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 George Reisman's Blog on Economics, Politics, Society, and Culture

July 2006  

This blog is a commentary on contemporary business, politics, economics, society, and culture, based on the values of Reason, Rational Self-Interest, and Laissez-Faire Capitalism. Its intellectual foundations are Ayn Rand's philosophy of Objectivism and the theory of the Austrian and British Classical schools of economics as expressed in the writings of Mises, Böhm-Bawerk, Menger, Ricardo, Smith, James and John Stuart Mill, Bastiat, and Hazlitt, and in my own writings.

The contents of the blog are copyright © 2006 by George Reisman. All rights reserved. Permission is hereby granted to reproduce and distribute individual articles below electronically and/or in print, other than as part of a book. (Email notification is requested). All other rights reserved. George Reisman, Ph.D., is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics.


Monday, July 31, 2006

Wage Rates and Purchasing Power

An individual who earns more money per week is obviously in a position to spend more in buying consumers’ goods than is an individual who earns less money per week. For example, a man who makes $1,000 per week has the ability to spend $1,000 per week, while a man who makes only $900 per week has the ability to spend only $900 per week. (For the sake of simplicity, we’re ignoring such possibilities as going into debt or using up savings, and assuming that the individuals both want to live within their incomes.)

When there is unemployment and free-market economists urge the freedom of wage rates to fall as the means of eliminating the unemployment, many people think of examples like the above and conclude that the free-market solution would only serve to make matters worse. They reason, in effect, that now workers who had been earning $1,000 per week would only earn $900 per week and thus be reduced to spending only $900 per week instead of $1,000 per week. Generalizing from this example to wage reductions of any size, and to their effect across the whole economic system, people conclude that wage-rate reductions cause reductions in overall consumer spending and therefore must serve to make the problem of unemployment worse, rather than better. In fact, often going under the name of Keynesianism, this is far and away the prevailing doctrine on the subject and is why reductions in wage rates are rarely if ever advocated as the means of reducing unemployment in the present-day world.

However, let us approach matters now not from the perspective of an individual wage earner, but from that of the economic system as a whole, essentially just like Henry Hazlitt did in his brilliant Economics In One Lesson.

In the economic system as a whole, in any given year, there’s a certain overall total amount of payroll expenditures by business firms, i.e., a certain overall total amount of wage payments. There’s also a certain overall total amount of consumer spending that takes place in the year. Since it‘s always essential to think in terms of numbers when dealing with such matters, let’s assume that in the economic system as a whole in a given year total payroll expenditures amount to 400 units of money. (This is certainly a very small number of units, but each unit can be understood as representing as many billions or tens of billions of dollars as may be necessary for the 400 units to represent the actual total payrolls of the present-day United States. Thinking in terms of a small number of units allows us to avoid wasting valuable brain space in holding strings of unnecessary zeros in our minds)

Let’s also assume that total annual spending to buy consumers goods in this economic system is 500 units of money, with each unit of money representing as many billions or tens of billions of dollars as does each of the 400 units of money paid as wages.

So here we are: 400 units of money is total wage payments and 500 units of money is total consumer spending in our hypothetical economic system.

We can assume that 400 of the 500 of consumer spending represents consumption expenditure by wage earners, out of their 400 of wage incomes. The remaining 100 of consumer spending can be taken as representing consumption by businessmen and capitalists, out of profits, interest, and dividends, and/or out of previously accumulated capital.

Now imagine that in this hypothetical economic system, there is 10 percent unemployment. That means that there is also 90 percent, positive employment. Going from 10 percent unemployment to full employment means increasing positive employment in the ratio of 10 to 9.

Isn’t it clear that if total payroll spending were maintained, a 10 percent reduction in wage rates would secure full employment? That it would mean 10/9 the workers employed at 9/10 the average wage. Wouldn’t consumer spending also hold up in these circumstances, with 10/9 the workers spending 9/10 the average wage per worker?

And if the output per worker remained the same, wouldn’t the same total consumer spending of 500 units of money be sufficient to buy 10/9 the output at 9/10 the prices? And wouldn’t total profit in the economic system, and, by implication, the average rate of profit, be the same, despite the fall in prices? (Wouldn’t total profit essentially continue to be 500 units of money in the form of consumption expenditure minus 400 units of money in the form of wage payments?)

