Voice For Liberty

Category: Economics

  • Supply-side economics, instead of taxes, is cure for recession

    From April, 2010.

    Sound money and income tax cuts — the elements of supply-side economics — have produced economic growth in America, according to Dr. Brian Domitrovic of Sam Houston State University. When our country imposes inflationary loose money policies and high income taxes, economic growth suffers, as in the period from 1973 to 1982. Unfortunately, these are the policies of President Barack Obama and his administration.

    Domitrovic lectured on principles in his book Econoclasts: The Rebels Who Sparked the Supply-Side Revolution and Restored American Prosperity last night at Friends University. His lecture was part of the Law, Liberty & the Market lecture series, which is underwritten by the Fred C. and Mary R. Koch Foundation in Wichita.

    “Unemployment at nine percent, five grueling quarters of decline in GDP growth, the stock market snapped back from its horrid 50 percent decline, but still needing a good 25 percent to get back to its old high: this has been some economic contraction.” While this may sound like a description of the current recession, it’s not. Instead, Domitrovic was describing the recession of 1974 and 1975. The stagflation period from 1973 to 1982, characterized by both high unemployment and high inflation, was a dark period in American history.

    There was also a mortgage and foreclosure crisis during that decade, but it affected the most prudent homeowners the worst. Property taxes in California went up five-fold in a period of ten years. Selling your house resulted in the loss of half your equity because of the capital gains taxes that were in effect then.

    While unemployment is high today, inflation is low, with prices even declining slightly last year. Being unemployed while prices are rising at nine percent per year — or 33 percent during one two-year period — is much worse than being unemployed today.

    In 1980 the bank prime interest rate reached 22%. (It’s 3.25% today.) It was impossible to save money in the 1970s, as the real tax rates on saving exceeded one hundred percent.

    Our economic crisis today is the “junior partner” to the stagflation decade. Our current political leaders should not be comparing the current situation to the Great Depression of the 1930s. Instead, the stagflation period has better lessons to teach us. It took 20 years for American living standards to recover to the level attained before the Great Depression started, Domitrovic told the audience, so we should not implement the same policies in response to the current recession.

    Instead, we have a fairly recent crisis — the stagflation period — which was solved “so firmly, so efficiently, so permanently” that the quarter-century following this period is known as the “Great Moderation.” There was economic growth year after year, inflation nearly vanished, unemployment was low, interest rates settled, businesses started, and stocks and bonds boomed.

    It was supply-side economics that ended the stagflation and lead to the long period of prosperity, the Great Moderation. Failing to embrace supply-side economics as a response to the economic problems that arose in 2008 was one of our greatest mistakes.

    As the current crisis enters its third year, we should not be surprised that recovery is slow to arrive. “Tepid and incomplete recovery was, in fact, the record of the New Deal, which our policymakers have looked to for inspiration,” Domitrovic explained.

    Supply-side economics consists of stable money and marginal tax cuts. These are the policies that defeated stagflation and lead to the Great Moderation.

    Domitrovic explained that in 1913, two great institutions of macroeconomic management were created, the Federal Reserve system and the income tax. Prior to this time, the United States had no ability to conduct macroeconomic policy, either fiscal or monetary policy.

    Since 1913, the economic history of the U.S. has been that of “serial disaster.” From 1913 to 1919, prices increased by 100 percent. Prior to that, there had never a peacetime inflation in the U.S. The top rate of the income tax, which started at a rate of seven percent, had increased to 77 percent by 1917. From 1919 to 1921, the U.S. experienced its worse recession up to that time. Unemployment rose to 18 percent. Prior to this time, unemployment was not a problem.

    The fix was President Warren Harding’s Treasury Secretary Andrew Mellon telling the Federal Reserve to keep the dollar stable instead of trying to manipulate the price level, and the income tax rate was cut by two-thirds. As a result, from 1921 to 1929 inflation was low, less than one percent, and that nation experienced the boom known as the Roaring Twenties. Economic progress boomed.

    But in 1929, the Federal Reserve started to deflate the currency in an attempt to get prices back to the 1913 level. In 1932 the top income tax rate was raised to 63 percent from 25 percent. “There you have the Great Depression,” Domitrovic said. It was a crisis of macroeconomic management, not a failure of capitalism, as is commonly believed.

    Franklin Roosevelt instructed the Federal Reserve to keep the price level steady, which was one good policy he implemented. But he increased income tax rates.

    In 1947 income tax rates were cut and the Federal Reserve pursued stable prices after the inflation of World War II.

