Friday, October 21, 2011

Empty-Headed Protest

The Occupy Wall Street protesters carrying “Down with Capitalism” signs have been asked by reporters what they would put in its place. Silence and a deer-in-the-headlights look is the typical response. They’re not the first critics of capitalism who know far more about what they don’t want than what they do want.

The protesters’ predicament reflects a long tradition of the left, and illustrates a major difference between liberalism and conservatism. Conservatives provide details of what their objectives are; liberals provide virtually none.

Conservatives have a strong preference for a market-based economy. Virtually the entire vast body of microeconomics is about how a market economy works.

A market economy is a system, a system of “spontaneous order” (in the words of Friedrich Hayek). The order, however, is not magical. It has a well-known much analyzed structure and logic. It results from the interaction of elements such as the price system, the profit mechanism, competition, and self-interest. The interplay of these ingredients is how choices are made, how resources get allocated, and how economic growth occurs.

Starting with the publication of Adam Smith’s Wealth of Nations in 1776 there has been a long line of brilliant economists who have built on the intellectual foundation he established—David Ricardo, John Stuart Mill, Alfred Marshall, Friedrich Hayek, and Milton Friedman, among countless others.

The closest socialist equivalent to the Wealth of Nations is Karl Marx’s Das Kapital, published in 1867. Das Kapital, however, in no way addresses how a socialist or communist economy is supposed to work. The purpose of the book, and many since, is to describe the supposed flaws in capitalism and why capitalism is inevitably doomed. Many of the books since Das Kapital have been attempts to explain the interminable delay in capitalism’s collapse, the most famous being Lenin’s Imperialism, the Highest Stage of Capitalism. Like Marx, Lenin, and numerous others, the Wall Street protesters dearly long for the demise of capitalism, but somehow it keeps on ticking.

A primary theme of liberal economic theory, insofar as it exists, is “market failure.” The emphasis again is negative, not positive, reactive rather than proactive. Its purpose is to explain why the market can’t work, not why socialism can. It explains problems with the existing structure, but offers not even a vague outline of an alternative.

“Market failure” is a multi-purpose excuse for all manner of “government interventions.” It’s always automatically assumed, usually wrongly, that the intervention will solve some problem rather than making it worse.

In any economy choices must be made. Choice is necessary because human wants exceed available resources. That fact is what economists refer to when we talk about “scarcity.” Dealing with the implications of scarcity is the basic purpose of economic science.

If we decide to reject market choices, choices will nevertheless be necessary. Economic scarcity will still be very much with us. When you reject the features of the market there is not something that will automatically take its place.

What is the alternative to a market economy? The not-market? What exactly is that? How do they plan to allocate resources? Who or what will determine prices? How will incomes be determined?

No one has ever conceived of anything that works remotely as well in generating wealth as does the market. To date the only real-world alternative is an inferior and inefficient system of politicians and bureaucrats.

In a market economy the price system is the most important mechanism for dealing with scarcity. It signals to decision makers (consumers and producers) the relative scarcities of resources, goods, and services. Prices provide the essential information and the incentives needed to make efficient choices. If you reject the price system, some other mechanism will be needed to accomplish these crucial functions.

If we don’t allow supply and demand to determine relative prices, how will they be determined? You can’t just say, “From now on everything’s a dollar!”

Is there any underlying logic as to how resource allocation choices are made in Cuba or North Korea? They more or less take the attitude “Our policy is we reject capitalism!” The results, not surprisingly, are disastrous.

It is no accident that liberalism and socialism have no theoretical foundations. There are good reasons why no clearly articulated alternatives have been offered. The main one being it’s simply not that easy. If there were good alternatives available, or at least conceivable, we would certainly know about them.

Liberals apparently have the attitude, “We don’t need no stinkin’ theory!” Socialism and liberalism are fundamentally utopian in character. In utopia everything is attainable. It is based on an “unbounded” vision of the world in contrast to a world of limits and trade-offs. Issues such as efficiency are not a concern in utopia. Consequently, utopia needs no theory.

There are other reasons it could be argued that liberalism needs no intellectual foundation. For liberals choices are based almost exclusively on intentions. Intentions don’t really require a theory or structure. Intentions are self-contained — they are the starting point and end point. It is impossible to collect evidence about intentions. You would have to be a mind reader to do so.

The protesters are certainly free to express their dislike for capitalism. They should not be surprised, however, if others are reluctant to throw capitalism overboard before they’ve been offered a well-defined alternative.


Empty-Headed Protest October 20, 2011

Ron Ross Ph.D. is a former economics professor and author of The Unbeatable Market. Ron resides in Arcata, California and is a founder of Premier Financial Group, a wealth management firm located in Eureka, California. He is a native of Tulsa, Oklahoma and can be reached at

Wednesday, October 5, 2011

Friedman’s Four Ways

Sometimes the explanation for vexing problems is clear as can be after you see it. A perfect example is an observation made by the late Milton Friedman in a 2004 interview with Fox News:

There are four ways to spend money. You can spend your own money on yourself. When you do that, why you really watch out for what you’re doing, and you try to get the most for your money. Then you can spend your own money on somebody else. For example, I buy a birthday present for someone. Well then, I’m not so careful about the content of the present, but I’m very careful about the cost. Then, I can spend somebody else’s money on myself. And if I spend somebody else’s money on myself, then I’m going to have a good lunch! Finally, I can spend somebody else’s money on somebody else. And if I spend somebody else’s money on somebody else, I’m not concerned about how much it costs, and I’m not concerned about what I get. And that’s government. And that’s close to 40 percent of our national income.

