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By George P. Brockway, originally published January 14, 1991

1991-1-14 Our Austerity Recession Title

FINANCIAL EXPERTS are saying that the present recession was caused by consumers failing to consume. The supply side supplied, but the demand side didn’t demand. I’ll go along with that; but I’m dismayed that the supply-siders seem to have learned nothing from the experience.

1991-1-14 Our Austerity Recession Phil Gramm

I have just finished a decennial purging of what I whimsically refer to as my files; they were crowding me off my desk, much as the Federal deficit is said to crowd entrepreneurs out of the credit market. As the clippings and offprints fluttered into my wastebasket, I was struck by the volume and vehemence of those complaining that we Americans consumed too much or didn’t save enough (take your pick).

For 20 or 30 years now, all the respectable bankers (once upon a time every banker was respectable), all the respectable journalists, all the respectable economists have been moaning about how we Americans have been on a consumption binge. (If you want the facts of the matter, ask the Economic Policy Institute, 1730 Rhode Island Avenue, NW, Washington, DC 20036, for a detailed refutation by Robert A. Blecker.)  Ronald Reagan’s Right-wing revolution was supposed to exalt the supply side over the demand side. There were tax cuts for the rich and tax increases for the poor, because the poor would only waste their money by buying things they needed or maybe wanted, while the rich would invest theirs in Wall Street and make capital gains. Austere elements of the far Left joined in the chorus (of course, for ostensibly different reasons). Consumerism got a bad press wherever you turned. Sometimes it seemed that Ralph Nader was more subversive than the Chamber of Commerce believed him to be.

Among the worthies represented in the clippings I threw out were at least four Nobel laureates, one former chairman of the Federal Reserve Board, three former chairmen of the Council of Economic Advisers, six former Secretaries of the Treasury, one former Secretary of Commerce (who seems to have started a new anti-consumption committee every other week), a past chairman of the Committee for Economic  Development, nine officers or staffers of the Brookings Institution, almost everyone who has ever set foot inside the American Enterprise Institute, innumerable other professors and journalists and TV pundits, not to mention Presidents and Senators and Representatives and unsuccessful candidates for those offices. The idea has had its spokesmen in the International Monetary Fund and the World Bank (where it is known as austerity), as well as in Britain, France, Italy, Germany, Norway, Japan, and Kenya. It has not suffered from lack of publicity.

The present failure of consumers to consume is just what these doctors ordered. Some of the doctors-those who still believe in the efficacy of purging and bloodletting – are no doubt pleased with the resulting recession. A few are puzzled and silent. But most are as noisy as ever.

Many of the respectable economists, I shudder to say, were bashing consumption in the name of Keynes. They seem not to have noticed that he concluded Chapter 6 of The General Theory with these words: “the conception of the propensity to consume will, in what follows, take the place of the propensity or disposition to save.”

Classical economists had long held that consumption was a drag on investment. Back in 1803, Jean-Baptiste Say wrote in words that could be applauded today by Newt Gingrich, “It is the aim of good government to stimulate production, of bad government to encourage consumption.” The reasoning was simple. What is spent on consumption can’t be invested in production. Obviously. Keynes also agreed with the proposition-with one proviso: There has to be full employment. Not 4, 5 or 6 per cent unemployed, but really, truly, full employment. In that case, and in that case only, with the economy running flat out, nothing more can be produced; so whatever labor goes for one thing can’t at the same time go for something else. But with millions of men and women unemployed, it is always possible to increase production by giving them jobs.

What I don’t understand is how the notion that consumption is bad got started. If consumption is bad, then production must be, too. I’m used to writing jeremiads that nobody takes seriously (someday they’ll be sorry), but why should tens or hundreds of thousands of people be expected to band together to make automobiles if nobody is supposed to buy and drive them?

The consumption thing (to use a Presidential locution) is another of those fallacies of composition economists keep perpetrating. An individual who saves his money (even hiding it under the hearth) is more likely to die rich than someone who flings roses riotously with the throng. But if everyone in the land sits home, wasting not and wanting not, the economy runs down, and no one has anything to consume, or to save, either.

The consumption thing is vastly more threatening because the government is doing its best to participate. Look at what Gramm-Rudman-Hollings has done to us. As a result of the budget deal of a couple of months ago, the Federal government is committed to spending 30 or 40 billion dollars less next year than it had planned (conservatively) to spend, and the cuts will be greater in succeeding years. A considerable part of the “savings” will be at the expense of the states and municipalities, all of which are already short of funds because of the recession, and all of which are traumatized by childish and self-defeating taxpayers’ strikes. In order to balance their budgets, the states will have to cut down on their services – and that is simply another way of saying they will have to fire people. School class sizes will rise, and bridges will fall.

Taken as a whole, the government part of the consumption thing means that, one way or another, at least a million people will lose their jobs. Some of the affected will no doubt be those dreadful goldbricking bureaucrats we keep hearing about, but most will be employees of private business – a.k.a. free enterprise – for the government is the private economy’s greatest single market for goods and services. The billions of dollars the private economy will lose because of Gramm-Rudman-Hollings will make the recession both deeper and harder to climb out of.

FACED WITH this dismal prospect, a rational Congress would repeal Gramm-Rudman-Hollings, a rational President would sign the repealer, and together they would embark on a massive public works program. Everyone knows there is plenty to be done and plenty of people to do it. But everyone knows nothing of the sort will happen because of the deficit.

1991-1-14 Our Austerity Recession Warren RudmanSuppose our reaction to Pearl Harbor had been similar. In 1941 the Federal government was running a deficit equal to 4.3 percent of GNP. It jumped to 14.4 per cent in 1942 and to 31.1 per cent in 1943. Thereafter it fell, but remained above 7. 5 percent as late as 1946, and averaged 18 per cent over the six war-time years.

In contrast, consider the current deficit and its steadily rising estimates. Last February the Economic Report of the President presented figures predicting a deficit of 1.1 per cent of GNP, while according to the latest estimate of the Congressional Budget Office, the deficit will be at least 5.4 per cent of GNP.

Had we taken deficits in this range as cause for inaction in 1941, we would have run up the white flag no later than December 11, when Germany declared war on us. And we would have  spent the succeeding 39 years studying Japanese and German industrial management from the ground up.

