The multiplier is not prosperity

“I’m doing my part to help the economy!”

I’ve heard many folks make this joke after a big purchase. We snicker. We know they really bought it for the personal benefits they expect to gain. As we’ve been discussing in the comments, they bought it because they valued it more than what they gave up.

The joke implies the multiplier effect — the idea that your purchase stimulates economic activity. You buy a car, which means income for the car maker and workers, they spend that income on suits and shoes, and so on. And, by the time it’s all said and done every dollar of your purchase ‘stimulated’ more than a dollars worth of economic activity, which is measured as GDP.

For some reason, we don’t snicker when economists and politicians make this same claim. We should.

David Henderson, who doesn’t make this claim, does a great job explaining why we should snicker in his aptly titled essay, GDP Fetishism, which I discovered after reading a recent post of his about the ‘multiplier’ of foreign aid.

Also recommended, his latest post about subjective value, which is a topic we’ve touched on here recently in the comments.

To seek rent or not?

Rent-seeking has been a popular topic on this blog over the past week. In the comments of this post, Mike M asked if a company seeking to sell its products to government is rent-seeking.

I replied, yes and asked him what he thought.

Here are excerpts from Mike M’s well-thought out follow-up:

 I think there is a difference between “selling” your product (goods or services) to the government (just like an other consumer) and convincing them to buy your product (as opposed to others) and seeking to have the government (as a third party biased referee rather than as a consumer of your product) afford you some privilege that gives you an advantage (such as subsidizing your product or taxing or regulating the competitor’s product).

 In the first case, as long as the government representative is truly acting for the benefit of the government, he should be seeking to make a trade at FMV.

I agree.

A “rent” is essentially an excess return above the “normal” return in a competitive economic market.

Typically, we use the term to imply that one has lobbied the government to obtain some special privilege – something that’s been going on since governments and economies have existed and is not a unique occurrence in any economic system (although that does not mean that it is meant to be a part of that system). Rent-seeking differs from profit-seeking, in which two parties seek to extract value by engaging in mutually beneficial transactions.

What is important for us to realize is that the costs spent on lobbying for these privilege eliminates some of the beneficiary’s gains for the privileges and results in an economic inefficiency, i.e. less output results from the same inputs. The cost of obtaining the rent represents a use of real resources and is a loss to the economy as a whole.

I agree. Also, I think it’s worth highlighting that the cost of obtaining the rent is the rent-seeking.

The next excerpt, however, starts to get at one reason — after going through a similar thought process as Mike — I erred on the side of yes.

Of course, this goes out the window if he’s your cousin or you’ve offered him a bribe and he buys your product at an inflated price, but I think that’s a different “crime” than rent-seeking.

Unfortunately, so much of government spending, even if it initially starts out on the up-and-up, devolves into rent-seeking. That’s how we end up with $800 government hammers and toilet seats. That’s how education spending per student triples in a few decades with nothing but shiny buildings (and wealthy builders) to show for it.

While the bribe is a different crime than rent-seeking, it is also rent-seeking, because it is spending resources to gain something without creating value.

Next, government spending comes from taxes. Taxes are not value creating transactions. Rather, they are redistributive. So, government vendors are ultimately lobbying government officials for a slice of their redistributive taxing power.

How is that different from lobbying government for its other powers like enacting a tariff on sugar or restricting competition in a market?

One objection I can imagine to my case is that some of the money spent by government does create wealth.

This is true. But, to say these things create value isn’t enough. They have to create net value relative to opportunity costs.

Roads are great, for example. I’m eagerly awaiting a new road being built near my home. It will be profitable for me, because it will shave many minutes on my commutes.

When I think of that new road creating value for me, I think only of the benefit — how much time I will save. But, I never know the cost.  If the local, state and Federal government (all are pitching in) said I could have that road or $100,000, I might decide to take the $100,000 and continue to put up with the extra minutes on my commute.

