Voice For Liberty

Tag: Economics

  • Problem of low wages not easily solved

    It seems like an easy fix for social injustice: pass a law requiring employers to pay workers more than they would otherwise. Magically, everyone has more wealth.

    It would be nice if it were so easy and simple. Looking at only the immediate effects and listening to the rhetoric of some politicians and editorial writers, it would seem that a higher minimum wage is good. But considering all effects of a higher minimum wage reveals a different situation.

    As Milton Friedman writes in Capitalism and Freedom:

    Minimum wage laws are about as clear a case as one can find of a measure the effects of which are precisely the opposite of those intended by the men of good will who support it. Many proponents of minimum wage laws quite properly deplore extremely low rates; they regard them as a sign of poverty; and they hope, by outlawing wage rates below some specified level, to reduce poverty. In fact, insofar as minimum wage laws have any effect at all, their effect is clearly to increase poverty. The state can legislate a minimum wage rate. It can hardly require employers to hire at that minimum all who were formerly employed at wages below the minimum. … The effect of the minimum wage is therefore to make unemployment higher than it otherwise would be.

    There are those who say that increasing the minimum wage won’t have any impact on the demand for labor, and therefore people won’t lose jobs. But that is false. If it weren’t false, why not raise the minimum wage to, say, $25? Most people would say that at that level, employers wouldn’t hire low-skill workers because they aren’t “worth” that much. But some workers aren’t “worth” even the present minimum wage, or they could find jobs at this wage.

    (When we say workers aren’t “worth” a certain wage, we are really saying that the marketplace — that’s you and me — places a certain value on the output the worker is able to produce. It has nothing to do with their worth as a person. It has everything to do with their ability to produce goods and services that people are willing to pay for.)

    Furthermore, if we are willing to agree that raising the price of employing certain workers won’t decrease the demand for their labor, we also have to be willing to ignore the law of supply and demand, which states that as the price if something increases, less will be demanded. I am confident that this law applies.

    The problem is that an increase in the minimum wage does nothing to increase the productivity of workers, and increasing productivity is the only way that workers can make real progress.

    How do we increase worker productivity? One way is through education. Sadly, as documented in many articles on this website, our public education system is failing children badly.

    Capital — another way to increase wages — may be a dirty word to some. But as the economist Walter E. Williams says, ask yourself this question: who earns the higher wage: a man digging a ditch with a shovel, or a man digging a ditch using a power backhoe? The difference between the two is that the man with the backhoe is more productive. That productivity is provided by capital — the savings that someone accumulated (instead of spending on immediate consumption) and invested in a piece of equipment that helped workers to increase their output. Those who call for higher taxes — often the same people calling for a higher minimum wage — make it more difficult to accumulate capital.

    These are the things we must do to increase productivity, and with it, real wealth. If the solution was really as simple as some claim, that in order to increase the wellbeing of low-wage workers we could merely pass a law, shouldn’t we be outraged that this law wasn’t passed a long time ago?

    Then, if a law is passed to raise the minimum wage to x, shouldn’t we insist that it have been increased to x + $1, or x + $2, or x + …?

    No, the solution to low wages is much more difficult than that.

  • Remarks to Wichita City Council Regarding the AirTran Subsidy on July 11, 2006

    Mr. Mayor, Members of the City Council:

    You may recall that I have spoken to this body in years past expressing my opposition to the AirTran subsidy. At that time we were told that the subsidy was intended to be a short-tem measure. Today, four years after the start of the subsidy, with state funding planned for the next five years, it looks as though it is a permanent fixture.

    Supporters of the subsidy have made a variety of claims in its support: that the subsidy and the accompanying Fair Fares program are responsible for $4.8 billion in economic impact, that being a pioneer in subsidizing airlines is equivalent to the role that Kansas played in the years immediately prior to the Civil War, and that we would have a mass exodus of companies leaving Wichita if the subsidy were to end.

    I believe there is no doubt that fares are lower than what they would be if not for the subsidy. That points to the subsidy’s true achievement: government-imposed price controls. Its effect is to force many airlines to price their Wichita fares lower than they would otherwise. If it didn’t do that, there would be no reason to continue the subsidy.