It is no answer to say that there was a war on. Indeed there was, and we came out of it with total Federal indebtedness equal to 127.3 per cent of GNP – more than double today’s comparable figure. Yet when the War was over we set about rehabilitating Europe and ultimately did so with the Marshall Plan, at a cost to us, in 1990 dollars, in excess of $250 billion (see “Don’t Cash Your Peace Dividend,” NL, March 19, 1990).

Did we ruin ourselves by this profligacy? Hardly. It was not until 1975 – almost 30 years later – that the unemployment rate became as high as it is today. Aside from the flash inflation caused by precipitate lifting of price controls (over Harry Truman’s veto), it was not until 1974 that the Consumer Price Index rose at its present rate. Furthermore, after-tax profits as a percentage of GNP were higher than today’s in every postwar year except three Nixon-Ford years (1974, 1975and 1976) before Jimmy Carter appointed Paul A. Volcker chairman of the Federal Reserve Board in 1979.

Since then our mirror has cracked from side to side, and the curse of inaction has come upon us. That is what the record of unemployment, of inflation and of after-tax profits shows. It won’t do to point a finger at OPEC (see What Happened to Jimmy Carter,” NL, November 27, 1989). Some blame falls upon us for what we did because of OPEC that is, nothing much (and as I write we threaten to go to war in its defense). But the major blame falls upon us for casually and stupidly embracing the fallacy that a nation can save itself into a healthful economy.

If we could disabuse ourselves of this fallacy, the current recession would not last long, and the subsequent prosperity would show up the alleged prosperity of the past decade for the pallid fraud that it was. Unfortunately, those who urged the fallacy upon us continue to push it; we continue to follow them; and as a result the recession will be deeper and longer than necessary.

 The New Leader

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By George P. Brockway, originally published April 3, 1989

1989-4-3 Minimum Wage vs. Maximum Confusion Title

THE FIGHT in Congress over a minimum-wage bill was recognized by both sides to be largely symbolic. It was nevertheless worth making. The press and TV characteristically presented what little they reported of the debate as a clash of personalities. But fundamental issues were at stake, and one must hope the debate has gone at least a little way toward educating the public (and the Congress) on the way the economy actually works.

First, a bit of background: The minimum wage is now $3.35 an hour. It has not been changed for eight years, even though the Consumer Price Index has gone up 32.3 per cent in that time. If you work full time, $3.35 an hour comes to $134 a week or $6,968 a year, which is well below the poverty level. But of course the assumption of full-time work is what economists call a heroic assumption (meaning that it doesn’t hurt the economists who make it any more than heroic medical procedures hurt doctors).  In fact, 25.3 per cent of the people employed in America work part time roughly half of them because they can’t get better jobs and half because they prefer it that way. It’s a fair guess that almost all of the minimum-wage workers are in the part-time group.

At present about 4 million workers earn the minimum wage or less. (Economics is full of miracles: In mathematics there’s nothing less than the minimum, but in economics there’s a great nether region below the minimum because commerce that doesn’t cross state lines is not covered by Federal law.) There are in addition just over 6.5 million people officially classified unemployed, and just under 1 million more who do not count because they are too discouraged to look for work. That adds up to 11.5 million Americans who work or are willing to work yet still are a long way below the poverty level.

The bills recently passed by both the House of Representatives and the Senate provide for the minimum to go to $3.85 in October of this year, then to $4.25 in 1990, and to $4.55 in 1991 (by which time inflation will have wiped out most, if not all, of the increase). In an attempt to attract Republican votes, the bills include a subminimum training wage: 85 per cent of the minimum for a first-time employee’s initial 60 days.  This provision would phase out in 1992. Though the bills have substantial support in both houses, particularly among Democrats, President George Bush has threatened to veto anything that goes beyond $4.25 an hour. Thirty-five Republican Senators have promised to sustain a veto. That should pretty much do it.

The threatened veto is, naturally, presented as a kinder, gentler act. The conservative argument is that companies pay the minimum wage (or less) because they cannot afford to pay more. Since they are at the limit of their resources, a pay increase would force them to fire those paid the present minimum and to turn away inexperienced teenagers, blacks and women looking for entry level jobs. The net result, conservatives say, would be an increase in unemployment.

Anyone who bothers to look at the record, however, will find that employment has risen in seven of the eight years when the minimum wage has been raised; and the one year employment fell (1975) was a time of severe recession when the drop was expected for other reasons. Moreover, the 11 states that now have a statewide minimum wage higher than the Federal standard also have the lowest unemployment.

You will have noticed that the argument shifts back and forth between the fate of the economy as a whole and that of individual workers and individual businesses – in other words, between macroeconomics and microeconomics. Several times over the years I have called attention to the fallacy of composition, which often pops up when such shifts are made, and I’ve suggested that economists must love it because they do so much dancing. In brief, the fallacy assumes that what is true of members of a logical class is thereby true of the class itself. Sometimes this leads to the laughable, as when Engine Charlie Wilson averred, “What’s good for General Motors is good for the country.”

In the present instance, conservatives argue that what may be bad for some workers must be bad for all. Liberals, on the other hand, argue that the possible microeconomic effect of some job loss will be more than offset by the macroeconomic effect of better jobs in the economy as a whole, resulting in increased spending that will stimulate business into hiring more workers.

Over a quarter of the low-income workers would have to be fired for the total wages to fall. It’s a judgment call, and the call pretty much separates the optimists from the pessimists, and the liberals from the conservatives. I’m such a liberal optimist, I doubt that as many as 10 per cent would be fired. In that case the macroeconomic stimulus would be considerable, making it likely the 10 per cent would be rehired almost at once, thus intensifying the stimulus and making inroads on those millions of unemployed.

If you too are an optimist, I ask you to consider a special implication of what we have been saying. The happier world we have projected depends on an act of Congress combined with a President’s willingness to sign his name. There is no economic law that will achieve our goal. Rather the contrary. Standard economics pits businesses in such implacable competition with each other that even good-hearted employers are unable to pay more than the minimum, while workers compete so fiercely for jobs that even the stout-hearted can’t hold out for more. (That, by the way, is the Iron Law of Wages, which prompted Thomas Carlyle to coin the name for this column.) Thus wages tend inexorably to zero, and profits do as well. So, to be sure, do prices; but since no one will have any money, I’ve never understood what difference that makes. Individual companies can’t stop this fall; it takes governmental action. Hence the minimum wage.

