Topic: Political Philosophy

A Primer on State of the Union Economics

Until recently, President Obama’s December 4 “Remarks on Economic Mobility” were thought to preview his State of the Union address by defining “dangerous and growing inequality and lack of upward mobility” as “the defining challenge of our time.”  

That downbeat and divisive theme polled badly. As a result, the President is expected to recast the same story as “ladders to economic opportunity” (which is just another way of describing upward mobility). Obama’s passionately misinformed perceptions about rising inequality and falling mobility, however, are surely unchanged.

In his December 4 address, the President could find no official statistics to support his overblown claims about “growing inequality.” The Census Bureau and Congressional Budget Office report that the top 20 percent earns about half of all income. The CBO finds the top 20 percent received an average of 47.6 percent of all after-tax income since 1983, and roughly the same percentage (48.1) in 2010 and 2011. Yet the President insisted on claiming, “The top 10 percent [not the top 20 percent] no longer takes in one-third of our income – it now takes half.”

Unless the President thinks all affluent people are thieves, the top 10 percent never “take” any fraction of “our” income. On the contrary, they earn 100 percent of their own income.

Eschewing all official data, President Obama relied instead on estimates of pretax, pre-transfer income (which are clearly irrelevant to issues concerning taxes or transfers) from Thomas Piketty and Emmanuel Saez. Among many other problems with these figures, documented in my recent paper, growth in top incomes is exaggerated by including a rising share of business income formerly reported on corporate returns, and also by counting realized capital gains as income (in fact, selling assets does not make anyone richer). Lower incomes, by contrast, are grossly understated by completely excluding the huge and rising share of income from government transfer payments, now approaching $3 trillion a year.

“The combined trends of increased inequality and decreasing mobility,” said President Obama, “pose a fundamental threat to the American Dream, our way of life, and what we stand for.” As the title of his talk suggested, Obama was primarily focusing on decreasing mobility (since repackaged as decreasing opportunity), not increasing inequality per se. As he put it, “the problem is that alongside increased inequality, we’ve seen diminished levels of upward mobility in recent years.”

Two major studies by U.S. Berkeley’s Emmanuel Saez, Harvard’s Raj Chetty and others, find the President entirely wrong about diminished mobility. Their newest paper shows that, “children entering the labor market today have the same chances of moving up in the income distribution relative to their parents as children born in the 1970s.” Moreover, a narrowing “gap in college attendance between children from the lowest- and highest- income families… suggests that mobility in the U.S. may be improving.” The authors conclude that, “if one defines mobility based on relative positions in the income distribution – e.g., a child’s prospects of rising from the bottom to the top quintile – then intergenerational mobility has remained unchanged in recent decades. If instead one defines mobility based on the probability that a child from a low-income family (e.g., the bottom 20%) reaches a fixed upper income threshold (e.g., $100,000), then mobility has increased…” As for the President’s rhetorical effort to link top income shares with declining mobility, the authors find “little or no correlation between mobility and… top 1% income shares – both across countries and across areas within the U.S.” The biggest actual barrier to upward mobility, in fact, turns out to be single parenthood.

President Obama’s revealing December 4 lecture relied on irrelevant pretax, pre-transfer estimates to assert that the top 10 percent have been “taking” half of “our” income, and he used no evidence whatsoever to assert that upward mobility has been declining.

The defining challenge of our time may be to discover ways to stop politicians from using made-up numbers to excuse destructive and demoralizing economic policies.

Meet the Kronies!

If you want to get something done (or, just as often, not done) in Washington, you might just need … the Kronies.

Take, for example, Kaptain Korn:

Kaptain Korn is a mutant hero who can change shape at will. One minute he’s coating your corn flakes; another minute he’s bootleg liquor in your gas tank. Though he’s powerless without G-force, subsidies and mandates give Kaptain Korn the muscle he needs to push puny third world back down into the dust. Kaptain Korn ensures jokes stay corny, rears stay flabby and engines run less efficiently.

If you want to help defeat the Kronies, you might want to take a look at Cato’s DownsizingGovernment.org. Learn more from our video series on how to downsize specific departments (all videos will play below):

Mr. President, Increasing the Minimum Wage Is Wrong Medicine for Ailing Economy

When President Obama advocates a higher minimum wage in his State of the Union Address, he will no doubt argue that by increasing the minimum to $10.10, workers will have fatter pay checks and spend more, thus stimulating the economy and creating more jobs.  In fact, economic logic tells a different story. 

