Category Archives: The Market Process

Jean-Baptiste Say on Manufacturing Nostalgia and Industrial Policy

There is a reason the classics never go out of style. For example, on page 62 of Charles Robert Prinsep’s translation of Jean-Baptiste Say’s 1803 A Treatise on Political Economy, Say writes:

Production is the creation, not of matter, but of utility.

That one sentence captures one of today’s major debates: the decline of manufacturing. Which matters more: output for its own sake, or the value people get from that output? Most economists agree with Say that utility matters more. It doesn’t matter how much steel a factory can crank out if people don’t get value from it. On the opposite side are economic populists such as Oren Cass on the right and Sen. Sherrod Brown on the left.

Many politicians are convinced that manufacturing is in decline, and are advocating far-reaching industrial policies from Washington to save it. Unlike Say, they seem to believe that there is something intrinsically better about creating physical goods, rather than services, ideas, or technologies. To them, matter is what matters most. This is not a reductio ad absurdum. Cass, in his book The Once and Future Worker, advocates subsidizing industries and even entire towns engaged in manufacturing, even if their products create so little value that few people want to buy them. Rather than doing more with less, Cass argues for the opposite.

This view is mistaken in two ways. First, according to the data, U.S. manufacturing is in good health. Second, the size of this or that sector doesn’t matter anyway. What does matter is that people are able to create as much value for each other as they can. Sometimes that involves manufacturing, and sometimes it doesn’t. Policy makers in Washington will never be in a place to correctly decide that ever-changing mix.

Pre-COVID manufacturing output in the U.S. was at near-record levels, though dented a bit by President Trump’s trade policies. It is still too early to tell what COVID’s impact will be, but it almost certainly will not be good. Fortunately, economic fundamentals remain strong. While recovery will likely take a few years, manufacturing will likely resume its long-term steady climb.

Even when populists do acknowledge the data, they worry that manufacturing output growth is slower than in other sectors of the economy. This is why manufacturing’s share of GDP is smaller than it used to be. This is just a more nuanced version of the same mistake. The percentage of GDP taken up by this or that industry does not matter. What matters is that consumers are free to spend on what gives them value.

The ongoing shift from manufacturing to services is hardly at the same level as the earlier shift from farming to manufacturing. But the impulse to oppose the change is the same. Even Adam Smith, who was no Luddite, distinguished between “productive” labor, which was agricultural, and “unproductive” labor, which was most non-agricultural. Today, Cass and other industrial policy advocates draw a similar distinction between productive manufacturing and less productive non-manufacturing jobs.

The data have a problem with this argument, too. Even back in the 1940s and 1950s, the service sector had roughly triple manufacturing’s GDP share. The populists’ fixation on ratios, rather than how much wealth people are creating, is a similar mistake to the one in the inequality debate Iain Murray and I pointed to in our paper “People, not Ratios.”

Say’s Treatise was published in 1803, about a generation after Adam Smith and right at the point in history when industrialization was becoming noticeable in Say’s native France. This was the beginning of the Great Enrichment that has raised incomes in the richer countries by 30-fold or so, and is still operating today.

This brings up the second flaw in today’s economic populism. Not only do populists often get the data wrong, they make a fundamental error about what people value.

Say’s insight is that if people value something, it doesn’t matter if it was made this way or that way, or on a farm or a factory, or even whether it is a physical product that a person can hold, or sit on, or drive. This is true regardless of an industry’s NAICS code, which is an artificial distinction anyway.

The whole point of labor is to create value for people, not to create it only in ways that Peter Navarro or Elizabeth Warren approve of. As Say says, what matters isn’t matter; it’s utility.

Time for a Federal Price Gouging Law?

Amazon’s vice president of public policy, Brian Huseman, calls for a federal price gouging law in a recent post over at Amazon’s in-house blog. This is a bad idea for several reasons.

One is that there are already effective ways to reduce price gouging without regulation. At Amazon, Huseman writes, “We deploy dynamic automated technology to proactively seek out and pull down unreasonably priced offers, and we have a dedicated team focused on identifying and investigating unfairly priced products that are now in high demand, such as protective masks and hand sanitizer.”

This should be a competitive selling point for Amazon, not a call for more regulation. Regulations, remember, are made by the government we have, not the government we want. Amazon’s technology and in-house policies are almost certainly more effective than what Donald Trump, Nancy Pelosi, or Mitch McConnell would enact during an election year and a pandemic. Company-level policies are also more adaptable than federal-level policies as technology and circumstances change.​

In fact, if Amazon isn’t already doing so, it could license or sell its anti-price gouging technology to competitors for a profit. Price gouging is unpopular, and companies that fight against it look good to customers. Amazon does not need federal regulations to force this business opportunity into being.

