Volume 2, Number 45
14 May 2002

Economics Distorted

Dear Friends,

In TQE #44, I said that profits are earned through (1) innovations, (2) producing goods people want, and (3) operating efficiently. But Will Candler of Annapolis MD reminds me that profits also arise out of (4) pay-back (including tax breaks) for political support and (5) financial engineering. Will is right, but there are even more: (6) monopolies, (7) subsidies, and (8) rent and price controls. However, only the three that I mentioned are genuine profits; the rest are economic distortions.

The economic system becomes distorted when gimmicks are used to alter not only profits but the income from land and labor as well. Besides those mentioned above, gimmicks include the minimum wage, the "living wage," agricultural subsidies, tariffs, and other barriers to trade. These gimmicks all have in common that they reduce total production to less than would be physically possible with any given expenditure of resources, and they redistribute income from the politically invisible to those with greater political clout.

How? Well, the minimum wage and living wage cause employers to hire fewer workers and use machines instead, at greater total cost than workers alone at market wage. Those still at work benefit, while the invisible are those who are dismissed or who cannot be hired because their skills are worth less than the minimum or "living" wage. Farm subsidies cause farmers to grow the wrong crops, those that would not otherwise be marketable. Tariffs and other trade barriers lead us to produce goods that can be made abroad with less expenditure of resources.

I have told you before how I spent 25 years reading history books to discover how the world came to be divided into rich and poor. One of my conclusions, which I set forth in Centuries of Economic Endeavor (University of Michigan, 1994), is that those nations that became rich are the very ones that traded most and that formed the freest markets, with fewest economic distortions.

Their wealth did not come from imperialism. The greatest imperialists of twenty centuries were Rome, Russia, Spain, Portugal, Ottoman Turkey, Mongolia, the Incas, the Aztecs, and the Islamic countries. None of these became wealthy. On the other hand, a highly-praised book by Angus Maddison (The World Economy: A Millenial Perspective), just published last year, estimates that the development of Britain and France began before 1000 AD, much earlier than their imperialist days. Their wealth correlates more closely with inventiveness, innovation, and trade. No, the rich nations did not get rich by stealing from the poor.

As I explained in TQE #44, profit is both the life blood of the economy and one of many ways in which greed is made manifest. The other founts of greed include excessive wages (as in baseball players, speaking engagement fees charged by former high government officials, and CEOs), and in government intervention to transfer resources, in nonmarket ways, from some persons to others. The latter include farm subsidies, which cause the politically invisible poor to pay rich farmers excessively for their food. They also include all those activities, such as social security and health care, which could more efficiently be undertaken by private companies.

Social security and health care? Those very basics of human existence, that everyone should have? Yes, everyone should have them, but they need not be provided by government. Unlike my libertarian friends, I am even ready to say that we should tax the rich to subsidize social security and health care for the poor. But pay it in cash, require that it be spent for its purpose, and let the recipients choose the providers. Consider the money value of the hours and days spent by Congress deciding how much of these, and what kinds, everyone should have (one size fits all), and one easily sees what an inefficient use of time that is!

What, subsidize the poor? Did I not say that subsidies cause distortions? Yes, that too. Subsidies cause people to produce what would not otherwise be bought. In this case, retirement benefits and health care. True, a distortion, but I did not say all distortions are bad. Only most of them.

Now, let me turn to my omissions in TQE #44: (1) capital gains, (2) socially-desirable investment, (3) short-term capital flows, and (4) nonprofits.

Capital Gains

Are capital gains among the profits that are the life blood of the economy? The main difference is that profit is part of the real value of goods sold. Except for distortions, cost plus profit equals real value. But capital gains might be a nominal increase only. Suppose I sell you a house for $100,000, then all prices go up 50%, so you sell the house for $150,000, you have a capital gain, but it is the same house, with the same value relative to other goods. No real value has been created.

However, capital gain reflects an increase in real value when dividends are reinvested. For example, the reinvested earnings might buy new machinery. The monetary counterpart to this is an increase in the value of the stock held by the stockholder, therefore a capital gain.

The free market directs profit, whether in dividends or capital gains, to go where it is needed most. But in the Soviet Union and many less developed countries, profit was invested largely in political boondoggles, such as war, white elephant projects, payoffs to maintain and increase the ruler's power base, etc.. This explains much of why the USSR collapsed and why most of Asia, Africa, and Latin America is today underdeveloped.