    A pattern emerged: stable prices coupled with income tax cuts lead to recovery. When these policies are not applied, recovery was weak and collapsed. These patterns repeated through the rest of the century.

    During the Eisenhower Administration, the top tax rate was 91 percent. Eisenhower refused to cut taxes, and there were three recessions during his presidency.

    John F. Kennedy wanted to solve the crisis. His advisors told him to loosen money and raise taxes, even though the top marginal rate was 91 percent. The idea, according to recently-deceased economist and Kennedy adviser Paul Samuelson, was that by increasing the money supply people would spend money, which would cause production to increase and workers to be hired. But increasing the money supply produces inflationary pressures. The solution was very high income tax rates, which sops up the extra money that causes inflation.

    But Robert Mundell, only 29 years old at the time, wrote a memo that advised the opposite, advocating stable money and low taxes. Kennedy adopted this policy, and a great boom resulted for seven years.

    But Lyndon Johnson asked his Federal Reserve Chairman to increase the money supply, and passed an income tax surcharge to attempt to control the danger of inflation — the “neoclassical synthesis.” Inflation rose. Nixon increased the capital gains tax and established the alternative minimum tax. The result was the double-dip recession of 1969 to 1970, which cost more in economic output than the cost of the entire Viet Nam war.

    Still, the Federal Reserve kept increasing the money supply, and the income tax rate was increased. Nixon insisted that printing money would save the economy, and in order to control inflation, Nixon imposed price controls. The result was an investment strike. If businesses could not charge the prices they needed, they would enter other fields of businesses, such as commodities. The prices of commodities rose rapidly, and there was the terrible double-dip recession of 1974 to 1975.

    Mundell, along with Robert Bartley of the Wall Street Journal and others, started to encourage government to tighten the money supply and lower taxes. At the same time United States Representative Jack Kemp introduced a bill calling for a large tax cut and stable money. Kemp’s bill passed both houses of Congress with a veto-proof majority. But Jimmy Carter had it killed in committee.

    If not for Carter’s action, the Kemp-Roth tax cuts would have become law in November 1978. These tax cuts, had they been passed and been coupled with Carter’s appointment of Paul Volcker — an advocate of stable money — as chairman of the Federal Reserve in August 1979, would have found the policy elements of “Reaganomics” in place at that time. Domitrovic said the economy would have recovered rapidly, and it is likely that Ronald Reagan would not have run for president in 1980.

    Instead, the period from 1979 to 1981 was a brutal period of economic history, with high unemployment, high inflation, and tanking markets.

    Upon entering office, Reagan was able to implement sound money policy and tax cuts — by then called supply-side economics — and the economy started the boom that lasted for 25 years. During this time there was only one recession, in 1990 and 1991. This is in contrast to the three recessions during Eisenhower’s eight years in office.

    Supply-side economics is one of the greatest success stories in economics and government, Domitrovic said. Despite evidence of its success, despite the fact that every objection to it has collapsed, policymakers did not follow its policies in 2008. Objections to supply-side economics that have proven to be unfounded include:

    It is inflationary. This is the basis for George H.W. Bush’s characterization of supply-side economics as “voodoo” economics. But inflation since 1982 has been very low.

    It would cause crowding-out. This refers to the fact that tax cuts can cause budget deficits, and the government would have to borrow so much money that none would be available for private business investment. But the 1980s, 1990s, and 2000s were a period of historic expansion, with the Dow Jones stock market average increasing by a factor of 15 during this time.

    Government debt is a burden to future generations. But the nation experienced great prosperity and economic expansion during the Great Moderation, and interest payments on the debt were not a major burden.

    Tax cuts would place the U.S. in a “fiscal hole,” with budget deficits forever. But by the 1990s we were running budget surpluses. Domitrovic said that when Clinton balanced the budget in 2000, the total level of government expenditure was 18.4 percent of gross domestic product. In Reagan’s last year in office (1989) revenues were 18.4 percent of GDP. “In other words, Reagan’s tax policy plus Clinton’s spending policy was exactly sufficient for a perfectly balanced budget.”

    Supply-side economics causes inequality. But Domitrovic said that tax cuts mean that wealthy people don’t have to hide their income from taxes, making their income more productive publicly. Inequality has decreased.

    Summarizing, Domitrovic told the audience that the lessons of the Great Moderation are that when the institutions of 1913 — Federal Reserve and the income tax — are tamed, the American economy does wonderful things. Stable money and low taxes, combined with the entrepreneurial knack of Americans, produces remarkable economic growth and job opportunities. But when the macroeconomic institutions of 1913 run a muck the economy will suffer. The current policies of the Obama Administration — loose money and rising taxes — are not going to produce prosperity.

