designate China a “currency manipulator” on day one of his presidency, if elected.  In addition, he will impose countervailing duties on “cheap Chinese imports” as retaliation for the unfair currency manipulation.

On the day after Mr. Trump’s op-ed, Mr. Doug Parker and Mr. Keith Wilson lament, also in a Wall Street Journal op-ed, that the United Arab Emirates and Qatar unfairly subsidize their respective airlines with massive cash infusions.  (“Rigging the Game on Open Skies,” Nov. 11, 2015)  Mr. Parker is the chairman of American Airlines Group and Mr. Wilson is president of the Allied Pilots Association.  Like Mr. Trump, Messrs. Parker and Wilson claim that these subsidies hurt the United States by costing hundreds of thousands of jobs in the American airline industry.

The views of Messrs. Trump, Parker, and Wilson are hardly unusual among business leaders and corporate executives.  A quick look at the International Trade Commission’s website reveals that the ITC currently has some 30 active “import injury” investigations open and another 12 active “anti-dumping and countervailing duty” investigations.  These investigations seek to determine if imports are priced “unfairly” and thereby cause injury to specific U.S. industries or companies.  The current investigations run across a wide range of products, including among others chemicals, various steel and iron products, bricks, sundry welded products, woven ribbons, plastic tape, copper products, sugar, uncoated paper, plastic bags, wooden bedroom furniture, and even tissue paper and ironing boards.  All of these investigations are responses to U.S. companies’ claims of injury owing to unfair import competition.

Each of the above-described contentions illustrates an important – yet, unfortunate — fact, namely that mercantilist views run strongly among business leaders and corporate executives.  This is particularly regrettable whenever such leaders and executives take to a public forum and mistakenly equate their knowledge of business with knowledge of sound economics.  In point of fact, business and economics focus on quite different matters.  The danger of equating business acumen with authority on economics is that the former’s narrow focus on business success leads to the promotion of policy prescriptions that, although beneficial to parochial interests, are often harmful to the general interest.  Protectionism is perhaps the most blatant and harmful example of this phenomenon.

Case in point are Messrs. Trump, Parker, and Wilson.  Although all three claim to be supporters of free trade so long as it is “fair trade” and promotes American prosperity, each defines success only in terms of mercantilist metrics.  Specifically, each looks to export growth and job creation as the measure of a successful trade policy.  This perspective, however, stands in direct contradiction to Adam Smith’s central point that the wealth of a nation is measured, not by the quantity of goods that it sends to other nations or by resource employment, but by the amount of goods and services available for consumption by its citizens.

In his seminal book, An Inquiry into the Nature and Causes of the Wealth of Nations, Smith explained (as I discussed in greater detail in an earlier post here) that the sole objective of economic activity in a world of scarcity is consumption.  If human beings did not need to consume or if there were no scarcity, there would be no need for economic activity, let alone trade or trade policy.  Under real world conditions, however, people not only need to consume to stay alive but also possess wants and desires for goods and services that go far beyond the basic necessities.  Scarce resources must therefore be constantly employed to produce those goods and services.

In terms of trade, Smith went on to explain that, rightly understood, exports are a cost to a nation and imports are a benefit.  Exports mean that a nation’s scarce resources, including human employment, are being used up for another nation’s consumption benefit.  By contrast, importing goods and services allows a nation to consume while conserving scarce resources for deployment in other productive activities, thus expanding domestic production of consumable goods and services and permitting even greater rates of consumption.  The result is an increase in the nation’s total wealth.  Exports, and the resources that go into those exports, are the price a nation must pay for its imports.  As with all exchanges, the lower the price the greater the surplus value to the buyer.

Given this central tenet of economics about the genuine wealth of a nation, whenever the United States can obtain goods and services more cheaply by means of importing them than by producing them domestically, it benefits.  U.S. consumers are made better off.  This benefit will accrue regardless of why the imported goods are cheap, i.e., even if they are cheap because of subsidies or so-called currency manipulation.  Indeed, if subsidies or artificially undervalued currency is the reason, the true harm falls on the citizens of the nations providing the subsidies or “manipulating” their currencies.  Not only are those nations using up their scarce resources for the benefit of American consumers, but their citizens are being taxed to fund the subsidies and are being exposed to higher domestic prices because of the undervalued currency.  It is a double whammy.