It also explains why Hong Kong, Singapore, South Korea, and Taiwan raised the levels of their poorest to European standards in fifty years. It even explains why, after a quarter century of both consulting in the Third World and reading history, I converted from an economic planner into a classic liberal.

Socially-desirable investment

Should Friends invest in socially-desirable investment (no liquor, no guns, no war support)? Of course, if you wish. You can do that in a free market. The less free the market, the less possible it is for you to invest in line with your morality. It may be that you happen to agree with the morality of market interventions, but what about those times when you don't? Only a free market lets you act morally at all times.

Short-term capital flows

What about short-term money, that flits from country to country in search of the highest income, often destabilizing economies in their flights? This is sometimes known as "hot money." Nobel Laureate James Tobin, who died earlier this year, suggested a small tax on foreign exchange transactions (the "Tobin tax") to hinder such movements.

While most economists think of hot money as negative, I look at it a different way. Its adverse consequences chastise volatile governments for creating the conditions that cause money to come to and go suddenly. The Tobin tax is another way by which government tries to offset a problem that government creates. (Actually, Jim and I were in graduate school together. He was a good friend whose astuteness I often envied.)

Nonprofit organizations

What about nonprofit organizations? Well, here it depends on the organization. They do require capital, provided by charitable persons. Some nonprofits are good, some not. I can't make any generalization. I do remember a sign in a store window once: "This is a nonprofit company. It wasn't intended to be, but that is the way it turned out."

Sincerely your friend,

Jack Powelson

Readers' Comments:

Please send comments on this or any TQE, at any time. Selected comments will be appended to the appropriate letter as they are received. Please indicate in the subject line the number of the Letter to which you refer! The email address is tqe-comment followed by @quaker.org. All published letters will be edited for spelling, grammar, clarity, and brevity. Please mention your home meeting, church, synagogue (or ...), and where you live.

Call me cynical, but what about serfdom, wage slavery, and slavery? Could France and Britain have become so wealthy without the exploitation of human beings that occurred during this time period? I don't know how you or anyone can assert that these nations and others "did not get rich by stealing from the poor." Stealing human beings and enslaving them, forcing human beings to be tied to the land for existence and exploiting the labor of human beings without just compensation is certainly stealing in my book. But then, maybe it is just the "free market" price of doing business then as it is now.

— Jennie Crystle, Manitou Springs (CO).

I enjoyed your most recent edition of TQE. As you may well know, however, there is a powerful counterargument to several of the comments that you made regarding the creation of wealth by Western nations, particularly Great Britain. Eric Williams, in his 1994 book Capitalism and Slavery, argued that a significant fraction of the wealth used by Great Britain to launch its Industrial Revolution derived from the labor performed by black slaves on the sugar and tobacco islands of the West Indies during the early and mid-eighteenth century. Williams stated his thesis in fairly extreme terms, maintaining that, in effect, slavery launched British industry. Even though most historians have not adopted this extreme viewpoint, and many have taken issue with various of the details in his book, I do think that Williams' work has convinced many that at least some of the new wealth created in Great Britain during the late eighteenth century was indeed stolen from enslaved Africans.

— Chris Johnson, Manitou Springs (CO).

But Jack, if you "require that [government subsidy for social security and health care] be spent for its purpose," aren't you preempting my right to prioritize my own life — to choose high living before 65 over comfortable (or any) life after 65? By the way, I'm 66 and enjoying it, but there may be others who would not choose as I did. So maybe I don't have to spend the subsidy at all, but then I shouldn't be taxed for it, should I? Also, why retirement and health care? Aren't food, clothing, and shelter even more important?

— Bob Sheffield

You are absolutely right in all of this, and I share your sentiments. But I am thinking of "free riders," or those who specifically do not pay for goods that society, out of its compassion, will provide for them anyway. Our society will no longer allow people to die in the street because they do not have health insurance (I hope). — Jack

Nice to hear favorable words about profits and free markets in a religious or moral context; so many persons seem to think they are always in conflict. How do you describe the effect of a criminal statute, such as penalties for distribution or possession? Or a regulatory statute, such as FDA testing, licensing and prescription requirements? Are these distortions or subsidies of the drug market? or morally based? Or both? Justified? Same questions for environmental issues. My view is that government has a role to play in setting the rules, but I dispair of finding a method to minimize those rules and to keep the politicians from constantly declaring the need for more and more detailed rules. Thacherism raised some hope for a middle way between ossification and revolution, but it seems to be losing force.

— Richard Decou, Moorestown (NJ) Friends Meeting.