  • U.S. receipts and expenditures

    A recent op-ed by Sen. Bernie Sanders of Vermont in the Wall Street Journal (Why Americans Are So Angry: Republicans want the entire burden of deficit reduction to be carried by the elderly, the sick, children and working families), besides holding faulty reasoning in every paragraph, hold a few factual errors that deserve discussion.

    Raise tax rates to raise revenue

    For example, Sanders writes regarding the rich: “Their effective tax rate, in recent years, has been reduced to the lowest in modern history.” He’s arguing for tax increases on the rich as a way of balancing the budget. (Really, he just wants more money to spend. He’s not serious about closing the deficit.)

    There are many like Sanders and President Barack Obama who call for raising taxes, especially on the rich, as a way to generate more revenue and balance the budget. But try as we might, raising tax rates won’t generate higher revenues (as a percentage of gross domestic product), due to Hauser’s law. W. Kurt Hauser explained in The Wall Street Journal: “Even amoebas learn by trial and error, but some economists and politicians do not. The Obama administration’s budget projections claim that raising taxes on the top 2% of taxpayers, those individuals earning more than $200,000 and couples earning $250,000 or more, will increase revenues to the U.S. Treasury. The empirical evidence suggests otherwise. None of the personal income tax or capital gains tax increases enacted in the post-World War II period has raised the projected tax revenues. Over the past six decades, tax revenues as a percentage of GDP have averaged just under 19% regardless of the top marginal personal income tax rate. The top marginal rate has been as high as 92% (1952-53) and as low as 28% (1988-90). This observation was first reported in an op-ed I wrote for this newspaper in March 1993. A wit later dubbed this ‘Hauser’s Law.’”

    So tax rates may be low, or they may be high, but tax revenue, as a percent of GDP, remains nearly constant.

    Hauser's LawHauser’s Law illustrated. No matter what the top marginal tax rate, taxes collected remain an almost constant percentage of GDP.

    Tax revenue is down

    Sanders also wrote “The sum of all the revenue collected by the Treasury today totals just 14.8% of our gross domestic product, the lowest in about 50 years.” Sanders is incorrect here. In 2010 receipts to the federal government as a percent of GDP was 16.73 percent, according to the Bureau of Economic Analysis. For the first quarter of 2011, the figure is 16.97 percent. These numbers are much higher than what Sanders claims. He didn’t mention where he got his figures.

    From 1960 to 2010 — the 50 year period Sanders mentions — the average revenue collected was 18.32 percent of GDP. The current figure is lower than that, so Sanders is correct that current revenue collections are lower than recent history, and that may be what has Sanders worried.

    A look back at the history of federal receipts and expenditures is useful. A chart is below.

    While President Ronald Reagan was able to cut tax rates, he couldn’t control spending as easily, and that led to large deficits. As a percent of the economy, spending rose during his term, although by the time he left office it was at the same level of GDP as when he took office. The message of Reagan’s presidency is that it’s easier to cut taxes than to cut spending. But we must always be in favor of cutting taxes, and hope that politicians have the fortitude to cut spending to match.

    It’s doctrinaire among liberals today to cite President Bill Clinton and his tax increase as the cause of the prosperity of the late 1990s and the accompanying budget surpluses for several years. But his tax increase was not the only thing going on in those years that contributed to a budget surplus. The peace dividend, as defense spending fell during his term, helped. Clinton had nothing to do with the end of Cold War; he was just lucky to be in place to benefit from its end.

    If cutting spending relative to the size of the economy was Clinton’s goal — and I don’t think it really was — he was lucky to have a Republican Congress starting in 1995 to help him accomplish this goal. With a Democratically-controlled Congress, it’s unlikely that spending would have been restrained, and with that, no budget surplus. While many bemoan gridlock in Washington because nothing gets done, the gridlock of the Clinton years led to less spending — and that’s good.

    We should also remember that in 1997 the capital gains tax rate fell from 28 percent to 20 percent. Capital gains taxes collected soared. That was a Republican initiative, and it contributed to increased tax revenue during the Clinton surplus years.

    The Clinton years were good for controlling spending, starting in 1993 with spending at 22.56 percent of GDP, and exiting in 2000 with spending at 18.81 percent. As to the prosperity of the Clinton years, many seem to forget that much of it was based on a bubble that couldn’t be sustained — the dot-com bubble. While not as large as the housing bubble, it was prosperity that very suddenly evaporated.