What of real wages? If prices and wage rates both fall to the same extent, wouldn’t real wage rates be the same? In fact, wouldn’t real take-home wage rates actually increase because of the elimination of the burden of supporting the unemployed, who would now be employed and supporting themselves?

And notice the implication for how real wage rates can continually be further increased, namely, simply by virtue of labor becoming more and more productive and thus progressively increasing the supply of consumers’ goods relative to the supply of labor, thereby more and more reducing prices relative to wage rates.

This example, of 400 of wage payments and 500 of consumer spending, is a depiction of the economic world in terms of essentials. Mises would call it an imaginary construction. It is very highly simplified. Yet it is also extremely pregnant with implications: for employment/unemployment, for real wages, for profit/interest, and for much else besides.

Whoever starts to think about this example will have many questions, the answers to which obviously cannot be fitted into a brief article such as this. The questions can concern such things as the effects of adding the buying and selling of capital goods into the example, the effects of allowing for changes in the amount of spending in the economic system and for changes in the relationship between different kinds of spending, and more. For answers to all such questions, I invite those interested to read my book Capitalism: A Treatise on Economics. There I think they will find not only just about all of the answers they are looking for, but also many questions they have not thought of asking, along with the answers to those questions as well.

Monday, July 24, 2006

How Environmentalism Raises Profits at the Expense of Wages

In my last article, “How Government Budget Deficits Reduce Wages and Raise Profits,” I explained why those who complain about profits rising at the expense of wages should not blame the free market but, in part at least, the growth in government budget deficits. I’d now like to show that in addition they should blame the environmental movement and the government intervention that it has inspired.

Environmentalism operates systematically to withhold land and natural resources from the market. Wherever it can, it prohibits economic development, in the form of housing construction, power-plant construction, and road construction. It attempts to stop the opening of new mines and especially new oil fields. While it claims to favor what it calls renewable natural resources, it also attempts to stop logging operations, even though new trees can be grown to replace those removed. It has also succeeded in imposing limits on the emission of such chemicals as sulfur dioxide, nitrogen, and chlorofluorocarbons (cfcs) into the atmosphere, and in these cases systems of “tradable emissions rights” have been established. It currently seeks similarly to limit the emission of carbon dioxide into the atmosphere and to establish a system of tradable emission rights in its case too; indeed, a limitation on carbon dioxide emissions and a system of tradable emission rights for carbon dioxide already exist in the European Union.

Under a system of tradable emission rights, the government acknowledges long-standing emissions and confers a legal right for them to continue. For example, if for many years, a firm has been emitting a ton of sulfur dioxide into the atmosphere each year, the government may grant it a legal right to continue doing so indefinitely and, in addition, to sell that right in the market from year to year or to sell it permanently, just as the firm might rent or sell any other durable property that it owns. Newcomers who wish to emit sulfur dioxide, or established firms that wish to increase their emissions, cannot do so unless they buy emission rights from the firms that possess them. Emission rights quickly become scarce and progressively more valuable as the need for additional production of the kind that must result in more emissions intensifies and comes up against the barrier of the prohibition on a larger volume of emissions.

I do not know of any reliable estimates of the aggregate dollar value of the tradable emissions that are now purchased in a given year in the United States or around the world. But whatever it may be, it represents a clear addition to the aggregate amount of profits in the economic system. This is because the firms that sell their emission rights thereby have sales revenues for something that costs them virtually nothing whatever to provide. And so long as they sell these rights merely on an annual basis or for a limited term of years these sales revenues and profits will be recurring.

Furthermore, looking at things now from the perspective of the purchasers of the emission rights, the need to purchase emission rights equivalently reduces the funds available to business firms for the purchase of other things, notably capital goods and labor services. Thus, the effect of the existence of tradable emission rights is both an increase in the aggregate amount of profit in the economic system and a decrease in the aggregate amount of wages paid in the economic system.

The effect of payments for emission rights on wages can be further inferred from the following considerations. Assume for the moment that the price of emission rights were to count simply as an additional cost of production, added to all of the other costs of production, and to correspondingly drive up the prices of goods to the point required to cover this additional cost. If this happened, the quantity of goods demanded in the economic system would fall. It would fall simply as the result of the combination of higher prices and limited funds with which to pay prices.

The result of the fall in the quantity of goods demanded would be unemployment. If unemployment is to be avoided, the prices of goods must not rise. But in order for them not to rise, their costs of production must also not rise. In order for costs not to rise in the face of the addition of the new component of cost that is constituted by the price of emission rights, another primary component of cost, notably wages, must fall. In other words, the value of tradable emission rights ends up being at the expense of wages. Thus, environmentalism and the system of tradable emission rights serve to raise profits and reduce wages.