Shifting back to microeconomics, we are likely to find in boardrooms across the land another objection to raising the minimum wage. It cuts into profits, the gut feelings is, and cripples enterprise. This feeling is known as the wage-fund theory: it argues that the gross receipts of any enterprise form a fund from which wages, other costs and profits are paid. Therefore, as David Ricardo insisted, “There can be no rise in the value of labor without a fall of profits.” Karl Marx, an admirer of Ricardo, found the wage-fund theory handy in explaining the implacable opposition of labor and capital. Here, as in so many cases, we find the far Right in bed with the far Left.

But taking a peek at the real world, Joseph Schumpeter remarked the empirical fact that wages and profits tend to go up together. Really good times are at least pretty good times for everybody. Profits are high, wages are high, unemployment is low, and so, for that matter, is inflation. None of this could happen if the wage-fund theory were valid. It is not valid because wages are a cost of doing business, while profits are not.

Profit (or loss) is what is left over after all receivables have been collected and all bills paid. The costs of wages, interest, rent, and supplies can all be contracted for in advance; but profit is systematically residual. What’s to come is still unsure.

1989-4-3 Minimum Wage vs. Maximum Confusion boots

I’m talking about actual profit-the kind you pay taxes on. Business people talk also about “normal” profit – what they think an enterprise ought to earn to be worth the bother. There is obviously no such thing as normal loss. Normal profit is a planning concept. It is an estimate, even an expectation, but not an actuality. It is on the basis of this estimate that go/ no-go decisions are made, prices are set, and production runs are scheduled. Although in the real world some businesses are vastly more profitable than others, and more or less profitable from year to year, normal profits, making allowance for risk, are uniform, as are short-term interest rates. High-risk enterprises must promise high normal profits, yet in the real world the low-risk enterprises generally show the highest profits.

THERE IS clearly not much point in running an enterprise if it can’t earn the going interest rate and a bit more. You could lend your money to someone else and earn bank interest or better with no trouble at all. So the interest rate is what economists call an opportunity cost of normal profit: they are roughly equal. Consequently we have three related concepts: normal or hoped- for profit, the interest rate, and actual profit or loss. Since only the first two come out of the wage fund, only they are in conflict with wages.

A common error, from David Ricardo to Alan Greenspan, is to confuse interest and actual profits. Mathematical economists, too, have trouble with this phenomenon, because they are prone to work with normal profits rather than actual profits. Actual profits are earned in historical time, but mathematics knows only the present tense.

What Ricardo should have said was, “There can be no rise in the value of labor without a fall in the interest rate.” Wages and actual profits can and do go up and down together. They go up together when the interest rate is low, and they go down together when the interest rate is high.

As Henry Ford understood, it is in the rnicroeconornic interest of each business that all businesses pay good wages. For this macroeconomic phenomenon to happen reliably, it takes a law. It takes more than a minimum-wage law, but it takes at least that. It is not unlikely that pushing up the minimum wage would eventually push up the wages and salaries above it. That is why we have said (see “Reality and Welfare Reform,” NL, November 28, 1988) that doing something about the poor is inflationary unless a major effort is made to correct the massive maldistribution of income and wealth in this country.

That will not be easy, especially since we seem bemused by personalities, and since a previously wimpy personality will veto any attempt of personable Congressional leaders to move in the right direction. There is something more to the problem than David Rockefeller‘s objections to Michael Milken’s junky performance.

The New Leader

Originally published November 4-18, 1985

ECONOMICS studies what people do and should do in certain situations. Its analyses, like all analyses, search out the factors that make up the situations. Thus a market involves selling and buying, or supplying and demanding. It is obvious that the selling and buying are done by human beings, and that no actual person is only a supplier while very few are only demanders. Though there may be nothing the vintners buy one half so precious as the stuff they sell, they nevertheless do some buying. Since no individual is merely an embodiment of an economic function, personification of economic functions may rate as a variant of the pathetic fallacy, whereby emotions and reasonings are ascribed to inanimate objects.

The fallacy is common among economists (perhaps even more common than the fallacy of composition, which we have noted here many times) and it has fateful consequences. It exercises an almost irresistible attraction, even for writers who explicitly warn against it. Ludwig von Mises, a pundit revered among conservatives, is loud and clear enough in Human Action:

“The entrepreneurs, landowners, workers, and consumers of economic theory are not living men as one meets them in the reality of life and history. They are the embodiment of distinct functions in the market operations. Living and acting man by necessity combines various functions. He is never merely a consumer. He is in addition either an entrepreneur, landowner, capitalist, or worker, or a person supported by the intake caused by such people. Moreover, the functions of the entrepreneur, the landowner, the capitalist, and the worker are very often combined in the same persons.”

I quote extensively because when I came to this passage in von Mises’ massive book, my heart leapt up. It does me good to find virtuous ideas in the midst of others that set my teeth on edge. But by the time I had reached the end of Human Action, my pulse was racing from an excess of adrenaline, not from a surge of joy. In the end von Mises forgets what he has said about living combinations of functions. What he calls investing is done only in a certain way by certain people, and these certain people are exclusively entitled to the rewards. He opposes unemployment benefits because they make it “easier for the unemployed to remain idle.” He sneers at those who talk of economic justice. The pathetic fallacy has led him to a pathetically mean-minded view of the world.

At the other end of the spectrum, Karl Marx seems brazen in announcing his devotion to the fallacy. In the preface to the first edition of Capital he writes: “I paint the capitalist and the landlord in no sense couleur de rose. But here individuals are dealt with only in so far as they are the personifications of economic categories, embodiments of particular class-relations and class-interests.” No matter how much he despises them, he resists the temptation of blaming individual capitalists for what they do. Marx won’t talk of blame, and von Mises won’t talk of justice: The pathetic fallacy knows not right and wrong.

At the same time, Marx is conscious of the danger that philosophical notions like individuality may become reified. For this reason he distances himself from his mentor Hegel and makes his famous move to stand the dialectic “right side up again” in the Preface to the second edition of Capital, holding that “the ideal is nothing else than the material world reflected in the human mind, and translated into forms of thought.”

