Economic illiteracy is the root of most human problems: poverty, crime, unemployment, inflation, war, and even Pennsylvania’s government liquor monopoly. Otherwise bright folks (and many not-so-bright folks) approach economics as a child believes in Santa Claus and the Tooth Fairy. Prosperity and happiness come out of a fat man’s bag and obsolete body parts are exchanged for fiduciary media by winged pixies. In the adult version, prosperity and happiness are created by government spending and monetary policy. But just as Santa doesn’t actually slide down your chimney with a bag full of toys made by a tribe of indentured arctic elves, politicians cannot create wealth from legislating, regulating, taxing or money printing.* (*But they can and do divert and destroy wealth, phenomena that will be addressed in Part 2).
The best primer refuting economic myths and superstitions is Henry Hazlitt’s Economics in One Lesson first published in 1947. But for many, the suggestion to read economic treatises in one’s limited free time ranks behind an offer for a root canal sans anesthesia. The supply and demand curves caused brain aches in high school or college. No thank you, they say, you can keep your charts and theorems.
But charts and theorems are not needed to appreciate economic truths. Instead, common sense and an understanding of human action is all you need. In what follows I give you the basics.
- Wealth creation. Let’s start with a multiple choice question:
Aggregate national wealth is increased by:
- Money printing
- Government Spending
- High Import Tariffs
The answer is D. Wealth can only be created by production of goods and services. If you pick two bushels of apples, you’ve created two bushel of apples of wealth that you can consume or trade for other things. If you are a masseuse, you trade the value of the massage for stuff other people created. The more massages you can give (your productivity), the more you can trade for other people’s goods and services.
Your family’s wealth and real wages are related to what you produce versus what you consume. The more you can trade for your productivity (as a mechanic, lawyer, bricklayer, shopkeep, drug dealer, doctor, gardener, babysitter, tour guide, etc.), the wealthier you become. In other words, the more stuff you can buy from your earnings, the more prosperous you are. One hundred fifty years ago most Americans produced barely enough to eat. If their kids worked, it wasn’t because they were bad parents, but they needed all hands on deck to put food on the table and wood in the fireplace. They traded their limited productivity (based upon available technology) for food, modest shelter and little else. With the massive gains in productivity over the last century (thanks to both technological advances and capital accumulation), we are no longer so limited. Today, the average middle class worker exchanges his productivity for food, housing (with indoor plumbing and electricity!), cars, gasoline, shirts, Xboxes, iPhones, baseball tickets, craft beer, movies and literally millions of other consumer goods and services.
And just like families consider themselves better off if their real wages buy more stuff (rather than less stuff), countries also benefit in the same manner. The only way we can buy lots of imports like Hondas, plastic spider rings and $130 running shoes from other countries is that we, through our own productivity, have collectively acquired more wealth with which to buy stuff. Just as you prefer to “import” more stuff in your household (restaurant visits, ultra-premium dog food, plasma televisions and fuzzy bunny slippers) than you “export” (your productivity at your day job), so too you should rather live in a country that imports more, cheaper and varied things that collectively increases everyone’s real wages. On the other hand, when stuff costs more, your real wages go down. Common sense, right? Apparently not, though, for special interests that argue for trade tariffs which always (yes, always) result in higher consumer prices (and thereby lower the real value of your wages to prop up some politically-connected floundering industry).
Forget for a moment all that boring stuff about supply and demand curves. The basic rule is common sense. You will buy more apples at ten cents each than you would for a dollar each. You’d be more interested in selling your 1994 Honda for $10,000 than for $100. Thus, as general rule, we like to buy low and sell high. Billions of prices are set every day by people making voluntary exchanges. If the selling prices are perceived to be too high, demand slows and producers will reduce production. If selling prices are too low, demand increases and producers increase production. What anything is worth is entirely subjective and constantly changing, but the availability of price information guides people and producers decisions on how to best allocate their resources.
What happens, then, if the government sets a minimum price on apples, say $5 an apple? If the market price for apples is $2 an apple, fewer apples will be sold. Sure, rich people who are less price sensitive will still buy apples and others might forego other purchases to buy the occasional apple, but the laws of economics, like the laws of gravity, will eventually cause the supply of apples to match the lowered demand.
Wages are also prices, no different than prices for apples, iPhones, massages, haircuts or wallpaper. When a business plans its annual budget, it must include the prices of all inputs: labor, materials, software, machines, advertising, office supplies, all of the foregoing also known as the factors of production. For a business to be profitable, the factors of production must all be priced at or lower than their marginal productivity. A retail store, for instance, must pay for cash registers, shelving fixtures, rent, inventory, signs, utilities, insurance, employee wages and benefits, warehousing (assuming a bigger chain), transportation and so on. All these are factors of production. In a complex commercial environment, each of these factors must be priced in a way that still entices you, the consumer, to still want to buy the product. If they price wrong for too long, hello Chapter 11.
Otherwise perfectly smart people go haywire about wage prices. These Normally Smart People – who drive three miles out of their way to pay ten cents less per gallon in gas – believe that prices don’t matter for wages, that the government can mandate certain wages and benefits and that magically, the laws of scarcity and opportunity cost no longer apply.
The funny thing is, though, wages are just like apples, bowties and Steelers tickets. The more they cost, the fewer are bought. Thus, federal minimum wage law is a de facto mandatory unemployment law. Think for a moment about how the government discourages behavior. Cigarette taxes are designed to curb smoking. Carbon taxes disincentivize polluting. Speeding fines are meted out to deter speeding. These all work on the same formula – make the disfavored behavior more expensive and rational economic actors will act accordingly and reduce such behaviors. But for some paradoxical reason, the government that well understands the deterrent effect of fines and taxes is unable to perceive that increasing wage prices similarly discourages employment (and especially employment of those with low or no skills). In the politicians’ defense, it is conceivable that they are fully aware of the economic (and common sense) consequences of mandatory wage prices but are instead guided by some ulterior political motive; but such discussion, while undoubtedly interesting, is not germane to understanding basic economics.
In Part 2, I’ll address inflation and government spending.