    Economists tell us — and human behavior confirms — that when the price of any good is held lower than it would be in a free market, the result is a reduction in the quantity supplied.

    We see this happening. Earlier this year the Wichita Eagle reported that there are fewer daily flights supplied to and from Wichita, from 56 last year to 42 at the time of the article. It has been explained that the financial woes of Delta and NWA are to blame for this reduction. This is demonstrably false, as NWA recently added a daily flight to Wichita, and both airlines have added (and dropped) flights on many routes while in bankruptcy. Furthermore, even though in bankruptcy, theses airlines still desire to operate as profitably as possible.

    Now we learn that the legacy airlines — those established, older airlines that take pride in their comprehensive nationwide networks of routes — are revising their strategies. A Wall Street Journal article from earlier this year (“Major Airlines Fuel a Recovery By Grounding Unprofitable Flights” published on June 5, 2006) tells us that the legacy airlines are beginning to look at the profitability of each route and flight. They are not as interested as they have been in providing flights just for the sake of having a complete nationwide network.

    When we couple this change in airline strategy with our local price controls, I believe that we in Wichita are in danger of losing more service from the legacy airlines. If AirTran — a new-generation airline with low labor costs — can’t earn a profit on its Wichita route at the fares it charges, how can the legacy airlines be expected to do so? And if they can’t earn a profit on a flight to or from Wichita, and if they are beginning to scrutinize the profitability of each flight, can we expect them to continue providing service in Wichita?

    No government has ever been able to successfully impose price controls without the people suffering harmful consequences. As economist Thomas Sowell wrote in a 2005 column:

    Prices are perhaps the most misunderstood thing in economics. Whenever prices are “too high” — whether these are prices of medicines or of gasoline or all sorts of other things — many people think the answer is for the government to force those prices down.

    It so happens there is a history of price controls and their consequences in countries around the world, going back literally thousands of years. But most people who advocate price controls are as unaware of, and uninterested in, that history as I was in the law of gravity.

    Prices are not just arbitrary numbers plucked out of the air or numbers dependent on whether sellers are “greedy” or not. In the competition of the marketplace, prices are signals that convey underlying realities about relative scarcities and relative costs of production.

    Those underlying realities are not changed in the slightest by price controls. You might as well try to deal with someone’s fever by putting the thermometer in cold water to lower the reading.

    This is my fear, that someday I will open the newspaper and learn that American, United, Delta, Northwest, or Continental has reduced or even ceased service to and from Wichita. That day, when it becomes difficult to travel to or from Wichita at any price, that is the day we will feel the harm the subsidy causes.

    On a personal level, my job as software engineer requires me to make from ten to twenty airline trips each year. Some of the places I travel to — Jackson, Mississippi and Lexington, Kentucky, for example — are not served by AirTran. If I am not able to travel there, no matter what the price, I will either have to find a different job or move from Wichita.

    Mr. Mayor and Council Members, I urge you to reconsider your support of the AirTran subsidy. Even though the legislature and governor have agreed to pay for most of the subsidy, I believe the subsidy is not in our long-term interest. We need to let the price system, operating in a free market, do its job in guiding the allocation of scarce resources for both producers and consumers. The result may be more expensive fares. The alternative, which is the very real possibility of greatly reduced service to and from Wichita, is much more harmful.

    Other Voice For Liberty in Wichita articles on this topic:

    The AirTran Subsidy and its Unseen Effects
    As Expected, Price Controls Harm Wichita Travelers
    AirTran Subsidy Is Harmful
    Wichita City Council Meeting, April 19, 2005
    Wichita Eagle Says “AirTran Subsidies Foster Competition”
    AirTran Subsidy Remarks
    The Downside of Being the Air Cap by Harry R. Clements. This article makes a striking conclusion as to why airfares in Wichita were so high.
    Letter to County Commissioners Regarding AirTran Subsidy
    Open Letter to Wichita City Council Regarding AirTran Subsidy
    Stretching Figures Strains Credibility

  • The AirTran subsidy and its unseen effects

    Writing from Natchez, Mississippi

    In a June 16, 2006 column, Wichita Eagle editorial writer Rhonda Holman again congratulates local and state government for its success in renewing the AirTran subsidy, and for getting the entire state of Kansas to help for it.