The exploiting class and the exploited class, being based on materialistic functions, become monolithic and go at each other like the larger-than-life monomaniacal cudgelers in Goya’s “black painting, and we may wonder how materialization is an improvement on-or even a distinction from-reification. The notion of class is as surely an idea as anything in Plato or Hegel. No one has ever seen a class (except in a school) or heard one or touched one or smelled one or tasted one. Class is not a result of empirical inquiry.

It is no object of the senses. To talk of its force or action or reaction or progress is to talk pathetically. Class, in short, meets none of the usual tests for matter.

In the present connection, the idea of class is not only an odd ground for materialism, it imposes a rigidity on thought. The struggle is unremitting. It can be neither composed nor compromised but must be fought to the final battle. Marx’s vision is more generous than von Mises’, yet it is no less reductive.

What is true of the far Left and the far Right is true of most economists in between. Their analyses suggest to them the supply side or the demand side, public works or public austerity, saving or consumption, monetary policy or fiscal policy; and these impersonal policies or functions are in unremitting conflict.

To be sure, there is no lack of peacemakers ready to demonstrate that capitalists and workers need each other, nor is there a great lack of more or less grudging acceptance of that mutual need. Otherwise the economy would not work at all. There are periods, though, when the mutuality disappears. These are,  typically, periods of change, when business is faltering, or, quite the contrary, a technological leap forward seems possible or (depending on your point of view) desirable.

In depressions or recessions or growth corrections, some capitalists may lose some money (though mostly they do very well, and have done extraordinarily well the past five years), but what happens first is that many workers lose their jobs. This is so commonplace that no one ever thinks to defend it. I doubt that it can be defended. If both capital and labor are essential to production, by what right are things more worthy of protection than people? How is ownership more important than existence?

Technological advances have always been resisted by workers. How stupid of them! Britain could not have achieved its first breakthrough if landowners had not enclosed the commons and driven tenants off the land to make way for sheep. Later, had the Luddites had their way, the Industrial Revolution would have been aborted; and if the followers of Captain Swing had prevailed, the denizens of the cities could not have been fed even as well as they were.

As economists and editorialists continue to scold, such misguided people are with us still. Automobile workers resist giving up their jobs to robots; labor-saving machines are opposed as labor-eliminating devices. Why can’t these people see that new robotic industries will create new jobs, just as automobile making turned out to employ many more people than harness making? Why should anyone in his right mind fight to preserve mind-deadening work on the old-fashioned production line? What is so great about conditions in Southern textile mills that leads people to want to keep them going in the face of cheap imports from the Orient?

SOCIETY is certainly better off with more mechanization, more robotization. It is a blessing that the bulldozer and the earth mover have supplanted those who used to “push-a, push-a, push” on the Delaware-Lackawan. It is a blessing that the back hoe has made “ditch digger” an obsolete term of opprobrium. It is a blessing that the dishwasher has replaced the scullery maid. Not only is progress irresistible, it is largely beneficial.

But there is trouble in paradise. The trouble is systemic. The individuals who are displaced by progress are systematically denied the benefits of progress. Although the working class or the worker-as-function may be better off in the famous long run, many individual living workers are not, either in the short run or the long. As we have noted, when bad times befall, everyone may lose some money (well, almost everyone); however, the worker-as-function and the individual worker will often lose not only money but job, career, independent livelihood, sometimes forever.

The trouble is, I repeat, systemic. Short of war, the system is in no danger of immediate collapse, and it is without doubt a better system than that of India or South Africa or Chile or the Soviet Union or even Japan. Nonetheless, the conflict and squalor and heartbreak produced by this best of present systems, too, are unconscionable. One requirement for reform is cancellation of the pathetic fallacy and the reconstitution of economic man (and woman) as not merely producer or consumer, not merely worker or capitalist, not merely wage earner or profits engrosser, not merely time-clock-puncher or manager, but something of all of them, all at once, all the time, in theory and in law and in fact.

Another requirement is the redefinition of property. The need for this has, interestingly enough, been advanced by Friedrich A. Hayek, usually classed with von Mises as an ultraconservative (see “Strolling Down the Road to Serfdom,” NL, July 1-15). In Individualism and Economic Order Hayek criticizes “a slavish application of the concept of property as it has been developed for material things” (see“Life, Liberty and Property,” NL, July 11-25, 1983) and suggests that “There may be valid arguments for so designing corporation law as to impede the growth of individual corporations” (see “Big is Ugly,” NL, September 9, 1984).

The problem we have been discussing is approached from a different direction in an important short book by Professor Robert A. Dahl of Yale, entitled A Preface to Economic Democracy (University of California Press). A political scientist who, like Tocqueville, is concerned about the future of democracy, Dahl notes that it requires” a widespread sense of relative well-being, fairness, and opportunity.” He worries that this sense – this morale – is being eroded by the modern corporation with its dictatorial control and its unconscionable spread of rewards. Both, he argues, are unnecessary.

Dahl shows, point by point, that the case for political democracy is also valid for economic democracy. Again point by point, he considers the right to property and the peculiar form it takes today. At one stage he remarks drily, “Thus to say that [stockholders] are entitled to a return because they sacrifice the use of their money begs the precise question at issue: whether, if their money represents a return from property ownership, they are entitled to that money.” And later: “Given the passivity of stockholders in a typical firm, their utter dependency on information supplied by management, and the extraordinary difficulties of contesting a managerial decision, it seems to me hardly open to question that employees are on the whole as well qualified to run their firms as are stockholders, and probably on average a good deal more.” In conclusion, Dahl summarizes the experiences of a variety of existing employee-ownership plans operating here and abroad.

Readers of this column will recognize the relevance of Dahl’s argument to what I have been calling the Labor Theory of Right. I urge you to read his new book.

The New Leader

Originally published November 14, 1983

 

 

 

 

 

 

A FRIEND has taken exception to my proposal to limit or forbid the importation of foreign manufactures that threaten to destroy important domestic industries because of low prices based on the exploitation of local labor (“The Way to Protect,”November 14, 1983 NL, September 19). He says his freedom would be unacceptably abridged if he couldn’t buy a Japanese automobile, because he thinks they are better made than ours. He doesn’t deny that Americans are thrown out of work when our industries are shipped abroad, but he is confident that their distress is only temporary and perhaps not altogether undeserved. Besides, he objects to the word “exploitation” as old-fashioned rabble-rousing.