What is more, instead of a cost to the United States, the “jobs lost” that Mr. Trump and Messrs. Parker and Wilson claim occurs because of “unfair” trading practices are actually necessary to expanding domestic wealth. The freed up human and other resources are now available for new productive uses or for increasing the output rate of existing productive activities.  The available consumption pie is necessarily enlarged.  By contrast, the logical end of the Trump, Parker, and Wilson mercantilist argument is either autarky or at least significantly diminished trade, either of which must result in lower living standards for the American people.

To be sure, whether owing to market fundamentals or external foreign government policies, the vicissitudes of the international movement of goods and services, as well as capital, will result in certain industry-specific disruptions and transactional costs to individuals.  This inevitable consequence is by all means a basis for a compassionate nation to lend support to those who require retraining and other transitional assistance, but it is not a basis for protectionism and lower living standards.  To the contrary, every time that China devalues the yuan or another country subsidizes its export industries, we Americans should give a hearty thanks for the gift.

The House Freedom Caucus and Its Critics

Christopher DeMuth has long been one of the more distinguished leaders in the conservative intellectual movement.  As such, his views warrant a very high degree of respect.  In a recent Wall Street Journal op-ed, he contends that members of the House Freedom Caucus — a group of about 40 -50 highly conservative House Republicans elected with Tea Party support — are motivated more by opportunities for political theater and individual showmanship than by legislative accomplishments. (“The Decline and Fall of Congress,” Oct. 19, 2015)  In this case, Mr. DeMuth is wrong.

In making his argument, he offers the time worn idea that legislators must “go along to get along” and be willing to make trades and compromises in order to achieve desired legislative ends.  In Mr. DeMuth’s view, the process rewards those who are satisfied with incremental change.  Because the Freedom Caucus resists compromise, it must therefore hold political theater and showmanship more important than actual progress toward its ostensible long run goal to restore a limited federal government consistent with free people and free markets.

Although Mr. DeMuth’s argument may have some merit in the short run, it neglects the persistent failure of establishment Republicans to achieve real and permanent reversal of an ever growing federal government.  The fact is that establishment Republicans, notwithstanding campaigning to the contrary in election after election, have been fully complicit with Democrats in supporting anti-free-market and liberty-infringing legislation.  Examples include corporate welfare such as ethanol mandates, price controls such as federal minimum wages, uncritical support of a Federal Reserve that monetizes deficit spending, and an incomprehensible tax code.  Perhaps if just once establishment Republicans stood on the principles that they profess to hold, the Freedom Caucus might be more amenable to the kind of legislative compromise and incrementalism that Mr. DeMuth thinks more effective.  But the fact is that this show of principle never occurs.

Case in point is the current real opportunity to kill the Export Import Bank, which subsidizes foreign consumers by shifting credit risk onto U.S. taxpayers.  Authorization for the Bank ran out earlier this year, but Republican Leadership in the Senate — even though claiming to be opposed to reauthorizing the Bank — has used procedural gimmicks to provide still another vote on reauthorization in order to appease establishment Republicans as well as Democrats.  In the House, establishment Republicans have gone so far as to seek out and align with Democrats to force a vote that will give new life to the Bank.  Is it really any wonder that Freedom Caucus members distrust their establishment colleagues?    

Mrs. Clinton’s Repudiation of Scarcity

Imagine that you have all the ingredients to bake a twelve inch apple pie, including crust and filling.  Imagine further that the baked pie is initially cut into ten slices.  Under a new government program intended to ensure that everyone has access to quality pie, all citizens are required to buy pie insurance which, among other things, entitles each person to obtain one slice of pie each year at no out-of-pocket cost.  The pie provider bills the insurance company for each slice of pie it supplies to an insured. Assuming a population of eight citizens, after each person obtains one slice of pie, two slices remain.  These two slices might be provided, for example, at full cost or at least with a co-payment to two persons with special needs for additional pie.  Of course, once these last two pie slices are consumed, no pie remains until (1) additional ingredients are found or diverted from other uses, and (2) another pie production cycle ensues.

