The Insidious Guaranteed Income

26 Sunday Feb 2017

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Artificial Intelligence, Automation, Bryan Caplan, Cash vs. In-Kind Aid, Don Boudreaux, Earned Income Tax Credit, Forced Charity, Guaranteed Income, Incentive Effects, Mises Wire, Nathan Keeble, Permanent Income Hypothesis, Subsidies, Tax Cliff, UBI, Universal Basic Income

Praise for the concept of a “universal basic income” (UBI) is increasingly common among people who should know better. The UBI’s appeal is based on: 1) improvement in work incentives for those currently on public aid; 2) the permanent and universal cushion it promises against loss of livelihood; 3) the presumed benefits to those whose work requires a lengthy period of development to attain economic viability; and 4) the fact that everyone gets a prize, so it is “fair”. There are advocates who believe #2 is the primary reason a UBI is needed because they fear a mass loss of employment in the age of artificial intelligence and automation. I’ll offer some skepticism regarding that prospect in a forthcoming post.

And what are the drawbacks of a UBI? As an economic matter, it is outrageously expensive in both budgetary terms and, more subtly but no less importantly, in terms of its perverse effects on the allocation of resources. However, there are more fundamental reasons to oppose the UBI on libertarian grounds.

Advocates of a UBI often use $10,000 per adult per year as a working baseline. That yields a cost of a guaranteed income for every adult in the U.S. on the order of $2.1 trillion. We now spend about $0.7 trillion a year on public aid programs, excluding administrative costs (the cost is $1.1 trillion all-in). The incremental cost of a UBI as a wholesale replacement for all other aid programs would therefore be about $1.4 trillion. That’s roughly a 40% increase in federal outlays…. Good luck funding that! And there’s a strong chance that some of the existing aid programs would be retained. The impact could be blunted by excluding individuals above certain income thresholds, or via taxes applied to the UBI in higher tax brackets. However, a significant dent in the cost would require denying the full benefit to a large segment of the middle class, making the program into something other than a UBI.

Nathan Keeble at Mises Wire discusses some of the implications of a UBI for incentives and resource allocation. A traditional criticism of means-tested welfare programs is that benefits decline as market income increases, so market income is effectively taxed at a high marginal rate. (This is not a feature of the Earned Income Tax Credit (EITC).) Thus, low-income individuals face negative incentives to earn market income. This is the so-called “welfare cliff”. A UBI doesn’t have this shortcoming, but it would create serious incentive problems in other ways. A $1.4 trillion hit on taxpayers will distort work, saving and investment incentives in ways that would make the welfare cliff look minor by comparison. The incidence of these taxes would fall heavily on the most productive segments of society. It would also have very negative implications for the employment prospects of individuals in the lowest economic strata.

Keeble describes another way in which a UBI is destructive. It is a subsidy granted irrespective of the value created by work effort. Should an individual have a strong preference for leisure as opposed to work, a UBI subsidy exerts a strong income effect in accommodating that choice. Or, should an individual have a strong preference for performing varieties of work for which they are not well-suited, and despite having a relatively low market value for them, the income effect of a UBI subsidy will tend to accommodate that choice as well. In other words, a UBI will subsidize non-economic activity:

“The struggling entrepreneurs and artists mentioned earlier are struggling for a reason. For whatever reason, the market has deemed the goods they are providing to be insufficiently valuable. Their work simply isn’t productive according to those who would potentially consume the goods or services in question. In a functioning marketplace, producers of goods the consumers don’t want would quickly have to abandon such endeavors and focus their efforts into productive areas of the economy. The universal basic income, however, allows them to continue their less-valued endeavors with the money of those who have actually produced value, which gets to the ultimate problem of all government welfare programs.“

I concede, however, that unconditional cash transfers can be beneficial as a way of delivering aid to impoverished communities. This application, however, involves a subsidy that is less than universal, as it targets cash at the poor, or poor segments of society. The UBI experiments described in this article involve private charity in delivering aid to poor communities in underdeveloped countries, not government sponsored foreign aid or redistribution. Yes, cash is more effective than in-kind aid such as food or subsidized housing, a proposition that economists have always tended to support as a rule. The cash certainly provides relief, and it may well be used as seed money for productive enterprises, especially if the aid is viewed as temporary rather than permanent. But that is not in the spirit of a true UBI.