So, even when I see government spending that appears to have created some wealth for society, I don’t really know if it did relative to the alternative that could have been if someone had spent the resources more carefully.

What do you think, Mike?  What am I missing?

Money for nothing

I learned a few things from this EconTalk podcast with guest Casey Mulligan discussing his book, The Redistribution Recession.

One argument from the right against unemployment benefits is that it encourages people to stay unemployed so they can keep receiving it.

A standard retort from the left to that argument is that the unemployment payout is so small that nobody would choose that paltry sum over getting a job.

Mulligan points out that the sum is not trivial. Here’s Mulligan from about 24 minutes into the podcast (bold is mine):

Typically before the recession, unless you are well into the upper half of earnings, when you lost a job you got half of your earnings replaced. So if you used to earn $600 a week, you’d get an unemployment check for $300 a week. And I guess you are referring to kind of that $300 dollar number–it seems $300 isn’t very big. Well, if you earn $600–I earn more than $600 myself–but if you earn $600, then $300 is not all that trivial. Number one.

…number two: There’s all kinds of taxes you don’t have to pay when you are unemployed. Payroll taxes–forget about it. You don’t pay it when you are unemployed. A big chunk of income taxes you are not going to pay when you are unemployed. So when you put all of that together, without even getting to other help you might get from food stamps or Medicaid, put it all together, before the recession about 70%, maybe a little more, of your earnings would be replaced. Not half. And that’s without getting into, like I said, other types of programs.

And when you start with 70% as your baseline–so you are going to get 70% on the old rule, and you are going to put a bunch of new rules* in there–it pushes the 70% up to 85 or 90%. I don’t think we can call that trivial any more.

*The new rules Mulligan mentions earlier in the podcast are expansions made in other programs during in the recession like food stamps, mortgage payment relief and health insurance subsidies.

So, think about these choices:

Choice 1: Get a job making 70% – 100% of what you use to make and give up 40+ hours a week. After paying taxes and paying for more of your food, mortgage and health insurance, you are really making about 50% – 80% of what you use to make.

Choice 2: Don’t get a job (or at least not an official job). Keep making 70%+ of what you use to make.This includes unemployment and other programs. Keep the 40 or more hours of free time during the week, where you might find things to do for others off-the-books for extra cash (which maybe brings you to more than what you use to make).

After learning this, the ‘the unemployment payout is so small that nobody would choose that paltry sum over getting a job’ argument seems much less compelling. I’d say that it would be more of a surprise for someone to give up Choice 2 for Choice 1.

The whole podcast is worth a listen.  There are a couple other points Mulligan makes that I’d like to mention.

One (and some of this may be a mix of Mulligan’s points and my own). Unemployment is more of a choice than a condition that folks find themselves in ‘through no fault of their own.’

He contends that use to be the social norm. If you lost a job, there was more expectation on you to not burden your fellow citizens and to do something productive. So, for example, you were expected to have been responsible and saved for a rainy day when you did have a job. You were expected to make tough choices in your own budget to trim the fat. And, you were expected to find another job and take it and make ends meet, even if it was for less pay that what you used to make. At least you were being productive, responsible and continuing to add to your own work experience and skill set that may lead to bigger and better things.

The ‘social norm’ seems to have shifted to view what you use to earn and the budget choices you made then were things you were entitled to keep and that being out of job is something that you have absolutely no control over.

Two. The cost-benefit analysis of unemployment benefits has shifted. Unemployment benefits use to be viewed as a stop-gap to help folks in transition. It wasn’t really thought of something that would help the economy. Now the benefit-side of the cost-benefit analysis includes stimulative effects to the economy. But, Mulligan does a good job of addressing that belief:

It does put money in a group of people’s hands; it takes it out of another group of people’s hands. And the net reduction in the economy is actually less spending. Because, you know, you have less work going on. So there’s less total income to be spent. And so the people who are going to suffer from that, depending on the industry they work in, they are going to see the drop in demand for what they make. And they may not appreciate my story; but they don’t understand–they need to appreciate: Why aren’t their customers spending? If you drill down to the bottom of that you are going to see that the safety net expansions are a big part of it.