    We should take a moment to understand, however, that while the allure of the subsidy is undeniable, it may eventually extract a high price on Wichita. Currently, the legacy airlines provide service to Wichita and other small markets partly because they feel a duty to provide comprehensive, nationwide service. But that may be changing. In an article titled “Major Airlines Fuel a Recovery By Grounding Unprofitable Flights” from the June 5, 2006 Wall Street Journal, we learn that this may change:

    The big carriers, which for decades have doggedly pursued market share at any cost, now are focusing just as aggressively on the profitability of each route and flight.

    The so-called legacy carriers — those like American Airlines and Delta Air Lines, with big pension and other obligations that predate the industry’s deregulation in 1978 — have abandoned many of the tactics that have led to their cyclical weakness. They are increasingly unwilling to fly half-empty aircraft to stay competitive on a given route just for the sake of feeding their nationwide networks.

    As I have written before, if AirTran — one of the newer airlines without the baggage of high costs that plague the legacy airlines — can’t earn a profit on its service to Wichita, it may be that other airlines are not, either. This article tells us that we may be in danger of losing the service of the legacy airlines. And, as I have written earlier, there are a great many destinations you can’t get to on AirTran.

    (The same article also tells us that during much of the time of the subsidy, airfares were falling nationwide anyway: “… the Air Travel Price Index, a quarterly measure of changes in airfares, rose 9.1% in the fourth quarter of last year from a five-year low a year earlier.” So we might have had lower fares even without the subsidy. Of course, we can’t know that, just as subsidy advocates can’t know how much we’ve saved from the subsidy, no matter what they may say.)

    Our local government leaders simply do not have the knowledge needed to successfully run a planned economy, which, in essence, is what they are doing when they apply price controls to the airfare market in Wichita. That’s right. The subsidy is a form of price controls. After all, if the subsidy didn’t serve to reduce the price of airfare, what would be its reason for existence?

    No government has ever been able successfully impose price controls without the people suffering harmful consequences. As economist Thomas Sowell wrote in a 2005 column:

    Prices are perhaps the most misunderstood thing in economics. Whenever prices are “too high” — whether these are prices of medicines or of gasoline or all sorts of other things — many people think the answer is for the government to force those prices down.

    It so happens there is a history of price controls and their consequences in countries around the world, going back literally thousands of years. But most people who advocate price controls are as unaware of, and uninterested in, that history as I was in the law of gravity.

    Prices are not just arbitrary numbers plucked out of the air or numbers dependent on whether sellers are “greedy” or not. In the competition of the marketplace, prices are signals that convey underlying realities about relative scarcities and relative costs of production.

    Those underlying realities are not changed in the slightest by price controls. You might as well try to deal with someone’s fever by putting the thermometer in cold water to lower the reading.

    Municipal transit used to be privately owned in many cities, until local politicians’ control of fares kept those fares too low to buy and maintain buses and trolleys, and replace them as they wore out. The costs of doing these things were not reduced in the slightest by refusing to let the fares cover those costs.

    All that happened was that municipal transit services deteriorated and taxpayers ended up paying through the nose as city governments took over from transit companies that they had driven out of business — and government usually did a worse job.

    The immediate effect of the subsidy is a drop in airfares. The long-term effects, the effects that we can’t really see right now (even though the number of daily flights to and from Wichita has decreased in the last year) are unknown, but are likely to be quite bad for our town. These unseen effects of a policy are important, and, being unseen, are hard to spot, even if you’re looking. Frederic Bastiat, in his pamphlet titled “That Which is Seen, and That Which is Not Seen” http://bastiat.org/en/twisatwins.html said this:

    Between a good and a bad economist this cons
    titutes the whole difference — the one takes account of the visible effect; the other takes account both of the effects which are seen, and also of those which it is necessary to foresee. Now this difference is enormous, for it almost always happens that when the immediate consequence is favourable, the ultimate consequences are fatal, and the converse. Hence it follows that the bad economist pursues a small present good, which will be followed by a great evil to come, while the true economist pursues a great good to come, — at the risk of a small present evil.