More fundamentally, a UBI is objectionable from a libertarian perspective because it involves a confiscation of resources. In “Why Libertarians Should Oppose the Universal Basic Income“, Bryan Caplan makes the point succinctly:

“Forced charity is unjust. Individuals have a moral right to decide if and when they want to help others….

Forcing people to help others who can’t help themselves… is at least defensible. Forcing people to help everyone is not. And for all its faults, at least the status quo makes some effort to target people who can’t help themselves. The whole idea of the Universal Basic Income, in contrast, is to give money to everyone whether they need it or not.”

Later, Caplan says:

…libertarianism isn’t about the freedom to be coercively supported by strangers. It’s about the freedom to be left alone by strangers.“

Both Keeble and Caplan would argue that the status quo, with its hodge-podge of welfare programs offering tempting but rotten incentives to recipients, is preferable to the massive distortions that would be created by a UBI. The mechanics of such an intrusion are costly enough, but as Don Boudreaux has warned, the UBI would put government in a fairly dominant position as a provider:

“… such an income-guarantee by government will further fuel the argument that government is a uniquely important and foundational source of our rights and our prosperity – and, therefore, government is uniquely entitled to regulate our behavior.“

Fiat Money, Government and Culture

24 Wednesday Aug 2016

Posted by pnuetz in Monetary Policy

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Asset Price Inflation, Commercial Culture, Crony Culturalism, Debt Monetization, Distribution of Wealth, Federal Reserve Act, Fiat Money, Full Faith and Credit, Gresham's Law, Inflation, Jörg Guido Hülsmann, Mises Wire, Redeemability, Tyler Cowan

The money we use every day has roughly zero intrinsic value. That includes paper, coins made from base metals, and electronic bookkeeping entries that can be drawn on via plastic cards and communication devices. We take it for granted that all of these forms of payment will be accepted in transactions. The dollars we use in the U.S. are backed only by the “full faith and credit” of the U.S. government, which is quite a bit of nothing when it comes right down to it. This form of money is called “fiat money” because it derives value essentially by decree, including the government’s willingness to accept your dollars in payment of taxes. It’s a fine thing that such a level of trust exists in society, and most important is trust that the next seller will accept your dollars in trade.

An old maxim in economics known as Gresham’s Law holds that “bad money drives out good”, particularly when the “good money” and the “bad money” are assigned the same legal value in exchange. The good money, having greater intrinsic value than the bad money, will quickly disappear from use as a medium of exchange. Like any asset, the good money will be held as a store of value, but not used in routine transactions.

In the past, our “good money” consisted mainly of claims on precious metals. However, the U.S. government stopped redeeming dollars in gold in the 1930s, silver in the 1960s, and silver coins stopped circulating at about the same time.

What’s so “bad” about fiat money, given that we trust its usefulness in the next transaction? The lack of intrinsic value places its issuing authority, the Federal Reserve in our case, in a position of tremendous power and responsibility as the keeper of the “full faith” of the U.S. government. However, the Fed is privately owned (by banks), and no one at the Fed is elected. The members of its Board of Governors are appointed by the President to 14-year terms. The lengthy terms are hoped to keep the Fed independent and immune to political manipulation. Ostensibly, the Fed conducts policy in the objective pursuit of price stability and full employment. (Never mind that the two goals may be incompatible.)

The Fed, as the authority responsible for the nation’s fiat money, has traditionally allowed the money supply to grow by issuing “new money” in exchange for federal debt obligations, like Treasury bonds. The Fed buys the bonds, and the payment becomes a seed for new money growth. For the Treasury, which raises funds to finance government activities by collecting taxes and borrowing, this mechanism is quite convenient. The Fed can act to “accommodate” the government’s needs, essentially printing money to fund deficits.

Does it happen? Absolutely, although in the past few years, the Fed has demonstrated a more subtle variation on this theme, and one that is cheaper for the government. That will be the subject of a future post. The key point here is that with the cooperation of the monetary authority, the government avails itself of the so-called printing press. Thus, it is not answerable to taxpayers for any expansion in its spending. The government can commandeer resources as it sees fit, with no restraint from the governed.