Here Mulligan makes an atomic connection that so few others do. Income and spending derives from wealth creation (i.e. doing productive things), not the other way around. All unemployment benefits do is shift who is spending the wealth that is being created, so since you have fewer people creating wealth, there will be less overall spending.

In fact, this reminds me of a post of mine from 2011, Government is overhead.

Sugar and Exercise

Here are a couple other posts CrossFit visitors might be interested in reading:

1. William Banting figured out sugar and starch was bad…in the 1800s.

2. Economist Art De Vany wrote a book about his New Evolutionary Diet, which is a lot like the Paleo Diet, and inspired some new exercise thinking for me.

Source of evil

My blog received a big boost in traffic this week because, according to commenter Stephen (with minor corrections):

Founder of Crossfit had a talk in which he used rent-seeking as a reference and why that was bad for crossfit and against his business model which he likened to “Striving to excellence instead of striving to make money is a better way to run a business”

He then posted a link to a blog post I wrote in 2011 to distinguish rent-seeking (or as one of the excellent regular commenters here, Mike M, put it, “privilege seeking”) from capitalism. So, I’d like to thank the Founder of CrossFit, thank all who visited Our Dinner Table and thank to all who left a comment to advance the discussion — even those who disagreed with me.

I’m guessing he posted a link for rent-seeking because, as I point out in that blog post, so few people understand what rent-seeking is and the term itself is not intuitive.

Privilege seeking is a more intuitive term. Seeking privileges at the expense of others is about as spot on description as I’ve heard, so far.

Rent-seeking is using government to reduce consumer choices for the benefit of a special interest.

In my 2011 post, I used the sugar tariff as an example of rent-seeking. It works like this: Government adds a tariff to sugar imports, which results in a higher price paid for sugar products in the U.S. by consumers. The higher price benefits domestic sugar farmers who get to charge more since their foreign competitors’ sugar prices includes the tariff.

The objective of my previous post was to highlight that to the extent the tariff allows domestic sugar farmers to charge more, those profits are not earned through capitalism. But, too often folks see that as capitalism. In their eyes, profit and capitalism are almost interchangeable.

I’d like to commend the founder of CrossFit for shunning rent-seeking (it’d be great if he could hook me up with a set of pipe/monkey bars and maybe a small climbing wall for my basement :)). That means his strategy is to attract and retain customers by making their lives better, rather than using government to restrict their alternatives.

As it turns out, I happened to also listen to a Harvard Business Review podcast this week with guest John Mackey, Founder and CEO of Whole Foods Market. He has a new book titled, Conscious Capitalism.

capitalism

capitalism is actually beautiful (Photo credit: wallstalking.org)

In the podcast, Mackey describes his journey from spouting progressive to appreciative capitalist — and it sounds a lot like mine, except I haven’t founded any big companies, yet.

He discovered that how he viewed businesses when he was young — as greedy, singularly focused money-makers — wasn’t all true. He learned that businesses (usually) succeeded by providing something customers value, which is a tremendous overlooked (or perhaps taken for granted) benefit for society. It may be fun to hate on capitalism, but by gosh, don’t take away my iPhone, sort of thing.

But, I think Mackey misses something BIG. While I applaud Mackey and the Founder of CrossFit for eschewing rent-seeking and favoring customer value creation, i.e. for being capitalists, not all businessmen are capitalists.

One thing almost all business people have in common with the rest of us is that they are human. And one thing nearly all economists know about humans is they respond to incentives (though they differ in their beliefs by how much).

So, it follows that business people respond to incentives. They make more money when their companies do well. One way to guide their companies to success is through good-ol’ capitalism — providing the customer with products they value enough to buy.