Looking at price gouging legislation from Amazon’s perspective, but without the public relations filter, they stand to gain three things from a federal price gouging law:

  1. Regulatory certainty. One federal standard is easier to follow than dozens of state standards.
  2. Liability protection. Amazon will face fewer price gouging lawsuits if the company is cooperative with legislators, or even has a hand in crafting the rules.
  3. Rent-seeking, which is economists’ term for using government for unfair advantage. Price gouging legislation is a way for Amazon to raise rivals’ costs without having to improve its own offerings. Amazon has already invested in artificial intelligence algorithms (AI) and in enforcing guidelines for its third-party sellers. Many of Amazon’s competitors have not, especially the smaller ones.

There is something to be said for the first two items, though there are also arguments against them. But the third item, rent-seeking, is anti-competitive behavior at its worst. One of the primary reasons CEI opposes antitrust regulation, for example, is that antitrust regulations themselves are a major rent-seeking opportunity. Big companies routinely game the rules to thwart competition. Price gouging legislation is another example of the same rent-seeking process. These initiatives happen when companies compete in Washington, rather than the marketplace.

Other Factors

Amazon’s call for a price gouging bill might be part of a larger effort to get itself out of antitrust crosshairs. Ironically, such a bill would make retail less competitive. Not only would Amazon raise rivals’ costs, legislation would prevent companies from competing with each other to offer price gouging policies their customers most prefer.

The timing is as bad as the idea itself. Retail sales declined by 16.4 percent in the month of April, the worst ever recorded—for the second month in a row. Retailers have enough to deal with without having to spend resources complying with new rules their competitor helped to write.

There is a federalism angle, as well. A federal rule would impose standards on more than a dozen states that intentionally refuse them.

Prices Are More than Money

As any good economist will tell you, money isn’t everything. Prices are a lot more than money. Every good has a mix of both money and non-money prices. Price gouging legislation is ultimately ineffective because it only reduces ­money prices during a crisis. Tamping down on those means more severe non-money price increases. These cannot be legislated away.

A high money price causes people who don’t urgently need toilet paper or hand sanitizer to hold off until later, when the price goes back down. That leaves more left over for people who need it now. This matters a great deal during an emergency. On the other side of the equation, that same money price increase also induces producers and distributors to go the extra mile, often literally.

What about non-money prices? One example of a non-money price is when a good becomes harder to find. You might have to drive to a store further away or do some deep digging online for some potentially shady sources. Queuing and waiting lists emerge or shipping times might take longer. These things don’t cost money, but they still have a price. They are not measured in dollars, but in wasted time, extra hassle and stress, and lost opportunities. These non-money price increases leave people with less time left over for other things such as job searches, home schooling, or even taking some time for self-care.

Shortages will happen during a crisis. That is unavoidable. The question is how to deal with them. Just as pushing on a balloon doesn’t change how much air is in it, squeezing down on money prices with a price gouging regulation doesn’t actually do anything to stop price increases. It mostly just redirects them to non-money areas.

What is the correct mix of money- and non-money prices? That is a subjective value judgment. There is no truly right or wrong answer, which is another reason why federal price gouging legislation is bad policy.

Public opinion is pretty well set against price gouging. Importantly, though, most anti-price gouging activists have likely not considered the tradeoffs they would pay in steeper non-money prices. Some of them would likely change their mind if they did. Pollsters should find out. Corporate PR departments would likely change their tune quite a bit based on the results.

Federal price gouging legislation would not stop price increases or alleviate shortages. It would sharply increase non-money prices during emergencies and drive some economic activity into black markets. Companies can set their own price gouging policies without regulation, as Amazon has proven with a mix of AI and sanctions against violating sellers. The rent-seeking aspect of potential price gouging legislation is worth considering for people concerned about business ethics and about large companies gaining an unfair advantage over smaller rivals.

In short, a price gouging bill is #NeverNeeded. Congress has already passed enough harmful flash policy. There’s no need for still more.

Alvin E. Roth – Who Gets What ― and Why: The New Economics of Matchmaking and Market Design

Alvin E. Roth – Who Gets What ― and Why: The New Economics of Matchmaking and Market Design

Roth co-won the 2012 economics Nobel. His work focuses on solving coordination problems in markets. His most famous work is on matching donors and recipients for kidney transplants. But his insights also apply to other areas from matching college dorm roommates to football bowl game opponents, to marriage matchmaking, to residency and internship assignments for medical school graduates.

He has also greatly improved K-12 school placement systems in cities that allow a limited amount of school choice, such as New York City. In ranked-choice systems, many parents found it in their interest to rank their choices not in their actual order of preference. This level of gamesmanship gummed up the works for both parents and schools, and prevented honest signals from being sent. Borrowing from auction theory, Roth devised a lottery system that worked best when parents honestly ranked their order of preference when applying for schools. This made life simpler for parents, students, and schools, lowered the transaction costs of engaging in the lottery system, and made for better matches all around. Roth advises that similar lessons apply to students applying to college. Apply to the best schools you can, but don’t do early admission unless you have enough information to know that’s your best match. At the same time, apply to some “safe schools” since the better schools tend to be more competitive.