    Henry Hazlitt writes of the fallacy of unseen effects, but realizes they are often obfuscated by “the special pleading of selfish interests.”

    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.

    We must hope that the legacy airlines choose to continue their service to and from Wichita, in spite of our government’s action.

  • As expected, price controls harm Wichita travelers

    Writing from Tallahassee, Florida

    As reported in the Wichita Business Journal on May 12, 2005: “The average number of daily departures dropped to 45 in March 2006 from 54 in March 2005.”

    The effect of the AirTran subsidy is to reduce the price of airfare to and from Wichita. That is its stated goal. If the subsidy did not work to reduce prices, we would be wasting our money. The fact is that the subsidy does work to reduce airfares to and from Wichita. It also does what any economist could predict: it reduces the supply of air transport to and from Wichita. I think that’s why economics is called the “dismal science.” There really is no free lunch.

    The same article also reports this:

    Sam Williams, chairman of the Wichita Fair Fares campaign, believes that the airlines will see there is enough passenger growth to justify reinstating the lost destinations.

    “The numbers always showed that we had the ability in our catchment area to, over time, make this airport very successful,” Williams says. “Nothing has dampened my enthusiasm that that’s still going to happen.”

    I have a picture in my mind of a group of planners for, say, American or United or Northwest, planning whether to increase capacity to and from Wichita, or even if to stay in the Wichita market at all. If AirTran — a “new” airline with low labor costs — can’t earn a profit on its Wichita route at the fares it charges, how can the “legacy” airlines be expected to do so? And if they can’t earn a profit, how can we expect them to continue providing service in Wichita?

    The answer is this: we can’t expect the legacy airlines to continue their present levels of service in Wichita as long as we continue to apply price controls.

    For all the gushing over AirTran, try using it to get to some of the destinations I regularly fly to: Lexington, Jackson, Cincinnati, and Tallahassee. But I can get to these cities on most of the legacy airlines — the very airlines that we are punishing. If we lose the service of the legacy airlines, we will be in deep trouble.

    If we want to allow Mr. Williams’s dream of a successful Wichita airport to come true, we need to let market forces set fares. Any other solution will cause — and has already caused — our city harm.

  • The World Is Flat: A Brief History of the Twenty-first Century

    The World Is Flat: A Brief History of the Twenty-first Century
    Thomas L. Friedman
    Farrar, Straus and Giroux, 2005

    This interesting book explains in detail what many people already know: that advances in technology — and in politics to some degree — have made the world a smaller place. Not only have manufacturing jobs been moved overseas, but white-collar jobs such as accountant, computer programmer, radiologist, and many others can be done from anywhere in the world. Even a McDonald’s restaurant is not immune. At a McDonald’s drive-through in Cape Girardeau, Missouri, the person you speak to when ordering is not present in the restaurant you’re visiting. Instead, the person you’re speaking to is in Colorado, a long way from Missouri. But when considering telecommunications India, as a practical matter, is no farther away.

    There are some who don’t like this globalization, and they urge the restriction of trade in the name of protecting American jobs. Mr. Friedman believes, however, as I do, in the free-trade theory of competitive advantage developed by David Ricardo. This holds that the wealth of everyone is increased if each nation specializes in that which it possesses comparative advantage, and trades with other nations for other things.

    The problem is that the wealth is not spread equally. Some people are hurt when their jobs are outsourced overseas. While the wealth of America and India or China as a whole increases, some people lose. We, both as a nation and as individuals, need to be adaptable and realize that the jobs we trained for in school may not be around forever. Speaking from personal experience, my career as a software engineer is one that is often mentioned as susceptible to outsourcing.

    Although the issues dealt with in the book are mostly national and international, there is one in particular that is local. Mr. Friedman lays out the problems with American K-12 education, particularly education in science and math. And while America excels in the teaching of science and engineering at universities and graduate schools, that will start to change as more foreign scientists and engineers stay in their home countries.

    This problem with education is a local issue, as that is where the primary control over schools rests. We can either continue with the steady downhill slide of our schools (as compared with the rest of the world), or we can do something to change their course. If you believe that more spending by the state of Kansas will do the job, I hope for the sake of our nation’s children that you are correct. But we have spent more and more on schools only to see them worsen. It is time for Kansas to allow freedom and competition to work in schools.