But, another way for business people to make money is through rent-seeking. Whether it’s a sugar tariff that allows you to charge more or a state giving special tax breaks for auto plants to ‘attract jobs’, as government at all levels have gained more power, the value of rent-seeking has increased along with it. As Harry Browne put it:

Government is good at one thing: It knows how to break your legs, hand you a crutch, and say, “See, if it weren’t for the government, you wouldn’t be able to walk.”

You can blame greedy business people who are unlike John Mackey and the CrossFit founder for seeking profits without creating customer value, but you’d be blaming the wrong people. The right people to blame would be us, for letting government out of its cage to sell the power we give it to the highest bidder to do things like transfer $40/year of our money to rich, rent-seeking sugar farmers so they can continue to buy that power…with our money.

Think about that for a second, $40 isn’t much (which is why we’re not picketing in the streets about it). But, wouldn’t you rather use that $40 to buy something you value rather than give it to the sugar farmer so he can use it to keep getting it from you?

That’s a double-whammy. Whammy one: You lose your chance to buy something with that $40 that makes your life better. That value never materializes in society. Whammy two: Some of that money goes to do nothing more than to convince politicians to continue getting it. If you understand that, it shouldn’t be hard to see that shrinking government can help the economy.

RomneyCare lessons

Here’s another opinion piece worth-reading from the Wall Street Journal this morning. Key snippets:

The health reform that Mitt Romney passed in 2006 in Massachusetts presaged President Obama’s, and its results are showing what we can expect nationwide. The latest warning comes in a huge new tax increase proposed by Governor Deval Patrick.

But last August Beacon Hill was forced to impose new price controls and a cap on overall state health spending because “health-care spending has crowded out key public investments,” as Mr. Patrick puts it in his budget.

He’s right about that: Health care was 23% of the state fisc in 2000, and 25% in 2006, but it has climbed to 41% for 2013. On current trend it will roll past 50% around 2020—and that best case scenario assumes Mr. Patrick’s price controls work as planned. (They won’t.) In real terms the state’s annual health-care budget is 15% larger than it was in 2007, while transportation has plunged by 22%, public safety by 17% and education by 7%. Today Massachusetts spends less on roads, police and schools after adjusting for inflation than it did in 2007.

 

Shrinking middle class prop

Two non-pathetic economists, Don Boudreaux and Mark Perry (one has bought me beer), write in the Wall Street Journal today that the shrinking middle class is a nothing more than a political prop.

You should read their criticisms of cost and wage measurements. But, here are a few points that are more compelling to the average joe. First, the basics have never cost us less:

According to the Bureau of Economic Analysis, spending by households on many of modern life’s “basics”—food at home, automobiles, clothing and footwear, household furnishings and equipment, and housing and utilities—fell from 53% of disposable income in 1950 to 44% in 1970 to 32% today.

Second, gadgets of prosperity are available to all:

Today, the quantities and qualities of what ordinary Americans consume are closer to that of rich Americans than they were in decades past. Consider the electronic products that every middle-class teenager can now afford—iPhones, iPads, iPods and laptop computers. They aren’t much inferior to the electronic gadgets now used by the top 1% of American income earners, and often they are exactly the same.

Finally, a true measure. Would you trade what you earn and have today with someone from the 1950s or 70s?

Even though the inflation-adjusted hourly wage hasn’t changed much in 50 years, it is unlikely that an average American would trade his wages and benefits in 2013—along with access to the most affordable food, appliances, clothing and cars in history, plus today’s cornucopia of modern electronic goods—for the same real wages but with much lower fringe benefits in the 1950s or 1970s, along with those era’s higher prices, more limited selection, and inferior products.

I can’t believe anyone buys the shrinking middle class barb. For those of us that have been around for more than a couple of decades, we don’t need economists to point out that the suburban blossom of mcmansions and the roads becoming clogged 4×4 family passenger trucks occurred during this period where the middle class supposedly shrunk.