But wait.  There is a better solution to providing additional pie to everyone.  Specifically, the government could simply pass a law mandating that all citizens are entitled not to just one, but two slices of pie each year at no out-of-pocket cost.  Now each of the eight citizens can have two slices of pie each year.  Everyone is better off!

Of course, this solution is absurd, as there is no actual additional real pie to distribute.  There is still only one twelve inch pie cut into ten slices.  If each of eight citizens is entitled to two slices, all but two citizens would have to be denied a second slice.  In other words, there would be no pie left over to provide a second slice to six of the eight citizens.  Even this outcome assumes that a citizen is not entitled to a second slice until everyone has obtained at least one slice.  Without this rule, five citizens might consume all ten slices before three citizens consume any pie.

Alternatively, the pie might be cut into smaller slices so that there are sixteen.  In this case, there are now enough slices for each citizen to consume two slices.  No more total pie is being consumed, however, and the smaller slices may not adequately meet the needs of the insureds.

The point of this example is to illustrate that consumption must necessarily come out of real resources.  The using up of real resources is the true cost of consumption, and it is impossible to increase consumption in the absence of obtaining additional resources, which are scarce or otherwise deployed in other production activities.  It seems to me that this is not a complicated point, but it nonetheless appears to escape Hillary Clinton.

According to an article in today’s Wall Street Journal at A-4 (“Clinton Lays Out Plan to Cut Health Cost”), Mrs. Clinton, in her quest for the Democratic presidential nomination, has announced that, if elected, she will “improve” Obamacare by placing further limits on what insureds pay for healthcare.  Her goal, she says, is to reduce costs.  Her solution is to require insurance plans to permit three doctors’ visits a year before any deductible charges are made.  As quoted in the Wall Street Journal, Mrs. Clinton declared, “With deductibles rising so much faster than income, we must act to reduce the out-of-pocket costs families face.”

It is a shame that no one is asking Mrs. Clinton how this plan reduces the true costs of healthcare, namely the required resources to produce it.  She might also be asked where the additional resources are to be found or from what other productive activity they are to be diverted. If she favors more but shorter and less substantive doctors’ visits, she should explain how she has determined that such smaller but numerically more “slices” of the pie provide for superior quality healthcare.  Unless Mrs. Clinton magically discovers a means to eliminate scarcity – in which case there would be no need for any healthcare insurance – one should be highly skeptical of her pronouncements.

It Is Well Past Time to End the ZIRP

When I first began reading Federal Open Market Committee (FOMC) member Narayana Kocherlakota’s op-ed piece in the Wall Street Journal this morning, I thought that it had to be a deliberate parody on the Keynesian groupthink that characterizes the world’s central bankers.  (“Raising Rates Now Would Be a Mistake,” Aug. 19, 2015)  Then I realized that Mr. Kocherlakota is dead serious about wanting to continue the Fed’s zero interest rate policy (ZIRP) of the last six years, notwithstanding its failure to bring about anything close to a robust recovery from the 2008 financial collapse.

Mr. Locherlakota says that raising rates now would impede the Fed’s ability to achieve two goals: (1) raise inflation to its 2% target rate, and (2) stimulate spending via credit expansion and bank lending.  He fails to explain, however, how either of these goals arises from sound economic thinking.  In point of fact, both goals are highly questionable attributes of a growing and productive economy.

As for the first goal, Mr. Kocherlakota merely asserts that 2% inflation is how the Fed defines price stability.  No reason is given as to why 2% is superior to any other number, let alone superior to what most people outside of the FOMC would define as a stable price level — zero inflation.  In fact, a 2% inflation rate means that the purchasing power of a dollar will decline by almost a third over 20 years.  Not only is financial prudence on the part of households severely punished, saving is discouraged and debt-taking encouraged.  Diminished saving and increased debt, however, have never been shown to lead to sustained prosperity.