The law of demand is more powerful than the minimum wage law: when the price of anything, including labor, goes up, the quantity demanded goes down, other things constant.  No one has ever disproven this economic law—and neither the President nor Congress can overturn it.

The idea that raising the minimum wage will increase income confuses the price of labor (the wage rate) with labor income (wage rate x hours worked).  If a worker loses her job or can’t find a job at the higher minimum wage, her income is zero.  

Proponents of the minimum wage argue that those workers who do retain their jobs will consume more, which will increase aggregate demand and increase GDP.  But that line of argument is a case of upside-down economics.  Consumption is not a determinant of economic growth; it is the result of a prior increase in production.  Workers cannot be paid what they haven’t first produced.

A higher minimum wage—without a corresponding increase in the demand for labor caused by an increase in labor productivity (due to more capital per worker, better technology, or more education)—will mean fewer jobs, slower job growth, and higher unemployment for lower-skilled workers.  Higher-skilled workers and union workers will benefit, but only at the expense of lower-skilled workers, especially the young and minorities.  There is no free lunch.

Small business owners will see their profits cut, which will either drive them out of business or slow their expansion.  If prices are increased to offset the higher minimum wage—something that is difficult in globally competitive markets—consumers will have less money to spend on other things. Thus, there will be no net increase in employment. Moreover, an increase in the minimum wage cannot lead to an increase in aggregate demand unless the Federal Reserve accommodates the higher minimum by pumping up the money supply, which would lead to inflation and a loss of purchasing power. 

Mr. President, there is no magical way to stimulate the economy by increasing the minimum wage. The only sure way to increase jobs and wages for lower-skilled workers, and thus to increase their standard of living, is to increase economic growth.  The minimum wage is neither necessary nor sufficient for economic growth.  Hong Kong grew rich without a minimum wage because it undertook the reforms that fuel growth: free trade, low tax rates, limited government, a stable rule of law that safeguards private property, sound money, and low costs of doing business.  The United States should do likewise. 

Increasing the minimum wage is the wrong medicine for an ailing economy.  Further government intervention in free markets is the path toward socialism, not market liberalism.  Letting free markets determine wage rates is consistent with a free society and also with economic logic.  It is the surest path toward greater income mobility as younger, low-skilled workers get experience and move up the income ladder.  Cutting that ladder off by mandating a higher minimum wage is a recipe for poverty not progress.   

The Minimum Wage: Immoral and Inefficient

Democratic politicians are desperate to make up for ObamaCare’s disastrous roll-out.  Thirteen states are increasing their minimums this year, and some Democrats believe raising the national minimum wage is a winning campaign issue for November.

There’s no doubt that raising the minimum wage would reduce employment and slow economic growth.  Worse, government wage-setting is immoral.  It is unfair and wrong for politicians to posture as philanthropists while forcing other people to pay higher salaries.

The first question is the minimum’s impact on employment and price levels.  The answer is clear:  the cost of higher wages will be borne in varying degrees by customers, workers, and investors.  As I wrote in the American Spectator:

as Nobel Laureate Milton Friedman observed, there ain’t no such thing as a free lunch.  Arbitrarily raising the cost of labor—there is no principled basis for choosing any particular government minimum—will increase prices, reduce investor returns, and cut employment levels.

Most vulnerable are workers with the least education, experience, and skills, who tend to be young and minorities.  Forcing up wages will not only reduce overall employment, but shift jobs toward higher-skilled workers who are more productive and thus warrant higher pay.  The minimum wage also encourages mechanization, since it makes economic sense for companies to invest more in machines to spend less on labor. 

In effect, the minimum wage is a tax on labor-intensive companies.  No surprise, then, as explained by Mark Wilson of Applied Economic Strategies in a Cato Institute Policy Analysis:  “The main finding of economic theory and empirical research over the past 70 years is that minimum wage increases tend to reduce employment.” 

The strangest claim may come from the Financial Times, which editorialized:  “a higher wage would stimulate the economy without adding a dime to federal spending.”  However, to the extent raising the minimum increases the total amount of wages, it does so by redistributing the money from other people, who end up with less to spend on consumption. 

No doubt, the employment impact of a small increase, especially if salary levels have been rising, would be modest, which explains recent economic studies demonstrating lesser job loss.  But the less significant the increase, the less meaningful any potential benefit.