It would be nearly impossible to exaggerate how many of our current economic problems are explained by Friedman’s four ways of spending money. Think of the four ways in the order they’re presented as S1, S2, S3, and S4. As Friedman explains, the effectiveness of how money is spent declines inexorably as you move from S1 to S4.

The important demarcation line in ways money can be spent is between S2 and S3. In other words, the issue that matters most is your money versus someone else’s money. If you’re spending your own money on someone else, your spouse or children, for example, you still take the expenditure seriously. You still pay a price if you don’t look for bargains.

A new Gallup survey finds that “Americans believe, on average, that the federal government wastes 51 cents of every tax dollar, similar to a year ago, but up significantly from 46 cents a decade ago and from an average 43 cents three decades ago.” This is a good example of “the wisdom of crowds.” The trend shows that the crowd is wising up regarding the implications of gargantuan government.

The survey respondents are correct in their assessment of how government spends money, and you need go no further than Friedman’s distinctions of how to spend money in understanding the source of the problem.

My guess would be that many of the respondents would think the government doesn’t necessarily need to waste half the public’s money. The problem, however, is it’s the nature of the beast. Because of the realities Friedman refers to, the government will never be able to spend money as effectively as the private sector.

The problems associated with how the government spends money are not the result of who’s running the government. The problems are systemic. Unless government is seriously downsized, waste and inefficiency will remain problems no matter which party is in power.

The source of the problem can be further clarified by keeping in mind the observations of another economist, Steven Landsburg: “Most of economics can be summarized in four words: People respond to incentives.” (That’s the first sentence in his excellent book, The Armchair Economist.)

The incentives for spending money wisely and efficiently are simply too weak when it’s not your own money. It’s no skin off your nose if the benefits of the expenditure are a small fraction of the costs. When it’s your own funds being used, you will not only restrict your expenditures to things having more benefits than costs, you will choose the ones you think will have the highest ratio of benefits to costs.

When it’s your own money you’re spending, it costs you something when you spend it foolishly. That’s not to say that we never spend our own money foolishly, but it comes out of our own hides when we do. When we spend our own money foolishly, we’re left with less money to spend well. It’s a self-policing structure. Of course, your incentives are even stronger when you worked hard for the money in question.

When a politician or bureaucrat spends taxpayer money it’s treated essentially a freebie. It’s only natural that taxpayer money gets treated like monopoly money. Politicians and bureaucrats have virtually no incentive to care about the value of an expenditure or its cost. This is a profound disadvantage of public spending that will never, ever go away.

Contrary to the straw-man accusations of some liberals, conservatives do not advocate zero government expenditures. Conservatives definitely are not anarchists. Nevertheless, the inherent and inescapable inferiority of spending someone else’s money on someone else is a strong argument for minimizing the size of government. The public’s opinion that the amount of government waste has been increasing parallels the exponential growth of government.

The Solyndra fiasco is another recent confirmation of Friedman’s observations. Despite alarm bells going off, the Obama administration pushed the doomed endeavor forward. Why not? It wasn’t their money, after all. Because it has now becoming so notorious, it appears the administration may pay a political price. Nevertheless, half a billion dollars of taxpayer money has gone down a rat hole. Unfortunately, Solyndra is the rule, not the exception. Absurdly generous public employee pension plans are another predictable result of spending someone else’s money.

Friedman said that the fourth spending alternative is how we spend forty percent of GDP. He was, I think, referring only to budgetary expenditures. Forty percent is a lot. Unfortunately, it understates the full extent of the problem.

The vast regulatory apparatus of the government is basically a system of spending someone else’s money on someone else. It is estimated that government regulations currently cost the economy $1.7 trillion a year. For example, requiring a private business owner to spend hundreds of thousands of dollars to comply with the American with Disabilities Act is a clear case of spending someone else’s money on someone else. Requiring a private business to spend a million dollars doing an “environmental impact report” is a clear example of spending someone else’s money on someone else. Spending a million dollars or more on an EIR, in fact, is an example of spending someone else’s money for no one and for nothing. Minimum wage laws likewise are a case of spending someone else’s money on someone else.

The billions of hours Americans spend each year preparing their tax returns is a case of spending someone else’s time on someone else. Time is money, as they say, and most people I know complain a lot more about a scarcity of time than they do of money.

When you spend your own money (or time) on yourself, or for your loved ones, the process is essentially self-regulating. The incentives are automatically aligned with waste minimization. When such incentives are not present, elaborate and complex systems of rules and artificial punishments must be put in their place. There can never be enough rules and regulations to match the effectiveness and elegance of the self-regulating market.


Friedman’s Four Ways October 5, 2011

Ron Ross Ph.D. is a former economics professor and author of The Unbeatable Market. Ron resides in Arcata, California and is a founder of Premier Financial Group, a wealth management firm located in Eureka, California. He is a native of Tulsa, Oklahoma and can be reached at

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