    While increased global competition may worry some, it holds much promise to others. Mr. Friedman traces the complex interaction of many companies, located in many countries, that was necessary to build the Dell notebook computer he recently ordered. This complex supply chain comprises what Mr. Friedman calls “The Dell Theory of Conflict Resolution, the essence of which is that the advent and spread of just-in-time global supply chains in the flat world are an even greater restraint on geopolitical adventurism than the more general rising standard of living that McDonald’s symbolized.” (The reference to McDonald’s is from the “Golden Arches Theory of Conflict Prevention” advanced in his book The Lexus and the Olive Tree, which held that no two countries which both had McDonald’s had gone to war with each other.) As countries become more intertwined, as our livelihoods and investments become dependent on worldwide cooperation, the risk of war declines. That, along with the increased wealth that free trade brings, is good news for everyone.

  • Economics In One Lesson, 50th Anniversary Edition

    Economics In One Lesson, 50th Anniversary Edition
    Henry Hazlitt
    Laissez Faire Books, 1996

    This book, first published in 1946, explains common fallacies (a false or mistaken idea) that are particularly common in the field of economics and public policy. At the very start of the book Mr. 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, though, is the scope of the dangers Mr. Hazlitt identifies. That’s because government is much expanded and more assertive today than when this book was written. In 1946 the New Deal was not very old, and the tremendous expansion of government social programs was still in the future. We should take these lessons as even more important today.

    It is the 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 Mr. Hazlitt tells us, one group wants special favors from the government, and although 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 promote the policy as good for everyone. This is largely the job that lobbyists perform, and billions are spent on it each year. That’s because a powerful government has the ability to bestow valuable favors, those favors being paid for by someone else, someone often not easily seen.

    An example of overlooked secondary consequences is government spending. When government spends, it means 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 will be building 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 Mr. 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 — although they do not say this, either because they do not recognize it or it doesn’t matter to them — calling for fewer exports.

    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 Mr. 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 while dated a bit, cuts through the fog and haze of economics and public policy and lets us understand the effects of our government’s policies.

  • The wonderful and frightening uncertainty of competition

    Writing from Miami, Florida

    In a recent column by John Stossel (Competition Works) we find this paragraph:

    Take education. Bureaucrats like to say, you will go to this school, because we said so, and you will be taught according to this program, because we said so and we know best. Those of us with confidence in markets think you could do better deciding for yourself. Neither the bureaucrats nor the freedom lovers can judge what’s in your interest better than you can. One big difference is, we know what we don’t know, while they think they know everything.

    Competition. A dirty word when applied to government and education. It’s really a simple concept. Its straightforward hope is that people should be able to make choices about what they want to do, rather than being told what to do by the government.

    When applied to public education, the importance of competition and consumer (parental) choice is paramount. When children are forced by law to attend a school day after day, year after year, government imposes greatly on personal liberty. When that imposition is not fruitful, that is, when children do not learn and when they are exposed to the appalling conditions we are told are common in public schools, we greatly harm liberty and education.

    What Mr. Stossel says is true: when government and education bureaucrats take responsibility for educating your children, they take on immense responsibility. Given the results of public education in recent years as written about on this website (see Lack of Literacy is Threat to Liberty, Schoolchildren Will Be Basically Proficient, and Class Warfare, for example), it is beyond belief to realize how vehemently politicians, education bureaucrats, and teachers unions insist on retaining control over education.

    It is vitally important that parents be put back in control of the education of their children. Being able to freely choose where their children attend school is the first step. That means eliminating all public schools and government involvement in education. I don’t think that will happen, though, so the next best step is to empower parents through vouchers to select where their children will go to school.

    Vouchers and the competition they foster will be good for all schools. Harvard economist Caroline Hoxby found that in Milwaukee, the public schools improved in response to competition from voucher schools. This was in a school system where about only 15% of the schoolchildren were eligible for vouchers:

    From 1998-1999 onwards, the schools that faced the most competition from the vouchers improved student achievement radically — by about 0.6 of a standard deviation each year. That is an enormous, almost unheard-of, improvement. Keep in mind the schools in question had had a long history of low achievement. Yet they were able to get their act together quickly. The most threatened schools improved the most, not only compared to other schools in Milwaukee but also compared to other schools in the state of Wisconsin that served poor, urban students.