That’s the key point made by Jörg Guido Hülsmann in a post on the Mises Wire blog, “How Fiat Money Destroys Culture“. On that note, I’d say first that enabling the displacement of private commerce for government-directed activity is a sure-fire prescription for degrading the culture. Government is not and never will be a font of creativity. Capitalism and markets, on the other hand, deliver an astonishing degree of cultural wealth to every segment of society. The freedom to create and share art, cuisine, customs and technology, without interference by government, is the very essence of culture. Some might object that government often serves as a conduit for bringing cultural works to the public, and that government can and does direct resources to the arts. There is an extent to which that’s true, of course, but it may be a deal with the devil: public sector support for new art is often subject to strings, politicization, and favoritism. That’s crony culturalism, to coin a phrase.

Hülsmann discusses other cultural repercussions of fiat money. By enabling the government to compete for resources with the private sector, and by swelling the quantity of money relative to goods and assets, fiat money puts upward pressure on prices. This might manifest in the prices of goods, the prices of assets, or both, and it might be very uneven. This changes the distribution of rewards in society in fundamental ways.

Price inflation penalizes those who hold currency. Hülsmann says:

“In a free economy with a natural monetary system, there is a strong incentive to save money in the form of cash held under one’s immediate control. Investments in savings accounts or other relatively safe investments also play a certain role, but cash hoarding is paramount, especially among low-income families. … By contrast, when there is constant price inflation, as in a fiat-money system, cash hoarding becomes suicidal.“

Price inflation also rewards those in debt. Strictly speaking, this is true only when inflation accelerates unexpectedly, since lenders tend to demand sufficient interest to offset expected inflation. Hülsmann blames the widespread growth of debt financing in modern society on fiat currency. There is an element of truth to this assertion, but it strikes me as an exaggeration, given the advances in financial markets and technologies over the past century or so. We are much better at allocating resources inter-temporally than in 1900, for example, so the growth of consumer and business debt over the years should be viewed in the context of future earning power and enabling technology. Still, there are those for whom these markets and technologies are out of reach, and the destructive effect of inflation on their ability to save should not be minimized. This contributes to greater dependency at the lowest levels of the socioeconomic spectrum, a very regrettable kind of cultural change.

Growth of the money stock tends to reward many at the top of the socioeconomic spectrum, partly because it is associated with stock market appreciation. Again, when the Fed buys government bonds, or mortgage bonds, or any other asset, it always finds willing sellers, usually brokers/dealers and banks. Successful bidding by the Fed for assets is the first step in lifting asset prices (and reducing yields). But market participants tend to know all this in advance. Therefore, private traders will bid up asset prices in advance, assuming that the Fed has indicated its intentions. Other assets, being substitute vehicles for wealth accumulation, will also be bid upward, as a given amount of income produced by an asset is valued more highly when competing yields are low. After the Fed completes a round of asset purchases, the process can repeat itself.

Goods inflation and higher asset prices generated by continuing debt monetization and distorted interest rates tend to skew the distribution of wealth toward the top and away from the bottom. Moreover, if cost and pricing pressure build up in goods markets, those with the greatest market power always fare best. Thus, debt monetization has the potential to be a very inegalitarian process, and one not based on fundamental economic criteria such a productivity. This too represents a damaging form of cultural change.

A more accurate form of Gresham’s law might be the following: government ambition drives out “good money”. The existence of fiat money creates an avenue through which the expansion of government can be funded without approval by current or future taxpayers. This ultimately leads to a stagnant economic environment and a stagnant culture: government displaces private activity, the economy’s growth potential and vibrancy deteriorates, and society’s ability to support all forms of culture declines. To add insult to injury, the process of monetizing government debt punishes small savers and rewards the privileged. The distribution of cultural rewards will follow suit.