    Then President George W. Bush took office. In 2001 spending as a percent of GDP was 19.25 percent, and it rose slowly during his term, reaching 21.80 percent in 2008. Then it exploded to 24.75 percent in 2009 and slightly less in 2010. For the second quarter of 2011, the trend is upwards, as spending reached 25.50 percent of GDP.

    From the end of World War II to the start of Reagan’s presidency, spending steadily rose, relative to the size of the economy. From Reagan to Clinton we did a good job reversing this trend. But starting with the second Bush, and rapidly accelerating with Obama, spending is rising off the chart. It will be difficult to reverse this trend, but we must. Even though tax revenue has declined, we must remember what Milton Friedman taught us: the true measure of the size of government is spending, as spending not paid for today is taxation put off to the future.

    Federal receipts and expenditures as percentage of gross domestic productFederal receipts and expenditures as percentage of gross domestic product.

  • Job creation at young firms declines

    A new report by the Kauffman Foundation holds unsettling information for the future of job growth in the United States. Kauffman has been at the forefront of research regarding entrepreneurship and job formation.

    Previous Kauffman research has emphasized the importance of young firms in productivity growth. Research by Art Hall found that for the period 2000 to 2005, young firms created nearly all the net job growth in Kansas.

    So young firms — these are new firms, and while usually small, the category is not the same as small businesses in general — are important drivers of productivity and job growth. That’s why the recent conclusion from Kauffman in its report Starting Smaller; Staying Smaller: America’s Slow Leak in Job Creation is troubling: “The United States appears to be suffering from a long-term leak in job creation that pre-dates the recession and has the potential to persist for an unknown time. The heart of the problem is a pullback by newly created businesses, the economy’s most critical source of job creation, which are generating substantially fewer jobs than one would expect based on past experience. … This trend has only worsened since the onset of the most recent recession. The cohort of firms started in 2009, for example, is on track to contribute close to a million jobs less in its first five to ten years than historical averages.”

    The report mentions two assumptions that are commonly made regarding employment that the authors believe are incorrect:

    First, policymakers’ focus on big changes in employment because of events such as a new manufacturing plant or the recruitment of a business to a community ignore the more important fact that our jobs outlook will be driven more by the collective decisions of the millions of young and small businesses whose changing employment patterns are not as easy to see or influence. Second, it is just as easy to be deluded into thinking that the jobs problem will be solved by growth in the number of the self-employed.

    The importance of young firms is vital to formulating Kansas economic development policy. Kansas Governor Sam Brownback has incorporated some of the ideas of economic dynamism in his economic plan released in February. The idea of dynamism, as developed by Dr. Art Hall, is that economic development is best pursued by creating a level playing field where as much business experimentation as possible can take place. The marketplace will sort out the best firms. The idea that government economic development agencies can select which firms should receive special treatment is sure to fail. It is failing.

    While the governor’s plan promotes the idea of economic dynamism, some of his actual policies, such as retaining a multi-million dollar slush fund for economic development, are contrary to the free marketplace of business experimentation and letting markets pick winning firms.

    At the City of Wichita, economic development policy is tracking on an even worse direction. Among city hall bureaucrats and city council members, there is not a single person who appears to understand the importance of free markets and capitalism except for one: council member Michael O’Donnell, who represents district 4 (south and southwest Wichita).

    The policy of Wichita is that of explicit crony capitalism, with city leaders believing they have the wisdom to develop policies that recognize which firms are worthy of taxpayer support. And if they want to grant subsidies to firms that don’t meet policies, they find exceptions or write new policies. Elected officials like Wichita Mayor Carl Brewer and city council member Jeff Longwell lust for more tools in the economic development toolbox.

    At the Sedgwick County Commission, two of the five members — Karl Peterjohn and Richard Ranzau understand the importance of free markets for economic development. But the city has a much larger role in targeted incentives for economic development, as it is the source of tax increment financing districts, industrial revenue bonds, economic development exemptions, community improvement districts, and other harmful forms on economic interventionism.

  • Federal grants seen to raise future local spending

    “Nothing is so permanent as a temporary government program.” — Nobel Laureate Milton Friedman

    Is this true? Do federal grants cause state and/or local tax increases in the future after the government grant ends? Economists Russell S. Sobel and George R. Crowley have examined the evidence, and they find the answer is yes.

    Their research paper is titled Do Intergovernmental Grants Create Ratchets in State and Local Taxes? Testing the Friedman-Sanford Hypothesis.