Two questions are mixed together here. The first I find difficult to take seriously. It is nowhere writ – not in the Bill of Rights, not in the Magna Carta, not in the Sermon on the Mount, not in the Code of Hammurabi – that my friend has a right to buy a Subaru, no matter how well it may be made. For various pragmatic or prudential reasons, the government will not interfere with his use of money except reluctantly and after due reflection; yet many uses are now routinely denied him, and there is no use that cannot, in principle, be denied. Money is, after all, a social, not an individual, creation. The issue is not whether denial is legitimate, but whether denial in this particular case is reasonable.

The other question is one of fact. In setting forth my proposal, I specified two steps that would have to be taken before barring a given import: “First, we decide that certain of our important industries are threatened in our home market by severe competition from foreign industries. Second, we determine whether that threat is made possible by wages or conditions that we would consider “exploitative.”

Now, whether these conditions apply to Subaru or not can readily be determined. I repeat: It is a question of fact, not of theory. For the purposes of our argument, my friend conceded that the conditions do apply, and that thousands of Americans in Detroit are thrown out of work because of Japanese labor policies. He nevertheless maintained that in the long run not too much suffering would be caused by the collapse of the American automobile industry; and that if suffering is caused the way to alleviate it is directly through the dole, not by forbidding the importation of Subarus.

I’m afraid that no doubt exists about the suffering, and it is by no means confined to the automobile industry. As I have previously said, as long as the American standard of living is higher than the Oriental standard of living, there is nothing whatsoever that cannot be manufactured more cheaply there than here. This goes for high-tech industries even more than for smokestack industries, because the technology of the former is in fact simpler and the capital requirements less extensive.

Nor is there any doubt that very little of the suffering we have so far seen will be alleviated by the so-called recovery. What’s going on now does not fit into the late Joseph A. Schumpeter‘s theory of new industries – ” railroad construction in its earlier stages, electrical power production before the First World War, steam and steel, the motor car, colonial ventures” – Ieading the upswing of fresh business cycles. The only new industry now on the horizon is high-tech, which, as noted, is high-tailing it for the Orient, and is not a big employer anyhow. For this reason, all the vague talk of retraining the millions of our unemployed fellow citizens is cruel nonsense. Retraining for what?

My friend is a compassionate man and is willing to consider the problem. Like Mr. Micawber, he expects something to turn up, but in the meantime he is willing to institute the dole (he is not a Reaganite) and to pay for it with a progressive income tax.

I am not one to say that it could not be done. Indeed, I say that it should be done. It is little enough. A dole at the poverty level might seem a bonanza for a part-time textile worker; it is a disaster for a veteran automobile worker who has saved a little money, started a family, bought a house, and nurtured the American dream. If, as some tell us, he was overpaid, then the dream was a fraud.

That is one side of the problem: the unconscionable cost to American workers of my friend’s assumed right to buy a Subaru or a Hong Kong sports shirt. The other side is the cost to my friend in taxes. Being in thrall to classical economics, he wants to balance the budget. At present rates, the Federal income tax raises about $285 billion, leaving a deficit of about $200 billion. A poverty-level dole would cost another $100 billion; a halfway decent dole would be double that. Thus to do what my friend wants to do would require income taxes one and a half times (if he doesn’t balance the budget) to two and a half times (if he does balance) those now in force. A flat tax at that rate of increase, let alone a truly progressive tax, would be a lot to pay for a Subaru. And millions of our fellow citizens would be condemned to aimless, hopeless lives.

Against this dreary scenario, my friend raises the specter of the Smoot-Hawley Tariff, sponsored by reactionary Republicans in 1930 and ever after blamed by junior high school civics texts for the Great Depression, the rise of fascism, World War II, the Cold War, and innumerable minor irritations. The analysis doesn’t rise even to the level of post hoc ergo propter hoc[1], for the Great Depression was already well under way when Smoot-Hawley was passed, while fascism had been in power in Italy for eight years, and was rapidly growing in Germany.

An interesting thing about Smoot-Hawley is that its original impetus came from distress on the farms. Although by the time the bill was passed, duties were raised on almost everything under the sun, the presenting complaint in President Hoovers call for a special session of Congress was largely agricultural. Today there is again distress on the farms, but its cause is different. This time no one is underselling us in our domestic market, or in our international market. The trouble, instead, is that the Poles and others who want our wheat haven’t anything to pay us with. (Except, my friend says, golf carts: Would you have believed that almost all carts on American golf courses were made in Poland?) The Poles have coal for sale, but so have we-and so do the Germans, the French, the Belgians, the British; (One of the “reindustrializing” schemes that has been advocated and, for all I know, implemented involves rebuilding the port of Norfolk to facilitate the export of coal to God knows whom.)

Since the Poles can’t pay us for our wheat, we had to fall back on our ingenuity. The solution was simplicity itself: We lent them the money. Partly we lent it as a nation through the Export-Import Bank, and partly we had it lent for us by our friendly bankers. Of course,

Chase and Citibank and the rest didn’t exactly use our money; they used the Arabs’ money, deposited with them because of the high interest rates the Federal Reserve Board encouraged, allegedly to fight inflation. Just as bankers become unwitting partners of debtors to whom they lend too much money, however, we as a nation have become the unwitting partners of the banks that now have shaky foreign loans far in excess of their assets[2].

THE UPSHOT of all this is that we the people of the United States will in effect pay our farmers for the wheat that is in effect given to the Poles. I have nothing against the Poles, but it occurs to me to wonder why it is better to give our wheat to them than to poor fellow citizens, whom we expect to feed themselves on a supplement of less than a dollar a day. Charity should no doubt be world-wide, yet it should certainly begin at home.

The result of the banks’ loans to Brazil et al. in many ways is worse. The Brazilians invested the money (which, you will remember, couldn’t be lent to New York City because it was a “bad risk”) in building up their industry, particularly steel. Thanks to their low wages, they are now driving American steel out of the world market and to a considerable extent out of the domestic American market. To repay the loans, though, Brazil has to export still more steel and import less of whatever it imports. It must adopt what the bankers and the International Monetary Fund (IMF) aseptically refer to as austerity measures. This means reducing Brazil’s standard of living, and consequently paying its steel workers even less than at present.

If the bankers’ scheme succeeds, by no means a certainty, additional American steel workers will lose their jobs. Should the scheme fail, the banks will come crying to Uncle Sam to bail them out (they’re already lobbying for an increase in our contribution to the IMF), and we will in reality have given Brazil the steel mills that are destroying our industry and putting our fellow citizens out of work.