Mr. Kocherlakota’s second goal, increased spending, is similarly misguided.  A focus on spending neglects capital accumulation, which is essential to productivity gains and economic growth. Capital accumulation, moreover, requires saving to finance the new capital.  Hence, incentivized spending and debt-taking, buttressed by lower saving owing to an inflation tax, must result in a lower rate of capital accumulation and ultimately diminished growth prospects over the long haul.

In the end, price controls never work, and interest rate manipulation will be no exception.  Eventually, the massive distortions in asset pricing created by the six-year ZIRP must be corrected.  At that time, the tools that the Fed has in its bag will have been seriously depleted, and the correction will likely be long and deep.

Given six years of tepid recovery, it is well past time to jettison the ZIRP and return to free market principles in which interest rates are freely determined in the marketplace by peoples’ time preferences and an honest monetary policy.

Janet Yellen and the Power to Tax

Article I, Section 7 of the Constitution states, “All Bills for raising Revenue shall originate in the House of Representatives.” In other words, the Framers wanted to make sure that, when taxes are imposed on the people, the legislation giving rise to those taxes springs from the people’s House, the body closest to the nation’s citizens. No doubt the Framers thought that the taxing power of the federal government should not be taken lightly or at a distance from the people.

Janet Yellen, Chairwoman of the Federal Reserve Board, evidently has determined that she is a virtual member of the House of Representatives, and, in fact, holds a controlling position. She and the other members of the Federal Open Market Committee have publicly and repeatedly stated their desired intention to use monetary policy to achieve a continuous inflation rate of two percent a year. The targeted inflation is specifically in consumer prices. This means that Ms. Yellen has decided that income earners, savers, and holders of cash assets should be taxed annually an additional two percent. At this rate, the purchasing power of a dollar will decline by almost a third over 20 years.  As far as I know, no citizen voted for this tax, nor endorsed a member of the House of Representatives campaigning on such a tax.

The theory behind this inflation tax is grounded in modern monetary thinking, which is a synthesis of traditional Keynesianism and Monetarism (hereinafter, “modern Keynesianim”).* The theory holds that economic well-being and prosperity come about through spending. Therefore, spending, and especially consumer spending, must be encouraged. Indeed, saving is anathema to the theory.

One sure way to encourage spending is to punish financial prudence and frugality on the part of individual households. A positive inflation rate continuously maintained by design achieves this objective. People are incentivized to forego saving and spend now before the value of their income and cash assets decline even further.

A second way to encourage spending is to incentivize debt-taking. Continuous inflation, especially accompanied by artificially low interest rates, achieves this objective too. Debt-takers obtain relatively high value money to spend in the current period, and pay it back with relatively devalued money in a later period.

A key factor in this modern thinking is the idea that prices adjust faster than wages. Although a few prices may be fixed for a period by contract, most prices, especially consumer prices, can change quickly, if not immediately. By contrast, wages, more often fixed by contract, are usually slower to adjust to inflationary pressure. Even when not fixed by contract, burdens on both employees and employers can be severe with frequent turnover. Thus, even when higher wages might be had elsewhere, small gains in income may not be worth the burden of changing jobs.

Given this price/wage adjustment disparity, household incomes do not keep pace with price inflation, which creates still another incentive to accelerate spending.  In addition, business earnings increase because revenues are rising faster than costs (i.e., prices are going up, while wages remain sticky). Hence, stock values inflate. This asset inflation, according to the modern Keynesians, produces a wealth effect that also encourages spending. That is, stockholders see their investments rise in nominal value, feel richer, and spend more. In addition, the sticky nominal wages mean that real wages decline over time, thus creating more demand for labor by businesses. Taken together, all of these behaviors – households spending now rather than later, asset holders feeling wealthier and spending more, and businesses increasing demand for labor — bring about prosperity in the form of higher GDP and full employment. So goes the modern Keynesian story.

It is the story that continues to be taught in mainstream economics Ph.D. programs, and it is the story to which most prominent macroeconomists adhere. It is also the story most prevalent in the financial media. The core premises of the story survive despite the continuation of boom and bust cycles. Indeed, even the severity of the 2008 financial crisis and the historically slow recovery in its aftermath have done little to crack the edifice of modern Keynesianism.