    The difference between this research and most is that Sobel and Crowley look at the impact of federal grants on state and local tax policy in future periods.

    This is important because, in their words, “Federal grants often result in states creating new programs and hiring new employees, and when the federal funding for that specific purpose is discontinued, these new state programs must either be discontinued or financed through increases in state own source taxes.”

    The authors caution: “Far from always being an unintended consequence, some federal grants are made with the intention that states will pick up funding the program in the future.”

    The conclusion to their research paper states:

    Our results clearly demonstrate that grant funding to state and local governments results in higher own source revenue and taxes in the future to support the programs initiated with the federal grant monies. Our results are consistent with Friedman’s quote regarding the permanence of temporary government programs started through grant funding, as well as South Carolina Governor Mark Sanford’s reasoning for trying to deny some federal stimulus monies for his state due to the future tax implications. Most importantly, our results suggest that the recent large increase in federal grants to state and local governments that has occurred as part of the American Recovery and Reinvestment Act (ARRA) will have significant future tax implications at the state and local level as these governments raise revenue to continue these newly funded programs into the future. Federal grants to state and local governments have risen from $461 billion in 2008 to $654 billion in 2010. Based on our estimates, future state taxes will rise by between 33 and 42 cents for every dollar in federal grants states received today, while local revenues will rise by between 23 and 46 cents for every dollar in federal (or state) grants received today. Using our estimates, this increase of $200 billion in federal grants will eventually result in roughly $80 billion in future state and local tax and own source revenue increases. This suggests the true cost of fiscal stimulus is underestimated when the costs of future state and local tax increases are overlooked.

    So: Not only are we taxed to pay for the cost of funding federal and state grants, the units of government that receive grants are very likely to raise their own levels of taxation in response to the receipt of the grants. This is a cycle of ever-expanding government that needs to end, and right now.

    An introduction to the paper is Do Intergovernmental Grants Create Ratchets in State and Local Taxes?.

  • Public opinion on debt ceiling and government spending

    While the economic future of the United States seems grim, the encouraging news is that large swaths of Americans are starting to understand the reality of the situation and what must be done to place our economic house in order. This is my conclusion after viewing a new video by Bankrupting America.

    The two-minute video gathers public opinion from a number of recent sources such as Gallup and CNN. And while the news is gloomy, the bright spot is that according to these public opinion polls, I believe Americans are starting to understand.

    For example, 78 percent of Americans think the country is on the wrong track. That’s bad news. The good news is that 73 percent believe spending is to blame for the federal deficit, while only 22 percent believe insufficient tax revenue is to blame.

    In another measure of public opinion, only 13 percent believe the debt ceiling should be raised without conditions.

    This is progress. It’s the good news we can pluck from all the bad news, because we need people to understand the gravity of the situation before we can expect them to take appropriate action.

    The video is available by clicking on Public Pulse: What Do Americans Really Think about the Debt Ceiling and Government Spending?

    Separately, Bankrupting America has completed all three volumes of its Budget Briefing Book. Theses books — pamphlets, really — are short and provide much information about the federal budget and government finances.

  • Corporate jet incentive, or tax dodge, or kids’ safety?

    Yesterday President Barack Obama denounced the tax breaks given to owners of corporate jets. Described by MSNBC Television program host Rachel Maddow as a “corporate tax loophole” that allows “giant corporations to dodge their taxes,” Obama cast the issue as corporate fats cat vs. kids: “You go talk to your constituents — the Republican constituents — and ask them, are they willing to compromise their kids’ safety so that some corporate jet owner continues to get a tax break?

    (Yes, I sometimes watch the leftist television news programs — so that you don’t have to.)

    Maddow, if you’ve ever watched her show, is given to snarky exaggeration as her style. The use of the term “dodge” is an example. Most people would think that “to dodge” means to avoid completely, and that’s what Maddow would like her viewers to believe: that these giant corporations are paying no taxes at all when they buy these planes.

    The reality, however, is different and much less sensational. Since the tax in question is an income tax, we must first calculate income. That means accounting for the expenses incurred in running the business. For assets with a long lifespan, depreciation is used, whereby a portion of an asset’s cost is deducted each year from income. With the U.S. corporate income marginal tax rate at 35 percent, being able to deduct one dollar in depreciation saves 35 cents in taxes.

    The issue in question, as identified by Lachlan Markay is an economic incentive implemented in the form of accelerated depreciation for purchasers of corporate jets. This provision allows companies to deduct depreciation costs from their income sooner, so they save on taxes now rather than later.