Crucial to Roth’s work is his distinction between thick and thin markets. Thick markets have numerous buyers and sellers with all manner of different preferences. Thin markets are much more difficult to find matches in. Some of the biggest challenges Roth has faced involved thin markets that lack a price system. For example, not only do kidney donations have to match the recipient’s blood type, it is illegal to compensate the donor in every country except, of all places, Iran.

This is where Roth falls short. The obvious solution is to allow price systems to emerge. As numerous economists have pointed out, banning compensated organ donations quite literally kills people. It is one of the most immoral policies a government can enforce. Roth’s work has consisted of second-best workarounds of these bad policies. He has saved hundreds, if not thousands of lives—his Nobel is well-earned. The trouble is that Roth is aware that his matchmaking work treats symptoms rather than problems, and seems content to leave it at that. He does not oppose paid organ donations. But he is also in no hurry to work to change social norms and government policy in a more humane direction.

The astute reader will notice that even in lower-stakes markets where Roth has worked on solving coordination problems, they tend to be either non-profit markets or markets that do not use money. He has devised brilliant systems to work around a lack of a price system, and some good rules of thumb that any non-price market designer can use. But, as with organs, in many cases the better solution is simply to introduce a price system where possible.

At one point, looking back on one of his more successful designs, Roth was proud to view himself as an engineer, rather than a mere student, seeking understanding. This is hubris on his part. Adam Smith famously warned that people are not chess pieces that can be moved around the board as a planner sees fit. The pieces have their own wants and desires. They move on their own in ways nobody can foresee. Roth’s second-best solutions are often improvements. But they are just that—second-best. Even the wisest, most compassionate designer cannot meet peoples’ needs as well as an honest price system can allow people to adapt and create for themselves, on their terms.

Vlad Tarko – Elinor Ostrom: An Intellectual Biography

Vlad Tarko – Elinor Ostrom: An Intellectual Biography 

Tarko is quickly establishing himself as a top-notch economist. In this, his first book, he offers the best available introduction to Nobel Laureate Elinor Ostrom’s work and the concept of polycentrism. Ostrom was the first, and so far the only, woman to win the economics Nobel [Update: I wrote this review before Esther Duflo co-won the 2019 prize in October]. She and her husband Vincent, also an accomplished economist and political scientist, ran a famous Workshop at Indiana University where they paid less attention to disciplinary boundaries than they did to solid theoretical and empirical research.

Elinor Ostrom also popularized the concept of polycentrism. It’s essentially a more finely graded version of federalism. The United States’ federal system has three main levels of government—federal, state, and local, plus a few in-between grades, most commonly counties. But not all services, Ostrom argues, fit cleanly into one of those categories. Services such as parks, police, and schools, have nothing to do with each other. They may also have different optimum characteristics. So why are they often provided at the same fixed level of government? What if a school district’s optimum size extends beyond a city’s boundaries? What if a park district would be better run as multiple, hyperlocal districts? Moreover, these optimum sizes will vary from place to place. A further complication is that these optimum sizes and structures are constantly changing and evolving as culture, technology, and demographics change. Nothing else stays the same, so why should the sizes of government “firms?”

From this polycentric framework, Ostrom teases out some ground rules for institutional design. One is that smaller is usually better. Most federal issues can be more effectively handled at the state level. Many state-level issues can be handled at smaller gradients, whether regional water or irrigation authorities, transportation authorities, or neighborhood-based policing, a term which now means nearly the opposite of what it did when Ostrom began using the term. Two, because times change, institutions need to be designed with flexibility in mind. They need to be able to grow, shrink, merge, separate, and evolve as circumstances dictate. The goal is the service, not this or that corporate structure, so make change easy.

Ostrom was much more than a theorist. She placed a far greater emphasis on field research than most scholars. This empirical backing greatly improved not just her own work, but that of her many students and collaborators. Tarko shares pictures, stories, and the research she conducted across the country and abroad over her long career. For an introduction to her thought and her broader approach, Tarko is an excellent place to start.

Joel Mokyr – A Culture of Growth: The Origins of the Modern Economy

Joel Mokyr – A Culture of Growth: The Origins of the Modern Economy

Mokyr’s larger thesis is that technology is the most important driving engine of growth. It’s not the only factor, but the most important one–and it isn’t the direct factor. Lurking one level beneath technology are cultural attitudes about technology and progress. This, to Mokyr, is where the real explanation lies for the origins of the modern economy. The Romans had the technology for the steam engine. But Roman culture wasn’t interested in applying technology to improving production processes the way the 18th-century Britain was when James Watt was a young man. So steam power remained a novelty toy for the wealthy, and was soon forgotten.