Even so, there is a growing heterodox literature attacking this edifice and, in particular, the performance of the “Fed.” Much of this literature focuses on the period since the end of the Bretton Woods gold-exchange standard, which President Nixon jettisoned in 1971. Mr. Nixon’s decision made the dollar a full-fledged fiat currency and opened the door for the Fed to engage in wide ranging monetary discretion. This critical literature is too voluminous to discuss here. I will, however, set out a few reasons as to why I believe the prevailing paradigm should be abandoned.

First, even taking modern monetary theory as valid notwithstanding its failures, I am not aware of any explanation from Ms. Yellen, any of her fellow FOMC members, or any prominent macroeconomist as to why two percent is the appropriate inflation rate to target. Why not three percent? Or, one percent? Or, one and a half percent? As far as I know there is nothing in the analytics of the theory itself that determines this two percent. It seems to be nothing more than a preferred fancy of the monetary policy elites.** At a minimum, if the people are to be taxed an extra two percent a year, there should be a firmer foundation for that tax than simply the whims of unelected central bankers.

Second, the theory’s focus on consumer spending neglects capital accumulation. Capital accumulation is essential to economic growth. It is the basis for productivity gains in the economy. Capital accumulation, however, requires saving to finance the new capital. By making saving unattractive by means of the inflation tax, the rate of capital accumulation will be lower than what it otherwise would be. Although the inflation policy may give the illusion of stimulating economic activity in the short term, the longer term consequences of diminished growth prospects are a severe and lasting social cost.

Third, by most any measure, the Fed has historically performed poorly in taming the business cycle or making booms and busts less frequent. In fact, internal instability is built into modern monetary policy. Two factors, in this regard, are noteworthy. First, because the interest rate is one of the most important prices in any economy, its manipulation by the Fed creates massive price distortions and makes asset price discovery far more difficult. As a result, much malinvestment occurs. Such malinvestment ultimately has to be liquidated during a subsequent bust. Second, even if wages adjust more slowly than prices in the short term, they must eventually catch up to prices as pressures toward economy-wide equilibrium take hold. The boom therefore rests on an unstable platform. It can only persist if prices continue to outpace wages, an unlikely event.   The bust must inevitably follow.

Fourth, it is noteworthy that, in the 100 years since the Fed’s founding, the price level in the U.S. has increased by over 2300%, meaning that the value of the dollar has dropped by over 95%. (This information comes from the Bureau of Labor Statistics and can be viewed here.) That is hardly a record to be proud of. What is more, it shows just how severe an inflation tax can be over time.

Fifth, aside from economic and theoretical defects, an inflation tax that punishes prudence and thrift creates a culture that discourages personal responsibility. This comes about in two ways. First, prudent saving for a rainy day or for retirement requires a willingness to see those savings depleted in real terms every year. Certainly at the margin, fewer people will choose to save, or save as much, with this looming prospect. Second, the inflation tax encourages debt-taking. Debtors are rewarded by inflation by being able to pay back loans with cheaper money. As a cultural phenomenon, widespread debt-taking leads to irresponsible spending, especially as it relates to short term spending by “maxing” out one’s credit cards, which often have among the highest interest rates. With thrift and saving being irrational, instant gratification becomes the norm.

Where does this leave us?  Regrettably, Janet Yellen’s tax on the American people is unlikely to be unconstitutional, as it does not derive directly from a “Revenue Bill” within the meaning of Article I, Section 7. Moreover, the Federal Reserve System, although a creation of the government, does not itself operate as a government agency. Therefore, short of amending the Fed’s enabling legislation and taking away its independence to manage monetary policy, there is likely little the people can do to avoid the Yellen tax. Even so, I think it is important that people at least know that the tax exists.

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* For simplicity, I will use the term, “modern Keynesianism” herein to mean this synthesis. In so doing, I neglect the fiscal policy side of Keynesianism, which is not relevant to my discussion.

** Incidentally, this whim is worldwide. Mario Draghi, the head of the European Central Bank, similarly has stated his determination to maintain a two percent inflation rate. Not uncoincidentally, Mr. Draghi was American-trained at MIT and is well ensconced in the modern monetary paradigm.