It must be stressed that if wage rates do not fall in order to offset the additional costs constituted by the value of tradable emission rights, then the result is both higher prices and unemployment. In this case, while wage rates in terms of money do not fall, wage rates in terms of buying power still fall because the same wage rates in money must be used to pay higher prices for goods.

The fact that such are the consequences of the system of tradable emission rights should not be taken as a criticism simply of that system. The imposition of the same environmentalist restrictions on production without an accompanying system of tradable emission rights would result in even worse consequences. This is because the costs of complying with the environmental regulations would then be far greater, with the result either that prices would have to rise or wage rates fall by that much more.

For example, a firm that could avoid a million dollars of additional costs if it could emit an additional ton of sulfur dioxide would simply have to incur those additional costs even though elsewhere in the economic system there was a firm that would incur additional costs of only a few thousand dollars if it reduced its emission of sulfur dioxide by a ton. The absence of tradable emission rights in this case would cause the needless imposition of almost a million dollars of unnecessary costs, requiring a corresponding rise in prices or fall in wages in the economic system. It is clearly the substantially lesser evil in this case even if the right to emit a ton of sulfur dioxide were to be sold for several hundred thousand dollars.

The problem is not the system of tradable emission rights. The problem is the prohibition of the increase in emissions that is the necessary accompaniment of the increase in production. The prohibition of additional emissions thus serves to prohibit the increase in production. Of course, in the absence of prohibitions on additional emissions, there would be no basis for the existence of systems of tradable emission rights, and thus they would simply not exist.

As indicated at the beginning of this article, environmentalism’s prohibitions on production go far beyond those that have been accompanied by systems of tradable emission rights. With or without tradable emission rights, the effect of imposing laws and regulations based on environmentalism is to make land and natural resources artificially scarce relative to human labor and thus to enhance the economic value of land and natural resources while reducing the economic value of human labor, above all, wage rates. In the terminology of the old British classical economists, what environmentalism is doing is increasing the portion of national income that takes the form of “land rent,” and doing it at the expense of the portion of national income that is wages.

The rise in the economic value of land and natural resources—the rise in land rent—shows up in the form of a rise in profits. All net monetary earnings derived from the ownership of land or natural resources are profits from the point of view of business accounting. Profits rise to the extent that the prices of minerals and of agricultural products rise relative to the costs of producing them. And precisely this is what happens when the demand for these products rises and environmentalism has meanwhile succeeded in preventing commensurate increases in their supply.

The leading example of this phenomenon at present is the recent rise in the price of oil and natural gas. A growing population and a growing need for oil here in the US, coupled with major economic progress in China and other parts of Asia, has substantially increased the demand for oil and natural gas. However, the environmental movement has done everything in its power to prevent increases in the supply of these commodities.

It has prevented the development not only of the oil deposits in the North Slope of Alaska but also oil and gas deposits on the continental shelf off California and the Gulf Coast, as well as oil and gas deposits present in the vast land areas set aside as wilderness preserves and wildlife areas. In addition, it has prevented the construction of new atomic power plants, whose existence would serve to diminish the demand for oil by the electric power industry and thus make oil more available for other purposes, and at a lower price. The same is true in connection with coal mining. Its expansion too is blocked, and thus the availability of this major substitute for oil is also held back. The result is that the need for oil is made that much more intense and its price correspondingly higher.

Different parts of the supply of minerals and of agricultural commodities have different costs of production. For example, there are some petroleum deposits which are so easily accessible and so productive that they can be exploited at a cost of production of perhaps just $3 or $4 per barrel. But such petroleum deposits can meet only a small portion of the demand. The rest of the demand must be met by exploiting higher-cost deposits, deposits with a cost of production of $10, $20, $30 per barrel, and more. Every time the price of oil rises because its supply is prevented from increasing, profits are increased on all the petroleum deposits in production.

The same principles apply to wheat production and housing construction. The result of all increases in demand not matched by an increase in supply, because environmentalism prevents the increase in supply, is a rise in price and an increase in the portion of the good’s price that reflects the resulting greater scarcity and higher value of land and natural resources. And, as we have seen, this higher value of the economic contribution of land and natural resources that environmentalism causes takes the form of higher profits.