    Accelerated depreciation doesn’t increase the total amount of depreciation that can be deducted from income. Of course, taking a deduction this year rather than in a later year is valuable.

    So it’s not a “dodge,” as Maddow told her viewers. But it is a benefit to the companies that take advantage of it.

    The real question is whether these manipulations of the tax code are harmful or beneficial. Certainly Congress did not believe they were harmful when it passed the legislation that created this special accelerated depreciation, available for only a short time for purchasers of specific assets. It was designed to provide a stimulus to a specific industry. And if that term “stimulus” seems familiar, the legislation that created this accelerated depreciation incentive was part of H.R. 1: American Recovery and Reinvestment Act of 2009, also known as ARRA, also known as the stimulus bill, and one of the first legislative initiatives by President Obama.

    Now the president, evidently, feels this wasn’t such a good idea. Or he has decided that purportedly rich corporations are a convenient and politically expedient opponent. Attacking them fires up his base, as evidenced by Maddow’s over-playing of this matter.

    This is also an example of using the tax code in order to achieve an economic or social policy goal. In this case, one industry benefits, but others don’t. The remaining taxpayers have to make up the difference in lost tax revenue. Or, the country simply goes deeper in debt, and the cost is passed on to future generations.

    A further effect is that by making corporate jets cheaper (because of the accelerated depreciation), companies are induced to spend in this area when — absent the incentive — they might make alternative investments. So the question is: Are discounted corporate jets a wise investment for companies who otherwise might not buy them, at least not this year? Are Congress and the president smart enough to know that investment should be directed to this area? Todd Tiahrt, who represented Wichita at the time, thought so. That city, of course, is home to several companies that manufacture the types of airplanes targeted by Congress.

    But what benefits one city or one industry is not necessarily good for the rest of the country. A better course is to simply cut tax rates and let each company decide how to direct its capital investment.

  • Speculators, by profiting, provide a service

    Speculators are selfish people, acting only to make as much profit as possible for themselves without concern for the welfare of others. By doing so, they provide a valuable public service.

    That’s not what we hear when oil and gasoline prices — to take a recent example — go up. News commentators from across the political spectrum condemn speculators, blaming them for rising gasoline prices.

    The mechanism of the speculator is to buy something like oil when prices are low, then to sell it when prices are high. By doing so he earns a profit. (An alternative is to sell things he does not yet own when prices are high, and then buy to fulfill his obligation when prices are low.)

    The speculator, in this definition, does not hope to profit by processing and distributing the commodity he is buying and selling, as does an oil company or flour miller. He simply hopes to make a profit based on the changing prices — up or down — of oil or wheat.

    It is said that speculators are buying oil now and therefore driving up the price. That’s probably true, and it illustrates one of the beneficial services that speculators provide: they reduce volatility in prices. If speculators are correct and the price of oil spikes sometime soon, the present buying by speculators makes the spike less steep. It also induces consumers to conserve.

    Writing about speculation in food markets, Walter Block explains the beneficial effects:

    First, the speculator lessens the effects of famine by storing food in times of plenty, through a motive of personal profit. He buys and stores food against the day when it might be scarce, enabling him to sell at a higher price. The consequences of his activity are far-reaching. They act as a signal to other people in the society, who are encouraged by the speculator’s activity to do likewise. Consumers are encouraged to eat less and save more, importers to import more, farmers to improve their crop yields, builders to erect more storage facilities, and merchants to store more food. Thus, fulfilling the doctrine of the “invisible hand,” the speculator, by his profit-seeking activity, causes more food to be stored during years of plenty than otherwise would have been the case, thereby lessening the effects of the lean years to come.

    If the spike in prices does occur, what will speculators do? They will sell their oil, and that action will drive down prices, making the spike less steep. Here the speculator makes a profit by providing the service of making the oil shortage less severe. His hoarding of oil, bought when prices were low, makes it available in times of need, and less expensive, too. The speculator is rarely given credit for that in public, although this is how the speculator earns a profit.

    It is possible for speculators to do harm, however. If the speculator buys, he drives up prices. Then suppose the price of oil falls, and the speculator is forced to sell. His actions have increased the volatility of oil prices and have sent false price signals to the market. Citing again Block’s food example: “What if he is wrong? What if he predicts years of plenty — and by selling, encourages others to do likewise — and lean years follow? In this case, wouldn’t he be responsible for increasing the severity of the famine? Yes. If the speculator is wrong, he would be responsible for a great deal of harm.”

    In these cases, the speculator has suffered financial losses. These loses are a powerful market force that drives “bad” speculators — meaning those who guess wrong about future prices — out of the market.