A very high percentage of foreign trade follows the patterns I have outlined, distorting economies everywhere to the principal benefit of bankers. There are, naturally, many things we want or need to import; oil (because we are too witless to cope with our energy requirements), tungsten, chrome, bauxite, coffee, and there are many things we can, without special government assistance, export to pay for them. But the necessity, or even the desirability, of foreign trade has been grossly oversold.

Trade is one of the modes of civilization (that is what makes economics a humanistic-and ethical-discipline). Trade also adds to wealth – the wealth of individuals, of nations, of the world. It does this by increasing and rationalizing employment, for wealth is the product of work. When trade expands employment for both partners, the prosperity of both is advanced, and David Ricardo’s Law of Comparative Advantage (see “How Our Sun May Rise Again,” NL, July 12-26, 1982) can be said to apply. Conversely, when trade brings about unemployment for one of the partners, its advantage disappears. Trade will always result in some unemployment in a competitive situation, and the unemployment will be compounded where the competition is based on gross wage differentials. If Japanese citizens were to buy up the output of Korea’s nascent automobile industry in preference to Subarus and Toyotas, Japanese wealth would be decreased, and you may be sure that the Japanese government has imposed effective restrictions.

Microeconomically – that is, company by company-foreign trade can be very attractive. Once a company is successful in its home market – factories built and paid for, experience gained – it takes little extra effort to open an export business, and economies of scale will make that business extraordinarily profitable at the margin, especially when stimulated by tax incentives. The profitability of multinational conglomerates is enhanced by their ability to manufacture where wage scales are the lowest (and declare their profits where taxes are the lowest).

When we shift from microeconomics to macroeconomics – from firm to nation – we find (as we frequently do in such shifts) that we have committed the fallacy of composition. What is good for each firm individually is not necessarily good for the nation. In the circumstances we have been discussing, some (not all) American exports are being paid for by us in the shape of high interest rates that inordinately benefit a few, and we will doubtless bear the further cost of rescuing banks in danger of failing. On the other side, some (not all) American imports are being paid for by individual citizens in the shape of shattered prospects and grinding poverty.

These outcomes are not divinely ordained. They are the result of policies deliberately, albeit perhaps blindly, adopted. If this be rabble-rousing, as I told my friend, make the most of it.


[1] A logical mistake which assumes that when things happen in a sequence that means that the second event was dependent on or caused by the first.

[2] Reading this in 2012, post the late 2000’s mortgage fiasco, I can change this sentence by replacing “shaky foreign loans” to “shaky mortgages” and not have missed a beat.

Originally published May 3, 1982

AN OLD TEACHER of mine once tried to “motivate” (a word he would never have used) his sullen pupils by arguing that Latin is the road to success in any line of endeavor. He was ready for us when we cited Henry Ford as an exception. “Ah, yes,” he replied, “but think of how much more successful Mr. Ford would have been if he had studied Latin.”

That kind of argument provides the principal, if not the sole connection between macroeconomics (the economics of the nation or world) and microeconomics (the economics of the firm or individual), as they are at present understood. Ordinarily the link is silently assumed. The root of both branches, like the root of both words, is the same. Surely, too, it is obvious that the prosperity of the nation depends on the prosperity of the entities that make it up.

I shall nevertheless dare to express doubt. For I have had the experience, not once but several times, of seeing the firm for which I work prosper in what were generally judged to be bad times. And, I am sad to report, I have also seen the contrary. There used to be, moreover, a bit of folk wisdom to the effect that the book business is, for various almost plausible reasons, depression proof. (Some say that it is prosperity-proof, as well.) In the face of all this, how can one assert a connection between macroeconomics and microeconomics?

My old Latin teacher would have had no trouble with that question. He would readily have granted that our firm could prosper in bad times, and then rejoined: “Think of how much more prosperous you’d have been if the times had been good.” That is a hard argument to meet and an impossible one to formulate. It seems the most obvious of common sense, but there is no way to test it. The fact of the matter is that our company sometimes-not always-prospered in bad times; beyond this fact we have merely wild surmise.

Indeed, I would suggest that the connection between macroeconomics and microeconomics actually is silently denied about as often as it is silently affirmed. The former head of General Motors who served as President Eisenhower’s Secretary of Defense, Engine Charlie Wilson (so called to distinguish him from Electric Charlie Wilson, at the time head of General Electric), was greeted with derisive laughter when he made his way into the dictionaries of quotations with the howler, “What’s good for General Motors is good for America.” You don’t have to cudgel your brains to think of lots of examples of business doing good for itself at the expense of the national interest. In such instances, macro and micro seem to be at war with each other rather than mutually supportive.

Many college curricula are also unmindful of a possible connection. It is not unusual to be able to take an introductory semester of micro without macro, or vice versa, or a semester of each in either order. It doesn’t matter, because the truth is one doesn’t depend on the other.

The discontinuity is not to be wondered at but to be expected. For we have here another instance of the fallacy of composition (see my “Productivity: The New Shell Game,” NL, February 8, on how this turns up in discussions of productivity). Webster’s New International Dictionary, using almost identical language in both the second and third editions, defines the misleading reasoning as follows: “The fallacy of … assuming that what is true of each member of a class or part of a whole will be true of all together.” Websters then gives an example from economics: “If my money bought more goods, I should be better off; therefore we should all benefit if prices were lower.” The fallacy of composition might well be called the characteristic economics fallacy.

In its relatively benign form it may underlie proposals to operate the government on “sound business principles”- that is to keep accurate accounts. Somewhat more dangerous is the belief, widespread at least among businessmen, that success in business is an indicator of probable success in government. This can lead to a lot of benefit- cost analysis and similar foolishness. Or it can lead to reliance on bankers (who are not, properly speaking, really businessmen) to settle monetary and financial questions (what is good for Citibank and Chase may in fact be very bad for America, as the Polish crisis has shown).

It is in the fields of taxation and regulation, however that the most dangerous misapplications of microeconomic principles to macroeconomic problems come. Reaganomics is frankly built on such reasoning, and the Democrats have been floundering because they tend to accept the same fallacies. As things stand today, their uneasy feeling that it is bad to be mean to the helpless is what distinguishes them from the Republicans. The sentiment is a credit to them; in a rational world it would be a badge of honor to be called a do-gooder. Yet feelings are an inadequate response to a ruthless and fairly consistent program, especially if one has the despairful suspicion that the theory behind the program may turn out to be pragmatically correct.