In sharpest contrast to today’s markets that are distorted by environmentalism and the government intervention that it has brought about, a free market would produce results of an opposite kind. In a free market, with its powerful incentives to increase production and to find new and more efficient ways of doing so, supply would increase not only commensurately with the increase in demand but more than commensurately. Lower-cost methods of production would be found that would make it possible for prices to be driven down rather than up. A free market operates to increase the supply of useable, accessible land and mineral deposits relative to the supply of human labor and thus to make them progressively cheaper in real terms.

Accordingly, profits based on the ownership of lower-cost natural resources and farm land would be sharply contained, and even diminish, as scientific and technological progress and capital accumulation served to make available more such deposits and farm land or equally good or better substitutes for them and thus to drive the prices of products produced by means of such deposits and land closer to their low costs, meanwhile further reducing those low costs.

In a free market, wages rise relative to the value of land and natural resources and are thus correspondingly higher relative to profits. This was the record of the United States and the rest of the Western World for approximately 200 years following the start of the Industrial Revolution.

Environmentalism is a movement dedicated to the undoing of the Industrial Revolution. If not checked, one of its results will be the progressive reduction of wages and the further elevation of profit incomes based on the ownership of land and natural resources.


     Monday, July 17, 2006

How Government Budget Deficits Reduce Wages and Raise Profits

In recent years there have been growing complaints over slow growth in wages compared to profits. Those who make the complaints usually offer little in the way of explanation. Here is a part of the explanation: growing government budget deficits.

Government budget deficits are financed partly by the creation of new and additional money. But for the rest, they are financed by selling government securities to the citizens, who pay for the securities with money that already exists and which is part of their savings. If the government had not been running at a deficit and had not needed to sell these securities, the citizens would have used most of the savings with which they buy the government securities to buy corporate securities and in other ways to make their funds available to business firms.

Those savings, in the hands of business firms would have been used to purchase capital goods and to pay wages. These wages, however, never come into existence if the savings out of which they would have been paid are diverted to the government to finance its deficit. Thus, wage payments in the economic system are smaller because of government deficits.

Yes, it is true that the government itself pays wages to some extent. But it is unlikely to do so to the same extent as do business firms. And to whatever extent the additional wage payments it makes out of the proceeds of its securities sales are less than the wage payments that business firms cannot make because of the diversion of part of what would have been their capital funds to the government, total wage payments in the economic system are reduced.

In addition to this likely reduction in overall wage payments in the economic system, the effect of government budget deficits is an increase in the aggregate, i.e., total, economy-wide, amount of business profits. Here’s why.

Whether business gets money to finance its purchase of capital goods and payment of wages, or the government gets money to buy goods and services, including meeting its own payroll, and, of course, simply to give money away in carrying out various welfare-state functions, the amount of business sales revenues in the economic system will be pretty much the same. This is because a dollar from the sale of a good to a business firm and a dollar from the sale of a good to the government is still a dollar of sales revenues. A dollar from the sale of a good to an employee of business or dollar from the sale of a good to a government employee is again still a dollar of sales revenues. And finally, a dollar from the sale of a good to someone who has received his money under one or another of the government’s welfare-state programs is no less a dollar of sales revenues than a dollar spent by someone who had earned that dollar.

But here’s a crucial difference: The dollars spent by business firms in buying capital goods and in paying wages sooner or later show up as costs of production. Those costs of production, of course, must be deducted from sales revenues in calculating profits. Aggregate profit in the economic system reflects their subtraction.

To the extent that government budget deficits divert funds from the purchase of capital goods and the payment of wages by business firms, their effect is sooner or later to reduce the magnitude of costs of production in the economic system and equivalently to increase the aggregate amount of profit in the economic system. Costs reflect prior outlays of money. To the extent that those outlays are less, the costs will be less. The reduction in costs of production raises profits equivalently, because, as we have just seen, the amount of sales revenues in the economic system is the same either way; it’s the same with or without the budget deficits. In the face of the same aggregate sales revenues, reduced aggregate costs mean equivalently higher profits.

So growing budget deficits are part of the explanation of profits rising relative to wages.

Before concluding, it’s necessary to point out that a rise in profits achieved in this way is not a cause for joy. What is present is an illustration of the dichotomy identified by Ricardo that often exists between monetary value and physical wealth. (See his Principles of Political Economy and Taxation, chap. XX.) Aggregate money profit is up, but in large part that is the result simply of the expenditure for capital goods being down. What that signifies is less previously produced wealth being available to serve in the production of future wealth. A part of the output of the economic system that would have gone into the production of future output is instead diverted to the government’s consumption and to the consumption of those to whom the government gives money.