    The real danger is when government attempts to speculate. That’s a possibility at the current moment, as many are recommending that the U.S. government sell oil from the strategic petroleum reserve in an effort to lower the cost of oil. That’s speculation — the oil was bought at a time when the price was lower, and is now contemplated being sold at a higher price.

    The problem with government speculation is that government does not face the market discipline that private-sector speculators face. When they are wrong, they lose their capital. They go out of business. Government faces no such discipline. When government is wrong, it goes on.

    Government attempts at regulating speculators are certain to fail, too. Almost any such regulation will seek to reduce the profit potential of speculation. But that is what drives the speculators and makes the system work. Without the potential for profits, speculators will not take the risk of losses, and they will not perform their beneficial function.

  • Economic freedom leads to better lives for all, says video

    Economic freedom, in countries where it is allowed to thrive, leads to better lives for people as measured in a variety of ways. This is true for everyone, especially for poor people.

    This is the message presented in a short video based on the work of the Economic Freedom of the World report, which is a project of Canada’s Fraser Institute. Last year Robert Lawson, one of the authors of the Economic Freedom of the World report, lectured in Wichita on this topic. The current video is made possible by the Charles G. Koch Charitable Foundation.

    One of the findings highlighted in the presentation is that while the average income in free countries is much higher than that in the least-free countries, the ratio is even higher for the poorest people in these countries. This is consistent with the findings that economic freedom is good for everyone, and even more so for those with low incomes.

    Civil rights, a clean environment, long life expectancy, low levels of corruption, less infant mortality, less child labor, and lower unemployment are all associated with greater levels of economic freedom.

    What are the components or properties of economic freedom? The presentation lists these:

    • Property rights are protected under an impartial rule of law.
    • People are free to trade with others, both within and outside the country.
    • There is a sound national currency, so that peoples’ money keeps its value.
    • Government stays small, relative to the size of the economy.

    Over the last ten years, the United States’ ranking has fallen relative to other countries, and the presentation says our position is expected to keep falling. The question is asked: “Will our quality of life fall with it?”

    Economic freedom is not necessarily the platform of any single political party. It should be noted that for about seven of the past ten years — a period in which our economic freedom has been falling — there was a Republican president, sometimes with a Republican Congress. The size of government rose. In 2005 the Cato Institute studied the numbers and found that “All presidents presided over net increases in spending overall, though some were bigger spenders than others. As it turns out, George W. Bush is one of the biggest spenders of them all. In fact, he is an even bigger spender than Lyndon B. Johnson in terms of discretionary spending.” This was before the spending on the prescription drug program had started.

    Critics of economic freedom

    The defining of what economic freedom means is important. Sometimes you’ll see people write things like “Bernie Madoff was only exercising his personal economic freedom while he ran his investment firm.” Madoff, we now know, was a thief. He stole his clients’ money. That’s contrary to property rights, and therefore contrary to economic freedom.

    Or, you’ll see people say if you don’t like government, go to Somalia. That country, one of the poorest in the world — but not the poorest — is used as an example of how bad anarchy is as a form of government. The evidence is, however, that Somalia’s former government was so bad that things improved after the fall of that government. See Peter T. Leeson, Better Off Stateless: Somalia Before and After Government Collapse and History of Somalia (1991–2006).

    You’ll also encounter people who argue that some countries are poor because they have no natural resources. But there are many countries with few natural resources that have economic freedom and a high standard of living. Most countries that are poor are that way because they are run by corrupt governments that have no respect for economic freedom, and follow policies that stifle it.

    Some will argue that economic freedom means the freedom to pollute the environment. But it is in wealthy countries that the environment is respected. Poor countries, where people are struggling just to find food for each day, don’t have the time or wealth to be concerned about the environment.

  • Hazlitt’s ‘Economics in One Lesson’ relevant today

    Note: The Kansas chapter of Americans for Prosperity is holding a series of viewings of videos on this important book. The next meeting is Monday May 9 at from 7:00 pm to 8:30 pm at the Lionel D. Alford Library located at 3447 S. Meridian in Wichita.

    Economics In One Lesson, first published in 1946 and recently reissued by the Ludwig von Mises Institute, explains fallacies (false or mistaken ideas) that are particularly common in the field of economics and public policy.