Mobility, Safety Nets & Sticky Webs

23 Thursday Jun 2016

Posted by pnuetz in Big Government, Welfare State

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Affordable Care Act, Andrei Schleifer, Basic Income Guarantee, Christopher Jencks, Curley Effect, David Henderson, Dependent Class, Don Boudreaux, Earned Income Tax Credit, Edward Glaeser, Employment Incentives, Extreme Poverty, Henry Hazlitt, Kathryn Edin, Labor Force Participation, Luke Shaefer, Marginal Revolution, Medicaid expansion, Michael Tanner, Milton Friedman, Mises Wire, Obamacare, Social Safety Net, Tyler Cowan, Universal Basic Income, Veronique de Rugy, War on Poverty, Welfare State, work incentives

We’re unlikely to reduce the share of the U.S. population living in economic dependency under the current policy regime. So many aspects of tax law, regulation and aid programs are designed as if to perpetuate or perhaps even worsen the situation. I’ve discussed this topic before on Sacred Cow Chips in “Degrees of Poverty and the Social Safety Trap“, and “Minority Politics and the Redistributionist Honey Trap“.

Many supporters of aggressive anti-poverty efforts take umbrage at any suggestion that government aid might discourage the poor from engaging in productive activities. They imagine an implication that the poor are “lazy”, perfidious or otherwise undeserving of assistance. Whether that is a misunderstanding or merely rhetorical bite-back, the fact is that it is rational to respond to incentives and there is no shame in doing so. Unfortunately, many assistance programs contain incentive traps or income “cliffs” that discourage work effort. This applies to food stamps, rent subsidies, Obamacare subsidies, and many more of the 120+ federal aid programs and other state and local programs.

Here’s a new example from a research abstract posted at Marginal Revolution: The Medicaid expansion had very negative effects on labor force participation. The funding for Medicaid expansion at the state level was authorized by the Affordable Care Act (ACA) — aka Obamacare, but only about half the states went along with it. From the abstract:

“I find a significant negative relationship between Medicaid expansion and labor force participation, in which expanding Medicaid is associated with 1.5 to 3 percentage point drop in labor force participation.“

The direction of impact is hardly unique, and as Tyler Cowen notes at the link:

“Work is good for most people, and it is even better for their future selves, and their future children too.“

The negative impact of Obamacare is more massive than the estimate above might suggest. Veronique de Rugy at Reason.com discusses how “Federal Programs Keep People Poor“. While most of her article is about the negative impact of high marginal tax rates on the employment prospects of the poor, she also recalls an ugly CBO estimate of the ACA’s impact:

“In 2014, the Congressional Budget Office—Congress’ official fiscal scorekeeper—revised its original estimate to report that because of the law, by 2024 the equivalent of 2.5 million Americans who were otherwise willing and able to work will have exited the labor force.“

There are several different channels through which the negative effects of the ACA operate: Small employers are incented to limit their hiring and the hours of employees, and federal subsidies (and sometimes state benefits) are available to individuals only so long as they remain below certain income thresholds. Again, this is typical of many government aid programs (the Earned Income Tax Credit (EITC) being an exception). More from de Rugy:

“When the government takes away a person’s benefits as his income goes up, it has the same effect as a direct tax. And remember, when you tax something, you usually get less of it. That means these programs can actually hinder income mobility: In order to continue receiving their government cash, individuals are forced to limit the amount they earn. Thus, they have an incentive not to try to climb the income ladder by putting in extra hours or signing up for job training and educational programs.“

Mises Wire recently carried a reprint of an essay by the great Henry Hazlitt, “How To Cure Poverty“. The gist of Hazlitt’s argument is that government largess simply cannot create wealth for society, but only diminish it. The mere process of redistributing the current “pie” consumes resources, but that is minor compared to the future reduction in the size of the pie brought on by the terrible incentives inherent in income taxation and many government benefit programs:

“The problem of curing poverty is difficult and two-sided. It is to mitigate the penalties of misfortune and failure without undermining the incentives to effort and success. … The way to cure poverty is … through … the adoption of a system of private property, freer trade, free markets, and free enterprise. It was largely because we adopted this system more fully than any other country that we became the most productive and hence the richest nation on the face of the globe. Through this system more has been done to wipe out poverty in the last two centuries than in all previous history.“

Harvard professors Edward Glaeser and Andrei Schleifer have written about “The Curley Effect: The Economics of Shaping the Electorate“, which posits that redistributive policies that are harmful to constituents can be rewarding to politicians. The paper deals with policies that encourage emigration of affluent voters away from cities, but which nevertheless reward politicians by increasing the proportion of their political base in the remaining constituency. It seems to apply very well to many major cities in the U.S. However, it certainly applies more broadly, across states and nations, when affluent people and their capital are mobile while the less affluent are not, especially when benefits are at stake. It’s no secret that promises of benefits are often attractive to voters in the short run, even if they are harmful and unsustainable in the long run.