The Democrats have been kidded into believing that President Carter was from their ranks, and that his failures proved the Great Society was a bum idea. As a result, they have not only supported the Reaganomic tax breaks for the rich but have mindlessly tried to outbid the Republicans for the favor of the oil industry. Several, not excluding notorious liberals like Teddy Kennedy, are demanding credit for being in the forefront of actions to dismantle some regulatory agencies. The reasoning, again, is a fallacy of composition.

Current theories of microeconomics assume that the purpose of business enterprise is profit maximization, and a now well established principle of successful business management is that it is sensible to cut your losses. Any fledgling MBA has a quick eye for seeing how a firm’s activities can be divided into _ semiautonomous “profit centers,” plus a quick ear for hearing which profit centers are yielding a desired rate of profit, which ones can be made to do so, and which ones are hopeless. Those in the last category may be profitable; they are simply not profitable enough. The minimum acceptable rate of return is the money-market rate. If you can get roughly 15 per cent by lending your money to someone else, there clearly is no point in bothering to run a business that earns less. Or if in the normal course of your business you borrow money from banks, and pay the prime rate of roughly 16.5 percent, you’re obviously losing money on a profit center that doesn’t earn that much.

So the weak profit centers should be sold if possible, liquidated if not. You will probably have to take a loss, but more than half of your loss will be paid for by the government via the reduction of your income and hence of your tax bill. The funds thus freed can then be applied to the promising profit centers, or put into the money market, or used to reduce your corporate debt. Whether you sell or liquidate, the overall profit of your company will be improved.

There is no doubt that this barbarism works. Consider a profit center that is earning 5 per cent on invested capital of a million dollars, while the firm’s target is 15 per cent. Even if the weak profit center-workers, customers, machinery- is abandoned at a total loss, the after-tax result will be that more than a half million dollars will be available for use in the centers that earn 15per cent or more. Fifteen per cent of a half million dollars is $75,000, while 5 per cent of a million is only $50,000. It’s as simple as that, and the underlying principle is similar to that of the Blitzkrieg.

Let us note in passing that this sort of thing is encouraged by the corporation income tax, and that a higher tax would encourage more of it. It is of course also encouraged by the interest rates produced by the Federal Reserve Board’s monetarist policies.

NOW TRANSFER this microeconomic thinking to macroeconomics. Just as in a firm there are many profit centers, in a nation there are many firms. In the same way, therefore, that a firm is strengthened by eliminating relatively weak profit centers, the nation will be strengthened by eliminating relatively weak firms. From this, Reaganomics follows as night the day. And in the long dark night it makes sense to foster the strongest and starve’ the rest. It makes sense to embrace the reality that in monetarist economy strength is a question of financial-not productive-capacity, even though that may be literally counterproductive. It makes sense to keep the interest rate high and to push the bankruptcy and unemployment rates higher. It makes sense to promote the amalgamation of whatever industry remains.

If you stop to think about it, none of this makes sense. It is the most vicious, most debilitating nonsense you could imagine. But it is what results from the application of microeconomic principles to macroeconomic problems.

I hasten to emphasize that this sort of thinking is not the exclusive province of the Business Roundtable and other far out Republicans. During a Democratic administration alleged to be liberal, I was involved in discussions with representatives of the Federal Trade Commission and was told that bookstore chains deserve much better terms than individual stores because economies of scale benefit the consumer. Had the FTC lawyers looked at the actual situation rather than at their doctrine, they would have noticed that the chains, for a variety of reasons, would collapse without the more favorable terms. But my main point is that the notion of economies of scale is a notion in microeconomics. When the government-in this case the FTC-gets involved in microeconomics, it usually makes or perpetuates a mess.

Until the Democrats learn this lesson, we will have no relief from Reaganomics. It may well happen that the Republicans will achieve disaster so quickly that the Democrats will win in the fall elections. But so long as the Democrats, too, are bemused by microeconomic doctrines, the dark night will continue.

The President pleads for patience, for more time to allow his program to “take hold.” He will probably get his time give or take a few wrist-slaps at the Pentagon budget-because the Democrats, like him, are in the thrall of theories that have proved successful on the level of individual firms and individual banks. Let it be stipulated that those theories do in fact work on that level; they are uncivilized even there, but they do “work.” But let it some day soon be understood, and insisted upon, that the economy of the nation-and of a free market-is based upon entirely different principles.

The New Leader

Originally published February 28, 1982

The Dismal Science

PRODUCTIVITY:
THE NEW
SHELL GAME

BY GEORGE P. BROCKWAY

WE HAVE a new economic sport in town. Oskar Morgensterns theory of games has been with us for decades.  Comparatively recently, Lester C. Thurow gave us his pretended zero-sum game. Now President Reagan has created a 33-member National Productivity Advisory Committee headed by former Treasury Secretary William Simon. The committee has not yet announced the rules for its planned year-long study, but I have no hesitation in telling you that it will result in the additional refinement of a modernized shell game that has been played informally ever since the present inflation started. In this extraordinary contest there is a pea under every shell-yet you and I always lose.

The shells, all identical of course, are made of a statistic devised by eminently respectable economists. It is called the Productivity Index, an apparently innocent and objective figure obtained by dividing the Gross National Product of a period (usually three months or a year) by the total number of man-hours worked in the period. If I had not promised to try to refrain from grousing about how the GNP is compiled, I’d say the Productivity Index is what you get when you divide a grossly misleading estimate by another that is merely an educated guess. Even those who calculate it will admit that its ostensible precision is spurious, and that at best it may sometimes be useful in comparing one period with another. As the automobile advertisements put it, “Your mileage results may be different.” Indeed.

The vice of the Productivity Index, though, is not that it is an estimate based on estimates (thus multiplying their unreliability). The vice is that it does not measure-and cannot measure what its users pretend it measures.

Let’s go back a bit. We learned in school-perhaps from one of the academic experts on the President’s new committee-that the factors of production are land, labor and capital. Some add technology to the list, and others add an array of propensities to do this, that or the other. No matter. The point is that regardless of how many items you have on your list, labor is only one of them. Consequently, dividing the GNP by the number of hours worked to determine productivity is like using the average number of yards gained per first down to decide the winner of a football game. You might do that if you were Howard Cosell, but not otherwise.