    At the very start of the book Hazlitt explains:

    Economics is haunted by more fallacies than any other study known to man. This is no accident. The inherent difficulties of the subject would be great enough in any case, but they are multiplied a thousandfold by a factor that is insignificant in, say, physics, mathematics or medicine — the special pleading of selfish interests. While every group has certain economic interests identical with those of all groups, every group has also, as we shall see, interests antagonistic to those of all other groups. While certain public policies would in the long run benefit everybody, other policies would benefit one group only at the expense of all other groups. The group that would benefit by such policies, having such a direct interest in them, will argue for then plausibly and persistently. It will hire the best buyable minds to devote their whole time to presenting its case. And it will finally either convince the general public that its case is sound, or so befuddle it that clear thinking on the subject becomes next to impossible.

    In addition to these endless pleadings of self-interest, there is a second main factor that spawns new economic fallacies every day. This is the persistent tendency of men to see only the immediate effects of a given policy, or its effects only on a special group, and to neglect to inquire what the long-run effects of that policy will be not only on that special group but on all groups. It is the fallacy of overlooking secondary consequences.

    At first it seems as though not much has changed since the end of World War II. What has changed, however, is the scope of the dangers Hazlitt identifies. That’s because government is much expanded and more intrusive today than when this book was written. We should take these lessons as even more important today.

    It is overlooked consequences that cause harm. They are overlooked sometimes because they are difficult to see, as in the broken window fallacy explained by Frederic Bastiat and also in this book. They are also “overlooked” because, as Hazlitt tells us, one group wants special favors from the government, and because there is no way to grant these favors without harming some other group, the favor-seeking group will seek to hide, obfuscate, muddle, or minimize the bad effects. At the same time they will promote the policy as good for everyone. This is roughly the job lobbyists perform, and billions are spent on it each year. That’s because a powerful government has the ability to bestow valuable favors, but those favors are paid for by someone else, someone often not easily seen.

    These two ideas — the special pleading of selfish interests and the overlooking of secondary consequences — are the core ideas of the book. As Walter Block explains in his introduction (This Book is So Me) to the Mises Institute’s new edition of this book:

    … the plan of Economics in One Lesson is clear: drill these insights into the reader in the first few chapters, and then apply them, relentlessly, without fear or favor, to a whole host of specific examples. Every widespread economic fallacy embraced by pundits, politicians, editorialists, clergy, academics is given the back of the hand they so richly deserve by this author: that public works promote economic welfare, that unions and union-inspired minimum-wage laws actually raise wages, that free trade creates unemployment, that rent control helps house the poor, that saving hurts the economy, that profits exploit the poverty stricken; the list goes on and on.

    An example of overlooked secondary consequences is government spending. When government spends, it must tax or borrow. What government spends is not available for individuals to spend. When we see magnificent public works (say a new downtown arena in Wichita), we don’t see all the things that would have been bought had the government not taxed to build the public work. We see the jobs created by the public work — all the construction workers that built the new arena — but we don’t see the jobs destroyed because people had to reduce their spending elsewhere.

    Foreign trade is a case where people often fail to grasp the complete picture. We often see exports as something good for our economy, while imports are seen as bad. Imported things are things that American workers can’t compete with, and so American jobs are lost, it is often said. But as Hazlitt says: “It is exports that pay for imports. The greater exports we have, the greater imports we must have, if we ever expect to get paid. The smaller imports we have, the smaller exports we can have. Without imports we can have no exports, for foreigners will have to funds with which to buy our goods.” So those wanting restrictions on imports are also calling for fewer exports — although they do not say this, either because they do not recognize it or it doesn’t matter to them.

    In recent years we have been told that our is a “consumer-driven” economy, fueled by people tapping their home equity that accumulated from increased home values, or spending by going into debt. It is as though if consumers started saving rather then spending on immediate consumption, the American economy would collapse. But Mr. Hazlitt tells us that “saving is only another form of spending.” After all, what is done with money that is saved? Today, few put their savings under the mattress. Instead, it is loaned to a bank or invested. Then it is spent on capital goods, which businesses use to increase their productive capability. The key fact is that businesses spend it. And, they spend it on capital goods that either expand their capacity to produce, or decease their present costs of production. Either way, that is good for everyone. It means more jobs, and better jobs. But this saving is derided as not being “productive.”

    As a conclusion Hazlitt tells us:

    And this is our lesson in its most generalized form. For many things that seem to be true when we concentrate on a single economic group are seen to be illusions when the interests of everyone, as consumer no less than producer, are considered.

    To see the problem as a whole, and not in fragments: that is the goal of economic science.

    This is a very valuable book which cuts through the fog and haze of economics and public policy and lets us understand the true effects of our government’s policies.

    An excerpt of this book can be read at One Lesson.