The welfare state appears to have helped to sustain many of the poor at an improved standard of living after accounting for benefits, or it has prevented them from falling into “deep poverty”. However, it hasn’t succeeded in lifting the poor out of dependency on the state. Pre-benefit poverty rates are about the same as they were the late 1960s. In addition, Christopher Jencks observes that the “Very Poor” have in fact become poorer. That’s discussed in his review of “$2.00 a Day: Living on Almost Nothing in America” by Kathryn Edin and Luke Shaefer. Jencks presents statistics showing that those in the lowest two percentiles of the income distribution have suffered a fairly sharp decline in income since 1999. Many of these extremely poor individuals do not avail themselves of benefits for which they could qualify. In addition, the EITC requires earned income. A job loss is a wage loss and, if it goes on, a loss of EITC benefits. Unfortunately, work requirements are more difficult to meet in the presence of wage floors and other distortions imposed by heavy-handed regulation.

A guaranteed national income has become a hot topic recently. Michael Tanner weighs in on “The Pros and Cons…” of such a program. There are many things to like about the idea inasmuch as it could sweep away many of the wasteful programs piled upon each other over the years. It is possible to construct a sliding-scale guarantee that would retain positive incentives for all, as Milton Friedman demonstrated years ago with his negative income tax concept. However, as Tanner points out, there are many details to work out, and the benefits of the switch would depend upon the incentive structure built into the guarantee. As a political plaything, it could still be dangerous to the health of the economy and an impediment to income mobility. Don Boudreaux has registered objections to a guaranteed income, one of which is based on strengthening the wrongheaded argument that we derive all rights from government. Even more interesting is David Henderson’s take on a basic income guarantee. He finds that the budgetary impact of a $10,000 guarantee would equate to a 30% increase in government spending, and that assumes that it replaces all other assistance programs! Henderson also discusses the public choice aspects of income guarantees, as well as moral objections, and he concludes that there are strong reasons to reject the idea on libertarian grounds.

The economy is riddled with too many subsidies, penalties and bad incentives that distort the behavior of various groups. The well-to-do often benefit from subsidies that are every bit as distortionary as those inherent in many public assistance programs. They should all be swept away to restore a dynamic economy with the potential to lift even more out of poverty. There could be a role for a guaranteed income on the grounds that it is better than what we’ve got. But we should recall the words of Hazlitt, who reminded us that we’ve come so far on the strength of property rights, private initiative, and free trade. Left unfettered, those things can take us much farther than the ugly pairing of beneficence and coercion of the government behemoth.

Suicides Happen, Guns or Not

20 Monday Jun 2016

Posted by pnuetz in Gun Rights

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British Coal-Gas Story, Don B. Kates, Gary Mauser, Gun Rights, Guns and Suicide, Harvard, Impulsive Suicide, International Suicide Rates, Mises Institute, Mises Wire, OECD Suicide Comparison, Passion Suicide, Premeditated Suicide, Ryan McMaken, Teenage Suicide

heads

Gun-rights deniers often assert that access to guns increases the suicide rate, a question recently addressed by Ryan McMaken on the Mises Wire blog. He shows conclusively that suicide rates across countries are not related to gun laws. While gun ownership in the U.S. is extensive, and most gun deaths in the U.S. are suicides, the U.S. suicide rate is in the middle of the pack for OECD countries. Most of those countries have more restrictive gun laws. In fact, the U.S. suicide rate is lower than in Austria, Finland, France, Belgium, and Japan. Gun ownership rates are extremely low in Austria, France, and Japan. Therefore, suicide rates appear to be unrelated to legal gun ownership and the restrictiveness of gun laws. These facts, and simple logic, suggest that an individual in a state of extreme desperation has alternative means of taking their own life.