Perhaps if we take your statement that the rich nations did not get rich by stealing from the poor, we still must deal with the fact that they did go on to eventually do that: take over the resources from other (poor) places without commensurate compensation. What then is the role of ethics? Much of the effort to "tinker" with free economy, whether competent and effective or misguided and tragic, is born of real needs for equity and justice, to improve the status quo that has resulted if a strictly free economy runs on its own. Whereas the market does maximize profits, it has no compassion. People with compassion have the power to impose ethics on their actions. If we don't allow ethics to postulate that certain wages are exploitive of dire need, if we say that if someone who has not been able to produce something worth trading can just starve, if we say that people must accept the free market consequences without interference, then where is the role of ethics, or of charity?

— Steve Willey. Sandpoint Friends Meeting

Ethics and charity can be expressed by sending such people money and/or offering to help them produce something worth trading, if that is what they want (but don't do it if they don't want it). In a compassionate society, no one should starve. — Jack

I would like one of your future letters to treat irredeemably low-productivity professions like nursing, care giving, social work, artists, musicians, writers, teachers and child care workers, police and firemen and so on. I notice that a capitalist society doesn't necessarily deliver all the things we may desperately need. A little distortion in this direction would be fine with me!

— Trudy Reagan, artist, Palo Alto (CA) Meeting

I am an advocate of socially responsible investing. I have usually beaten the bench marks slightly. But I have a different twist on it. I am looking for well managed companies. Companies that try to protect the environment, have a loyalty to their employees, and learn from diversity tend to be well run. I also like a decentralized management structure. I do analyze their financials. I do not make a bad investment just because it looks like a well run company. I tend to be a long term investor. That saves transaction costs. It is remarkable how often in a free economy that you can do well doing good.

— Lee B. Thomas, Jr., Friends Meeting of Louisville (KY).

I would like to express my appreciation to you for having produced one of the few intelligent and interesting web sites that I have encountered to date.

— William Hibbs, Philadelphia (PA) Friends Meeting.

Economic theory is truly distorted! It is distorted in assumption. I urge friends to visit various parts of Dieoff at yahoo for intelligent discussion of the reasons that economics fails the test of science. There is a large literature in ecology that discusses the failure of economics. [Editor's note: the Yahoo discussion Dieoff seems to have died off, but interested readers can go to http://dieoff.org/ instead for similar material. — LC, 2 March 2005]

Economics fails to address the issues of thermodynamics. This may seem strange reason to question it, but all other sciences subsume the more basic sciences. Biology does not reject the laws of chemistry, does it reject the laws of physics, Economic theory totally ignores the fact that it is contained within the earth's ecosystems. It does this because it has to explain why exploitation of natural resources, slave labor, are Good for the earth. Economics is the constant reinterpretation of human history in the service of those who favor accumulation of wealth; the hubris is incredible. It does not address the ecological/ biological reality in which it is subsumed!! The incredible rate of other species extinctions is a serious indictment of the whole field of study, but economists as a whole totally ignore these 'losses.' Only human centered wealth is valued!

For those of you looking for religious references please read about Jubilee, and the biblical teachings of Jesus. Forgiveness of debt and redistribution of wealth, was a concept Jesus clearly supported.

— Charlie Thomas, Cascabel Worship Group, Tucson (AZ).

Two comments: (1) That's not the economics I studied, and (2) Charlie, do you redistribute only your own wealth and forgive only debts to you, or would you require that others do the same? — Jack


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Publisher: Russ Nelson, St. Lawrence Valley (NY) Friends Meeting

Editorial Board

  • Roger Conant, Mount Toby Meeting, Northampton, MA.
  • Caroline Conzelman, Boulder (CO).
  • Ann Dixon, Boulder (CO) Meeting of Friends.
  • Virginia Flagg, San Diego (CA) Friends Meeting.
  • Merlyn Holmes, Boulder, Colorado.
  • Janet Minshall, Anneewakee Creek Friends Worship Group, Douglasvillle (GA).
  • Jack Powelson, Boulder (CO) Meeting of Friends, Principal Editor.
  • J.D. von Pischke, a Friend from Reston, VA.
  • Geoffrey Williams, Attender at New York Fifteenth Street Meeting.

Members of the Editorial Board receive Letters several days in advance for their criticisms, but they do not necessarily endorse the contents of any of them.

This newsletter was formerly known as The Classic Liberal Quaker.

Copyright © 2002 by Jack Powelson. All rights reserved. Permission is hereby granted for non-commercial reproduction.

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