In contrast, those who claim that raising today’s minimum would have no impact on employer behavior fail to demonstrate the courage of their convictions.  If government can hike wages without harm, why stop at $10 or $15 an hour?  Why not go to $1000 or $1500?  Then everyone in America could be rich at no cost to anyone!

Yet there is an even more fundamental issue.  The minimum wage is the modern perversion of compassion into coercion:  I believe there is a moral imperative for you to earn more, so I force someone else to pay more.  I feel moral while sticking someone else with the bill. 

However, if “we,” the citizens of America, believe people should earn more, then “we,” the citizens of America, not a few labor intensive businesses, should pay for those above-market wages.  Opposing the minimum wage is simple fairness.

While many advocates no doubt are true believers, for some fairness talk is pure twaddle.   John Cassidy wrote in the New Yorker:  “In the current political environment, there is little chance of pushing through another hike in income-support programs.  Raising the minimum wage pushes the burden onto corporations and consumers.” 

Washington should be systematically reducing, not increasing, the cost of doing business.  Yet the regulatory-happy Obama Administration has been imposing multiple burdens on commerce, starting with ObamaCare. 

The next time someone rises to support arbitrary government wage-setting, they should be asked what they are doing personally to help the economically disadvantaged.  Raiding the wallets of others does not count as compassion

RIP Economist and Cato Friend Walter Oi: An Advocate for Liberty and the Volunteer Military

With most people focused on the coming of Christmas, the death of economist Walter Oi received little attention.  Educated at the University of Chicago and appointed professor at the University of Rochester, Oi was an outstanding labor economist.  He was no mere ivory tower advocate of liberty.  He was a Nisei, or second-generation Japanese-American.  At age 13 during World War II his family was interned in California.

Life didn’t get easier for him.  His eyesight steadily deteriorated, and he could not read text upon entering college.  He fully lost his sight in 1956.  Yet he went on to gain a PhD, teach, research, serve on presidential commissions, and gain a long list of honors.  His career should embarrass the rest of us.

Moreover, like Cato’s late chairman, Bill Niskanen, Oi stood on principle irrespective of cost.  In warm tribute to the latter, economist David Henderson, a University of Rochester colleague and another Cato Institute friend, pointed to Oi’s criticism of the future prospects for agriculture when teaching at Iowa State University and opposition to proposals for government reparations for the internment of Japanese-Americans.

Oi’s research interests were many but, Henderson wrote:  “If you are an American male younger than 66, you should take a moment and give thanks to economist Walter Oi.  Walter died on Christmas Eve 2013.  Even though you probably haven’t heard of him, he has had a profound effect on your life.  He helped end military conscription in the United States.”

I am one of those who was able to choose my own way, rather than be subject to presidential diktat and sent off to fight in a stupid, unnecessary foreign war.  Tens of thousands of Americans would have been alive had the draft not been available in the 1960s to provide a guaranteed supply of cannon fodder for Lyndon Johnson’s and Richard Nixon’s misadventure in Vietnam.

Many people played critical roles in causing this self-proclaimed free society to rely on a free people for its defense.  Richard Nixon, who proposed the All-Volunteer Force.  Martin Anderson, for whom I later worked in the Reagan White House, who convinced Nixon to tackle the issue.  Milton Friedman, who served on the famous “Gates Commission,” which recommended the shift.

And Walter Oi, who served as a staff economist on the latter panel.

As Henderson, who now educates military officers at the Naval Postgraduate School, explained, Oi’s “passion for free labor markets was what motivated his work on the draft.  His contribution was to point out—and estimate two costs.  First, there was the hidden cost imposed on draftees and ‘draft-induced’ or ‘reluctant’ volunteers.  …  The second cost Oi estimated was the increased annual budget outlay needed to eliminate the draft.”

The AVF obviously was a moral triumph.  It also turned out to be a practical achievement.  The military did far better recruiting people who wanted to serve than impressing those who only wanted out.  Today America has the finest military it has ever fielded, and the best in the world. 

As I wrote in a Cato Policy Analysis:

Indeed, a draft would degrade the military’s performance, requiring induction of less-qualified personnel, who are rejected today, and raising the rate of ‘indiscipline’ by filling the armed services with people who don’t want to serve.  It comes as no surprise that the military leadership opposes conscription.