The most nuanced argument that guns encourage suicides is based on a dichotomy of premeditated suicides versus suicides of impulsivity or passion. Most impulsive suicides, according to this view, are carried out with faster, less painful and more reliable methods, which would include the use of guns. That’s based in part on interviews with suicide survivors and the mental health records of non-survivors. However, it would not be surprising to learn that survivors actually had less intent to begin with; a comparison is impossible because we can’t ask the non-survivors. And whether a mental health record, or the absence of one, is always a reliable guide to the degree of impulsivity is open to question. So while there are differences in the mental health records of firearm suicide victims versus those who have used less reliable methods, the conclusions seem to rest on fairly unreliable measures of impulsivity or on survivor-only samples. Researchers don’t have much choice in the matter, but drawing conclusions based only on survivors is prone to severe bias.

McMaken shows that guns account for most suicides only among those of age 55 and above, a group that is likely to be the least impulsive. Teenagers might be expected to be the most impulsive, but they tend to have lowest rates of suicide by firearms. However, a teen might not have ready access to a gun even if one is in the home. The teenage suicide rate is even less related to gun ownership across countries. New Zealand, Ireland, Finland and Canada come in much higher than the U.S. on this sad measure, and Australia, Japan, Switzerland, Belgium and Sweden are above the U.S.

At the previous link, the “British coal-gas story” is told to argue that cutting off a common means of suicide will lead to a permanent reduction in suicides. In this case, a changeover from coal gas for heating and cooking to natural gas is alleged to have led to a permanent decrease in total suicides in Great Britain in the 1960s, as death by “sticking your head in the oven” was no longer very reliable. However, other research has found compensatory increases in other forms of suicide, so the coal-gas lesson is suspect.

A Harvard study (circa 2007) by criminologists Don B. Kates and Gary Mauser focused on the ties between guns, murder and suicide; they concluded that suicide does not bear a relationship to gun possession. The authors examined cross-country and within-country data:

“There is simply no relationship evident between the extent of suicide and the extent of gun ownership. People do not commit suicide because they have guns available. In the absence of fire‐ arms, people who are inclined to commit suicide kill themselves some other way.”

Suicide is a manifestation of despair so deep that the victim simply cannot get on with life. Guns have nothing to do with that anguish. It may be true that failed attempts often lead to a renewal of spirit, but survivors still have a high rate of suicidal recidivism. Moreover, the question of the depth of the original intent for survivors is open to question. Those choosing guns for suicide might think it’s the best alternative, but clearly other alternatives will be chosen when guns are unavailable. The claim that access to guns makes people more vulnerable to taking their own lives is not supported by the data.

European Incomes Compare Favorably To Mississippi Delta

29 Thursday Oct 2015

Posted by pnuetz in Europe, Social Democracy

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European economic growth, Euroscerosis, Income comparisons, Median Income, Mises Wire, Mississippi Delta, OECD, Social Democracy, State purchasing power

Europe is no utopia, not even Scandanavia, contrary to the fictional accounts of the American Left. Much of Europe is actually rather pinched by U.S. standards. This link from Mises Wire shows that median incomes in Sweden and Germany would place those countries among the poorest U.S. states. The comparisons at the link are based on OECD data from 2012. Here are some examples in terms of median income:

The U.K. is poorer than any U.S. state (Mississippi is at the bottom in the U.S.);
Sweden is poorer than all but 12 states;
Denmark is below all but 13 US states;
Germany is below all but 9 US states, and France is below Germany;
Only Luxembourg, Norway, and Switzerland would rank as high-income states, were they part of the U.S.

The results are even more striking after adjusting for purchasing power across individual states in the U.S.:

“… we find that Sweden’s median income ($27,167) is higher than only six states: Arkansas ($26,804), Louisiana ($25,643), Mississippi ($26,517), New Mexico ($26,762), New York ($26,152) and North Carolina ($26,819).

We find something similar when we look at Germany, but in Germany’s case, every single US state shows a higher median income than Germany. Germany’s median income is $25,528. Things look even worse for the United Kingdom which has a median income of $21,033, compared to $26,517 in Mississippi.“

Again, Luxembourg is the standout. It would rank as the second highest state in terms of real median disposable income, were it part of the U.S.