    Milwaukee shows what public school administrators can tell you: Schools can improve if they are under serious competition.

    Competition is magically wonderful and powerful. It motivates people to dream of doing things once thought not possible. Some fear competition because they think it means that we must all work harder, that we must work longer. But that’s not always the case. Competition means that businesses or schools or government agencies must serve the interests of their customers because the customers have choice. It doesn’t always mean working harder. It might mean changing just a little — or sometimes a lot — to offer what the customer really wants.

    What competition means, and we can be sure of this, is that we can’t be sure of the future. Instead of government bureaucrats planning our futures for us and our children, feeding us the same things that didn’t work yesterday, we would face a future of uncertainty. That is frightening, sometimes. But it holds a lot of promise. As Mr. Stossel writes:

    I can’t tell you about all the wonderful schools that would appear if students were able to bring their public funding to any school, public, private, or religious. No one individual can begin to imagine what competition would create.

    He is absolutely correct. We simply do not know what would happen if the entrepreneurial creativity of America is put to work. There are some small examples: private schools, charter schools, and other semi-public experiments. But even charter and magnet schools are under the control and influence of the existing education and political establishment. They aren’t truly free, and therefore don’t benefit from all the benefits of innovation.

    Some fear that unleashing free market forces on education and letting experiments happen will expose some children to schools that don’t work. That’s undoubtedly true. In Milwaukee some of the charter schools have closed for various reasons. The failure of these schools means that market forces — competition, in other words — works. Bad schools lose students and close. That doesn’t happen in the world of government. The children that had the misfortune to attend these poor voucher schools could have done better in other schools. But today children attend failing schools that slog on forever, and they don’t have any opportunity to escape.

    That is what we must work to change: children trapped in schools that doom them to failure.

  • How a good column on the bad lottery fell apart

    Writing from Miami, Florida

    A recent column in The Wichita Eagle by Randy Scholfield starts out fine, but falls apart near the end. (“Is the lottery the best bet for workers?” February 24, 2006, available at http://www.kansas.com/mld/kansas/news/columnists/randy_scholfield/13945602.htm.)

    Mr. Scholfield tells us how the lottery is not a very good bet. He references a survey that tells us how about half of us believe we have a better chance of obtaining a retirement nest egg through winning the lottery rather than by saving and investing.

    He then tells us that the large majority of those playing the lottery are poor and don’t have college degrees.

    What Mr. Scholfield writes is true. I’d like to illustrate in more detail just how true it is.

    Here is how the math works: If you invest $1.00 each week of the year, and you earn 10% on those contributions, at the end of 30 years you will have $9,409. After 40 years you would have $25,316.

    These amounts may not seem like much, but you get that for saving just $1.00 per week. If you saved $10.00 each week (I suspect many people spend that much or more on the lottery each week) you would have about $253,000 after 40 years. That’s a significant sum of money.

    Plus, if you hold these savings in a Roth IRA, this money will be tax-free when you withdraw it. Lottery winnings are taxed.

    Can you earn 10% on your savings? You almost certainly can if you invest these funds in a mutual fund that invests in a broad range of U.S. stocks. That is, invest in an index fund that is based on the S&P 500 index or a broader stock market index. (See Book Review: The Random Walk Guide to Investing.)

    The 10% figure is approximately the return of the U.S. stock market over the last 100 or so years. Some years the market goes up more than that, and some years it goes down a lot. But over a long period of time, we can expect returns of about 10%. (If investing in something that has risk concerns you, consider the risk of gambling on the lottery.)

    The index fund you select must have low costs. An index fund with high costs will return much less. An index fund that has expenses of 1.5% per year, which some do, would return only $16,682 instead of $25,316 for each dollar invested each week. That’s due to the power of compounding over long periods. You must also select a fund with no sales charges, called a “no-load” fund. If you selected a “load” fund, where part of what you save goes to sales commissions rather than shares of the fund, you might have less than $16,000 rather than the $25,316 you could have by selecting a no-load fund.