Walter Oi was sui generis.  He personally suffered from tyrannical though democratic government.  He overcame disability without complaint.  He risked job and opposed government benefits because he valued honesty and principle.  He backed his commitment to liberty with wide-ranging and quality economic research.  And he made a huge difference in the lives of tens of millions of his countrymen.

RIP Walter.

Chinese Liberal Mao Yushi Turns 85

Mao Yushi accepts the 2012 Milton Friedman Prize for Advancing Liberty

All lovers of liberty and limited government should celebrate Mao Yushi’s 85th birthday on January 14.  He was a signatory to Charter 08 and the recipient of the 2012 Milton Friedman Prize for Advancing Liberty.  As chairman of the Unirule Institute of Economics in Beijing, Mao Yushi has been instrumental in spreading classical liberal ideas in China.  In 1998, he commissioned the first Chinese translation of F. A. Hayek’s classic text, The Constitution of Liberty.  Unirule (Tianze or “Universal Rule”) conveys the fundamental principle of liberty under the law. 

Mao was educated as a mechanical engineer but later became interested in economics and how China could make the transition from central planning to a market economy.  In 1957, he was purged from the Chinese Communist Party during the Anti-Rightest Campaign, and he lost his job as a railroad engineer.  Later, during the Cultural Revolution, he lost his property when Mao Zedong outlawed private ownership. 

After Deng Xiaoping’s opening to the outside world in 1978, Mao Yushi was invited to rejoin the CCP but refused.  Instead, he became a leading critic of the Party’s monopoly on power and an advocate of free markets and civil society. 

In a recent essay, “Returning Mao Zedong to Human Form,” he argued that Chairman Mao should be subject to open criticism and not be viewed as a god—and called for removing Mao’s picture from Tiananmen Square and from the Chinese currency. As Nobel Peace Prize winner Liu Xiaobo has said, Mao Yushi’s “bravery is worth our respect.”

At Unirule, Mao Yushi has attracted many younger scholars to discuss the institutions necessary for a market economy, particularly private property rights and a legal system that protects basic human rights.  He holds that the state should protect the people who should be free to choose—an idea that goes back to Lao Tzu. 

In addition to drawing from the work of Hayek, Mao Yushi and his colleagues at Unirule have developed the ideas of Nobel Laureate economists Douglass North and Ronald Coase, focusing on the “new institutional economics.”  Peaceful development requires nurturing the right institutions and, in Coase’s words, requires a “market for ideas,” not just for goods and services.

In China’s Future: Constructive Partner or Emerging Threat? (Cato Institute, 2000), Mao Yushi wrote, “”The major obstacle to developing market institutions in China is the special privilege rights that lie beyond, and conflict with, human rights.”  That obstacle is still present, and Mao is still fighting for the people’s rights.  His courage in advancing freedom and civil society in China—through his writings, Unirule, Fuping Development Institute, and, most recently, the Humanism Economics Society—deserves our admiration and respect.

Uncertainty and Economic Fluctuations

Economist Nicholas Bloom (Stanford) has produced a nice summary of his work on uncertainty and economic fluctuations:

This review article tries to answer four questions: (i) what are the stylized facts about uncertainty over time; (ii) why does uncertainty vary; (iii) do fluctuations in uncertainty matter; and (iv) did higher uncertainty worsen the Great Recession of 2007-2009? On the first question both macro and micro uncertainty appears to rise sharply in recessions. On the second question the types of exogenous shocks like wars, financial panics and oil price jumps that cause recessions appear to directly increase uncertainty, and uncertainty also appears to endogenously rise further during recessions. On the third question, the evidence suggests uncertainty is damaging for short-run investment and hiring, but there is some evidence it may stimulate longer-run innovation. Finally, in terms of the Great Recession, the large jump in uncertainty in 2008 potentially accounted for about one third of the drop in GDP.

The crucial unanswered question is why uncertainty increased in 2008.

One possibility is that consumers and firms could not readily judge the severity of the financial crisis.

A different possibility is that consumers and firms were confused by the federal government’s aggressive new policies (e.g., bailouts) and uncertain about whether the incoming Obama administration would emphasize fiscal responsibility (e.g., scaling back entitlements) or expanded redistribution (e.g., Obamacare and higher tax rates).

The two possibilities are not mutually exclusive. But it matters a great deal which is quantitatively more important.  With luck, Bloom’s future work will address this issue.