Category Archives: The Market Process

How the Overtime Rule Hopes to Design Higher Salaries, But Can’t

The Labor Department has just issued a new overtime pay regulation for salaried employees. Under the new rule, all salaried workers earning less than $47,476 per year must be given overtime pay when they work more than 40 hours in a given week. This roughly doubles the previous threshold of $23,660. This will affect an estimated four million workers, raising their wages by $12 billion over the next decade, or an average of $1.2 billion per year.

By my calculations, that’s roughly $300 per worker per year. That can certainly help families with bills to pay—the problem is that this pay bump comes with tradeoffs. These range from reduced salaries to reduced hours—avoiding overtime pay altogether—to reduced non-wage benefits such as paid vacation, free parking, free meals, and other perks. These tradeoffs could easily cancel out any pay increases, leaving working families no better off than before, and possibly worse off.

Trey Kovacs is CEI’s resident expert on the overtime rule (see also CEI’s coalition letter we sent to Capitol Hill). But I cannot resist commenting on Labor Secretary Tom Perez’s remark that “[t]hese good paying middle class jobs were not a fluke brought about by an invisible market forces. They were good paying middle class jobs by design[.]”

F.A. Hayek’s most famous quote, from his final book, The Fatal Conceit, is “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” Secretary Perez has unintentionally played right into Hayek’s invisible hand.

Employers would be delighted to pay every single one of their employees minimum wage, from the lowest entry-level position all the way up to high-powered senior executives. But they can’t, because market forces won’t allow it. Markets are the reason middle class salaries exist at all. Absent any top-down direction from Secretary Perez or other political operators, employees leverage their skills to bargain for higher wages. If your employer isn’t paying you what your skills are worth, you can take your talents elsewhere.

High turnover and the constant training that goes with it hurt a company’s bottom line. That is why Henry Ford paid his workers very high wages by the standard of the time. As workers gained experience and skill, they created more value. Better for Ford’s bottom line to pay skilled workers a middle class wage and keep them around than to have to constantly search for and train rookies.

A similar process plays out all over the economy, from construction to accounting to photography. Middle class wages are the product of human action, not human design. People respond more readily to their incentives than to political orders. Bottom-up, not top-down.

If anything, the overtime rule gives employers an incentive to be less generous to their employees, not more. And that may be just what we see in the coming years. Secretary Perez’s design will likely turn out rather differently than he intends. This is unfortunate, but also completely foreseeable.

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State of the Union: Economic Band-Aids for Poverty and Unemployment

One of progressivism’s most admirable traits is its concern for the little guy. But many progressive policies for alleviating poverty, unemployment, and other social problems don’t work as advertised. This is because those policies often focus only on the desired outcome, and ignore the deeper processes that ultimately generate those outcomes. This misplaced focus was on full display in President Obama’s State of the Union speech.

This is a subtle point that would benefit from an analogy. Suppose, while slicing vegetables, that you accidentally cut your finger. The sensible thing to do is put on a band-aid. But in the long run, you are far better off knowing and practicing proper knife safety. The band-aid eases the immediate problem. But if you focus on the long-term process of safety, you are far less likely to get hurt in the first place.

Now apply this thinking to the President’s call for passing the $10.10 federal minimum wage bill currently winding its way through Congress. A lot of people aren’t making very much money. The obvious thing to do is legislate a raise for them. Pass it! Some people will clearly benefit; no doubt many of them will appear at press conferences if the increase is enacted. But there is a tradeoff. Those raises are offset by reduced hours and even firings for other people.

There is also an unseen cost to the minimum wage: workers who are never hired in the first place. These minimum wage casualties cannot be trotted out in front of cameras because we don’t know who they are. But we do know that they exist. They are mostly young, and they are disproportionately minorities. These workers lack experience and skills because they haven’t lived long enough to gain them yet. It may not be worth it to pay an employee at that skill and experience level $10.10 per hour.

Pricing people out of employment prevents them from getting the experience they need to get higher-paying jobs later in life. It makes the old paradox even more painful: without experience, you can’t get the job, but without the job, you can’t get experience.