    (To simply these calculations, I have assumed that you make the contribution for the whole year at the start of the year, rather than a little each week. This doesn’t have much impact on the final figures.)

    Now consider the lottery: The average jackpot of the Super Kansas Cash game over the last year was about $360,000. By investing $22 each week as illustrated above, you would have about that much after 40 years.

    If you instead spent $22 each week on this game (each play costing $.50, probability of jackpot is 1 in 2,517,200) for 40 years, you would have about a 1 in 28 chance of ever winning the jackpot. Contrast this with the near certainty of the long-term returns of the stock market.

    There are other lesser prizes that you would certainly win many of as you made all these bets, and I haven’t considered these prizes. But offsetting these small prizes is the realization that you’d pay income tax on the jackpot from the lottery. The earnings in a Roth IRA, on the other hand, are yours tax-free.

    So far, so good for Mr. Scholfield. But then his column takes a downward spiral. We’ll see just how far down it goes in a future post.

  • The Undercover Economist

    The Undercover Economist
    (Exposing Why the Rich Are Rich, The Poor Are Poor — And Why You Can Never Buy a Decent Used Car)
    Tim Harford
    Oxford University Press: 2006

    This is an enjoyable book that explains the basics of how economics works, which is to say, how the world works. Mr. Harford doesn’t go into any technical detail at all, so there are no charts and graphs to decipher (although a very few are used for illustration), and there are no mathematical formulas.

    Mr. Harford seems to believe more than I do that government may need to step in and correct some types of market failures. All in all, though, I agree with almost everything Mr. Harford writes.

    In one chapter, Mr. Harford correctly assesses the current U.S. health care payment system as a mess. What he proposes as a solution is health savings accounts, where a low cost (about $1,500 per year) insurance policy to cover catastrophic charges is combined with individually owned health care savings accounts. People manage their own health care savings accounts. They get to keep what they don’t spend, so there is an incentive to spend wisely and reduce the need for health care through prevention.

    Mr. Harford, with slight modification, believes in the random walk theory of security prices. I don’t think I would trust an economist who doesn’t.

    In a chapter titled “Why Poor Countries Are Poor” he explains, using his trip to Cameroon, how terrible a plague political corruption is. That alone, he says, is the most important reason why most poor counties stay poor. He didn’t mention lack of formal property systems as described in Hernando De Soto’s book The Mystery of Capital.

    A chapter on globalization explains relative advantage and how it contributes to the increased wealth of nations that participate in free trade. A quote:

    Contrary to popular belief, it is simply not possible for trade to destroy all of our jobs and for us to import everything from abroad and export nothing. If we did, we would have nothing to buy the imports with. For there to be trade at all, somebody in America must be making something to sell to the outside world.

    He explains the Lerner theorem, which says that a tax on imports is exactly equivalent to a tax on exports. Another interesting insight:

    Trade can be thought of as another form of technology. Economist David Friedman observes, for instance, that there are two ways for the United States to produce automobiles: they can build them in Detroit, or they can grow them in Iowa. Growing them in Iowa makes use of a special technology that turns wheat into Toyotas: simply put the wheat onto ships and send them out into the Pacific Ocean. The ships come back a short while later with Toyotas on them. The technology use to turn wheat into Toyotas out in the Pacific is called “Japan,” but it could just as easily be a futuristic biofactory floating off the cost of Hawaii. Either way, auto workers in Detroit are in direct competition with farmers in Iowa. Import restriction on Japanese cars will help the auto workers and hurt the farmers; they are the modern-day equivalent of “frame breaking” [what Luddites did to mills and machines in England].

    (Perhaps Mr. Harford has never been to Iowa, because in my experience, Iowa wheat fields are rare. Corn, however, is abundant.)

    The problem is that the change that trade brings about affects different groups in different ways. Politicians love trade protection measures because they generally help a small, well-defined group immensely, at a lower and perhaps unnoticed cost to the rest of the people.

    This book, combined with a few others such as Thomas Sowell’s works and Common Sense Economics: What Everyone Should Know About Wealth and Prosperity (all reviewed on this site) will work to increase anyone’s understanding of how economics works.