Europe certainly has its charms, not to mention its share of old wealth, but the contention that it is more “advanced” economically than the U.S. is laughable. This is not a new development, and economic growth in Europe has been dismal (and negative in a number of countries) over the past eight years. The notion that the socialist democrats of Europe have created a prosperity that the U.S. should envy is a myth.

Artwork or Art Work? Effort or Value?

21 Wednesday Oct 2015

Posted by pnuetz in Human Welfare, Liberty

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Carl Menger, Karl Marx, Labor Theory of Value, Liberty.me, Marginal Product, Michael Bunch, Mises Wire, Ryan McMaken Frederic Bastiat, Value Creation

I know a talented artist who refuses to sell his paintings for less than he values the hours spent rendering them. His work is vibrant and arresting, but he doesn’t sell many paintings, which frustrates him greatly. I know very little about marketing artwork, but I do know that his pricing rationale is foolish. For one thing, the hours expended on a particular work are a sunk cost that he should forget if he wants to sell. And he doesn’t know this, but his opinion on pricing is an implication of Karl Marx’s labor theory of value, the flawed proposition that all value derives from the labor necessary to produce it.

Of course, value is in the eye of the beholder. In any potential exchange, value is determined in the first instance by the subjective assessment of a prospective buyer. Their willingness to pay is based on the enjoyment or utility they expect to gain from the transaction. There is no deal if the seller is unwilling to trade at that price; no one benefits unless the seller is thrilled to do the work without compensation, happy to consume or enjoy their own output, or gratified to simply hold it in inventory. My artist friend isn’t happy with that outcome, but his valuation has not passed a market test. Exactly where is the economic value of his labor? This is a cruel reality to those who scrape by in pursuits that often fail market tests, but it’s a reality that allows resources to be guided into uses that are most highly-valued and that satisfy wants most effectively.

It is surprising to me that the labor theory of value is so thoroughly embedded in the public’s thinking. Ryan McMaken at Mises Wire addresses this point in “Nobody Cares How Hard You Work“. Employers and employees often mistake hours worked and even effort for economic value. Working hard is thought to be admirable, but it is not always consistent with value creation:

“… too many workplaces still subtly communicate to employees the idea that intense effort, usually in the form of long hours, is the best route to a promotion. In fact, though, if you can do your job brilliantly and still leave at 3 p.m. each day, a really good boss shouldn’t object. And by the same token, you shouldn’t cite all the effort you put in when making your case for a raise. Why should a results-focused boss even care?“

At Liberty.me, Michael Bunch’s “A Misunderstanding of Labor and Value” offers some excellent quotes on the distinction, including this from Carl Menger:

“Value is a judgment economizing men make about the importance of the goods at their disposal for the maintenance of their lives and well-being. Hence value does not exist outside the consciousness of men.“

Ignoring the contribution of existing capital to production is an obvious error made by proponents of the labor theory of value, who argue that all value creation should be returned to labor as a reward. Bunch quotes Frederic Bastiat on this topic:

“Without these things [i.e., capital], the labor of man would be unproductive, and almost void; yet these very things have required much work, especially at first. This is the reason that so much value has been attached to the possession of them, and also that it is perfectly lawful to exchange and to sell them, to make a profit of them if used, to gain remuneration from them if lent.“

Yes, capital is man-made wealth, and labor plays an obvious role in its creation. Once extant, however, capital is a productive asset that enhances the productivity of labor as well. As property, its owners must be rewarded at least its marginal product, just as labor must be rewarded at least its marginal product. If the total product is deemed of sufficient value by buyers, then the activity will continue to the benefit of all concerned.

Bunch’s real intent is a bit off-topic: he seeks to refute the notion that patriarchy in the U.S. is active in assigning under-compensated roles to women. I’m not convinced that it’s necessary to debunk the labor theory of value to make that point.

Is the labor theory of value irrational? Yes! Behavioral economists agree, as the links above point out. There are certainly times when the theory drives the subjective market valuations of buyers. Some behavioral economists use this as a rationale for government intrusion, but there is every reason to believe that an external authority would produce more distorted valuations and allocate resources less efficiently than the flawed market participants. And after all, in a free society, it is not incumbent on an authority to second guess private decisions. A good outcome is whatever floats your boat.