The chase after an end result—higher wages for low-skilled workers—ignores the larger social processes at work in the economy. In the long run, wages are tied to productivity. The more a worker produces, the more his services are worth to his employer. Instead of mandating higher wages, a process-oriented reformer emphasizes policies that allow workers to be more productive.

A deregulatory stimulus along the lines of what Wayne Crews and I have been proposing for some time would do nicely; workers would spend less time complying with rules and more time being productive, and thus better paid. It would also remove obstacles to innovation and technological advance that are the long-run drivers of increasing productivity and wealth creation. When that process is blocked, wages stagnate.

Unfortunately, the topic of regulation did not come up even once during the entire speech. Hopefully this does not reflect the administration’s priorities.

The same outcome-over-process oversight is in the President’s proposal to extend–restore, in his words–unemployment benefits. If someone loses their job, the obvious thing to do is to give them a helping hand while they look for a new job. But again, unemployment insurance has tradeoffs that at least offset the advantages.

People respond to incentives. And unemployment benefits reduce one’s incentive to look for a job. They allow some people to wallow in discouragement longer than they otherwise would. Other people decide that receiving benefits can let them wait until a higher-paying job opens up, instead of having to take an available, if unappealing job right away. The result is unnaturally high unemployment. This is not the policy’s intention, but it is very much its result.

More effective policies would make the hiring process easier. Reducing compliance burdens would reduce the regulatory friction scraping against otherwise-promising new hires.

As companies grow, more and more rules affect them. When a company reaches 4 employees, it becomes subject to the Immigration Reform Act and its associated paperwork. At 15 employees, the Americans with Disabilities Act comes into play, and the Family and Medical Leave Act announces its presence at 50 employees. There are many others.

Many companies stop hiring when they come up against these thresholds, because they can’t afford them. Reducing these burdens would do far more to ease the sting of unemployment than extending unemployment benefits.

As in past years, the President used Tuesday’s State of the Union speech to describe the equivalent of band-aids for injury-prone cooks. But he seems unaware that the long-run process of practicing kitchen safety is what it takes to ultimately reduce the amount of culinary casualties. As in the kitchen, so in the economy.

CEI Podcast for November 12, 2013: CEI’s “I, Pencil” Film Wins Award

I-Pencil
Have a listen here.

CEI’s short film “I,Pencil,” based on Leonard Read’s 1958 essay, won the first annual Reason Video Prize on November 6. The prize honors short-form films on individual rights, limited government and the free market. Nicole Ciandella wrote the adapted screenplay for the film.

Markets in Everything: Rat Tails

During the Korean War, the Chinese government accused the U.S. of engaging in germ warfare–air-dropping canisters filled with germs and bacteria-infused insects and pests not just in Korea, but in China, too. The accusation sounds ridiculous now, but at the time, it sounded somewhat plausible. General MacArthur, after all, openly mused about using nuclear bombs in Korea, and nearby Japan used biological weapons just a few years earlier during World War II.

The propaganda campaign caused a nationwide scare, as well as major cleanup efforts. As historian Frank Dikötter explains on p. 148 of his new book, The Tragedy of Liberation: A History of the Chinese Revolution 1945-1957,
the campaign also caused a most unusual market to form:

From north to south, people were also required to kill the ‘five pests,’ namely flies, mosquitoes, fleas, bedbugs[,] and rats. In Beijing every person had to produce the tail of one rat every week. Those who greatly exceeded the quota were allowed to fly a red flag over the gate of their house, while those who failed had to raise a black flag. An underground market in tails rapidly developed.

Market orders emerge, even during some of history’s darkest hours.

How to Shut Off a Great Debate

Aaron Ross Powell has an excellent, thought-provoking  post over at libertarianism.org on how many of classical liberalism’s opponents tend to argue against libertarian caricatures that have very little to do with the real thing. This talking past one’s target instead of to it hurts both sides. Progressive and conservative thinkers would benefit from testing their ideas against quality opponents. And libertarians/classical liberals are unfairly tarred. Ad hominem attacks are getting in the way of what could be an enlightening intellectual discussion for everyone involved.