Technophobic and neophobic cultures tend to have less technological progress. As such, they tend to be less prosperous and grow more slowly—and even then, much of the growth is “catch-up growth” when technologies long established elsewhere reluctantly enter through osmosis. There is a good deal of intersection here with Deirdre McCloskey’s work, which focuses more on wider bourgeois values. But Mokyr confines himself for the most part to technological norms rather than wider arguments about attitudes about letting people have a go, whether through commerce or life’s many other worthwhile aspects.

Mokyr has written several books applying his technology-and-culture thesis to different historical periods. His thinking has evolved over time, though the general framework has proved sturdy enough to pass the test of time. A Culture of Growth focuses mostly on Europe from 1500-1700, from roughly the end of the Renaissance, through the Scientific Revolution, up to the Enlightenment’s earliest stirrings. Essentially, these two centuries laid the cultural ground the Industrial Revolution needed before it could stand on its own.

See also Pierre Lemieux’s review, which goes into much more detail than this one.

Arthur Diamond – Openness to Creative Destruction: Sustaining Innovative Dynamism

Arthur Diamond – Openness to Creative Destruction: Sustaining Innovative Dynamism

This book reminded me a bit of Wired cofounder Kevin Kelly’s What Technology Wants in its tech- and innovation-centric hyper-optimism. His optimism isn’t quite as sober as the Julian Simon, Deirdre McCloskey, or Hans Rosling variety, but Diamond’s enthusiasm is contagious. Readers interested in this subgenre might also like John Tamny’s The End of Work and Diamandis and Kotler’s Abundance: The Future Is Better Than You Think.

One useful contribution Diamond makes is a deep dive into just how disruptive new technologies are. For workers, the changes are often less severe than commonly thought. When cars replaced buggies, they still needed wheels, frames, and upholsteries, for example. Those workers’ skills did not become obsolete, though they did have to evolve. Many disruptive technologies take years or even decades for widespread adoption.

Ultimately, Diamond makes a culture-based argument for explaining technological progress. It takes more than research and development, or available capital for entrepreneurs. It takes a culture that approves of such things. People need to be willing to try something new and see if they like it or not. They need to have a certain audacity, or at least a positive view of it. People aren’t likely to give it a go if it makes them a pariah. Though Diamond openly admires Schumpeter—hence the phrase “creative destruction” in the title—ultimately his argument owes more to Joel Mokyr and Deirdre McCloskey.

Jean-Baptiste Say – A Treatise on Political Economy

Jean-Baptiste Say – A Treatise on Political Economy

Say was an early 19th century French economist, most famous for what we now call Say’s Law. It is often cynically misunderstood as meaning “supply creates its own demand.” A more accurate statement is that “abundance makes more abundance possible.”

Think of it this way: if you produce more value, have more you can trade to others in exchange for other things you value. If everyone does this, the result is a virtuous circle of growing prosperity. Even if people just act in their own self interest, other benefit. The more people who do this, the more people benefit, and to a greater degree.

Say’s Law is a very deep concept to which this short review cannot do justice; suffice it to say that when it clicked in my head, it gave me a major “eureka!” moment I have only experienced a few times in my life.

Say also roundly refutes the labor theory of value that John Locke, Adam Smith, and later, Karl Marx all used. But Say stops short of the subjective theory of value that Walras, Jevons, and Menger independently developed in the 1870s, and that nearly all economists use today.

In that respect, Say is an important bridge figure in economic history. He also displays much common sense on trade barriers, rent-seeking, and political corruption, and dispels common romance about preserving obsolete industries and jobs. On those issues, he remains pertinent reading nearly two centuries after his death.

Say’s book is also long overdue for a new English language edition–a perfect project for the good people at Liberty Fund. The old-timey edition linked to above (courtesy of Liberty Fund, naturally) has distracting and uninformed editorializing in endless footnotes by the translator and editor. They are less than helpful and beyond irksome–and date from 1830.

Say’s name is not obscure, but his Treatise is surprisingly hard to find. The link above might save interested readers some time. In the meantime, let us hope a new edition will come out sometime soon. Say still has much to teach us.

Pro-Market, Not Pro-Business

Charles Sauer’s new book Profit Motive: What Drives the Things We Do quotes from a paper Iain Murray and I coauthored:

Young Murray cite Sauer Profit Motive

The book is here. See also Iain’s and my paper “The Rising Tide: Answering the Right Questions in the Inequality Debate,” and our companion paper “People, Not Ratios: Asking the Wrong Questions in the Inequality Debate.”

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.

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.