The effect of this cannot fail to be that the productivity of labor in the economic system will be less than it otherwise would have been and that real wages in the future will consequently suffer from production being less than it otherwise would have been and thus from prices being higher than they otherwise would have been. And, ironically, as an integral part of these developments, while total costs of production in the economic system, are lower, unit costs of production will be higher than they otherwise would have been, because of the reduced output that results from the smaller total outlays of business and the consequent reduction in the supply of capital goods available for use in further production.

In sum, the effect of government budget deficits is lower money wages, higher money profits, and lower real wages to the extent that the deficits serve to increase prices and unit costs on top of reducing money wages.

    Tuesday, July 04, 2006

No Fourth of July Celebration at The New York Times/Pravda

The New York Times does not mention Independence Day on its editorial page. And there is no word of celebration of it on its Op-Ed page. What is present on the Op-Ed page is a further demonstration of that newspaper’s hostility to the fundamental values on which the United States was built.

One article, titled “Spinning the Revolution,” seeks to undercut the value of the American Revolution by presenting it not as the kind of great world-shaking event that it was, signifying for the first time in human history the establishment of a government dedicated to the protection of individual rights, but as a matter of mere “spin,” manufactured by a collection of writers and pamphleteers. In the same vein, it belittles the value Americans have rightly attached to the Declaration of Independence and the United States Constitution by sarcastically describing those documents as being viewed as “sacred scripture."

Another article,
“Billionaires to the Rescue,” which compares Warren Buffet’s gift of $31 billion to charity to the charitable giving of Andrew Carnegie early in the last century, proceeds as though it never heard of such a thing as the right to the pursuit of happiness. Clearly revealing the perspective of a collectivist, it dares to ask,

Is society served by permitting so much capital to be accumulated by so few? Should we have to rely on the usually unfulfilled hope that fortunes of this magnitude will be put to a good cause? What becomes of a society that must rely on "gifts" from a handful of socially conscious billionaires to save its schools, cure disease and alleviate poverty?

 The author believes that “society,” i.e., politicians and government officials have the right to thwart the individual’s accumulation of wealth, thereby denying his right to the pursuit of happiness. In claiming that it is an accidental matter whether large fortunes are put to a good cause, he reveals his ignorance of the fact that the fortunes are invested in business firms as capital, and thereby serve as the source of supply of goods and services to consumers and of demand for the services of wage earners. He demonstrates further ignorance in failing to realize that the high profits out of which fortunes are accumulated are the result of introducing a series of important innovations in the form of new and better products or more efficient methods of production.

He also does not realize that all that prevents the charitable giving of fortunes from resulting in a reduction in the well-being of consumers and wage earners is their continuing to remain invested rather than being consumed by the recipients of charity. The consumption of the recipients of charity needs to be held within the limits of the income on the capital in order for this destructive outcome to be avoided.

Finally, seizing the fortunes by the government to “save . . . schools, cure disease and alleviate poverty” will accomplish little but the reduction of capital. Schools, books, and all the means of learning are properly the province of private business firms meeting the demand of consumers, just as is the supply of food and clothing. Likewise, curing disease is properly the province of privately owned pharmaceutical firms, hospitals, clinics, and of physicians in private practice. The alleviation of poverty is the daily work of businessmen who introduce the newer and better products and more efficient methods of production: in addition to being the source of fortunes, these last are the source of the rise in the standard of living of everyone. They are what enable almost everyone in the modern world to be well fed, clothed, and housed and to have such goods as indoor plumbing, central heating, refrigerators, stoves, telephones, and television sets.

To the extent that schools, medical care, and poverty represent problems in need of solution, the first step in the solution is removing the government from the picture and allowing the profit motive and the pursuit of happiness to succeed in solving these problems. That is a principle to be remembered on America’s Independence Day.

These pathetic articles are what The Times has to offer on the day dedicated to the celebration of America’s existence. It is an alien publication, dedicated to collectivism and the worship of the State, to principles the opposite of those on which the United States was founded. Over the years, it has been the champion of Stalin, of Mao, and of Castro, and more recently, of the reincarnation of socialism known as environmentalism. One cannot expect it to be the champion of Washington and Jefferson and of the United States. And it certainly is not.


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