Aaron held his fire to one common attack fallacy, that state equals society. But there are more. One of them has been around for at least 80 years, when Hayek made his first public lectures in the 1930s at the London School of Economics. One of those lectures later became the title chapter of volume 3 of his collected works, The Trend of Economic Thinking. His familiar lament appears on pp. 14-15 of that book:

 No serious attempt has ever been made to show that the great liberal economists were any less concerned with the welfare of the poorer classes of society than were their successors. And I do not think that any such attempt could possibly be successful.

Instead, (classical) liberal apathy towards the poor is simply assumed. The argument can be summarized as follows:

  1. The primary concern of many progressives is helping the poor.
  2. Libertarians tend to favor different economic policies than progressives.
  3. Therefore, libertarians do not care about the poor. QED.

This is not a rigorous argument. Steps 1 and 2 are mostly true. But an Olympic-caliber long jumper couldn’t make the leap to step 3. It denies the possibility that the two sides simply prefer different means to similar ends.

This is a shame. There is a wonderful debate just waiting to be had on a number of fronts. Are the poor better served by letting economic processes emerge from the bottom up, or by expertly managing the economy from the top down? Which focus is more important to bettering the lot of the poor, absolute poverty or relative poverty? Is it better to approach the economy as a biologist, seeking merely to understand evolving market processes, or is it better to be an engineer, with an aim to tinker, fix, and improve specific outcomes?

Classical liberals tend to prefer the first answer to each of those questions; progressives tend to favor the second answer to each. But to the extent that the two sides engage each other at all, it tends to be of roughly the same tenor and quality as the “they don’t care about the poor” argument outlined above. An honest debate requires the end of such reflexive ad hominem attacks.

Adam Smith himself, painted by people who haven’t read him as the ultimate atomist individualist, based his whole defense of free markets on his belief that they would bring the masses out of poverty and into prosperity. This was his highest priority. His belief in the deep interconnectedness of people across the world, brought together by our shared natural tendency to truck, barter, and exchange, is also why economics is inherently a social science.

But reading Adam Smith can be a chore, which is why few people bother. Let’s look instead at the raw data, as provided by Jim Gwartney and many others in the annual Economic Freedom of the World report. They find that, in absolute terms, poor people are far less poor in relatively free-market countries than in more controlled economies.

This opens up an entirely new area for honest intellectual debate. Nothing close to a pure free-market economy exists on Earth. So is this free-market prosperity due to the free-market elements that do exist, or is it due to the mixed economy’s more constructivist elements? To my knowledge, this debate has not happened. This is largely because of thought-closing fallacies such as Powell takes on in his post, and the ones I discuss here and elsewhere.

Smart Process, Not Just Smart People

Don Boudreaux’s latest Pittsburgh Tribune-Review column is simply superb, echoing both Israel Kirzner and Deirdre McCloskey:

The undeniably smart Steve Jobs’ vision for an affordable smartphone was dazzlingly creative. But that vision would have amounted to zilch had not many other people been available to help make Jobs’ vision a reality. Some of these other people were also smart. Others were of only ordinary intelligence. And almost every one of them was a complete stranger to Jobs.

Yet somehow, they all cooperated with Jobs and with each other to create the iPhone.

What has not been around, unlike smart people, for tens of thousands of years is the smart process that encourages the globe-spanning cooperation that makes goods such as the smartphone possible.

As Don points out, this “smart process” is a market economy. This is the Kirznerian insight that a market is not a thing or a place. It is an ongoing, never-ending process. Or, as Kirzner described market competition, a discovery procedure. Don also alludes to Deirdre McCloskey’s insight that this smart process cannot work unless people let it. Public opinion has to value things like innovation and commerce, and not look down its nose at them. The more that people denigrate entrepreneurs, the fewer of them there will be — and that means no smart phones, no matter how many smart people there are.

Read the whole thing.

CEI Podcast for November 16, 2012: I, Pencil: The Movie


Have a listen here.

Nick Tucker, producer and director of the new CEI short film “I, Pencil,” discusses the importance of Leonard Read’s classic essay, how the project got started, and how ideas like spontaneous order and connectivity are genuinely inspiring.