If one persists in using only “hours worked” to arrive at the Productivity Index-as we can be pretty sure the President’s committee will-one is in effect declaring that the contributions of land and capital are negligible. They don’t have to be counted, because they count for nothing. Any way you look at it, that’s going to be pretty funny talk coming from a committee that is as conservative as the President dares make it-and he’s a brave man. I will tell you straight out that I am something of an old-fashioned entrepreneur, and you’ll never catch me saying anything like that. In fact, you’re not likely to convince me that the interest rate-to name only one other factor-has nothing to do with productivity.

Well, despite the reservations we may have, that’s what the shells in this game are like. Now let’s examine some of the peas that have been used in the informal games we’ve seen of late; we’re odds-on to see them again.

The first pea is an all-purpose variety that always turns up on metropolitan bars and suburban bridge tables: No matter where you look, it just seems that people aren’t willing to work the way they used to. This is what the Productivity Index seems to show, and it certainly seems plausible, remembering how hard you and I used to work when we were young. In the old days we didn’t have coffee breaks and extended vacations and … No doubt you can think of examples as well as I can. This part of the game is just a warm-up, to get everyone in the proper mood.

The next pea is more serious. It is the America-has-gone-soft pea. We let them beat us in Vietnam (or beat ourselves); investigative journalism got out of hand over Watergate; and now a court has said that creationism isn’t science. It’s hard to tell what the country stands for anymore. Moreover, since there’s too much money chasing too few goods’, it’s no wonder that productivity is down and we have to have this recession to get us back on the track. (You may think it odd that a recession, which is defined as fall In Gross National Product, could be a way of increasing productivity. But let that pass.)

Under the third shell there is the archaic-industry pea. The industry in question is usually important in the military-industrial complex, so our role as leader of the free world is said to be at stake. The afflicted industry is unhappily mature, obsolete, decrepit, and hence unable to compete with the newer, more modern, more efficient plants that the Germans and Japanese had to build because we blew up their old ones in the War. Although this is certainly an ironic state of affairs-that being blown up is good for you-we intellectuals have learned to live with irony and actually find it more to our taste than simplicity. (I seem to remember that the British were heavily bombed, too; yet their factories are said to be even worse than ours. Nor does bombing seem to have been a great blessing to the French on one side, or to the Italians on the other. But let that pass.)

At any rate, we’ve been hearing that U.S. Steel made a bad mistake in staying with the Bessemer process instead of switching to whatever it was the Germans and Japanese switched to, and that therefore it needs protection from foreign competition. (Steel’s mistake would seem to have been a mistake on the part of management, though it isn’t nice to point. I wonder why bankers who deplore that mistake are so eager to underwrite the same management in its takeover of Marathon Oil. It is surely a very pretty irony that botching the steel business fits you for success in the oil business. And it does raise questions about how difficult it can be to run an oil company, and what can possibly justify the $1 million annual salary of Mobil’s president. But let that pass, too.)

If you were not born yesterday, you can readily see that the America-has gone-soft pea can be used to justify not merely the recession but more particularly the recession’s effects in rising unemployment, lower wages and union busting generally. The archaic-industry pea can be used to justify fast write-offs for tax purposes and low capital-gains taxes to encourage what is called investment but is actually speculation (I’ve fussed about that before and no doubt will again). In other words, the   winner of the new shell game is always Reaganomics.

THERE’S NO WAY you and I can stand a chance here, unless we look again at the so-called Productivity Index. As we’ve noted, it is flawed macroeconomically by its failure to take account of such crucial factors as the interest rate. Microeconomically it overlooks the obvious fact that in any particular firm the efficiency of the labor force depends in large part on the skill and luck of the management. Where management decides to manufacture a product that turns out to be unsalable (say, a gas-guzzling automobile), the result tells us nothing about the efficiency of the production line. Similarly, a badly run production line will yield bad results no matter how hard the individual workers work.

More fundamentally, the Productivity Index is guilty of the fallacy of composition, which is the assumption that what is true of every member of a class is true of the class itself. Thus it is fallaciously said that since every firm is run to make a profit, the nation is run to make a profit. (This points, too, to the fundamental fallacy of Marx’s theory of surplus value, but we won’t go into that now.) In the case of the Productivity Index, the fallacy appears in the use of “hours worked” as its denominator.

The Productivity Index, let us remember, is a simple fraction, whose numerator is the GNP and whose denominator is “hours worked.” As with any fraction, the value of this one can be increased by increasing the numerator (two-thirds is greater than one-third), or by decreasing the denominator (one half is also greater than one-third). An individual firm can increase its profits (“productivity”) even in the face of declining sales, provided it can cut its labor costs still faster; and this is the course surviving firms take in a recession.

But transfer the same thinking to the economy as a whole and you are saying that the nation’s productivity can be improved (or the nation made stronger and wealthier, if that’s what you want to talk about) by deliberately-in cold blood- fixing it so that nine or 10 or 11 million potential workers don’t do any work. With the denominator decreased, the index should go up. This is absurd on its face and vicious in its results.

While recognizing the vicious absurdity of the Productivity Index, you may still want to measure the efficiency of the economy. There is a pretty good figure for doing that: the GNP per capita. This won’t show you why the economy is more or less efficient than it used to be (and, as I have suggested, I could tell you a tale about the GNP). Yet at least the term “per capita” includes us all; and we are all, employed and unemployed alike, members of the nation the” N” in GNP. Further, if you look at the GNP per capita you will see what common sense has already told you: that a deliberately induced recession what we have today-is stupidly and pointlessly cruel to millions of men, women and children, as well as destructive of the national interest.

The cruelties and absurdities of the Reaganomic shell game flow from the apparently innocent and objective Productivity Index that well-intentioned economists have devised. It has been observed before that the road to hell is paved with good intentions. We may not, I fear, be quite so sure of the intentions of the bankers and brokers and politicians who are hot for Reaganomics. In that case we might inquire what it is they produce that qualifies them to lecture the rest of us on productivity.

The New Leader

[Over a year later a letter was received regarding this article. That letter and George Brockway’s response are found here: http://wp.me/p2r2YP-5Q]

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